Methven and Associates, the Business Law Counselors

Issues with Software Agreements

Introduction.

Software license agreements raise a number of issues for both licensors and licensees. Frequently the creator of the software wishes to maintain control and therefore gives a license rather than selling ownership of the software.
1. Terminology. The "licensor" is the party granting the license (often but not always the owner) and the "licensee" is the party using the license (sometimes the user, but sometimes a sub-licensor).
2. Creator’s Rights. Note that if a commissioning party does not have a written agreement with an independent contractor, the work developed will be owned by that contractor – and the commissioning party will have only a non-exclusive license to use it. Moral of the story: if you are the commissioning party (or an owner who is hiring an independent contractor to update the work), be sure to have a written agreement where you receive ownership of the work.
License Grant.

There are many different ways the grant of a license can be structured.
1. Entities Entitled to Use. From the licensor’s viewpoint, it’s essential to determine which entity or entities are entitled to use the software.
  1. Subsidiaries and Affiliates. For example, if a parent company is obtaining the license, are wholly owned subsidiaries entitled to use the license for no extra fee?
  2. Divisions. Another issue is whether different divisions in the same entity can use the license at no extra fee. (A division is merely an accounting unit within an entity, unlike a subsidiary, which is a separate legal entity).
  3. Independent Contractors. Yet another issue is whether the licensee’s independent contractors (which may be individuals or companies) are allowed to use the software.
  4. Acquisitions and Mergers. If the user acquires or is acquired by another company or merges with another company, the number of people using the software may dramatically increase. This can be an issue because where the licensor might have had two paying clients, it now has only one.
    1. One way to deal with this issue is to have the license state that any acquisition or merger involving the licensee will constitute an assignment and will terminate the license unless both parties agree in writing to continue the license.
2. Perpetual or Fixed Term. A license can be for a fixed term (such as one year) – though of course it can be renewed if both sides agree (it may have specific options to renew) -- or it may be perpetual as long as long as all payments are made. It may be an advantage to the licensor if the term is fixed, since the licensor is free to raise the price for any subsequent renewals. Conversely, if the licensee plans to be using the software for an extended period of time, the licensee may want a long license term or renewal options with specified prices.
3. Revocable or Irrevocable. An irrevocable license cannot be revoked if the licensee later violates the license agreement. This may be appropriate in limited cases, for example if the licensee is making a single payment and is concerned for some reason that the licensor might try to wrongly claim breach of the license agreement in the future. On the other hand, the licensor often will not agree to this, since it means that the licensor can only sue the user for any damages for breach and cannot stop the user from continuing to use the software, even if the user is violating the license.
4. Exclusive or Non-Exclusive. A license is exclusive if only one user is allowed to use the software. Obviously, often a licensor will insist on the right to license the software to multiple parties. On the other hand, there are situations where an exclusive license is appropriate, such as where the licensee will be acting as a distributor and sublicensing the software to end users.
  1. Still, because an exclusive license prevents the licensor from making money from other users, exclusive licenses generally require that the user make minimum payments according to a schedule – or the license otherwise lapses or at least becomes non-exclusive.
5. Worldwide or Geographic Limitations. A license can also be worldwide or limited to certain geographic areas, such as one or more specified countries or states. This may to be the situation where at least one exclusive license will be granted. If it’s not specified, a user will have the right to use the software anywhere.
6. Site licenses. It may be useful for a licensor to limit the license to specified physical sites – or to a specified number or range of individual users – particularly where the licensee may be growing substantially.
7. Carving up by Field. It is also possible to grant a license for use in a specific industry only (such as auto parts). This type of grant needs to be very specific or there may be arguments about what endeavors the license covers.
8. Source Versus Object Code. The license should specify whether the licensee will receive a source code (the programmer version) of the software or only an object code (computer readable) copy of the software. For security purposes, licensors almost always want to provide only an object-code version.
Installation, Support, Updates, Custom Programming.
1. Installation. The license should make clear whether installation by the licensor is included in the price. If it is, the licensor will want to limit the number of installations required by computer or server. Often the licensor will want to state the minimum hardware requirements (and any third-party software requirements) that the user must satisfy, and will also want a provision stating that the licensor is not responsible for incompatibilities in the user’s system.
2. Training. The license – or a related document – should specify whether the licensor provides training.
  1. Limits on Free Training. Frequently the licensor will want to limit the number of hours of free training provided, the number of people who receive free training, the types of people who receive training (sometimes training is limited to the licensees technical personnel) and the location(s) of the training.
  2. Limits on Paid Training. Often additional training is made available at an hourly rate. If so, the agreement needs to specify if travel time is billed (and whether, for example, air fare is limited to coach class), if there is a limit on how far the licensor’s trainers must travel, if meals and hotel expenses are billed and what limits there are on them, etc.
3. Support. There are many types of support that can be provided. Sometimes support is included as part of the price, but frequently it is listed as a separate item, either on an hourly basis or with the user purchasing support time in blocks. Frequently the user can purchase different levels of support.
  1. Telephone Support. Often telephone support is provided, either on a 24/7 basis or limited to specified hours and days. In the latter case, one needs to specify time zones and whether there is support on specified holidays. Sometimes telephone support is limited to the user’s technical personnel, so that the licensor is not answering basic computer questions. Email support is often lumped together with telephone support.
  2. Access to the User’s System. Sometimes the licensor will insist on electronic access to the user’s computer system, since that can obviously minimize the time needed to fix problems.
  3. In-Person Support. If in-person support is provided at no additional price, the licensor will want to limit the number of hours, travel distance, etc. For in-person support that is separately paid, there are the same issues as with separately paid training: whether travel time is billed, whether there is a limit on travel distance, and whether travel expenses, meals and hotel expenses are billed and have any limits.
4. Bug Fixes. Of course the licensee wants provisions that bugs will be fixed at no charge, but no software is ever bug-free and the licensor will not want to agree to fix all bugs but only those that have a significant effect on using the software. Defining this can be tricky, of course.
  1. Limitations on Bug Fixes. Often the licensor will want to restrict fixes to bugs that prevent the software from materially accomplishing the tasks it is supposed to (often as set out in the brochures), with the licensor having the right to make determine this in its sole discretion. The licensee probably will want the right to take the issue to arbitration if it disagrees with the licensor’s decision.
  2. Categorization of Bugs. Sometimes bugs are divided into categories based on how important they are, with the licensor required to fix a given bug within a specified period of time depending on how material the bug is.
5. Updates. One question is whether the licensee is entitled to receive updates as they become available, and another is whether the licensee must pay for the updates. Often any updates that are released within a defined period (say one year) are free, but any subsequent update must be obtained at the price set by the licensor if wanted.
6. Custom Programming. The license frequently specifies whether custom programming is available to the user and what the prices are for it.
  1. If custom programming is provided, the license should specify who owns the custom programming. Sometimes the licensor will insist that while the licensee receives the right to use the custom programming, the licensor owns it and can license it to other customers. Conversely, the licensee may insist that it have the right to obtain – whether for a fee or at no charge – any custom programming that the licensor acquires rights to.
Modifications by Licensee.

One issue is whether a licensee is allowed to make modifications or add-ons to the software. Often the licensor does not want to grant this type of right for fear that the licensee may make modifications that cause problems. Of course, if the licensee is receiving only object code, it may not have the ability to make modifications or add-ons, though it’s still best to specify that this is not allowed, since licensees may be more clever than the licensor realizes. Whether or not the licensee is given a right to make modifications or add-ons, the license should specify whether the licensee is required to inform the licensor of the new work, whether the licensee or licensor owns the new work, and whether the licensor can use the new work with other customers. Without any specification, the licensee will own any modifications or add-ons that it creates.
Payment Provisions.
1. Percentages of Gross and Audits. Where the licensee is acting as a distributor and will be sublicensing the software to end users, often the license payments are structured as a percentage of the amounts paid by the end users. When this is the case, a (lower) percentage of gross revenues (less taxes, shipping and returns) is recommended. If a percentage of profits is used instead, there frequently are arguments about what costs are deductible. If a percentage of profits is used anyway, the deductible costs should be defined extremely carefully.
  1. In any case, the licensor will want to include a provision allowing it to audit the licensee’s books. Often these provisions state that the licensee bears the cost of the audit if the payments are off by more than a specified percentage from what the books show they should be.
2. Most Favored Customer Provisions. Sometime a licensee will demand that if the licensor grants a later licensee more favorable terms, the earlier licensee is entitled to a modification of its license to include those terms. Obviously, licensors tend to resist this.
Software Escrows.

Particularly if the licensee will only be receiving object code but anticipates using the software for an extended period of time, the licensee may be concerned about what happens if the licensor goes out of business or proves unable or unwilling to provide support and modifications. In this situation the licensee will often demand that an escrow for the source code be created.
1. Identity and Compensation of the Escrow. Some issues are who will be the escrow and how much will they be paid. There are, of course, companies that provide this service.
2. Conditions of Release. Perhaps more important is the issue of the circumstances under which the source code is released. In particular there may be arguments over whether the licensor is providing the bug fixes, support, custom programming, etc. that the license may call for. Ultimately, the matter may need to be subject to arbitration.
3. Updated Versions. The licensee will certainly want the license to require the licensor to deposit updated versions of the software with the escrow company promptly as changes are made.
4. Bankruptcy. Where the licensee is concerned that the licensor may go into bankruptcy, the licensee may insist that the escrow company be given actual title to the software.
Exports.

Software that has military use or involves cryptography may be subject to U.S. export controls. There are different types of export licenses that may be required, depending on the sensitivity of the software and the country to which it is being exported.
Implied Warranties

Unless care is taken, implied warranties can arise from oral representations (from sales people, etc.), brochures, advertisements, etc. Because in many situations software is considered "goods", the Uniform Commercial Code may also automatically create warranties of merchantability (a vague warranty of good, fair quality) and fitness for a particular purpose.
1. Disclaimers. One way a license agreement can minimize or eliminate this problem is if it states that there are no other warranties except as expressly set out in the agreement, including any warranties of merchantability or fitness for a particular purpose. (The latter two have to be specifically rejected.)
  1. Conspicuous Language. Disclaimer language generally must be conspicuous, e.g., in capital letters or bold type; otherwise consumers (and others) may not be bound by it.
  2. Initials. Some go as far as having the other side initial the disclaimers.
2. Integration Clause. Another thing that the license can do is specifically state that its provisions supersede all prior agreements and representations.
3. Performance Specifications. In turn, the licensee often wants the license agreement to specify what the licensee needs the software to do. Sometimes the way this is handled is for a provision to be included stating that the software will work substantially as described in specified written materials (such as the brochure).
Remedies/Limitations of Liability

Because claims by a disgruntled licensee may be large relative to the amount of money the licensor is making from the software, the licensor will frequently want to include various provisions to limit the licensor’s liability.
1. Replacement or Repair. One provision that can be used expressly limits the licensee’s remedy to replacement or repair of the software at the licensor’s option. If this is not done, the user may go out on his/her/its own and replace or repair – at prices far higher than the licensor would incur – and then try to force the licensor to pay for it.
2. Consequential Damages. Another provision that can be added states that in no circumstances will the licensor be liable for special or consequential damages or lost profits (or lost data). Often the consequential damages (alleged lost profits, etc.) will be vastly more than the direct damage.
3. Liability Limit. Yet another provision can state that in no case will the licensor’s liability exceed the amount paid by the licensee. Obviously, this is to prevent damages that could otherwise exceed the amount the licensor receives from the licensee.
  1. This should be a separate paragraph from the disclaimers of warranty, since some courts that strike a disclaimer clause will also strike a limitation of liability clause if they are part of the same paragraph.
Invalidity

Because some states (and countries) have laws limiting what can be done with disclaimers and limitations of liability, the licensor should be sure the license includes a provision saying language along the lines that if any provision is found to be void or unenforceable, then the narrowest portion possible is removed and the remainder of the license continues to apply.
Jurisdiction and Choice of Law
1. Jurisdiction. Generally the licensor will want a paragraph stating that lawsuits (and arbitration) may only be brought where the licensor’s headquarters is located; otherwise often the licensee can bring litigation where it is located. Particularly if the licensor is granting licenses to multiple licensees, the licensor will not want the risk of being sued all over the country.
  1. Where the licensee tries to insist that any litigation be brought where it is located, one compromise is to state that whoever is the plaintiff has to bring the lawsuit in the other party’s location.
2. Choice of Law. Particularly if the licensor is licensing to multiple parties, the licensor will also want a provision stating that the law of its state will govern any disputes.
  1. In doing this it is important to say that the state’s law – excepting its conflicts of laws provisions – governs the agreement. Otherwise the state’s law regarding contracts made across state lines may put the litigation in the licensee’s state.
Arbitration and Mediation
1. Definitions. Arbitration, also known as "private judging", is where an arbitrator is appointed to hear evidence and make a decision that is generally binding on the parties. Mediation is where a facilitator attempts to persuade the parties to reach a settlement – but the mediator usually has no power to force the parties to reach a settlement and the mediator does not issue a decision.
2. Advantages and Disadvantages. Arbitration is often faster and less expensive than litigation. In addition, while court cases are a matter of public record, arbitrations are private. Note, though, that some feel that arbitration tends to favor defendants somewhat more than litigation does. In any case, if arbitration (and/or mediation) is desired, it must be specified in the license agreement.
3. Discovery. Assuming that an arbitration provision is included, if depositions or interrogatories are desirable (versus just production of documents by the other side) a clause specifically providing for those forms of discovery must be included. Otherwise discovery in arbitration is usually limited to obtaining documents from the other side. (Of course, this common limitation on discovery can be a very good thing in terms of minimizing costs.)
4. Class-Action Arbitration. If the licensee is providing licenses to multiple parties, it may well want to ensure that the arbitration clause states that class-action arbitration is not allowed. Otherwise if there is arbitration, a number of other licensees may join in.
5. Mediation. Mediation is successful perhaps 75% to 80% of the time and is even faster and cheaper than arbitration.
  1. Advantages and Disadvantages. Mediated settlement are more likely to be paid, and mediation can be advantageous when the parties have to deal with one another in the future or when the industry is small and reputation is important. On the other hand, there is no guarantee that a mediation will be successful.
  2. If Mediation Fails. One approach that is often used is for the license to require mediation first, with arbitration then occurring if the mediation is not successful. Note that generally the mediator cannot also act as the arbitrator, though there are some exceptions.
International Agreements
1. International UCC. Unless the parties are sure they want it, any international agreement should expressly exclude application of the United Nations Convention on Contracts for the International Sale of Goods (sometimes called the International UCC), which imposes a number of terms that they may not want. It applies automatically otherwise (at least in those cases where the software constitutes "goods").
2. Payment. Licensors will want to include a provision that the licensor is paid up front or that a guaranteed payment mechanism such as a letter of credit is used. Note that different countries have different rules about cancellation of credit-card charges; some have much easier payment-cancellation policies than the U.S.
3. International Arbitration. Where a U.S. company is dealing with people or businesses with no assets in the United States (or who are wary of the U.S. courts), the license agreement should include an international arbitration provision.
  1. Advantage. It is much easier to get a foreign court to enforce an arbitration award than a judgment obtained in the U.S. court system.
  2. The New York Convention. If international arbitration is desired, the license agreement needs to state that the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards will apply. Otherwise enforcement can be difficult.
    1. A list of countries that have signed the Convention may be found at http://arbiter.wipo.int/arbitration/ny-convention/parties.html
    2. Note that some countries do not recognize this Convention – and some countries make it impossible to obtain enforcement in any case.