Software license and/or service agreements have approached or surpassed leases and insurance contracts as the most-complicated-yet-most-essential non-core agreements that businesses enter into. Because most enterprises are not in the business of licensing software, however, companies on the licensee/customer side of these agreements routinely fail to make well-informed and intentional decisions about the terms of those agreements. While the topic is too complex to be thoroughly examined in a brief article, some ways to avoid common missteps from the customer side can be identified for consideration the next time you are reviewing or negotiating a software license or service agreement.
1. Don't assume you can't negotiate
Often customers assume that the non-price terms of a software license or service agreement are non-negotiable. Sometimes that is true – Microsoft is probably unlikely to individually negotiate the terms of a license for Excel software with a small business. However, for transactions involving large customers, new providers, or providers attempting to gain market share in a new segment, meaningful negotiations and changes to the provider's "form" contract often occur. Additionally, even providers unwilling to negotiate the general terms of their standard agreement are often more flexible regarding the content of exhibits or schedules to the agreement. The adage, "if you don’t ask, you don't get" certainly applies; if there are terms you would like to see changed, it is certainly worth asking.
2. Understand the pricing and use schemes
Software isn't a tangible, singular item, so the pricing structure for the right to use it varies considerably. It can be licensed to a user, or it can be provided as a service, or both. The agreement can give the right to have a fixed number of unique, identified users, or a fixed number of concurrent users, or number of server installations, or a fixed number of installations, or hours of access, or the right to store and use a certain amount of data. Just as it would be important to know whether your law firm bills by the hour or by the project in making use of that firm, you need to understand how the pricing structure works. A failure to understand the "unit of measure" for a software agreement can cause serious problems, and result in frustrating restraints, significant unexpected charges, or even lawsuits by the provider seeking to recover for "unauthorized" use that you believed permissible. Understand the pricing structure and use rights, and assign an appropriately senior person to monitor compliance.
3. Get promises in writing
Like most sophisticated business contracts, software license or service agreements almost invariably contain a merger or entire agreement clause disclaiming any representations not contained in the contract. This means that promises made about the software by sales or technical personnel in sales meetings, demonstrations, or even via email, are not reliably enforceable. Whatever promises or assurances you need in order to feel comfortable with the agreement should be spelled out in the agreement or its attached documents.
4. Get measurable promises
Warranties promising a "good and workmanlike" or "industry standard" level of reliability or performance are certainly important, but their lack of precision means that disputes over them can last for years. A purchaser should seek both general quality promises and, to the extent possible, more empirical performance level promises. The appropriate metrics will vary by circumstance; percent availability levels for a cloud-based service are common, while transaction processing speed might be an appropriate metric for inventory or billing software. Quantified performance markers can put a disappointed purchaser in a much stronger position when trying to convince a provider that there is a real problem that needs to be addressed.
5. Carefully look at the indemnification provisions
Software that fails to perform can hurt your business directly, but it can also hurt it by exposing your business to claims by third parties. Most software licenses and service agreements come with indemnification provisions regarding third party disputes, often centered around intellectual property disputes. These IP indemnifications are important for a customer (and should be reviewed carefully), but can be completely inadequate to address other liabilities to third parties, particularly if the provider has otherwise disclaimed or limited liabilities. For instance: What happens if a major retailer suffers a major data breach as a result of a security weakness in a piece of software licensed under an agreement that limits liability to a refund of license fees? Or if billing software used by a hospital contains a glitch that causes all bills to patients or payors to be erroneously inflated, resulting in a class action or a qui tam claim? Make sure the agreement's indemnification provisions will help you put responsibility for such claims back to the provider.
6. Consider the intellectual property investment you intend to make
Some software is relatively plug-and-play, easy to make work with other technology, and leaves little to the user except actual use. Other software, however, may be highly customizable, or even require new code to make function with other technology that your business uses. Most software licenses and service agreements contain extremely broad and one-sided provisions shifting all intellectual property that is related to the software to the provider. This means that the provider might well note your innovative configuration and decide to market it – perhaps to your competitors – as their own offering. If you contemplate your IT department doing lots of customizing, consider negotiating some joint intellectual property ownership or at least a confidentiality obligation on the part of the provider.
7. Look for a range of meaningful remedies
Always ask what happens if the product or service does not deliver as expected. Many customers see that there are termination rights for a failure of the provider or the product to perform and assume that this is sufficient. However, once a piece of software has been integrated into your business, terminating the agreement – and your use of the software – may be easier said than done. If you have software that was intended to perform four functions, and it does three functions well, and the fourth poorly, is termination of all functions really your preferred outcome? Purchasers are often better served by having a range of meaningful remedies for product or service problems, including the right to partial refunds, the right to reduction in ongoing or future payments, the right to upgrade at no charge to a higher-level offering from the providers, or even the right to secure a replacement product or service for the deficient portion of the product/service in question.
8. Think about renewal from day one
Some licenses are perpetual, but most licenses, and virtually all service agreements, have specific durations, which means they have end dates. What happens when that end date comes and you want to keep using the product or service? Once you have integrated a technology into your business processes, filled it with your valuable data, configured it to suit your needs, and invested employee time in learning to use it, your motivation to renew may be much stronger than to enter the initial term of the relationship with the provider. Providers know this, and sometimes use that need to renew as leverage to extract much higher rates at renewal time. Consider whether you want to build in renewal rights that establish pricing in advance, or at least puts an outer boundary on a price change; if so, be certain that the renewal right can be exercised unilaterally by you, the customer.
9. Have an exit strategy in mind
No software is useful forever; your new agreement will someday be the old agreement. Eventually, whether in months or in decades, your business will want to make a change to a different technology – perhaps one from a different provider. How will you manage that transition? If the old provider was cloud-based, how will you move your data? If you manage to move your data, will it be in an accessible, usable format? Will your old and new systems need to overlap in time? Answers to these questions will help guide you as you negotiate your agreement and its provisions regarding the obligations of the parties around termination.
10. Anticipate bankruptcy by the provider
While many software companies are blue chip entities with apparently endless financial resources, there are many that are still working to convert their innovations into positive balance sheets and income statements. Doing business with such providers can give your company access to truly revolutionary technology at prices below those demanded by the more established market players, but can also expose you to the risk that your provider will encounter financial difficulty during your license or service agreement term. Source code escrow can guard against some of the more extreme risks of those circumstances, but if the source code is only placed in escrow upon a combination of events and a demand by the customer, will you know to invoke the escrow provision before the provider's debtors force it into bankruptcy? If you are relying on a source code escrow provision, and the code is not already in escrow, you may want provisions that automatically cause the source code to be placed in escrow without an affirmative request from your company. At a more basic level, if services are to be provided over a course of years and you have doubts about the financial viability of the provider, structure payments so that a complete provider collapse immediately following a payment does not deprive you of too much value.
These are just a few of the many points of software licenses and service agreements that can be significant, but they are often overlooked by customers who are not in the licensing business themselves. While it is rarely possible to draft agreements to avoid all risk, considering the points above and negotiating the best deal your company can will help ensure that whatever remaining risk is undertaken as a calculated business decision.
David B. Darden is a partner at Parker, Hudson, Rainer & Dobbs LLP in Atlanta, Georgia. He advises clients on software licensing and software service agreements, in addition to assisting clients with business litigation, intellectual property litigation and health regulatory litigation needs.