Understand the intricacies of your company’s software licenses

June 17, 2008

If you can think of a business in the United States today that doesn’t license software, you deserve a prize. Now try to think of any commodity even remotely as pervasive as software that is not sold to the end user, but instead is licensed. If you can, I’ll double the prize.

Yet, many businesspeople who are spending thousands — if not millions — of dollars per year on software fail to understand basic mechanics of software licenses.

As with any contract, there are two basic kinds of software licenses: the kind that is negotiated and the kind to whose terms the licensee simply must adhere. The latter category is usually what is referred to a EULA (end user license agreement), and can include licenses known as click-wrap, shrink-wrap, or browse-wrap licenses.

An EULA is more or less an “adhesion contract,” that is, the software company sets the agreement’s standardized terms on a “take it or leave it” basis, and the user has no real bargaining power.

EULAs can include terms as fearsome as any found in the fine print on the back of an amusement park ticket. They generally cover consumer software and other software that is perpetually licensed, and come with little or no support. These licenses are often enforceable, and present challenges for business owners, but that will be discussed in detail another day.

Instead, I’ll focus on software that requires not just installation, but can only operate after (generally expensive and time-consuming) installation and configuration.

The true price paid

So-called “enterprise” software includes packages such as finance, content management, inventory management, decision support, and supply chain management, among many other systems. Licenses for such mission critical software components should be purchased with the maximum contractual protections that can be obtained.

If the license purchaser is depending on the software for critical company operations, close attention must be given to provisions that can make or break not simply the transaction, but, in extreme cases, the licensee.

Some software licenses that ought to be negotiable are not. Really large vendors (Microsoft and IBM are examples that come to mind) provide standard contracts where payment and pricing terms may be negotiable, but most other provisions are presented as though they are cast in stone.

However, the large vendors also know to give away just enough in a license agreement to maintain at least the appearance of good customer relations. For example, some vendors offer indemnifications, but with qualifications and caps that limit the value of the indemnity.

Payment and pricing provisions are usually the first provisions to look at in any license agreement. Software licenses can take a number of different forms.

For example, in recent years, many vendors have moved to a subscription model, in which the customer makes periodic payments for a license to a software package and any updates, and to obtain support services.

Another example that has been somewhat supplanted by subscription models is a perpetual license in exchange for a license fee, with maintenance (the right to receives updates as they are released) and support (the right to receive technical assistance) provided for a fee that must be paid annually or on some other periodic basis.

Whatever payment and pricing terms are offered, the customer must be wary of a vendor’s attempts to disguise the true price being paid for the software. For example, enterprise software generally requires consulting services, very often provided by the vendor, in order for the software to be installed, configured, and often customized.

Properly scoping and limiting the fees to be paid for consulting services is important to ensure that the vendor does not make up for a low license fee with high consulting fees.

When a subscription model is offered, the customer should ensure that the license or subscription agreement includes a provision limiting future increases in subscription fees. Otherwise, the vendor may establish the customer’s dependence on software, and then increase the price to be paid for the software knowing the customer cannot afford the business impact of ceasing to use the software. The customer should similarly seek limits on potential increases of ongoing maintenance and support agreements.

How far does it reach?

As with any license, the customer should pay attention to the scope of the license. Software licenses may be territorial, and are often limited to one or more specific customer sites. Licenses may be based on servers, or CPUs, or usage tied to some other physical hardware.

Licenses may also specify “named users” or place other limits on the users — or “seats” — that may use software. The scope of a software license is of course tied to the license fees.

Like payment and pricing, other significant software license provisions have analogs in general commercial agreements. Indemnifications, warranties and limitations on liability can loom large in software licenses. Each of these provisions raises concerns for the software licensee.

Indemnifications and agreements to defend in the event a claim is brought are especially important to software licensees. While real property damage and personal injury may seem like remote concerns to a software user, such indemnifications are desirable. More important, even critical, to a software licensee is indemnification for liability for intellectual property infringement.

People often raise their eyebrows at this assertion, but they shouldn’t. Given the stratospheric costs of patent litigation, and the prevalence with which owners of patents covering software have asserted their rights in recent years, a failure to obtain intellectual property indemnification can be very expensive.

I have been involved in patent infringement cases where the defendant had contractual indemnification, and I have been involved in cases where the defendant did not. Cases in which the defendant can invoke a contractual provision to call on a vendor for defense and ultimate payment for any liability are cases with much happier defendants.

As with any significant purchase, a software licensee should seek warranties from the vendor to assure the value of the purchase. Of course, the warranties ultimately provided will depend on the licensee’s negotiating power. Most vendors attempt to provide very limited warranties, instead promising to resolve software defects through an agreement’s support provisions.

For example, a typical warranty provision might disclaim all warranties except a promise that, for a limited time, often ninety days, the software will be provided on a medium free of defect, and that the software will operate as described in its documentation. Longer and stronger warranties obviously have more value and can sometimes be obtained, particularly from newer vendors or where the vendor is hoping to provide further software, or perhaps consulting services, to the customer.

There is an irony: generally the vendors most willing to grant liberal warranties, indemnifications, etc., are the vendors with the shallowest pockets who are least able to redeem such promises.

Look at the provisions

Many software vendors disclaim liability altogether, or limit liability to the amount of fees paid under the license agreement.

Depending on the customer’s negotiating leverage, the customer might seek to increase such caps, particularly where the software is being used for mission critical functions such as finance, inventory management, supply chain management, or the like, and a failure of the software could mean a failure of the business.

While the vendor will want to disclaim consequential damages, such as lost profits, a business that, for example, is unable to ship product if a software system fails may want to limits the scope of the vendor’s disclaimer of liability.

At the same time, many vendors refuse to make limitations on liability reciprocal, arguing that if the customer causes damage to the vendor’s software — for example by copying it or reverse-engineering the software to obtain source code — the damage to the vendor could be unlimited. Regardless of whether such concerns are exaggerated, from the customer’s perspective, of course, agreeing to potentially unlimited liability under any circumstances is a questionable proposition.

Software, like much business equipment, is not always as fungible as it may initially appear. A given software package may be interchangeable with software provided by competitors only to a limited degree. Thus, customers often feel they have no choice but to accept a vendor’s terms, or that it is not worth risk to a relationship to negotiate better terms.

As mentioned above, this is sometimes true. But in many cases, customers needlessly accept provisions in software licenses that will haunt them later. As with any commercial agreement, software agreements should be scrutinized to ensure that they do not present undue commercial risk, and that they provide true business value to the licensee.

Charles A. Bieneman practices intellectual property law in Bloomfield Hills, Mich.

Written by Charles A. Bieneman  |  Filed Under Intellectual Property 

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