Opinion

Avoiding nasty contract surprises

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Taking some time to review the supplier's terms early on can help you to avoid contractual traps and get the most from your software licensing agreement, says Jimmy Desai

Companies' appetites for procuring software have been reinvigorated recently. However, sometimes not much time is spent reviewing the terms and conditions relating to the software supply.

Problems with the contract terms may initially go unnoticed, but can provide nasty shocks later on. Having the right approach to the terms can assist with making a project successful.

It is essential to see the terms as soon as possible. Then you can compare these to the terms of other suppliers, clarify the supplier's offering - which may differ from what the supplier's sales force have told you - and avoid early commitment without knowing the full picture.

Also, the terms are often silent on key customer requirements, and seeing the terms early allows time for negotiation.

A customer may also be surprised at the supplier's willingness to change the terms at the start of a deal due to the supplier's eagerness to secure new business and knowledge that the customer may be considering other suppliers.

Contractual nasties can be spotted by a lawyer reviewing the terms for you. However, major points to look for when you initially look through the terms include:

Price

Although a general price may have been agreed, a customer will be looking to:

  • Pay in arrears if possible.
  • Have price caps where prices can only rise, say, once annually and by no more than a recognised index (such as the retail prices index).
  • Obtain "most favoured nation" clauses - ie clauses ensuring you are not charged more than any of the supplier's other customers for the same software.

Limitation of liability

This is a very important clause. The suppler will try to limit its liability to a specific sum and will typically exclude its liability for indirect losses.

What this means, in general, is that if the supplier were to breach the terms, then despite the fact that you may have suffered huge losses as a result, for example if the software fails, you will only be able to recover up to the amount which the suppler has limited its liability.

Where indirect losses have been excluded by the supplier, any claim you make will be reduced so that all indirect losses will be stripped out.

Exiting

Customers will want flexibility in their contracts to respond to changing business needs. Typical termination events include material breach or insolvency.

However, you may want other exit events including:

  • Break points after certain periods, for example, after each 12-month period.
  • Terminate for convenience - for example, upon 90 days' notice. If the supplier is taken over or merges - particularly if the resulting organisation has a different culture to the original supplier.
  • The ability to keep using some parts of the software but terminating use of other parts of it.

Software

This is a key definition because it will help to establish:

  • Exactly what software is going to be provided.
  • Whether the software will include any modifications, enhancements, new releases and new versions. If not, then these may cost more.
  • Whether any supporting documentation (manuals, technical specifications etc) will be provided.
  • Whether just the object code of the software will be provided.

Assurances should be sought by the customer, including that the software is owned by the supplier, that the software has no bugs or viruses in it and that there is no litigation relating to the software that could impact on your use of it.

Intellectual property

The customer will want to ensure that the supplier owns all of the intellectual property in the licensed software. If you are sued by a third party for using the supplier's software then you will want to be indemnified by the supplier for any losses suffered.

Support and maintenance

It is important to have a service level agreement (SLA) which identifies the software services to be provided, the service levels and target, and any credits which may be payable if targets are not met.

The software licence and software maintenance provisions should be agreed at the same time. Otherwise if the software maintenance deal is agreed later it may contain unfavourable terms, which you may have to accept if you have already committed to acquiring the software.

Escrow

Typically the source code to the software will not be provided, so you should ensure that it is deposited with a third party agent, for example the National Computing Centre in Manchester.

If the supplier becomes insolvent or is unable to maintain the software then you will be able to access the source code from the third party agent in order to continue the maintenance of software.

Exit plan

If the contract expires or is terminated then there should be a plan as to how you are allowed to use the software so that there is an orderly run-off period. Otherwise, if you have to stop using the software straight away, it could lead to severe business difficulties.

Boilerplate clauses

These are typical legal clauses at the end of the terms. These can include:

● Entire agreement clauses: what this means is that the terms will contain all the terms and conditions relating to the licensing of the software to the customer and that nothing else will apply.

This means that any promises made by the supplier prior to the terms being signed will not be included unless these promises appear in the terms.

Practically, this means that you have to be very careful to ensure that all promises and assurances the supplier has made in respect of the software actually appear in the terms.

Otherwise, except where the supplier has acted fraudulently, you will not be able to rely on any of these promises and assurances.

  • Waiver and severability: a waiver clause usually states that if a party decides to waive its rights to claim against the other party for a breach of the terms, then the party which waives its rights to claim is not barred from making that claim later on.

A severability clause usually provides that if any part of the terms are invalid or unenforceable then those parts will be stripped out of the terms and the rest of the terms will continue to apply.

  • Force majeure: this provides that a party is not responsible for failing to perform its obligations under the terms if such failure is due to events beyond its reasonable control.

For example, this could occur if the supplier fails to provide maintenance services because the town and building from which it provides these is flooded.

However, force majeure clauses should be examined carefully. For example, the supplier may state that strikes are force majeure events.

However, the customer may argue that strikes are within the supplier's reasonable control - for example by the supplier paying its workforce more to avoid strikes. This term could, however, be amended to say that "industry-wide strikes", such as rail strikes, qualify as force majeure events.

  • Assignment: the terms should allow the customer to assign its software licences to a third party so that fresh licences do not have to be purchased by that third party if it purchases the customer's organisation.
  • Third-party rights: the terms will often exclude third-party rights to enforce the terms. What this means is that where the customer and supplier are a party to the terms then any other person that could benefit from the terms - for example end-users - are prevented from enforcing the terms against either the supplier or the customer.
  • Law: it is very important to make this clause comprehensive. Not only should it say which law the terms should be governed by - for example, English law - but it should also state the jurisdiction where the case is to be heard.

The cost of a misunderstanding

The case of Vogon v the Serious Fraud Office highlighted that prices can be misunderstood by the parties. This case centred on the meaning of "database".

Vogon was providing and charging the fraud office on the basis of the work done by Vogon in respect of each database. The ambiguity related to whether "database" meant each individual user's file or the entire server.

The fraud office won on its construction of the word "database", and therefore only owed Vogon about £20,000, rather than in excess of £300,000.

However, the whole dispute, including all the time, effort and costs of litigating this matter, could have been avoided if the pricing and payment had been clear in the contract at the start and by including worked examples.

The need to specify jursidiction

In the case of Sawyer v Atari, Chris Sawyer, a computer games developer, had an agreement with Atari governed by English law when a dispute arose over royalties.

Atari argued that despite the agreement being governed by English law, most of the issues involved accounting matters and that the relevant witnesses and documents were in the US. Therefore, according to Atari, the dispute should be adjudicated upon in the US, but using English law.

After consideration by the English court, it was decided that the appropriate forum was the English court, taking all the circumstances into account. However, if the agreement had specified that the jurisdiction should be England then this dispute could have been avoided.

Steps to success

To ensure your project is sucessful:

  • See the terms at the start
  • Negotiate key points in the terms
  • Get a lawyer to review the terms to spot hidden dangers

Jimmy Desai is a partner at technology law firm Tarlo Lyons

Read article: Case studies: negotiating software licences

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This was first published in July 2006

 

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