Software Licensees Beware!
Posted on Jun. 12, 2013

Ten of the Most Common Legal Pitfalls for Software Licensees/Customers in Software License and Service Agreements

If your company has ever licensed expensive software from a third-party software provider, you might be surprised to learn from statistics just how risky software licensing can be for customers.  For example, in one survey, 93% of software implementations took longer than expected.  In another survey, only 51% of customer respondents viewed their software implementations as being successful.  In the same survey, implementation costs were found to average 25% over budget.  In yet another survey, 31% of software implementations were cancelled prior to completion, and 53% cost over 190% of their original estimates. 

Given the bleak reality portrayed in these startling industry statistics, it is shocking to me that a substantial number of software licensees fail to read, much less negotiate, software license and services agreements with their providers.  Many customers simply sign or click through such agreements and move on.  Still fewer customers hire lawyers who specialize in software licensing to advise them on such agreements.  When something goes wrong, such customers often find themselves with few remedies or protections. 

While as a software licensing lawyer I am clearly biased on this subject, I highly recommend that you hire me, or someone like me, to advise you on your next large software licensing transaction.  Software license and services agreements are notoriously one-sided in favor of software providers, routinely lacking even the most basic of protections for customers.  You can gain significant economic, operational, and legal protection simply by asking that the provider make certain basic changes to the agreement before you sign or click through it. 

This blog will describe ten of the most common pitfalls for licensees/customers of expensive software.

Pitfall 1:  Failure to Negotiate the Amount of the License, Maintenance, and Technical Support Fees

You would be surprised at the ease with which you can obtain discounts on these fees from your software provider simply by asking for them (up front, of course).  Discounts of 20% are not uncommon for certain software.

Pitfall 2:  Failure to Ensure that the Scope of Your Permitted Use of the Software Is Sufficiently Broad

Does the scope of your license permit you to do with the software what you actually intend to do?

Pitfall 3:  Failure to Address What Rights You Have to the Software Upon Termination of Your Agreement or the Bankruptcy of the Provider?

If the software you are licensing is mission critical for your business, or if it would require significant time to implement replacement software in the event that things do not work out with your existing provider, consider how to protect yourself.  First, you might require that the software provider escrow the software source code with a neutral third party escrow service.  Such source code would be released to you in the event that the provider goes bankrupt or unfairly terminates your agreement.  Second, you might require that the provider continue to allow you to use its software for a reasonable period following any termination of the relationship so that you can transition to a new provider (otherwise, the provider might cut you off from the software immediately).

Pitfall 4:  Failure to Insist that License, Maintenance, and Support Fees Be Paid Over Time or Be Tied to the Achievement of Milestones

Software providers often require that you pay most of all of these fees up front.  It is wiser to pay them over time or upon the achievement of certain implementation or performance milestones.  It is also wise to consider holding back a portion of these fees until you have received and accepted software that functions in accordance with the warranty (i.e. 20% or more).

Pitfall 5:  Failure to Get a Proper Warranty On the Software

Your warranty on your software should at a minimum include something to the following effect:  “The software will function in substantial conformance with the specifications set forth in the documentation.”  You should also get other warranties from the provider, including:  the provider owns the software and has the right to license it to you; the software does not infringe upon the software of third parties; and the services (i.e. implementation, customization, etc.) will be performed in a workmanlike manner in accordance with industry standards.

Pitfall 6:  Failure to Demand Remedies In the Event the Software Does Not Function Properly

The provider should covenant with you to promptly repair or replace the malfunctioning software (at no additional cost to you).  If the provider is unable to do so within a reasonable period of time, you should get a full refund.

Pitfall 7:  Failure to Specify Adequately the Provider’s Technical Support Obligations

The agreement should include “severity levels” for bugs in the software and should specify the provider’s response and correction times for each severity level (i.e. significant bugs should be responded to and corrected more quickly).  Do not allow the provider to unilaterally determine the severity level of a given bug.  Instead, use objective criteria for determining severity.

Pitfall 8:  Failure to Place Caps on Increases in Maintenance and Technical Support Fees

Technical support and maintenance fees can increase significantly during the life if your software license.  Consider placing an annual cap on such increases that is tied to a fixed percentage (i.e. “no more than x% per year”) or to the annual increase in the consumer price index.

Pitfall 9:  Failure to Address the Cap on the Provider’s Aggregate Liability to You

Software providers will try to place a cap on their maximum liability to you in the event that things go terribly wrong.  Ensure that this cap is appropriate.  The industry norm is to cap the provider’s maximum liability to you at an amount equal to anywhere from (1) the fees you have paid to the provider in prior 12 months, to (2) all fees you have paid to the provider over the life of the relationship.  Make sure that the cap does not apply to your losses arising from the provider’s fraud, gross negligence or intentional misconduct, or from the infringement of the provider’s software on the intellectual property rights of third parties.  Finally, make the liability cap mutual, meaning that it also caps your liability to the provider.

Pitfall 10:  Failure to Insist that the Provider Indemnify You for Your Losses

Indemnification means that the provider must make you whole and pay your legal fees in the event that you suffer significant losses because of something the provider did or failed to do.  At a minimum, insist that the provider indemnify you for its software’s infringement of third party software.  You might also insist that the provider indemnify you for its breach of your agreement.  Insist that the indemnification include payment of your attorney’s fees. 

 

Alexander F. Kennedy is a business lawyer at the law firm of Jones Waldo Holbrook & McDonough PC in Salt Lake City. He can be reached at (801) 534-7224 or akennedy@joneswaldo.com.

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