Drafting separate software license and services agreements can be a useful risk management tool, but parties to these contracts need to be aware of the contractual provisions and factual circumstances that can undermine their effectiveness.

When drafting a software license agreement, a licensor has a variety of contractual tools available to mitigate risk and limit liability. For example, the licensor can include a clear and conspicuous disclaimer of warranties that expressly references the warranty against infringement and the implied warranties of merchantability and fitness for a particular purpose. The licensor can attempt to limit the length of potential exposure by contracting for a shorter limitations period. The licensor can further attempt to limit the available damages by including a contractual provision that excludes “indirect, special, consequential or incidental damages” or limits total liability for direct damages to “the total amount paid or payable under the agreement.”

When a licensee requires implementation, software customization, support or other services associated with the licensed software, it is not uncommon for software license terms and associated services terms to be included in a single agreement. To the extent the parties wish to limit damages to certain fees paid under a single agreement framework, the agreement might simply state that direct damages are capped at fees paid for services (as opposed to both service fees and license fees). However, there may be reasons to cover the terms for the software license and related services under separate agreements — a software license agreement governing the terms of the software license and a separate services agreement governing the associated services to be performed with respect to the licensed software.

Parties to software license agreements and separate services agreements should be aware of the potential pitfalls that exist when employing this two-contract approach. If the parties’ intentions of entering into two separate contracts are not explicit, there is risk for all parties of exposure to damages under both contracts based on the argument that the two contracts should be treated as mutually dependent contracts, such that the breach of one contract constitutes a breach of the other. Properly drafted agreements under the two-contract approach should have the effect of limiting the total liability of each party by precluding a party from seeking damages under both contracts when the alleged breach only relates to the obligations set forth in one agreement.

Example

To illustrate, consider the following hypothetical from the perspective of a licensor’s potential damages: Company A seeks to license and customize an integrated software solution in order to automate and manage supply chain logistics through Company A’s internal enterprise resource planning (ERP) system. Company A obtains proposals and negotiates with a software company (Vendor A), which represents that its out-of-the box business process management (BPM) software can support 95 out of the 100 requirements provided by Company A. The five additional requirements are critical to Company A’s ability to use the BPM software to its full potential in support of Company A’s business operations. Company A enters into a software license agreement, under which it agrees to pay Vendor A $500,000 for the right to use Vendor A’s BPM software. On the same day, Company A also enters into a services agreement, under which it agrees to pay Vendor A $300,000 for services required to configure and customize the BPM software. Both agreements contain clauses providing that total liability shall not exceed the total amount paid under the agreements.

The services agreement sets an estimated delivery date for the customized interface and software product, which Vendor A fails to meet. After several months of working with Company A, problems continue to persist with the user interface and functionality of the software. Company A sends a notice of termination and seeks a full refund of all monies paid under both the software license agreement and the services agreement. Vendor A argues that Company A is not entitled to recover under the software license agreement because the alleged breach relates solely to work performed under the services agreement.

The question of whether our hypothetical Vendor A will prevail in capping its damages at $300,000 turns on the terms of the parties’ agreements. If the parties’ services agreement expressly incorporates the software license agreement by reference and provides that a breach of the services agreement constitutes a breach of the software license agreement, then the parties’ decision to enter into two separate agreements with two separate limitation of liability provisions carries little weight. Even in the absence of such a clear contractual provision, merely referencing another agreement may be enough to incorporate it therein if the reference indicates that it is made for the purpose of making such writing a part of the contract.

If, on the other hand, the agreements do not reference one another and they further contain integration clauses specifying that each agreement is the entire agreement and supersedes all other prior or contemporaneous oral and written agreements, then Vendor A will be in a better position to argue that its damages should be capped at $300,000. The presence of an integration clause, however, is not conclusive evidence that the parties entered into an integrated agreement.1 A licensor seeking protection by entering into two separate agreements should be aware that a court may find that an agreement has been implicitly incorporated by reference based on the context in which the parties created the agreement at issue.2

Interpreting Separate Agreements

As a general rule, “instruments executed at the same time, by the same contracting parties, for the same purpose, and in the course of the same transaction will be considered and construed together as one contract or instrument, even though they do not in terms refer to each other.”3 Whether a court will take the further step of treating separate agreements as mutually dependent, such that the breach of one constitutes a breach of the other, is a question of fact that depends on the intent of the parties.4 Courts look to see whether the parties would have entered into one agreement without execution of the other agreement.5 In the example above, the fact that the five missing requirements were critical to Company A’s ability to use the BPM software would likely be an important fact in this analysis.

The contractual principles applicable to interpreting and enforcing separate agreements have important implications for parties entering into software transactions. Due to the nature of software transactions, the touchstones for interpreting such agreements together are often met. When parties enter into separate license and services agreements, the agreements are frequently signed contemporaneously, involve the same parties, relate to the same purpose (i.e., implementation of a customized integrated software solution), and are part of the same transaction. Such transactions are typically preceded by a licensee seeking bids for a customized software solution, which evidences an intent to license one integrated product. In such circumstances, a licensee has a strong argument that it never would have entered into a separate license agreement without the promises made by the licensor in the services agreement.

Even if the parties have two separate agreements that contain two separate limitation of liability and integration clauses, a court may find that the parties intended to treat the agreements as one. Perhaps more importantly, because questions of intent are usually inappropriate on summary judgment, a licensee may be able to survive a summary judgment motion on the issue of whether damages should be capped under the services agreement’s limitation of liability clause. This unsettled issue makes litigation more costly and also makes it more difficult for the parties to resolve the dispute.

Drafting Guidance

The two-contract approach can be a useful risk management tool, but parties to these contracts need to be aware of the contractual provisions and factual circumstances that can undermine its effectiveness. To avoid a finding that the two separate agreements should be treated as mutually dependent, the parties’ intentions must be clear in the four corners of the documents. At a minimum, a licensor seeking to maintain the separateness of the license and services agreements should draft strong integration clauses and avoid cross-referencing the agreements. To make this intent even clearer, the licensor should insist on the inclusion of provisions stating that each party acknowledges that services are being purchased separately from any product licenses, fees for the services are separate from any fees paid for products, payment obligations under the services agreement are not contingent on the purchase or use of any product, and the licenses granted under a license agreement are not subject to payment of fees under the services agreement. Conversely, a licensee of an integrated software solution should insist on incorporating the license agreement by reference in the services agreement and expressly stipulating that the breach of one agreement constitutes a breach of the other.

In the absence of clear contractual provisions governing the separateness or dependency of the two agreements, both parties increase the likelihood of costly litigation and protracted discovery on the issue and diminish the likelihood of settlement.