IT suppliers often provide their prospective customer with their standard software licence agreement.  Before agreeing to these terms a customer should consider the key provisions of the agreement to ensure that they align with their intended use of the software and the risk profile of the transaction.  This note examines 3 of the key provisions that need to be considered in reviewing the software licence.

1. Licence scope - Does your intended use fall within the scope of the licence?

It is critical for the customer to review the scope of the licence granted to ensure that the scope of the licence aligns with the proposed use of the software.  The customer will need to consider the limitations that are placed on the use of the software.  Standard limitations in software licences include restrictions on:

  • who can use the software (eg only employees of the licensee?);
  • where the software can be used (eg only on a named or specified server and at a specific location?);
  • the number of people that can access the software (eg limitations on the number of concurrent users); and
  • the purpose for which the software can be used (eg only for internal purposes of the licensee).

If the customer outsources part or all of its IT infrastructure or engages contractors to perform certain activities in its IT environment the customer will need to ensure that the licence does not preclude the use of the software in an outsourced environment or by third party contractors.

The scope of any limitation on “access” to the software needs to be considered carefully.  If the software is to power functionality which the customer wants to make accessible to its customers via the web it is critical that such “access” does not contravene limits imposed by the licence on who can “use” or “access” the software.

If the licence limits the servers on which the software can be installed or the number of users who can access the software it is worth checking whether the licence has a reliable mechanism for obtaining the licensor’s permission to install the software on another server or obtain additional licenses of the software.  Are additional fees payable if the software is moved to a different machine or additional licenses needed?  If so, what is the basis on which these fees are calculated?  It is generally better for the customer to agree this process up front (including any potential increase in fees) rather than facing a potential breach of contract claim or being forced into paying additional fees to accommodate changed circumstances.

The customer will need to consider the purpose for which the software can be used.  In particular, many software licences limit the purpose for which the software can be used to a customer’s internal business and prohibit the customer from using the software to provide services to third parties.  Where the customer is part of a corporate group, the customer should ensure, to the extent necessary, the scope allows for the software to be used for the benefit of the other members of the corporate group.

2.  IP Infringement - To what extent should the supplier be liable?

An IT service provider will generally try to limit or exclude liability in relation to claims by third parties of IP infringement.  They may do this by not including any warranty or indemnity in connection with a third party IP infringement claim or by providing limited warranties and indemnities.  In addition to considering the financial exposure the customer may face if they were to become a party to IP litigation, for the purposes of assessing the potential risk associated with this, the customer should consider the impact on their business if they were ordered to uninstall and no longer use the software within a short period of time.

Some software companies offer non-infringement warranties limited by reference to the state of their knowledge; eg that they are not aware of any infringement claims.  While such a warranty may be justified in the context of patent infringement claims there would seem to be no justification for such a limitation in relation to copyright claims.  Breach of copyright can only result from actual copying and is wholly within the software company’s control.

Other software companies do not provide any warranty relating to non infringement, but do provide an indemnity in connection with third party IP infringement.  While a non-infringement warranty may be implied into a software licence on ordinary common law principles the scope for any such implication is likely to be removed because of the presence of a term making clear that the only applicable warranties are those expressly given.  The consequences of accepting an indemnity without a corresponding warranty need to be understood.  The customer may find themselves in a position where they are indemnified against the costs, damages etc associated with a claim (to the extent these are covered by the terms of the indemnity) but the customer may have no right to terminate the licence - because there has been no breach of any representation that the licensed software does not infringe.  The customer’s desire to cancel the licence, recover their advance paid fees and move to an alternative product may therefore be frustrated.

The terms of any indemnity needs to be carefully reviewed.  For example, US suppliers may try to limit the indemnity to loss flowing from infringement of US patent, copyright or trademark.  If the customer is located in Australia and the software is being installed on the customer’s server in Australian then the indemnity should not be limited to infringement of US IP rights.

Further, some software suppliers will try to limit the indemnity to the amount of an award made by a court rather than all costs and expenses arising as a result of a claim.  The cost of defending an IP claim could be significant and the customer may have a material exposure if the indemnity is limited to the amount of an award made by a court.

A software supplier may seek to have the right to conduct any defence of a third party IP claim with the customer being required to provide reasonable assistance.  While in principle this is a reasonable position to adopt, it is in the customer’s interests to ensure that any assistance the customer is required to provide in relation to such defence is at the supplier’s cost.  Further, it is appropriate to ensure that the supplier cannot settle the claim without the customer’s consent if the settlement involves an admission of liability by or on behalf of the customer or requires an act or omission of the customer (eg a payment or future non use of the software).  If the customer’s consent is not required there is the risk that the settlement of the matter is prejudicial to the customer interests (eg the customer receives a notice stating that under the terms of the settlement the customer must uninstall a business critical piece of software within 7 days).

3.   Liability cap - Do you need a floor?

Many licence agreements include a liability cap that is calculated by reference to the amount of fees paid during a stated period.  For example, the liability of the supplier may be capped at an amount equal to the fees paid by the customer in the 12 months before the event giving rise to the loss.  This formulation may mean that the amount of the cap is variable.  That is, if an event giving rise of loss is suffered in the first 3 months of the agreement, the fees paid (and hence the capped amount), depending on the fee structure, may be less than the fees paid (and hence the capped amount) at a point later in the term of the contract. If a cap on liability is acceptable to the customer, we recommend that a floor amount is included in the cap.  That is, the cap on liability is the greater of a specified dollar amount and the fees paid in the proceeding 12 months.

Furthermore, it is customary to exclude a number of heads of loss from the liability cap. For example, loss arising from breach of privacy, confidentiality, IP infringement and death or personal injury are generally excluded from the cap on liability.