Legal Tips for Drafting and Negotiating Software License Agreements

8 mins read

Enforceability Generally. Legally strong software licenses: (a) contain standard, typical, customary clauses, and (b) call for users’ special attention to all other clauses.  Users usually don’t read software licenses because they all look the same to an untrained eye. Courts are aware of that fact and they tend to side with users when the software vendor tries to enforce unusual, surprising and unanticipated terms that limit the users’ rights.

(Non-Appearance-Based) Arbitration clause is very convenient for software companies that sell internationally. Instead of going to court, the parties can resolve disputes remotely, quickly, inexpensively and confidentially via arbitration. With non-appearance-based arbitration, the dispute gets resolved by telephone, Skype; the parties do not have to actually go to the hearing. The arbitrator decides the case based on documents submitted by email and other means. The American Arbitration Association (AAA) is one of the most established non-profit organizations that administers arbitration proceedings for those who wish to resolve conflicts out of court.

Unlike the court proceedings, arbitration is confidential, informal and you do not necessarily need an attorney to represent you because arbitrators are not as strictly bound by the formal legal procedures as judges are. Many commercial arbitrators are pro-business, have significant business background and can relate to the issues you are facing. All of the above means that you will get to state your case in plain English, in private, to people that can relate to the issues you are dealing with. So, generally speaking, you have a better chance of winning at arbitration than at trial but even if you lose, at least you will not usually have to spend large sums of money on attorneys.

States in the U.S. have a strong policy favoring arbitration. Nevertheless, sometimes courts strike down arbitration clauses that are deemed unconscionable, especially when they are buried in pages of other legal mumbo jumbo and the party offering the clause is a dominant sophisticated party (business), offering a deal on a “take it or leave it” basis to an individual consumer. In California, we often see arbitration clauses invalidated in employment contracts, or contracts of adhesion such as clickwraps, shrinkwraps that nobody ever reads, even though, yes, they should. To prevent this from happening, it is important to make sure the arbitration clause is brought to the consumer’s attention and the consumer understands that both parties are signing away their constitutional right to a jury trial. A properly drafted arbitration clause is a good deal for both parties and will withstand the judicial scrutiny, considering the states’ strong policy in favor of arbitration. Without arbitration, many consumers simply wouldn’t know where to start filing a lawsuit, and the costs of trial are often more than the case is worth.

European (pro-consumer) countries have gone the route of statutorily limiting the scope of arbitration and other presumptively unfair clauses in consumer contracts. As a result, in such pro-consumer countries, I cannot offer the end user a software license with the standard US happy-go-lucky arbitration clauses, disclaimers and limitations of warranties. Normally, it is best to include Indemnification Clause (see below) which makes the distributor in that country liable for making EULAs compliant with the local law. Read Software Licensing Issues for US Businesses in Europe and Japan to get an idea of potentially problematic software/mobile application licensing clauses in foreign jurisdictions.

Neutral Venue Clause is a great way to limit liability for websites that act as a platform for users to interact, make deals, aggregate or share information such as online reviews. Examples are websites which are platforms for people to offer services or products to each other or the public at large, websites that compile reviews regarding a certain industry or types of products, websites that contain interactive features such as forums and chat rooms, matchmaking/dating websites. Neutral venue clause states that you are a not a party to any deals users enter into (even if you collect a fee for your service), therefore, you cannot be held liable for any monetary, reputational damages, bodily injury or deaths arising out of the users’ activities, deals, contributions and interactions on your site. For example, if your website has a forum and user(s) posted links to copyrighted movies, books or any other third party intellectual property without your knowledge or approval.

Intellectual Property is a standard and important clause that you have to get right. Users keeps their own data, you keep the IP ownership rights to the software. If any third party technology must be used with the software licensed, it’s a good idea to include a statement that usage of such third party technology  is governed by the terms of the third party technology license agreement and not under the present software license.

“Software is licensed to you, not sold” is an important theme to emphasize to ensure that users do not get any ownership rights in your software. A good clause to include may go something like this:

Licensee acknowledges that Company has no delivery obligation and will not ship copies of the Company software program to Licensee. Licensee agrees that Licensee does not acquire under the agreement any license to use the Company program in excess of the scope and/or duration of the services. Upon the end of this Agreement, Licensee’s right to access or use the Company program and the services shall terminate.

Consider keeping the Maintenance clause and the Service Level Agreement (SLA) simple. In case of SaaS, when you update the software on your system and fix the bugs, all users automatically benefit from it in a SaaS arrangement. So, it’s usually enough to have Maintenance encompass 99.(xxx)% uptime warranty, various performance standards, system administration, system management, and system monitoring. SLA would normally address different time frames for fixing problems.

Subscriber Reference. If you have clients that have influence and recognition in their fields, it might help you to have the right to mention the fact that they are your client. For example:

Subscriber agrees that Company may identify Subscriber as a recipient of services and use Subscriber’s logo in sales presentations, marketing materials and press releases.

Indemnification (or “Hold Harmless”) is an important clause that acts as your insurance for another party’s wrongdoing. Suppose, somebody hired you to develop a website or a mobile application and gave you the pictures to use. Pictures turned out to be from a copyrighted clipart, the owner of which now sues you for copyright infringement. Indemnification clause guarantees that your client will be responsible for your legal fees and other expenses incurred while defending against this.

Choice of Law/Governing Law and Jurisdiction clause ensures you will not get sued in another state or a foreign country when a customer over there buys a product or service from your website. Under the current statutory and case law, such a customer may sue you because your website could be deemed as “reaching out” to his jurisdiction by virtue of being out there on the Internet. This is especially true with websites that have interactive features (as opposed to merely informative sites with just your contact info) encouraging users to submit forms and orders.

Limitations/Disclaimers of Warranties clauses are pretty standard but you need to know which ones to choose for your particular business model because not all liability can be disclaimed and you risk a lawsuit if you are too greedy.

Non-Solicitation, Non-Circumvention clauses are particularly useful if you are a middle man or woman that does not want to be cut out of the deal. For example, you are a real estate broker or you are running a website that matches buyers and sellers. So, you include non-solicitation and non-circumvention provisions which prevent parties from dealing directly with each other in order to avoid paying your fee.

Liquidated Damages is a lump sum payment for breach of contract. For example, you rent an apartment out to commercial or residential tenants. You have a duty to mitigate damages and try your best to re-rent in case of an early breach (and to provide accounting within 21 days of tenant moving out). However, some tenants breach during the high season, some during the slow times, you have “midnight movers,” and it’s always difficult to figure out exactly within the California-prescribed statutory 21-day period how much exactly will any particular tenant owe you before you re-rent the property. When the 21 days are up, you have to refund the unused portion of the deposit, even though the place is still not re-rented, and good luck suing ex tenant, especially if he or she moved out of state (if you even know the new address). So, instead of going through this trouble, you include a clause that the fee for early lease termination is two months worth of rent and the security deposit may be used for it.

In order for a liquidated damages clause to be valid, two conditions must be met: 1) the amount of the damages identified must roughly approximate the damages likely to fall upon you, and 2) the damages must be sufficiently uncertain at the time the contract is made that such a clause will likely save both parties the future difficulty of estimating damages.

Cumulative Damages clause ensures that you get to add up your fees and penalties, without any one of them being exclusive of another.

Severability clause means that if any provision of your contract is held invalid, the rest of the contract still stands, even though the plaintiffs will often try to invalidate the whole contract.

Entire Contract clause basically means that the contract represents the complete and final agreement. It prevents people from claiming there are some terms not listed in the contract that affect your deal.

Reporting to credit agencies in the US gives you more leverage in debt collection because clients are less likely to default on their debt. Reserving your right to pursue debt via debt collection agencies gives you another advantage, even though the debt collection agencies are required by law to stop contacting the debtor if he or she tells them to cease communication.

Confidentiality. If you host and monitor users’ proprietary business information and other sensitive data, it’s best practice to include a confidentiality clause where you agree to keep their sensitive information secret and not use it for yourself.  It’ll give users’ a peace of mind knowing that you’re bound by the confidentiality clause not to disclose or use that information. If you use subcontractors, the confidentiality clause must state that you will bind those subs to at least the same level of confidentiality as your own software license binds you.

Warranty and Limitation of Liability. SaaS deal is a particularly sensitive source of potential liability since you’re undertaking to maintain large amounts of others’ important data. Therefore, consider including a disclaimer encouraging users to back up their data and to acknowledge that your software is provided “as is” to be used at own risk with no warranty of any kind, no liability for lost profits or other special damages. It’s a fairly standard practice to disclaim all warranties in the US but software companies have to be a lot more careful with that in the EU and other countries, as outlined above.

Independent Contractor clause ensures that parties to the software license are not liable for each other’s mistakes (as they would be in a partnership or a joint venture deal).

Audit clause gives you the right to inspect user’s business to ensure that your program is not used on unauthorized (unpaid) computers/locations. Even if you know you’ll never bother auditing any user, it’s still good to have an audit clause because its very presence in the license will deter many users from trying to cheat you.

Read also: Legal Tips for Drafting and Negotiating Software License Agreements

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