For most businesses trading in today’s digital world, software is vital and can impact their performance and success. As a software supplier (for example, a developer or owner), you can monetise your software in several ways, including by licencing it to customers. However, when licencing software, it is crucial to have robust software licence agreement to protect you from legal risks and avoid disputes.
In this guide, you will learn how to manage the use and distribution of your software with a licence agreement in business-to-business transactions. We’ll explain how to protect your software and use it to benefit customers, thereby creating fruitful business relationships. For help tailoring software licence agreements and any managed services contracts to meet the needs of your business, speak with our friendly team of expert IT solicitors.
Note that there are various types of software licence agreements. Here, the key focus is traditional, on-premises licence agreements. These are different from Software-as-a-Service models, which are covered in our separate guide to SaaS agreements.
- What is a software licence and why do you need one?
- What are the different types of software licences available, and when would you need them?
- 3. What should be considered in a software licencing agreement?
- What are the common mistakes to avoid when licencing software?
- How can I ensure my software remains protected under a licence agreement?
- What are the best practices for negotiating licencing terms?
What is a software licence and why do you need one?
A software licence is a contract setting out the rules under which a software owner allows third parties to use its software. Software contains intellectual property (IP) rights and is protected by copyright, meaning a licence is needed to protect the software owner’s asset and grant third parties permission to use it.
Software licences are important for both software suppliers and customers:
- As a supplier, you need to set out rules on how your software can and cannot be used, ensure your customers pay you and protect yourself from liabilities which could arise.
- As a customer using software, you need to ensure you have the right to use software for the purposes you require it and certain flexibilities, such as the right to end the contract if you no longer wish to use the software.
What are the different types of software licences available, and when would you need them?
Software licences come in a variety of forms, to address a wide range of circumstances - from individual user licences to company-wide licences allowing organisations to install as many licences as they need, to Software-as-a-service (SaaS) models, to End User Licence Agreements.
When licencing software, you should carefully consider what rights you are seeking to grant, how the software will be provided to customers and then draft your software licence agreement accordingly.
The most common ways of licencing software are:
- On-premises software licencing. This is where software is licenced to customers to run on their own local systems. The customer is granted an ‘on-premises’ licence to install and use the software on their own systems.
- SaaS software licencing. This is where the customer will be given a right to use the software, but it will not be installed on the customer’s own machines – rather, it will be hosted on the supplier’s systems. SaaS is a unique type of licencing model whereby software is made available online and a customer doesn’t need to download it. Examples of SaaS platforms include Mailchimp and Zoom. Under a SAAS model, the customer subscribes to a service which is hosted on the cloud. As such, SAAS agreements are more service based and focus on issues such as the quality of the SAAS product, uptime, and responsibility if the service is not available.
On-premises software is often more appropriate where a customer requires a niche product, specific for their business, which is critical for their operations.
3. What should be considered in a software licencing agreement?
There are various key issues which need to be covered in a software licence agreement. The types of provisions will also depend upon the type of licence (e.g. whether it is an on-premises or Software-as-a-service licence).
Some of the key considerations (amongst others) for on-premises licence software agreements include the following:
Intellectual Property (IP) Rights
A software licence agreement must include robust IP provisions, protecting the rights in the software being licenced. The licence must (unless otherwise agreed with the customer) make clear that all IP in the software is the property of the software owner and that the customer doesn’t acquire any rights in the software, apart from a limited licence to use the software for specific purposes.
Commonly, software is licenced on a non-exclusive basis and licence agreements give the customer a non-exclusive, non-transferable right to use the software. This is crucial, as the software owner should retain the right to licence the same software to other customers and prevent the customer from giving other third parties rights to use its software. If the parties do agree upon exclusivity (which is uncommon), then special attention would be required when it comes to drafting the licence agreement.
IP provisions in a software licence agreement need to be carefully considered and bespoke, depending on the type of software being licenced. For example, the software supplier may need to grant the customer a licence to use ‘third party IP’, if any third-party code forms part of the licenced software.
IP issues are a critical risk for customers. For example, customers will often demand that the supplier of software indemnifies (i.e. compensates) them for any third-party IP infringement claims brought against them because of their use of the licenced software. If this happens, software suppliers should ensure that they understand the IP issues applicable to their licences and protect themselves from risk contractually.
Scope Of Rights Granted To The Customer
It is crucial that software suppliers carefully consider what they are licencing to customers and the scope of those rights.
The software licence should cover key issues such as:
- What software is being licenced – often, including a technical specification can help define what software the customer is being licenced.
- What the customer can do with the licence – commonly, use of the software will be limited to the customer being able to run the software for its business purposes and make a back-up copy. Any bespoke permissions agreed with the customer (for example, the right to modify the licenced software) would need to be expressly and clearly set out in the licence agreement. Further, the licence should explain what customers are not allowed to with for software. For example, licences often include strict restrictions against the customer reverse engineering software or licencing it to third parties.
- The licence duration and territory – the licence should state which countries the customer can use the software in and whether it will be a fixed-term, rolling or perpetual licence.
- User permissions – it is critical to set out who can use the software, for example whether the software will be used by one entity, or a group of entities and how many authorised users are permitted to use it.
Liability is a critical issue in software licence agreements. As a software supplier licencing your software to a customer, you will need to ensure that your contract includes a robust limitation of liability to limit your liability to the customer for breaching the agreement.
Without a carefully drafted limitation of liability clause, you could face unlimited liability as a software supplier and there would be no financial limit on the level of damages a customer could claim against your business if things go wrong.
As a practical example:
- Imagine as a software supplier, you licence a customer the use of a bookings platform for their website. The software has a default, meaning the customer could not receive booking for two weeks and missed out on several new business opportunities. As a supplier of software, you will want to avoid liability for losses the customer suffered when the software wasn’t working. Having a robust limitation of liability clause could help limit your liability in this scenario.
However, it is common for customers to push for negotiations on liability clauses. The approach to take will depend on various factors such as the value of the deal and the bargaining power of the parties. Liability issues can be high risk – for example, customers will often ask for unlimited liability for data breaches. Software suppliers should seek legal advice if they are unsure on the implications of liability proposals from customers.
Warranties are also a key issue to consider. It is common for customers to expect a warranty regarding the performance of the software and for a supplier to warrant, at the very least, that the software will perform in all material respects in accordance with its specification for a fixed period. The length of the warranty period will depend on the nature of the software. The appropriate warranties to offer the customer should be carefully considered by the software supplier.
Payment terms are critical and will need to be tailored to the type of software licence being granted. For example, whether there will be a one-off licence fee payable at the start of the contract, or recurring fees.
As a software supplier, you’ll also need stringent payment terms protecting you if the customer fails to pay – such as the right to revoke the licence.
Data protection and security are key issues in software licence agreements. This is particularly important if, under the licence agreement, the software supplier will have access to customer personal data.
Customers, as part of their supplier due diligence, may want to see the software supplier’s security standards and procedures and will expect strong data security measures to be in place.
If the software supplier acts as a ‘data processor’ when processing the customer’s data, the licence would need to contain mandatory terms due to the stringent rules under UK GDPR.
Support, maintenance, and updates to the software
A common aspect of software licence agreements is support, as software is not completely error-free. A software licence should deal with matters such as how frequently updates will be released and whether updates and bug fixes are included in the licence fees or subject to additional charges.
It is also important that any service levels agreed with the customer are documented in the agreement, particular for software which is business critical for customers. You should note that failing to perform on any agreed services levels could mean you are in breach of contract – emphasising the importance that only realistic, and achievable service levels should be agreed.
What are the common mistakes to avoid when licencing software?
Software licence agreements are complex and common pitfalls can lead to misunderstandings and sometimes, disputes.
Common pitfalls to avoid include:
- Unclear terms around the scope of the licence and how the customer is permitted to use it. Legal problems can arise if your software licence agreements do not clearly define what users can and cannot do under the licence. For example, as a software supplier, you risk the customer misusing your software if you do not clearly set out parameters on use. Further, a dispute could occur if there are mismatched expectations and misunderstandings regarding the software licence and what permission the customer is granted under it.
- Failing to properly define which individuals are permitted to use and access the software. For example, not specifying whether third party contractors of a customer can use the licence.
- Vague pricing terms which do not clearly set out the costs payable by the customer – for example, failing to define whether software installation or testing costs are charged additionally or are a part of the licence fee.
It is important to take care when drafting software licence agreements and avoid these pitfalls. For a software supplier licencing software, common mistakes could result in customers refusing to pay and ultimately, disputes.
How can I ensure my software remains protected under a licence agreement?
Protecting your software is critical. To do this, your licence agreement should include key provisions to achieve this, for example:
- Audit rights to ensure that the customer is complying with the terms of the software licence agreement. Your licence agreement can include strict audit rights allowing you to investigate and verify the customer’s use of your software. Your licence can include remedies if you find that the customer has breached its terms – for example, the right to compensation and to terminate the licence agreement.
- Termination rights to end the contract in specific circumstances. For example, you can include stringent provisions allowing you to end the licence agreement if the customer commits very serious breaches of contract. Setting out stringent termination rights can be a powerful way to stop customers misusing the software, particularly if they are heavily reliant upon it.
What are the best practices for negotiating licencing terms?
There are different approaches to take when it comes to contract negotiations, depending on the type of software being licenced.
Typically, ‘off the shelf’ commoditised software will be offered to customers on a non-negotiable basis. However, for more bespoke arrangements such as on-premises licences, customers may have more leverage to negotiate terms. As a supplier, you should keep an open mind and commercial view when it comes to contract negotiations – as saying no to any negotiations could mean loss of potential business.
Sometimes the software you are licensing will be critical for customer business operations, which would not be able to function without it. As a result, customers may identify risks and push to negotiate certain provisions to protect their best interests. It is important to hear customers out and work with them to give them comfort around those risks.
Key tips for negotiating software licence agreements:
- Preparing for the negotiations by understanding the other party’s objectives, planning what you are prepared to accept, and what is a dealbreaker.
- Being open and constructive – there may be key clauses around liability which are critical for the customer. Taking a constructive approach and listening to the customer’s concerns will help – by being reasonable, you are more likely to negotiate a successful deal and secure business.
- Taking legal advice if you are unsure. It may be tempting to agree to things at the negotiation table, to get the deal over the line. However, seemingly small contractual changes could put your business at risk. If in doubt, speak to legal advisors who can help you understand the risks involved and make an informed decision about them.
This guide has explained some of the key issues to consider for software licence agreements. However, there are a myriad of other issues to explore, and licencing software requires careful thought and strategic planning. It is vital that software suppliers ensure that their software licence agreements are robust and tailored from the outset. Poorly drafted software licence agreements could result in several negative consequences, cost the business time and money and lead to disputes.
If you would like advice and support with licencing your software, contact our experienced IT lawyers who are happy to help.