Software Licensing In Franchising
AMERICAN BAR ASSOCIATION
FORUM ON FRANCHISING
MINI-PROGRAM 4
IDENTIFYING AND PROTECTING YOUR INTELLECTUAL PROPERTY
October 22-24, 1997
Colorado Springs, Colorado
SOFTWARE LICENSING IN FRANCHISING
Presented by Van Elmore
Law Offices of Van Elmore
Denver, Colorado
INTRODUCTION
Software licenses have long been a central feature of rental car and hotel franchises. Today, many other types of franchises are providing franchisees with specialized software to assist the franchisee with business operations and to enable the franchisor to access the franchisee=s computer system to collect data such as the items or services sold and total dollars of revenue. Franchisors are consequently licensing more software to their franchisees and are also receiving licenses and assignments of software from software developers, including internet web site developers.
The primary scope of this paper, regarding the underlying types of intellectual property in software, will be in relation to copyrights and trade secrets. Copyrights in software should be registered with the Library of Congress. This may be done in a manner which protects the trade secrets within the software.[1] The focus of this paper will be on practical considerations and drafting issues from the standpoint of the franchisor, both as a assignee/licensee from a vendor and as a licensor to its franchisees. Rather than attempt to deal with every clause that might be contained within a software license, this paper will highlight certain areas that should be given particular consideration.
Software may be patented and therefore the associated license would include a right to use the patent. The expected life span of a software program is often relatively short, one to two years. The time involved in acquiring a patent for software is often longer than that period. In addition, although software patents are being granted, the clearest legal support for an application seems to exist for software which is intrinsically related to the workings of machinery. The cost of pursuing a software patent is also higher than the cost associated with registering a copyright for software. Consequently, many franchisors elect not to attempt to acquire a patent for their proprietary software. For these reasons, this paper will not deal with the licensing of patented software.
However, franchisors should be aware that it is possible for independently created software to infringe upon an existing software patent, many of which, unfortunately, are quite broad in scope. Therefore, either the software developer or the franchisor itself should investigate this potential with an appropriate patent search.
It should also be noted that licensed software could be considered to be a tied product or service from an antitrust perspective. There are a few cases which have dealt with the Atying@ of the software license and the software maintenance/service agreement.[2]
THE SOFTWARE LICENSE
In general, the software license is a contract which enables the use of the software by licensees. In a license of intellectual property, some, but usually not all, of the bundle of sticks that make up the copyright and trade secrets in the software, are given away to the licensee pursuant to the terms of the agreement.
In addition as a contract which sets forth the relationship of the parties, other issues should be agreed upon, such as; limitation of damages, limitation of warranties, modifications, reverse engineering, transfer, dispute resolution, bankruptcy and termination.
THE FRANCHISOR AS THE LICENSEE OR ASSIGNEE
Before the franchisor begins to license a computer program to its franchisees or place a web page on the Internet, the franchisor will acquire a program from an independent software developer or from an employee. This section will examine some of the issues that the franchisor/assignee/licensee should examine when receiving a program.
COMPILATION
All software programs are usually originally written by a human being. They are written in a computer language such as C++. Just as there are no copyrights in the French or English Languages there is no copyright for the selected computer language. These are merely methods of communication. Until they are fashioned into a particular message, there is no expression which is a necessary element of copyright[3]. There could possibly be a trade secret in the language but its general knowledge and use defeats trade secret claims. The programmer writes a particular program, whether for a computer application or for an Internet Web page, in source code and then often uses a compiler or interpreter software to convert the source code into object code, or other instruction, that speaks directly to the computer in a manner that will be compatible with a particular operating system such as Windows. The compiler or interpreter is a software which is licensed by major software houses, such as Microsoft. These utilities often add standard or prepackaged pieces of code to the finished product from their respective run time libraries. The run time library is a set of code routines which the compiler or interpreter software will automatically add to the final product. The programmer does not have the copyright for these pieces of the finished product and therefore can not assign the copyright in these pieces of code. The license to the programmer for the compiler permits use and distribution and the programmer may license use by the franchisor, but these are merely licenses to use the code, it is not an assignment. A purported assignment of copyright from an independent programmer will not transfer copyright in these portions of code to the franchisor. Similarly, code generated in-house by an employee, within the scope of his or her normal employment, will also not transfer the copyright in these pieces of code to the franchisor.
In most situations, this does not create a problem because the licensors of the compiler want programmers to use their compilers and to create applications which will be compatible with their software. Therefore, they are not motivated to police purported, but unauthorized, assignments of this code by the developer. The franchisor should carefully review the assignment/license from the developer to clarify this issue. In addition, the franchisor should consider, what treatment, if any, this situation should be given in its licenses to its franchisees and in its Uniform Franchise Offering Circular (UFOC) disclosure in Item 13.
THE PROGRAMMER’S TOOL BOX
Programmers often use some of the same sets of code over in different programs. They often describe these Routines as part of their Tool box. The franchisor, as the assignee of software from a developer, should be aware of this and should carefully review and revise, if necessary, the assignment/license from the developer to clarify what is being assigned and what is being licensed.
Some of the earliest cases dealing with software held that it was unprotected under copyright law.[4] It is now accepted that source code, object code and other aspects of software can be protected by copyright. Of course, facts and ideas which are contained in the code may not be protected. The courts are continuing to wrestle with what parts of a program, including both literal, such as the written code, and nonliteral, such as the screen displays, are appropriate subjects for copyright protection. In MiTek Holdings v. Arce Eng’g. Co., 89 F.3d 1548, 1555 (11th Cir. 1996), the court held that such nonliteral elements of the computer program, as the menu and sub-menu command tree structure were, in this instance, representative of a process and therefore not entitled to copyright protection. Although some portions of literal, as well as of nonliteral elements, may not be protected under copyright, they may still provide evidence of copying if they are duplicated.[5] It is therefore appropriate to cover both literal and nonliteral elements when dealing with the developer’s tool box.
Software developers will naturally want to reuse code which works. Franchisors purchasing software want to acquire as much of their unique code as is possible. It is becoming more common, therefore, to see contract language in the assignment/license from the developer which addresses this issue. Exhibit A suggests some contractual language for consideration regarding the tool box.
INDEMNIFICATION BY THE VENDOR FOR INTELLECTUAL PROPERTY OWNERSHIP AND PERFORMANCE
Every software developer should warrant that it is the owner of the assigned/licensed software and that the developer has the right to assign/license it to the franchisor. The assignment/license should also include a provision indemnifying the franchisor against any liability if a third party claims ownership of the program. The developer should be required to reimburse the franchisor for any damages and expenses incurred by the franchisor in defending or settling such a claim. The franchisor should consider who will have the right to control the defense of such claims. If the developer is a large entity, it may be appropriate to allow it to control the defense. In contrast, if the developer is a small organization or an individual the franchisor may wish to be able to control the defense. In addition, this indemnification should not be subject to the limitation of damages, by type or amount, which is found in the typical developer’s agreement.
Although developers are typically and understandably reluctant to provide warranties regarding performance of the software, the franchisor should consider the potential liability for itself after the software is licensed to the system. If general warranties and indemnification from the vendor are not available, the franchisor should consider negotiating for cost-free fixes and service for a significant trial period. In addition, the franchisor should attempt to acquire specific warranties, such as, that the program will work on an IBM compatible platform using Windows 95 and will allow remote access by the franchisor/host, etc.
THE PROGRAMMER’S KNOWLEDGE
The information between the ears of the programmer has been an issue in a number of cases. Although this arises primarily in the context of employer-employee, it should also be considered in the independent developer context, as well as at the time, whether through asset sale or acquisition, that the franchisor transfers its software to an assignee.
Generally, software created by an employee during the normal course of his or her employment becomes the property of the employer. This is supported under both copyright and trade secret law. In addition, the intangible knowledge of the programmer/employee has been held to be something which a previous employer can prohibit an employee from using on behalf of a subsequent employer in some circumstances. This was supported under a trade secret theory in Vermont Microsystems, Inc. v. Autodesk, Inc., 88 F.3d 142 (2d Cir. 1996). In this case, the court found that a former Vermont Microsystems employee had misappropriated trade secrets in designing similar computer aided design software for the new employer. The court held that the trade secrets did not have to be exactly copied in order to impose liability.
The burden of proof for a copyright infringement claim is usually on the plaintiff. Normally, a showing of an opportunity to copy and a substantial similarity will suffice. However, if the plaintiff can show that there is a striking similarity between the original work and the purported copy, then the burden shifts to the defendant to show that it did not copy. In the Autoskill, Inc. v. National Educational Support Systems, Inc., 994 F.2d 1476 (10th Cir. 1993) case, the court affirmed a preliminary injunction for infringement because, although the National Education Support Systems’ (NESS) reading software program was not a direct or identical copy of the that developed by Autoskill, the essential aspects are the same and one of the principals of NESS was previously an Autoskill salesman who knew the Autoskill Software well.
There is a growing doctrine of Inevitable Disclosure in relation to employee misuse of trade secrets. In Pepsico Inc. v. Redmond, 54 F.3d 1262 (7th Cir. 1995) the court temporarily enjoined a former employee of Pepsico from assuming a similar position at rival Quaker for six months and permanently enjoined him from disclosing Pepsico’s trade secrets. This was based in part on the fact that the new position would most likely require the employee to breach his confidentiality agreement with Pepsico. This was also the outcome in Lumex, Inc. v. Highsmith, 919 F. Supp. 624 (E.D. N.Y. 1996). The court in Lumex found that it would be inevitable that the employee would disclose important Cybex trade Secrets and that the employee could not eradicate the trade secrets from his mind.
As a result of this trend many programmers are now demanding that their confidentiality agreements contain a clause similar to the following:
Neither party shall be restricted from nor have any liability for using the residual information of the other party. Residual information means the ideas, concepts, know-how and other information that remains part of the general knowledge of a person after access to the tangible embodiment of the other party’s confidential information.
This language is not intended to diminish the protection of the actual trade secrets but rather to minimize the broad reach of the confidentiality agreement into general knowledge. This is a general template suggestion only. Each clause of this nature should be carefully drafted in order to express the inclusions and exclusions carefully.
DISCLOSURE
Item 14 is the primary section of the UFOC with regard to copyrights and trade secrets that may be contained in software. The specific requirements of Item 14 are supplemented by the requirements of Item 13 if relevant. Although the type of limitations set forth above regarding reservations for the tool box and the non-ownership of proprietary products of compilers and interpreters may not significantly limit the franchisor’s or franchisees’ use of the software, the UFOC drafter should consider whether an appropriate explanation of the exact nature of the franchisor’s ownership and rights (licensee for some parts of the program rather than owner) should be mentioned in this section.
In addition, software licenses and associated fees should be considered for disclosure in Item 5, Initial Franchise Fee, Item 6, Other Fees, Item 7, Initial Investment, Item 8 Restrictions on Sources of Products and Services, Item 9, Franchisee=s Obligations, Item 11, Franchisor’s Obligations and Item 17, Renewal, Termination, Transfer and Dispute Resolution.
FRANCHISOR’S LIABILITY TO FRANCHISEE
Defective software, which is licensed to a franchisee by the franchisor, may create liability for the franchisor. There are two primary theories under which such liability may arise: sale of goods and sale of a service.
The courts have varied as to their interpretation of a software license as a good or service. Generally, software is considered to be a good. If however, the software is extremely customized to the extent that the licensee can demonstrate that it was acquiring an expert service, then the software may be treated as a service. Given the attempts to hold franchisors to a standard of competency, it should not be surprising that efforts to qualify franchise system software as a service will be forthcoming.
If the software is considered to be a good, then it will be governed by the UCC[6] and a following section deals with mechanisms to negate warranties and damages under that theory. If the program is considered to be a service, then negligence theories in tort may be applied to the transaction. Normally, the licensor will be held to the standard of a reasonable amount of care in preparing the software. However, in the case of Diversified Graphics, Ltd. v. Groves, 868 F.2d 293 (8th Cir. 1989), the court held that Ernst & Whinney, an accounting firm, had been negligent and had breached a professional standard of care in recommending a consultant to create a computer system for its client, Diversified Graphics (D.G.), when the system was found to be totally inadequate. The Eighth Circuit Court of Appeals ruled:
D.G. presented sufficient evidence to support the jury’s finding of lack of professional care. D.G.’s theory for recovery based on negligence encompasses the notion of a consultant-client relationship and therefore the existence of a professional standard of care: E&W failed to act reasonably in light of its superior knowledge and expertise in the area of computer systems.
Although this case involved an accounting firm which was already under a professional duty, this type of consultant or computer malpractice is an area of liability that franchisors should give particular attention.
It is therefore very important that franchisors examine their license agreements carefully in regard to limitations of warranties and damages.
LIMITATIONS ON WARRANTIES
If, as is probable, the software is considered to be a good, then it is important to disclaim the warranties which are otherwise implied under the UCC. This must be done conspicuously in large bold print. In addition, express warranties can and should be made. The provision of some warranties helps to negate evaluations that the contract is unconscionable.
LIMITATIONS ON REMEDIES AND LIABILITY
Given the foregoing discussion regarding potential liability in tort, it is very important to limit liability and remedies in the license. Consider however, that if the only remedy available under the contract fails, then additional remedies may be pursued. For example, if the license limits the licensee to replacement of defective software and repeated attempts to repair the problem fail, then the licensee may pursue damages, etc., because the remedy failed of its essential purpose.
Limitations on liability will not be enforced if it would be unconscionable to do so. Unconscionability is difficult to prove in a commercial context however. Attached Exhibit B contains suggested contract language for limitation of warranties, liability and remedies.
MODIFICATIONS
It may be necessary to modify the software to meet the needs of a particular franchisee. If the franchisor allows the franchisee to accomplish this, the franchisee will need to have the source code in order to accomplish these modifications. A separate agreement should be generated to insure the limited use of the source code and its return immediately after the modifications are accomplished. All such agreements should bind not only the franchisee, but also any program developer that is creating the modification for the franchisee should also sign the agreement.
All modifications should become the property of the franchisor and the source code should be retained only by the franchisor. Under normal circumstances the franchisee should not be permitted to modify the software beyond the typical user selections and adjustments which are inherently available in the software.
The franchisee should be specifically prohibited in the license from decompiling or reverse engineering the software. This may not be enforceable if a shrink wrap license is used. In addition, the franchisee should be prohibited from making any copies, with the possible exception of one back up copy.
RETURN OF SOFTWARE
The disks, manuals and all other support materials should be returned to the franchisor upon termination, expiration or replacement of the software. Default of the franchise, or other agreements with the franchisor, should be grounds for termination of the license and vice versa. The franchisor should retain the right to inspect the premises to verify that none of the computers still retain the software. All these materials should also be returned upon transfer. The license should prohibit transfer and assignment by the franchisee. This will assist in defeating any claims that a first sale[7] has taken place for copyright purposes.
The copyright doctrine of first sale enables a purchaser of a copyrighted work to sell it to another person. Thus the sale of a book allows the purchaser to sell the book to someone else. It does not permit the creation of another copy. Therefore, transmission of software over the internet would not be possible since that would involve the creation of duplicates. First sale also permits display, at the location of the copy. Again, internet display would not be permitted since it would be viewed by people at locations other than the place where the copy was located on the server. In addition, even the finding of a first sale would not allow a purchaser to rent software, as that is specifically prohibited.[8] A finding that a first sale has taken place could defeat the software owner’s rights in the program from a copyright perspective.
Once the previous franchisee’s materials are returned, a new license should be entered into with the new franchisee. However, the franchisor should be free to assign the license. This will preserve the opportunity for acquisition and asset sales of the franchisor/licensor.
TERMINATION OF THE LICENSE AGREEMENT
At termination of the license agreement with the franchisee, the franchisor should have the right to enter and remove the program materials, despite the fact that this action should probably not be taken without the consent of the franchisee. The franchisee should also have the obligation to remove the program from all computers, including all lap-tops and to return all programs and materials. The franchisor should have a right to inspect to insure that all materials have been returned and that the program is no longer resident on any computer. The licensor may wish to have an injunction clause, without bond, which acknowledges and stipulates to the existence of irreparable harm to the franchisor and the absence of other suitable remedies, to enforce the termination provisions.
Termination of the license should be possible upon default of the franchise agreement, or any other contract between franchisor and franchisee. However, the license should also be terminable by the franchisor without another default in any other agreement. Short cure periods for certain defaults can be drafted, however defaults involving disclosure or other misuse of the program should be immediately terminable.
Although not technically part of a license, one area which is closely related and has often been the ground for disputes is the termination clause of the software development agreement, between franchisor and the developer. The franchisor should carefully review these provisions with a creative eye toward possible disputes. Although there is not a clear solution to many of these problems, the following suggestions may at least help with the analysis:
1.Craft appropriate provisions dealing with the probable reality that there may be a dispute over whether breach has occurred. For example, the developer says that it would have met the deadline but for the franchisor’s failure to provide necessary data on time.
2.Consider drafting provisions that don’t focus on termination of the entire agreement but rather focus on whether certain obligations, deadlines or intermediate goals have been met. Specific incentives or penalties may be appropriate for these clauses.
3.Evaluate whether termination clauses are appropriate which are not conditioned on breach. For example, the franchisor could buy out the contract at certain stages based upon a price formula.
4.Review surviving clauses carefully. If the deal falls apart, for example, the franchisor should be free to hire others to develop the same concept. In addition, the developer should not be able to divulge the underlying intellectual property.
5.The franchisor should acquire the source and object code and an assignment and license, as discussed above, for the completed portion of the program. That license and assignment should be signed in advance and included as an exhibit to the original development agreement. This agreement should also require the developer to periodically provide developing source and object code as the project continues.
BANKRUPTCY
Although it is worth considering whether the type of irrevocable licenses which are provided to a franchisor, to cover the intellectual properties that the developer can not assign, could be considered executory contracts and hence rejected by the trustee in bankruptcy, the primary issue in regard to bankruptcy is the concern of the franchisee that if the franchisor enters bankruptcy, that the franchisee may not be able to continue to use the software and that software updates and service from the franchisor may cease. There are two areas that should be considered in this context; the bankruptcy code itself and escrow arrangements for source code.
11 U.S.C. SECTION 365(n)
This section of the bankruptcy code provides some protection for franchisees regarding continued use of the software if the franchisor enters bankruptcy. In the case of Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. (In re Richmond Medal Finishers, Inc.), 765 F.2d. 1043 (4th Cir. 1985) cert. denied 106 S.Ct. 1285 (1986), the court denied the continued use by an intellectual property licensee by rejecting the executory contract, the license. This rejection worked quite a hardship on the licensee and Congress amended the bankruptcy code to prohibit such hardships in the future.
Section 365(n) works in the following manner:
1.The licensor is the debtor.
2.The trustee (debtor or a third party) rejects the license agreement as an executory contract.
3.The licensee may elect to retain its rights to the property licensed under the license agreement, as those rights existed immediately before the bankruptcy case commenced.
4.This includes, if provided by the license, any supplementary agreements such as the right to exclusive use of the property (which would usually not be the case in franchising).
5.This does not include any rights to compel specific performance of any other provision of the agreement.
6.This right will last for the term of the agreement plus any extension.
7.If the licensee elects this option then it:
a.Must make all royalty payments due under the contract for the term of the contract.
b.Is deemed to have waived:
i.Any right to setoff, and
ii.Any right to seek a payment of an administrative claim.
8.The licensee must elect this option in writing and the trustee will provide the licensee with the property (and any embodiment such as source code) held by the trustee to the extent provided for by the agreement, and the trustee will not interfere with the acquisition of the property and embodiment from a third party such as an escrow agent.
This does not assist with a trademark license since intellectual property is defined as trade secrets, patents, patent applications, plant varieties, copyrights and mask works.[9]
This was further construed in a manner that has some effect upon the structure of software licenses in the case of In re Prize Frize 1994 U.S. App. LEXIS 21337 (9th Cir. Aug. 7 1994, Civ. No. 93-55422). In this case the court interpreted the payments that the licensee needed to make under a Section 365(n) election.
Prize Frize had a french fry vending machine technology for which it gave an exclusive license to use, manufacture and market the machine to EBM. EBM was to pay royalties based upon a percentage of sales. EBM also agreed to pay a $1,250,000 license fee payable $300,000 in cash and $50,000 per month. Prize Frize declared bankruptcy before any installments were paid. Under Section 365(n) of the Bankruptcy Code, EBM was required to meet royalty obligations. EBM sought to pay only the royalty and not the license fees. The court held that the license fee was royalty for purposes of Section 365(n) in this case, because both payments, despite the different labels, were for the use of the intellectual property.
Following Prize Frize therefore, it is most desirable from the franchisor/licensor’s perspective to structure a license which has one payment for everything; service, updates and the use of the intellectual property. From the franchisee’s perspective, if the franchisor enters bankruptcy, it is better to divide the payments into sub-categories; so much for royalty, and separate payments for training, service and updates.
This case has ramifications for franchisors who desire to allocate all of the payments into the royalty for the franchise agreement and to therefore provide the software license with out a specifically allocated royalty. It is possible that if that franchisor entered bankruptcy, that the system franchisees could use the license royalty free. This might prohibit the rejection of the license and thus require that the franchisor provide service and the other obligations of the license.
ESCROW
Given the potentially disastrous impact on the franchisees’ businesse if the franchisor enters bankruptcy, or for some other reason defaults on its obligations to provide software support or updates, many astute franchisees may feel that Section 365(n) is thin protection. First, Section 365(n) only applies if the franchisor enters bankruptcy and, secondly, even in that circumstance, a lengthy delay may ensue prior to acquiring the source code pursuant to this code section. The franchisee’s business may be destroyed in this interim. Consequently, such franchisees may commonly require that the franchisor provide an escrow for the source code, modifications and updates in order to protect their service and update needs.
Such escrow arrangements do not necessarily defeat the franchisor’s ownership or the confidentiality protections of the intellectual properties of the program. An example of an escrow agreement is set forth as Exhibit C.
DISPUTE RESOLUTION
Although license agreements that are part of franchise offerings may be subject to the same restrictions on governing law, jurisdiction and venue as franchise agreements, the franchisor may select a number of different dispute resolution techniques in the license. In addition, since default of the license should also be a default under the franchise agreement it may be tempting to allow the franchise agreement to govern all dispute resolution. It should be considered, however, that certain situations may arise where it would be advantageous to have independent dispute resolution treatment in the license itself. Certainly, to leave the license silent is to encourage a race to the courthouse.
Although the franchisor should carve out, as a remedy, a court ordered injunction, as discussed above, for protection of the copyrights and trade secrets, such issues as the sufficiency of training, service, updates and modifications could benefit from mandatory mediation prior to litigation or arbitration.
Many of the same issues and preferences regarding arbitration exist within the license context as they do with regard to franchise agreements. The possible reduction of time and expense in arbitration may be offset by the lack of appeal. The privacy of arbitration may be outweighed by a desired precedent.
Careful drafting of arbitration clauses can offset many of the perceived negatives. In this context the selection of an arbitrator with, for example, at least five years of experience as a computer lawyer may be invaluable.
Certainly with a subject matter so sensitive to confidentiality concerns, both mediation and arbitration are appropriate techniques for consideration. Creative drafting can fashion a dispute resolution section which should be appropriate for the franchisor’s particular circumstances. The ABA Model Software License contains an option for arbitration. This particular arbitration addendum to the agreement is 11 pages long. It contains the possibility of appeal from the award that is set forth below:
An appealing party who has complied with the motion and notice provisions above may appeal the Award by filing an action for affirmative or declaratory relief concerning the subject matter of the arbitration, but not for other relief, exclusively in a court having general trial jurisdiction that includes the matter in controversy. If such a court exists within the venue specified by the nonappealing party pursuant to the previous paragraph, the action shall be filed in that venue. Such an action shall be filed no later than ten (10) business days after the date of the denial of the appealing party’s motion for reconsideration.
SOFTWARE LICENSE CHECKLIST
The franchisor will need to view this checklist differently, depending on whether it is granting or receiving a license. Many of these same considerations should also be addressed in the assignment of software to the franchisor.
1.WHAT is being licensed
a.Object code only?
b.New releases? Upgrades?
c.What documentation? Is it included in the definition of software or defined separately.
d.Expressly retain all rights not granted.
2.WHO is receiving the license
a.What legal entity?
b.Including parents, subsidiaries, affiliates?
c.Who can use the program
i.Full time employees with a need to know?
ii.Part time or contract employees?
iii.Agents, representatives or consultants of licensee? Are they required to sign confidentiality agreements?
3.WHERE may the license be used
a.On a single processing unit at a specified location?
b.On a specified type of hardware?
c.On a local area network (LAN)? How many users at once?
d.On several CPUs at a single location?
e.Anywhere within the corporation or other entity within a territory?
4.WHAT the licensee may and may not do
a.Use, execute and display the software
i.Only in licensee’s internal operation to process internal data or work of the licensee?
ii.To provide services for third parties?
b.Copy the software (one back up copy)?
c.Modify? Who will own?
d.Create derivative works? Grant sublicenses?
e.May not disclose program?
f.May not reverse engineer or decompile?
g.May not transfer, assign, sell, lease, sublicense or rent the program?
5.WHEN
a.Fixed Term?
b.Same duration as franchise agreement?
c.Define delivery, installation and acceptance terms.
6.OTHER RIGHTS OF LICENSEE
a.Warrantees by the licensor
i.Title and/or right to grant the license?
ii.Media not defective:
iii.Substantial conformance with functional specifications? Design Specs? Documentation? For what period?
iv.Limit the remedy for breach of the performance warranty? Sole remedy shall be . . . .
v.Exclusions This warranty shall not apply if the licensee has modified the program; the licensor does not warrant that the results from the use of the software . . . . or that it will operate error free.
vi.Disclaimer of implied warranties, such as title, merchantability, and fitness for a particular purpose (in bold caps)
7.PROPRIETARY RIGHTS INDEMNIFICATION BY LICENSOR
a.Scope? (Patents, copyrights, trade secrets?)
b.Licensor will defend against . . . .?
c.If the licensee is enjoined, the licensor will:
i.Acquire the rights necessary to enable licensee to continue?
ii.Modify the software to make it perform the same function, yet be non-infringing?
iii.Refund license fee (or a portion), accept return of program and materials and terminate license?
iv.Any conditions to the indemnification?
(1)Licensee must give written notice of claim within 10 days after receipt?
(2)Licensor must control the defense?
v.The indemnity should be the sole and exclusive remedy of the licensee if an infringement arises.
8.Support
a.Remote/On-Site
b.Hours
c.Warranty?
9.Training
10.Anti-virus protection?
11.Escrow
12.RIGHTS OF LICENSOR
a.Indemnification of Licensor by Licensee (damage to third parties, creditors)
b.Limitation of liability of the licensor to the licensee
i.Exclude liability for indirect, consequential, special or punitive damages
ii.Cap on actual, direct damages. If so, is it so small to be unconscionable or to fail of its essential purpose?
c.Specific termination rights
i.Termination by the licensor for the default by the licensee. Provide for cross default with franchise agreement.
ii.Termination by the licensee?
iii.What happens after termination?
(1)Return the software or destroy and certify
(2)Self-help?
(3)Inspection rights
13.INTERNATIONAL - In most situations the franchisor should prohibit international transport or use. Separate arrangements should be made for international situations.
14.PAYMENT TO LICENSOR
a.No royalty. Part of franchise concept and therefore paid for by franchise royalty?
b.One time or periodic payments
c.Separate payments for service and updates
d.Method of payment
e.Tax allocation
15.MISCELLANEOUS PROVISIONS
a.Mutual confidentiality
b.Assignment and transfer
c.Notices
d.Force majeure
e.Counterparts
f.Headings
g.Relationship
h.Consents, approvals and requests
i.Severability
j.Waive
k.Publicity
l.Entire agreement
m.Amendments
n.Governing law
o.Survival of terms
p.Third party beneficiaries
q.Hiring of employees
r.Non-competition
s.Further assurances
SHRINKWRAP LICENSES
A shrinkwrap license is a software license agreement which is usually placed on the box containing software disks and manuals. Since this license is visible through the clear plastic shrinkwrap around the box and since opening the shrinkwrap is considered to be acceptance of the terms of the license by the purchaser, it is called a shrinkwrap license. Shrinkwrap licenses are widely used in the mass market segment of software. To the extent that such transactions may not have a choice regarding the availability of signed license agreements, shrinkwrap may be the best practical solution for mass marketers. Franchisors have a much better opportunity to acquire a signed license agreement, however, and it is difficult to imagine many circumstances in which a franchisor would not want to acquire a signed license. Item 9 of the UFOC, Franchisee’s Obligations, requires the franchisor to Disclose the principal obligations of the franchisee under the franchise and other agreements after the signing of these agreements. (Emphasis added.) It could be argued that a shrinkwrap license lessens disclosure obligations because it is not signed.
Shrinkwrap licenses have received varying treatment by the courts and by commentators.[10] The majority opinion is still that shrinkwrap licenses are of doubtful protection in regard to trade secret aspects such as prohibitions against reverse engineering and contractual issues such as limitations on damages, etc.
In Step-Saver Data Systems, Inc. v. Wyse Technology 939 F.2d 91 (3rd Cir.1991) the plaintiff purchased software over the phone and then sent a confirming written order. Defendant seller supplied an invoice. No mention was made of the shrinkwrap license at the time the invoice was sent. The Appellate Court held that under the UCC a contract had been completed before the goods, and the shrinkwrap license on the goods, were received by the plaintiff. The terms of the shrinkwrap were held to be additional material terms which were not accepted by the plaintiff.
Similarly in Arizona Retail Systems, Inc. v. Software Link, Inc. 831 F.Supp. 759 (D. Ariz. 1993), the court held that the seller and buyer already entered into an agreement for sale of the software at the time of shipment before the buyer opened the package. The opening purported to trigger the license agreement terms. The sellers argument that it had conditionally accepted the buyer’s offer contingent on acceptance of the license terms was not accepted by the court.
An interesting case which bears upon the shrinkwrap question is ProCD v. Zeidenberg, 908 F.Supp 640 (W.D. Wis. 1996). Once again the court found that the software was a good and applied the UCC. The court also denied the terms of the shrinkwrap because in this case the license was inside the package and therefore not visible to the purchaser. For this reason ProCD has often been cited as supporting visible shrinkwrap licenses. (This case is also interesting because of the analysis of federal copyright preemption of other claims.)
From the standpoint of bolstering legal protection for software, signed licenses are still the most optimal choice. It is possible that the upcoming amendments to Article 2 of the UCC may improve the status of shrinkwrap, however, this would not be of any benefit if the software was held to be an expert service instead of a good. Signed licenses appear to be the safest course.
CONCLUSION
It is important for the franchisor to carefully review the assignment/license that it acquires from the software developer. This agreement has significant impact on what the franchisor acquires, the allocation of risk and the type of UFOC disclosures to be made.
The license agreement should address limitation of warranties, liabilities, termination, royalty payments, modifications, prohibitions against reverse engineering, scope of use and dispute resolution as discussed above. In addition, the franchisor may wish to provide a software escrow agreement.
Franchise system software is an expensive asset of the franchisor and therefore one which should be adequately protected. Franchisors should carefully analyze the legal realities of the acquisition of the software in the first instance and should insure that their licenses to franchisees reflect the type of precautions, both in terms of the value of the software as well as the potential liabilities which may arise from its use or malfunction, that are appropriate.
EXHIBIT A
Suggested Contract Language Regarding the Developer’s Tool Box
1 Company shall be the owner of the ABC Software Program (Program) including all codes, tools, logic, techniques, formats, designs, concepts, methods, processes, ideas, scenes, characters, content and ideas incorporated in the Program or developed by Developer in connection with the design and development of the Program, whether or not patentable or reduced to practice, and Developer hereby assigns, transfers and conveys to Company all right, title and interest in and to the foregoing items, along with all Proprietary Rights associated with any or all of the same.
2 Notwithstanding the foregoing section, Company shall not be the owner of, and Developer shall not assign: any standard routines, development tools (including compilers and interpreters and the proprietary products of their run time libraries), programming techniques, interfaces, tests, maps, animation, 3-D modeling, sound recording, video, photographs or other artwork that existed prior to the date of this agreement or that are used or developed by Developer in the creation of the Program and that are non-specific or non-identifiable (or can be made non-specific or non-identifiable) to the Program. Hereinafter collectively referred to as the Developer’s Standard Materials.
3 Developer hereby grants Company a nonexclusive, perpetual, royalty-free, transferrable worldwide right and license (including the right to sublicense)to use, reproduce, distribute, perform and display (publicly or otherwise), prepare derivative works of, make, sell, disclose and otherwise use and exploit any of Developer’s Standard Materials incorporated in the Program whether alone or as part of the Program.
EXHIBIT B
Suggested contract language for limitation of warranties, liability and remedies.
1. Limited Warranty and Disclaimer of Liability
a. Results Not Warranted. Licensor has no control over the conditions under which Licensee and Authorized Users use the Licensed Product and updates and does not and cannot warrant the results obtained by such use.
b. Limited Warranty. In addition to warranting that it has the right to grant the license contained in this Agreement, Licensor warrants that the magnetic media on which the Licensed Product or an update is recorded and any user manual leased under the terms of this Agreement are free from defects in material and workmanship under normal use. Licensor further warrants that the Licensed Product and any update of the Licensed Product will perform substantially in accordance with the specifications found in the user manual in effect as of the date of this Agreement. The warranties contained in this Section are made for a period of ninety (90) days from the date on which the Licensed Product or update is delivered to Licensee or from the date on which a user manual is leased by Licensee.
c. Limitations on Warranty. Licensor does not warrant that the functions contained in the Licensed Product or in any update will meet the requirements of Licensee or Authorized Users or that the operation of the Licensed Product or update will be uninterrupted or error free. The warranty does not cover any copy of the Licensed Product or update or any user manual which has been altered or changed in any way by Licensee or any Authorized User. Licensor is not responsible for problems caused by changes in or modifications to the operating characteristics of any computer hardware or operating system for which the Licensed Product or an update is procured, nor is Licensor responsible for problems which occur as a result of the use of the Licensed Product in conjunction with software or with hardware which is incompatible with the operating system for which the Licensed Product is being procured.
d. Exclusion of Implied Warranties. ANY IMPLIED WARRANTIES, INCLUDING WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE, ARE EXPRESSLY EXCLUDED.
e. Exclusion of Any Other Warranties. The warranties contained in Subsection b of this Section are made in lieu of all other express warranties, whether oral or written. Only an authorized officer of Licensor may make modifications to this warranty or additional warranties binding on Licensor, and such modifications or additional warranties must be in writing. Accordingly, additional statements such as those made in advertising or presentations, whether oral or written, do not constitute warranties by Licensor and should not be relied upon as such.
2. Limitation of Remedies
a. Replacement Sole Remedy. Subject to Section 22 of this Agreement, Licensor’s entire liability and Licensee’s exclusive remedy shall be the replacement by Licensor of any magnetic media or user manual not meeting Licensor’s “Limited Warranty.” In addition, while in no sense warranting that the operation of the Licensed Product will be uninterrupted or error free, Licensor will, as provided in Section 7 of this Agreement, assist the Licensee in the installation and maintenance of the Licensed Product and will supply the Key Person with corrected versions of the Licensed Product through updates.
b. Damages Limitation. LICENSOR DISCLAIMS ANY AND ALL LIABILITY FOR SPECIAL, INCIDENTAL, OR CONSEQUENTIAL DAMAGES (INCLUDING LOSS OF PROFIT) ARISING OUT OF THIS AGREEMENT OR WITH RESPECT TO THE INSTALLATION, USE, OPERATION, OR SUPPORT OF THE LICENSED PRODUCT OR ANY UPDATE OF THE LICENSED PRODUCT EVEN IF LICENSOR HAS BEEN APPRISED OF THE POSSIBILITY OF SUCH DAMAGES.
c. Limitation of Any Recovery. Subject to Section X of this Agreement regarding the Licensor’s indemnification regarding its ownership of the Licensed Product, Licensee specifically agrees that any liability on the part of Licensor arising from breach of warranty, breach of contract, negligence, strict liability in tort, or any other legal theory shall not exceed amounts paid by Licensee in fees for the use and maintenance of the Licensed Product.
EXHIBIT C
SOFTWARE ESCROW AGREEMENT
This Software Escrow Agreement (”Escrow Agreement”) is entered into and effective as of this ______ day of ________________, 199___, by and among _________________________, the owner of certain Software (”Owner”), _________________________ (”Escrow Agent”), and _________________________, a licensee of the aforementioned Software (”Licensee”), with reference to the following facts:
A. Licensee has entered into a Software License Agreement, a copy of which is attached hereto as Exhibit A and the terms of which are made a part hereof, whereby Licensee has the right to use Owner’s computer programs identified therein (”Software”).
B. Licensee has entered into a Software Maintenance Agreement, a copy of which is attached hereto as Exhibit B and the terms of which are made a part hereof, whereby Owner will support Licensee in the use of Owner’s Software(hereinafter “Software Maintenance”).
C. The uninterrupted availability of the Software is critical to Licensee in the conduct of its business.
D. As a consequence of the foregoing, Owner has agreed to enter into this Escrow Agreement to provide for the availability of the source code, as well as any corrections, changes, modifications and enhancements to such source code, in accordance with the terms and conditions hereinafter set forth.
NOW, THEREFORE, based upon the premises and respective promises and obligations contained herein, the parties agree as follows:
1. Deposits in Escrow
Upon signing this Escrow Agreement and every six (6) months thereafter, Owner shall deposit with Escrow Agent the source code for the Software, including all relevant commentary, explanations and other documentation, as well as instructions to compile the source code, plus all revisions to the Software source code encompassing all corrections, changes, modifications and enhancements made to the Software by Owner (the “Escrow Material”). Within seven (7) days after such deposit with Escrow Agent, both Owner and Escrow Agent shall give written notice of receipt to Licensee. The Escrow Agent is empowered to return to Owner, seven (7) days after the issuance of the written notice of receipt, all previous versions of the Escrow Material. The cost of preparation of the escrow material shall be borne by Licensee, such cost not to exceed $_________ per deposit.
2. Term
This Escrow Agreement shall remain in effect during the term of the Software License Agreement attached as Exhibit A. The Escrow Agreement, however, shall terminate automatically upon delivery of the Escrow Material to Licensee in accordance with the provisions herein.
3. Access to Escrow Material
Licensee may obtain the Escrow Material upon either of the following conditions:
(i) Owner is deemed to be in default, as defined herein; or
(ii) Licensee pays $_________ to Owner.
4. Default by Owner
A default by Owner shall be deemed to have occurred under this Escrow Agreement upon the occurrence of any of the following:
(i) if Owner has availed itself of, or been subjected to by any third party, a proceeding in bankruptcy in which Owner is the named debtor; an assignment by Owner for the benefit of its creditors; the appointment of a receiver for Owner; or any other proceeding involving insolvency or the protection of or from creditors, and same has not been discharged or terminated without any prejudice to Licensee’s rights or interests under the Software License Agreement within thirty (30) days; or
(ii) if Owner has ceased its on-going business operations, or the sale, licensing, maintenance or other support of the Software; or
(iii) if any other event or circumstance occurs which demonstrates with reasonable certainty the inability or unwillingness of Owner to fulfill its obligations to Licensee under the Software License Agreement, this Escrow Agreement, or the Software Maintenance Agreement between Owner and Licensee, including, without limitation, the correction of defects in the Software.
Licensee shall give written notice by certified mail to Escrow Agent and Owner of the occurrence of a default hereunder. Unless within fifteen (15) days thereafter Owner files with Escrow Agent its affidavit executed by a responsible executive officer clearly refuting each area of claimed default or showing that the default has been cured, then Escrow Agent shall upon the sixteenth (16th) day deliver to Licensee the Escrow Material and all revisions and additions thereto.
5. Obligations of Escrow Agent
a. Storage. The Escrow Material shall be placed and maintained in a vault located at _________________________.
b. Control. Control over access to the Escrow Material shall rest with Escrow Agent.
c. Delivery. Escrow Agent shall make delivery of the Escrow Material to the appropriate party or individual in accordance with the provisions of this Escrow Agreement.
d. Disclosure. Except as provided in this Escrow Agreement, Escrow Agent agrees that it shall not disclose or otherwise make available to any third party, or make any use of, the Escrow Materials without Owner’s prior written consent.
6. Ownership of Escrow Material
In all events, Owner or its successors or assigns, shall remain the owner of the Escrow Material. Licensee’s right to and interest in the Escrow Material shall be as a licensee only.
7. Confidentiality
Licensee shall at all times maintain the confidentiality of the Escrow Material and shall be liable for any breach of confidentiality for which Licensee is responsible. In no event shall Licensee be liable for incidental or consequential damages, including lost profits.
8. Compensation of Escrow Agent
a. Initial Fee. Upon execution of this Escrow Agreement, Licensee shall make payment to Escrow Agent of reasonable compensation for the escrow service in accordance with Escrow Agent’s published fee schedule then in effect. The current fee is $_________ per year minimum, and is due and payable at the initial set-up of the Escrow Agreement and escrow service for the first year.
b. Annual Fee. Thereafter, an annual fee at the then-published rate shall be payable by Licensee on the anniversary date of each succeeding year for which Licensee seeks to extend this Escrow Agreement. In the event of non-payment of Escrow Agent’s fees by Licensee, Escrow Agent shall give both parties sixty (60) days notice thereof. If the sixty (60) day notice period elapses without Escrow Agent having received payment from either party, Escrow Agent shall then have the option, without further notice to either party, to terminate this Escrow Agreement and to return to Owner all Escrow Material.
9. Indemnification of Escrow Agent
Escrow Agent shall not, by reason of its execution of this Agreement, assume any responsibility or liability for any transactions between Owner and Licensee other than for the performance of Escrow Agent’s obligations with respect to the Escrow Material held by it in accordance with this Agreement. The party on whose behalf, or pursuant to whose directions the Escrow Agent acts, shall indemnify and hold harmless Escrow Agent from any and all liability, damages, costs, or expenses including reasonable attorneys’ fees, which may be sustained or incurred by Escrow Agent as a result of the taking of such action.
10. Testing
Upon written notice to Owner and Escrow Agent, Licensee may conduct tests of the Escrow Material, under Owner’s supervision and at a location other than Licensee’s facilities, to confirm the conditions of the Escrow Material. Any direct costs associated with the testing of the Escrow Material, including expenses incurred by Owner, shall be borne by Licensee.
11. Resolution of Dispute
Should Owner and Licensee disagree on whether a default has occurred, the disagreement shall be decided immediately by arbitration in _______________ in accordance with the rules of the American Arbitration Association. The award of the arbitrator shall be binding and may be entered as a judgment in any court of competent jurisdiction.
12. Notices
All notices required by this Escrow Agreement shall be sufficiently given by mailing the same by certified or registered mail, return receipt requested, to the parties at their respective addresses, as follows:
Owner:
Licensee:
Escrow Agent:
13. Succession
The rights and obligations hereunder shall inure to the benefit of and become the responsibility of the heirs, successors, and/or assigns of the parties hereto. However it is understood and agreed that licensee may not assign or in any other manner transfer this agreement.
14. Entire Agreement
This Escrow Agreement and the documents marked as Exhibit A and Exhibit B hereto constitute the entire understanding of the parties. This Escrow Agreement may be amended or altered only by an instrument in writing signed by all parties hereto.
AGREED:
OWNER:
____________________________
Signature
____________________________
Name
____________________________
Title
____________________________
Address
____________________________
____________________________
Date
LICENSEE:
____________________________
Signature
____________________________
Name
____________________________
Title
____________________________
Address
____________________________
____________________________
Date
ESCROW AGENT:
____________________________
Signature
____________________________
Name
____________________________
Title
____________________________
Address
____________________________
____________________________
Date
Van Elmore has been licensed to practice law in the state of Colorado since 1977. His 30 plus years of Professional experience have been at both the executive level of corporate management and in private practice.
