Recent Lawsuit Illustrates Need For Legal Review of IT Contracts

January 8, 2008

A lawsuit filed in federal court in Tennessee late last year illustrates several lessons for managing the legal aspects of corporate information technology, particularly for any company contemplating an IT outsourcing. According to published reports and a copy of Nissan’s allegations in the lawsuit available online, automaker Nissan sued Software AG, a leading German software vendor, asking the court to rule that Nissan did not owe Software AG millions of dollars in additional license and maintenance fees as a result of Nissan’s outsourcing of certain IT services to Indian provider Satyam Computer Services, and additional millions as a result of the use of Software AG’s product by Nissan Canada and by Nissan dealers.

According to the lawsuit, Nissan licensed database software from Software AG in 1983. In 1999, the two companies entered into an amendment of their license agreement to permit Nissan to engage IBM as a “Designated Outsource Vendor.” In 2005 and 2006, Nissan brought some of the functions outsourced to IBM back in-house and subsequently engaged Satyam to assist in maintaining some applications. In conjunction with the Satyam engagement, Nissan sent a form letter to Software AG advising it of the engagement and seeking a consent, “if required.” According to Nissan’s lawsuit, Software AG responded, indicating that additional fees would be required to permit the transaction. The lawsuit also describes subsequent unsuccessful negotiations between the parties and further assertions by Software AG of unlicensed use of the software in question.

Nissan asserts that the additional fees sought by Software AG were over $10 million.

From papers filed with the court, this litigation appears to be concluding at an early stage, without Software AG’s side of the story having been made publicly available. Had the case proceeded to trial, the result would have depended on the specifics of the various agreements between the parties, the text of the amendment permitting the outsourcing to IBM and the exact nature of the use of the software by Satyam and Nissan’s affiliates. Nonetheless, the claim of a $10 million price tag to continue the use of software that has been licensed since 1983 should catch the attention of IT executives and the lawyers who support them.

Here are three best practices for the management of IT contracts suggested by this case:

1. Cover the enterprise. Software licenses should cover affiliate corporations as well as third party service providers that support the corporation.

Regarding affiliates, it is not unusual for a modern corporate enterprise to be made up of a multitude of different legal entities, with a range of different legal relationships to the particular corporate entity that may have signed the vendor license agreement. The signing entity may have multiple parent and subsidiary entities, there may be different business units in different legal entities, and other legal entities may be created for a wide variety of tax, accounting and financial planning reasons. Meanwhile the typical software license, at least as a starting point, recognizes only one legal entity – the party whose officer signed it. In an audit or a dispute with a software vendor, these legal distinctions may be the just the trigger for an unexpected large bill for unlicensed use of the software.

The enterprise is also likely to be made up of a variety of third party service providers who are not “the licensee” under the software license agreement, but who nonetheless use or access the licensed software. These include everything from non-employee “staff augmentation” contractors to consultants and outsource providers. Outsource providers today are not just the big ticket providers of corporate infrastructure, but also application developers, system testers and content converters, as well as providers of non-IT business process services, such as HR, tax or accounting outsourcers, where those parties are utilizing IT resources of the corporation.

The best time to encompass all these components of the enterprise under a software license agreement is at the time the agreement is initially negotiated. Counsel should seek to include broad definitions of “Affiliates” and “Service Providers” in the license, and then include appropriate language in the license grant clause incorporating these definitions. For example:

“Affiliate” of an entity means any entity which, directly or indirectly, controls, is controlled by or is under common control with such entity.

“Service Provider” means a direct or indirect third party performing services on behalf of Licensee or its Affiliates on an outsourcing, hosting, consulting or similar basis.

Licensor hereby grants to Licensee, its current and future Affiliates and Service Providers . . .

2. Cover the unexpected. Of course no license, no matter how broadly drafted, can be expected to cover every possible contingency for unanticipated future uses of the licensed software or for changes in the corporate structure. And it is not always possible or economical to negotiate terms as broad and flexible as those described above. One strategy that some companies use to address the possibility of a bill from the software vendor for future uses of licensed software is to pre-negotiate at least some aspects of the size and metrics of the license fee for any additional uses of the software. This could take a wide range of forms, including any one or more of the following:

  • A commitment on particular fees for additional uses;
  • A specific commitment to no fees for particular outsourcing scenarios;
  • A commitment to a particular discount level for additional uses;
  • A “most favored nation” commitment regarding treatment of the licensee as compared to other customers of the software vendor; or
  • A commitment to negotiate additional fees “in good faith.”

3. Revisit license terms. Finally, while software license agreements are static, and tend to sit in files untended to, the life of software in a corporate enterprise is anything but static. Business needs change, uses of software change, functions are outsourced, re-integrated and outsourced again. At the same time, the myriad of “affiliate” and “service provider” relationships that may require access to systems are ever changing. Simply assuming that the corporation has the legal right to redeploy a component of third party software as time goes on – just because it is in house and in use with maintenance fees paid – can be a costly mistake. Regular review of software agreements and legal participation in the changing needs of the IT group, particularly in association with any transaction involving redeployment or outsourcing of enterprise software, should be part of the ongoing activities of legal counsel to the corporate IT department.

Best practices for corporate IT contracting is one of the areas supported by the McGuireWoods Technology Transactions Practice Group. This practice group is part of the firm’s integrated Technology & Business Department, which provides legal services for business transactions driven by technology. These service areas are led by Department Co-Chair Steve Gold. For further information about this or any related topics, please contact us.