The Licence Agreement

The primary aims of a licence agreement are:

1. To define the terms on which the licensor, as the owner of the intellectual property rights in the software, permits its use;

2. To safeguard the licensor against any liabilities which the licensor might lay themselves open to the licensee; and

3. To incorporate any other relevant terms within the legal structure of the relationship, i.e payment of fees, termination provisions, confidentiality and so on.

One of the fundamental principles of the law of contract is that all the terms of the relationship must be brought to the attention of both parties at or before the time the contract is made. So, the licence agreement is usually made when the licensor accepts the order and despatches the software. Thus there is a direct contractual relationship between the licensor and the licensee, on terms clearly established at the time the contract is made.

However, there may be occasions when this is not practicable, either because the licensor is distributing their software through re-sellers (where the contract for sale is between the re-seller and the licensee, and the licensor is not a party to that contract), or by sales by telephone (where the contract is formed when the licensee calls and gives their credit card details and the licensor accepts the order by despatching the software) – whatever the case, the licensee does not get to see the licence agreement until they receive the package, which is after the contract has been formed, and so the terms of the licence agreement may not be binding.

Shrinkwrap Licence

In an attempt to fill this void, the computer industry has developed what’s called the 'Shrinkwrap' licence, where the licensee on opening the package finds a sealed envelope containing the disks, and printing on the envelope stating 'Do not open this envelope unless you agree to be bound by the terms of this Licence Agreement'.

On the face of it, this is not enough to overcome the principle discussed above, because by the time the licensor opens the packaging and finds the licence with a notice on the sealed disk envelope stating that they should not open the envelope unless they are willing to agree to the terms of the licence, the contract has already been formed and the terms of the licence were not made known to them at the time the contract was made. In order to be confident that a 'Shrinkwrap' licence will be effective (from a licensor’s perspective), the following steps should be taken:

1. The particular terms of the licence need to be drafted to take into account such factors as the particular product, client, marketplace, marketing strategy and typical user - in other words, to suit the licensee’s particular needs.

2. The licensee must be made aware - at or before the time of the contract - of the fact that what is offered for sale is the right to use the product on the specific terms of the licence agreement.

3. If the licensee does not have a genuine opportunity to see the terms of the licence agreement at or before the time of the contract, they need to be told that what they are buying is the right to use the software on those terms, and that if they are able to read the licence agreement they do not accept its terms, the licensee may return the software for a full no questions asked refund. Thus the initial sale contract becomes a contract where what the licensee buys is the opportunity to have the software on the terms of the licensors licence agreement, or a refund if he does not accept the terms. Various precautions need to be taken and followed scrupulously in marketing materials, in packaging, and in direct sales procedures.

4. The software disks must be effectively sealed inside, i.e. an envelope clearly marked with a notice that the licensee cannot help but see and read before they break the seal. The notice must draw attention to the terms of the licence agreement, and state that by the act of opening the envelope, the licensee accepts the terms of the licence agreement. The licence agreement itself should be either printed on the envelope, or on a separate sheet inside the packaging but outside the envelope. Again, adequate control measures need to be taken so that the licensor can prove this in every case.

Sales Not Licenses

Many shrinkwrap transactions are sales not licenses. More software transactions are intended to be sales. The basic legal concept is that any purported license agreement which is introduced after the sale has been consummated is not enforceable. No major mass-market software vendor appears to have a shrinkwrap license visible on the outside of its packaging. Some have a 1 or 2 line license notice on the outside of the package while others have nothing visible on the outside but do have a license inside the box. Due to the multiple ways that such software can be ordered (retail store, catalogue, telemarketing, preinstalled, etc.), there is a high likelihood that a court would treat many of these transactions as sales rather than ``licenses.'' Video game companies pioneered the sale of units of their software products. Many lower-priced application software packages are also distributed without any attempt to implement a license agreement. The consequence of the transaction being a sale is that the scope of use and other customer restrictions in shrinkwrap licenses are not enforceable, and attempts to limit warranties and liabilities are probably not effective.

Network Licensing

The proliferation of networks is causing licensing practices to evolve even faster to accommodate both users' and vendors' needs. Current primary network licenses are concurrent use, site, enterprise, and node. Concurrent use licenses authorise a specified number of users to access and execute licensed software at any time. Site licenses authorise use at a single site but are losing favour to enterprise licenses that cover all sites within a corporation because of more virtual computing environments. Node licenses are becoming less appropriate in the client/server environment, since the licensed software may be used only on a specified workstation which a user must log on to in order to access and execute the application.

Use measurement software (``license manager'') is allowing vendors to be more flexible in licensing arrangements. This management software monitors and restricts the number of users or clients who may access and execute the application software at any one time. This is important so a user pays only for needed use and a vendor can monitor such use to protect intellectual property.
License manager software can generate reports covering such items as the number of users waiting to use an application at a given time, the number of users accessing an application at a given time, the client they are accessing them from, and the cost of software in use at a given time. These reports can help identify changes needed in software procurement approaches. Asset-management software, which helps track the inventory of software used in a business, has also become an important tool. The software inventory identified in an audit can be reconciled with purchasing records and illegal copies removed.

Other innovative, use-related approaches have also been welcomed by users, such as currency-based licenses. Currency-based licensing provides a user with a specified monetary amount of software licenses, i.e., licenses for different business application software, so long as the total value in use at a given time is less than pounds.
Users would also like platform-independent licensing under which one license permits software to be used on a variety of different computer systems within a business, instead of buying a different license for each version of the same software used by different systems.

Distributed-Processing Licensing

Licensing for client/server and distributed processing environments must become even more flexible. Distributed processing may ultimately create a seamless virtual global computing environment in which new licensing approaches will be needed. More flexible licensing schemes that are easier to administer will be needed for the growing client/server and distributed processing environments. Keeping track of which software is licensed for use by ``x'' number of users can be a full time job. The shift to client/server computing is the most significant trend in the software industry today. This shift will ultimately move toward enterprise wide, peer-to-peer, distributed processing environments. Eventually, any platform may be able to function as a client or server.

Microsoft recently announced a new pricing policy for Back Office, a suite of integrated network, e-mail and database applications, in which servers and clients are licensed independently. Customers obtain a single server license for each server and a single license for each client. Most current licensing practices assume that a client needs access to only one server and, therefore, client and server pricing is bundled together. This requires a user to pay extra when a client may access more than one server. The new pricing model is intended to reflect the move to more distributed computing environments by separating client access from the server so a user pays only for additions, either more clients or more servers. In addition, the availability of such a suite provides the benefit of buying an integrated set of applications from a single vendor.

At present, vendors try to be very specific about the number of users per server because that is the price measurement mechanism generally available today. Users are seeking actual usage pricing within a distributed network rather than hardware-dependent pricing schemes. Many users want pricing to be on the basis of a software product's overall business value, i.e., actual usage levels, not the number of servers, concurrent users or size of the CPU on which it runs.

Other than, perhaps the act of access and time of use, there is no standard definition of "usage'' nor the means to measure such usage on a real-time basis in a network environment. There also are no pricing models. For example, current license managers monitor and restrict how many users may have access to and execute an application at any one time. Elements of value beyond mere access would have to be defined to measure usage for billing purposes. Different applications would likely have both common elements and distinct elements of value. Common elements could be frequency of access and time of use. Distinct elements, on the other hand, could be the frequency of the execution of an algorithm (in a design application, for example) or a module and would differ from product to product. The billing formula would likely be a combination of such value factors, probably with different weights. Global enterprise-wide software access and use requirements may make such technical capability a necessity. One approach is to incorporate management capabilities directly into the network operating system. Such functions must be invisible to the user and not cause any delay in application performance.

Evolving Pricing Models

License pricing models are evolving at the same time as computing environments are changing. User and vendor pricing requirements must be balanced so that new, as well as existing licensing approaches result in enough working capital for R&D for the development of new and enhanced software products. Flexible software licensing pricing needs to develop in ways that optimise bottom-line profitability for both vendors and users. From a vendor's viewpoint, the business issue is whether the pricing models result in enough revenue to fund the next generation of products. Revenue and profit estimates are more difficult to project in the changing computing environments. Revenue pressure is also causing some vendors to consider shifting from the present widely-used model of a perpetual license fee with about fifteen percent recurring maintenance revenues to other models with greater recurring revenues.

Object-Level Licensing

Licensing must go beyond the application level to the object level for business and multimedia applications. License managers to monitor and restrict use will be needed which permit licensing at the object or module level rather than at the entire application level. This is particularly important for objects which can be used for multimedia content.

Intellectual Property Protection

Statutory intellectual property protection is extremely important. Only statutory intellectual property protection (patent, copyright, trademark) is possible when software is sold rather than licensed since no agreement is needed to implement such protection. Trade secret protection is not feasible for software in the increasingly larger mass market because there is no enforceable confidentiality contractual provision and, in some cases, the sheer number of copies distributed. In other markets, the trade secret provision is often negotiated when a signed license is employed, which slows down the sales cycle. Therefore, vendors more critically evaluate whether to try to implement trade secret protection. Patent and copyright protection are often acceptable alternatives.

Software Performance Risks

While statutory intellectual property protection provides proprietary protection, insurance is the possible safety net for potential liability for mass-market software. Errors and omissions (``E&O'') insurance for performance risks is the only certain safety net available for mass-market software, since either no signed agreement is possible or a shrinkwrap license containing a limitation of liability may not be enforceable. Insurance is growing in importance as more complex software products are distributed by mass-market methods. For example, consider the risk level of a word processing package as compared to a computer-aided design package.

Volume Licenses

Corporate customers want some type of volume licenses for widely-used PC applications. Corporate and other major software users want volume licenses of some type (including enterprise and site licenses) for widely-used PC application software such as word processing and spreadsheets. They also desire value-added services in such arrangements. These multi-copy arrangements help reduce the incidence of piracy of such applications. Vendors continue to make application suites (discounted bundles of applications) attractive with volume licensing programs. Flexible licensing of software suites is also providing users a choice of which applications in the suite to deploy from a CD-ROM.

Signed Licenses

Signed license agreements are generally more user friendly. Even when a signed license agreement is employed, such agreements tend to be more readable, user friendly and balanced in risk allocation between the vendor and user than ever before. Reductions in software prices and competition in most software industry segments have created the need for simplification. The business goal is to reduce the cost and time of the negotiation phase of the sales cycle. While some negotiation may always be required, the strategy is to minimise it by improving the chances of receiving a customers' positive response to a standard agreement.

Patent Infringement Risks

The patent infringement risk is generally allocated to the vendor who puts software into distribution channels. Major software vendors are building patent portfolios of software related inventions for both offensive and defensive purposes. A portfolio can be used defensively for cross-licensing and to otherwise fend off or reduce the impact of infringement claims. While vendors carefully craft and qualify intellectual property indemnities in most license agreements, particularly with respect to patents, the bottom-line commercial reality is that users will force vendors to provide a reasonable degree of protection against patent, copyright, and trade secret claims in the geographical territory where the software will be used or distributed.

Specific License Agreements

Major U.S. companies are leveraging their software purchasing power more effectively and insist on using their own end use software license agreement forms if a vendor wants to do business with them. This business practice is also being imposed by some big UK and European companies but (as yet) not by Japanese companies.

Damage Limitations

Users are negotiating proposed damage limitation caps more aggressively. Vendors try to limit possible damages through two types of contractual provisions; a disclaimer of certain types of damages (such as consequential damages) and a maximum pound amount limit on liability (a ``cap''). A disclaimer of consequential damages is still acceptable in a negotiated license agreement in almost all instances. On the other hand, a cap on the vendor's total liability in the amount of the license fee is more difficult to implement than is, ``Licensor's total liability under this Agreement will be limited to the license fee.'' Some multiple of the fee is often the compromise reached. Even when a cap is negotiated, most discerning licensees will not agree to apply it to intellectual property infringement indemnities.

Performance-Warranty Disclaimers

"AS IS'' transactions, that is, without any performance warranty, are the exception in commercial transactions. Users want vendors to stand behind their product performance representations. Vendors usually offer a limited software performance warranty for a specified period with reference to user documentation or specifications. For example, compare the following two licenses:
``THE SOFTWARE IS PROVIDED `AS IS' WITHOUT WARRANTY OF ANY KIND, EXPRESS, IMPLIED OR OTHERWISE.''
``Licensor warrants that during the ninety (90) days following delivery to Licensee: (i) the Software will perform in accordance with its then current User Manual in all material respects; and (ii) the storage media containing the Software will be free from defects in materials and workmanship.''

Virus Protection

More customers are asking software vendors for a warranty of ``virus free'' software. For example:
``Vendor warrants that the Software contains no computer viruses or other contaminants, including but not limited to any code or instructions that may be used to modify, damage or disable Licensee's computer system.''
While there is more anti virus software available, this risk is more difficult for vendors to manage than performance risk because of the difficulty in detecting viruses.

Open Systems Issues

Open system issues are much more important in the work station and mainframe markets. Compatibility, portability and migration paths may be important factors in a buy decision for software. The license agreement may have to address these issues, including pricing implications.

Shareware and Freeware Licensing

Standard license rights provisions should be established for shareware and freeware to provide more certainty about deployment rights and obligations. Simplicity is not always helpful. Industry groups should establish a set of routine licensing rights and obligations for low or no cost software. The simplicity in how rights are presently granted results in too much uncertainty because any rights not expressly granted by a licensor are reserved.

For example: ``Permission to use, copy, modify, distribute, and sell this software and its documentation for any purpose is hereby granted without any fee, provided that the above copyright notices and this permission notice appear in all copies of the software and related documentation.'' This language is clearer than most but since the right to terminate the grant may be a reserved right, continuing use is unpredictable.

A business cannot deploy such software in important applications either internally or in a commercial product under such circumstances.

Two sets of licensing practices could be established; one for internal use only and the other for commercial distribution. The routine practices would cover copying, modification, network rights and permitted distribution. There would be no performance or no non infringement warranty or indemnity because of the low or no cost aspect of the transaction. A user can test performance but would remain at risk on infringement issues. No termination of rights would be permitted so long as the activities were within those authorised. Once such practices are established, the software owner could keep the grant simple: ``This software may be used for internal purposes as specified in the X Association licensing practices.'' The owner could also specify exceptions to the set of rights and obligations.

International Transactions

International transactions are an essential source of revenue. Greater percentages of vendor revenue are coming from international sales as opposed to domestic transactions. International transactions require vendors to have more knowledge of local licensing legal requirements such as the EC directive on copyright protection for software and of international payment mechanisms such as letters of credit. The EC interpretation of copyright law's ``first sale doctrine'' may cause a shift from perpetual licenses to annual licenses to prevent a ``license' from becoming a sale. Some vendors differentiate between U.S. and foreign markets by continuing to obtain signed licenses in foreign markets for enforceability reasons even when a shrinkwrap is used in the U.S.

Electronic Delivery

Licensing approaches must accommodate the emerging market requirement for electronic delivery of software. Current practices of distributing software must change as the economic need for conducting business in cyberspace enfolds. The software industry may shift to commercial distribution systems in which networks link software vendors and users to distribute all types of software. Software delivery and licensing will increasingly be implemented through networks including the Internet. Networks are already being used for the delivery and licensing of demonstration copies of software, and some vendors are delivering actual release copies. IBM, for example, reportedly is planning a service that would allow customers to order, receive and distribute software over its IBM Global Network and through online services such as Prodigy and the Internet. E-mail has become a widely-used means of software maintenance communications. Electronic delivery and licensing are components of a future integrated license and asset management tool. That software tool will be the enabling utility for distributing software, monitoring and billing for software use charges and for preventing piracy. It will provide more use flexibility and management capability for users while helping vendors protect their intellectual property.

Conclusion

In summary, both users and vendors must make adjustments as computing environments evolve. Vendors need to offer more flexible licensing options that fit the evolving environments and also protect their intellectual property. On the other hand, pricing for such options must be balanced in a way that the software industry continues to generate the revenues needed to grow and develop.