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Negotiating the “Non-Negotiable”:Tips and Tales from the Trenches of
IT ContractingSIM Capital Area Chapter and
the SIM Advanced Practices Council
January 13, 2015
Matthew C. Mousley
www.duanemorris.com
Disclaimer
The material presented in this presentation is not intended to provide legal or other expert advice, but rather is presented for general information only. You should consult knowledgeable professionals as to any legal or technical questions you may have.
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Presenter
Matthew C. Mousley
- Partner, Intellectual Property Group,Duane Morris LLP, Philadelphia
- Practice focuses on intellectual property and information technology, including transactions (licensing, development, sourcing, hosting, e-commerce) and litigation (patent and other intellectual property)
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Agenda
• Current issues in IT procurement• Why you should be involved and
thinking about these issues• How issues are addressed in specific
contractual provisions– Starting positions– Finding room to negotiate
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Current Issues in IT Procurement
• Transition to the cloud– “cloud-washing” of standard contractual provisions
• Scaling back reps and warranties• Vendors looking for greater data and IP
rights• Vendors limiting exposure generally and
specifically to third-party claims (e.g., patent infringement)
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IT Contracting
• Whether buying or selling IT products and services, there are several important contractual terms to consider and negotiate
• Buyers often don’t know exactly what protections they need and what provisions can be negotiated
• Sellers often don’t know where to negotiate and where to take a hardline
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Your Role in IT Contracting
• Involving a technical expert who knows what’s being purchased and, more importantly, how it will be used, adds value and efficiency to the negotiation process.– Identify “deal breakers” early on– Defer or skip issues that are low priority– Providing more context for use cases permits
flexibility in negotiation
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Your Role in IT Contracting (cont’d)
• Without the input of a technical expert, lawyers and procurement professionals can – spin wheels negotiating low priority items– make incorrect assumptions– settle on compromises that don’t reflect the user’s
needs
• Creative solutions to tough sticking points are easier with more context about the intended use of the product or service
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Overview of IT Contracting
Important provisions to review carefully:• License Grant/Description of Deliverables• Representations and Warranties• Ownership• Indemnities• Limitation of Liability
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Issues re License Grant/Description of Deliverables
• Look for and push back against “cloud-washing”– Using cloud services shouldn’t result in ambiguous or
absent fundamental terms
• Make sure license grant covers known intended use cases
• Try to anticipate future use cases• Review product and service descriptions for right
level of detail
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License Grant
• License to do what?– Access, use, copy, distribute, maintain, modify, create
derivative works– Further use in cloud service?
• Exclusive vs. non-exclusive• License metric: Users, seats, CPUs, cores• Term (perpetual, term, renewals)• Affiliate and contractor use (use and/or maintenance)• Geographic considerations• Assignment (plan for mergers, divestitures, reorg)
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Description of Deliverables
• Description of Products or Services– If no license grant, focus on the description of
deliverables– Enough detail (for standard product/service)?– Too much detail (for custom product/service)?– Effective reference to orders and statements of
work?– Does the description make sense to someone
unfamiliar with the transaction?
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Background reReps and Warranties
• Covenant: a formal agreement or promise– Express (affirmative statement) and implied (good faith and fair dealing)– If breached: all remedies under contract law
• Representation: a statement of a present or past fact– If breached: potential for misrepresentation or fraud– Damages: amount paid under the contract minus any benefits obtained,
potentially including cost of cover, extra labor expenses, expense related to different computer services, costs of equipment and maintenance, program conversion costs
• Warranty: a promise that certain existing or future material facts or conditions are or will be true– Express (affirmative statements, description of goods that are basis of
bargain) and implied (merchantability and fitness for a particular purpose)– Damages: difference between what was warranted vs. delivered
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Background reReps and Warranties
• What is to be gained via representation or warranty versus a covenant?– Representations can give rise to tort of misrepresentation and
therefore damages under tort law – Warranties generally limit damages to a reduction in price, but
also give rise to consequential damages, unless they are expressly limited
– Warranties are primarily governed by the UCC, so the law is well developed
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Background reReps and Warranties
• Does a breach of warranty increase the amount of damages?– Probably not– A warranty is conclusively presumed to be material while the
burden is on the party that is claiming the breach to show that a representation is material
– If the contract breach must be a material breach, a breach of warranty may help buyer to prove a material breach has occurred, but it likely won’t increase damages v. breach of a covenant because they are both subject to remedies under contract law.
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Background reReps and Warranties
• Does breach of warranty give rise to consequential damages in addition to direct damages?– Yes, but not if they have been expressly limited in the contract.
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Issues re Reps and Warranties
• Missing standard reps and warranties• Missing reps and warranties important
to intended use cases• Lack of detail in reps and warranties• Limited remedies for breach of reps
and warranties
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Reps and Warranties
• Common warranties– Performance
Materially conforms with vendor documentation or customer specification/requirements
Free from defects in materials/workmanship Service levels (e.g., uptime, schedule maintenance, backup
frequency, disaster recovery plans) Services performed in workmanlike manner
– Ownership/Right to License– No IP infringement– No malware or disabling code – Backward compatible
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Reps and Warranties
• Common warranties (cont’d)– Compliance with laws generally– Compliance with regulatory requirements (if in a
regulated industry) – No open source code (if any development)– Conditions of facilities (logical and physical security)– No discontinuation of services
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Reps and Warranties
• Breach of warranties - may contractually limit available remedies– Limit to return of goods and repayment– Limit to replacement of non-conforming goods and
parts– Under the UCC, consequential damages may be
excluded or limited except where the limitation or exclusion is unconscionable (or certain cases where it has been found that there was an exclusive remedy and it failed of its essential purpose)
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Issues re Ownership
• Clear ownership provisions are particularly important when the vendor is doing any custom development for the buyer, when the buyer is permitted to modify the vendor’s IP, or when the parties could be contributing to joint development of IP
• Scrutinize data rights, particularly where cloud services are involved
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Ownership
• What is a “work made for hire”?– A "work made for hire“ is defined by statute as
(1) a work prepared by an employee within the scope of his or her employment ; and
(2) certain statutorily-identified works specially ordered or commissioned that the parties expressly agree in a signed writing shall be considered a work made for hire.
17 U.S.C. § 101
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Ownership
• The statutorily-identified works for hire are works ordered or commissioned for use as:– a contribution to a collective work– a part of a motion picture or other audiovisual work– a translation– a supplementary work– a compilation– an instructional text, a test, answer material for a test, or an atlas
• This list does NOT include software per se.
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Ownership
• The author of a work made for hire is the employer or commissioning party, not the individual who actually created the work.
• As the author, the employer or commissioning party is the owner of the copyright in a work made for hire.
• Any reservation of rights by the individual who actually created the work must be made expressly in the signed writing. 17 U.S.C. § 201(b).
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Ownership
• Regardless of whether a customer and a contractor state in a professional services contract that software developed by the contractor for the customer is a “work made for hire,” the contractor may argue that the software does not fall into any of the statutorily-identified works made for hire.
• Therefore, typically, a customer will require an express assignment of the software from the contractor to the customer to ensure the customer’s ownership.
• In such case, the contractor may reserve a broad irrevocable license to software/materials assigned to the customer, including the right to create derivative works and sublicense.
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Ownership
• What is a “derivative work”?– A derivative work is a work based upon one or more
pre-existing works in any form in which the pre-existing work is recast, transformed, or adapted. 17 U.S.C. § 101.
– A derivative work may be separately copyrightable from the pre-existing work on which it is based. 17 U.S.C. § 103.
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Ownership
• Negotiation Point: How harmful is it to give a customer ownership in the copyright of a deliverable that includes material unique to a customer?– Not harmful unless:
The deliverable is a derivative work (e.g., the deliverable itself includes a template or other material that the vendor intends to use with other customers)
The deliverable includes something newly developed by the vendor that the vendor intends to use with other customers
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Ownership
• Negotiation Point: How do vendors handle deliverables that include customer content and vendor content? – Vendor can give customer the right to own the
deliverables subject to: Vendor licenses to customer the underlying vendor
content on which the deliverables are based; Customer grants back to vendor a broad license to
the deliverables that permits vendor to use them for further development/with other clients.
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Ownership
• Should customer and vendor ever agree to joint ownership?– Vendors should avoid contractual provisions that state that the
parties will jointly own any materials created– Joint ownership gives each party rights, but it also prevents each
party from controlling IP that it then wishes to control Copyright – unless stated otherwise, a joint owner needs to provide
accounting to the other party Patent – need to have ability to join a joint owner in any patent
litigation (or the joint patent holder can itself license to the infringing party)
Copyright/Patents – No right to grant exclusive rights without consent of the co-owners
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Background re Indemnification
• What is the purpose of indemnification? (1) provides a contract remedy to supplement other
remedies, including any tort or common law remedies;
(2) can be used to shift the risks;
(3) allows for the recovery of reasonable attorneys’ fees, defense costs, investigation expenses, discovery costs and court costs.
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Indemnification
• Common Indemnities – Limited to third-party claims involving:– Bodily injury/death– IP infringement– Breach of confidentiality
Inadequacies in security control systems– Violation of law– Employment claims– Breach of warranties (generally or specifically)
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Issues re Indemnification
• Parties avoid or limit indemnities to avoid or limit exposure– Vendors limiting indemnities re patent infringement (particularly
regarding combinations) and breach of confidentiality
• Indemnities should be limited only to “third-party claims” and not for direct or first-party claims
• An indemnity for a direct claim essentially says that, if there is a breach, the indemnitor is responsible for both the claim as well as any attorneys’ fees and costs of the indemnitee with respect to the claim (i.e., indemnifying for own breach)
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Issues re Indemnification
• What is the difference between “indemnify and hold harmless” v. “defend”?– “Indemnify” means payment by way of compensation– “Hold harmless” means holding the other party without
any liability arising out of the transaction– The obligation to “defend” means the indemnitor takes
charge of the claim and the indemnitee has no out-of-pocket expense for which to seek reimbursement
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Background re Limitations on Liability
• Two types of limitations on liability:– Qualitative: what types of damages
are unavailable as a remedy?– Quantitative: is there a cap on the
amount of damages available as a remedy?
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Background re Limitations on Liability
• Qualitative limitations on liability typically seek to limit available remedies to direct or general damages and exclude consequential and incidental damages– Direct damages are losses that naturally and usually flow from
the breach itself (e.g., expenses incurred before a breach in reliance on warranties, cost to repair a faulty product)
– Consequential damages are losses that do not ordinarily flow from the breach (e.g., expenses relating to third-party transactions or specific requirements not known to the breaching party)
– Incidental damages are expenses reasonably incurred in inspection, receipt, transport, custody of property, and cover
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Issues re Qualitative Limitations on Liability
• Direct or Consequential Damages?– Lost profits, revenues, or savings
Courts have found that, depending on the transaction, lost profits are something that could be deemed to be in the “ordinary course of the seller’s breach”—i.e., direct damages.
– Lost business opportunity– Lost use or loss due to delay– Work stoppage– Loss or damage to data– Loss of goodwill
• To avoid any dispute as to interpretation later, it is best to specifically classify these potential losses as direct damages or excluded consequential damages
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Issues re Qualitative Limitations on Liability
• A breach of warranty typically gives rise to consequential damages.
• But, a limitation of liability that expressly excludes consequential damages is generally enforceable to prevent this.
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Background re Limitations on Liability
• Quantitative limitations on liability typically seek to limit the amount of available damages—i.e., a “cap” on damages
• The cap can be stated as:– a sum certain (e.g., one million dollars ($1,000,000));– a variable (e.g., no more than the total amount paid by buyer
under the agreement)– a variable with a multiplier (e.g., no more than three times (3x) the
total amount paid by buyer under the agreement)– a variable with a time parameter (e.g., no more than the total
amount paid by buyer in the twelve (12) months prior to the claim)
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Issues re Limitations on Liability
• Limitation on Liability Carve-Outs– “Carve-outs” are items to which general
limitations on liability do not apply—i.e., items carved out from a limitation on liability and subject to a different limitation or unlimited liability
– The qualitative and quantitative limitations on liability typically have the same carve-outs, but this is negotiable
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Limitations on Liability
• Common Carve-Outs– Indemnification obligations (generally)
An indemnitee wants to ensure full indemnification on third-party claims
– Indemnification for or warranty against IP infringement If IP infringement claims are not addressed in general exclusion for
indemnities, an IP indemnitee wants to ensure full recovery for any IP claims (IP litigation is among the most expensive)
– Breach of confidentiality A breach of confidentiality can be devastating and very often risks
exposure much greater than any limitation on liability Can negotiate different limitations for different kinds of breaches
(e.g., trade secrets, protected health data, employee personal data)
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Limitations on Liability
• Common Carve-Outs (cont’d)– Violation of law
Can negotiate different limitations for different kinds of violations (e.g., data/privacy protection laws)
– Willful misconduct, recklessness, or gross negligence– Direct claims for personal injury, death, or property damage arising from
negligence Note that this could apply to loss of data, creating an ambiguity if loss of data
is expressly addressed in a qualitative limitation on liability– Failure to perform during a dispute between the parties
Buyers sometimes request this and vendors sometimes agree
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Limitations on Liability
• Due to a lack of clarity regarding whether a damage is a direct or consequential damage, a buyer will often request that specific types of damages be outside the limitation on type of damages or be identified as a direct damage, e.g.:– Reasonable costs for recreating or reloading data that is lost or
damaged– Reasonable costs of implementing a workaround due to a failure
to provide services– Reasonable costs of replacing lost or damaged equipment,
software, or materials– Reasonable costs and expenses incurred to procure services
from another source (i.e., cover)– Any amounts the vendor has agreed to pay under other provisions
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Take-aways
• Write contracts for someone with no knowledge of the deal – this is your most likely audience
• Consider whether the license grant covers full scope of foreseeable use (e.g., express, detailed rights, third-party users, assignment rights for business transactions) Review checklist of common warranties
• Carefully consider ownership issues, including all IP and data rights that could come out of the contract – joint ownership should be last option
• Indemnities should make sense economically and to allocate risks appropriately
• Limitations on liability need to be clear, but can be creative if the parties get stuck in negotiations – understand the basic principles and take issues one-by-one
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Resources
• H. Ward Classen, “A Practical Guide to Software Licensing for Licensees and Licensors” (5th ed. 2014)
– http://www.amazon.com/Practical-Software-Licensing-Licensees-Licensors/dp/1614388075
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Thank You!
Questions?
Matthew C. Mousley
Duane Morris LLP
(215) 979-1804