Chapter 5: Warranties, Indemnities, and Limitation of Liability

Three of the most difficult areas of negotiation in licensing transactions are the vendor's warranties, indemnities, and the limitation of liability. The approach used in most vendor form agreements is to warrant little, provide a narrow indemnity for intellectual property infringement, and limit their liability to, at best, a fraction of the fees paid under the agreement. While it is not generally possible or reasonable to require a vendor to assume unlimited liability for the performance of its software, it is possible by standing firm on these issues to dramatically improve the protections typically offered by vendors in this area. This chapter discusses the protections licensees can reasonably expect to negotiate in most licensing transactions.

The following sections of the form license agreement are discussed in this Chapter: 7 (Limited Warranties), 8 (Disclaimer of Warranties), 9 (Limitation of Liability), and 11 (Indemnity).

1. Warranties

It is common for vendors to exclude nearly every type of warranty, including the implied warranties of merchantability and fitness of the product for licensee's intended uses. This is neither fair nor appropriate. At minimum, the vendor should be required to provide the following basic warranties:

• Performance. That the software will perform in accordance with agreed-upon product Specifications, ^[1] and that the warranty period should extend for at least twelve, if not twenty-four months from the date of acceptance ^[2] (not delivery). In most instances, the preferred approach is to have the warranty period extend for the entire time during which the licensee purchases support services from the vendor;

• Services. That the vendor's services (e.g., installation, implementation, and support services) will be provided in a timely, workmanlike manner, in compliance with industry best practices;

• Compliance with Applicable Law. That the software will comply with all federal, state and local laws, rules and regulations. Licensees in certain industries may require specific warranties relating to issues that are unique to their businesses. For example, a broker/dealer may require a warranty that the licensor will comply with privacy requirements of the Gramm-Leach Bliley Act ("GLB") and its implementing regulations. Similarly, a healthcare provider may require a warranty that the licensor will comply with the privacy requirements of the Health Insurance Portability and Accountability Act ("HIPAA");

• Infringement of Intellectual Property. That the software will not infringe the intellectual property rights of any third person. Astute vendors will generally refuse such a blanket warranty. In such cases, the warranty can be limited to a representation by the vendor that, to the best of its knowledge, the software does not infringe the intellectual property rights of any third person. Such a knowledge-based warranty, in combination with an indemnity obligation for infringement claims, ^[3] generally provides sufficient protection for the licensee;

• Viruses. That the software will be free from viruses and other destructive programs;

• Disabling Mechanisms. That the software does not contain any time bomb or lock-up mechanisms. When triggered by the vendor, these mechanisms can cause the software and the licensee's data to become unusable and inaccessible. Vendors may use these protections to disable the software after the term of the license, but, more frequently, they use them to gain an unfair advantage in the event of a dispute during the term. For example, if the parties are involved in a dispute over professional service fees, the vendor could trigger the disabling mechanism to shut the software down until the dispute is resolved. The use of these "self-help" mechanisms is inappropriate in all but a very narrow range of applications (e.g., a piece of off-the-shelf software licensed for a defined trial period after which the software will not be useable until the licensee purchases a term or perpetual license). Because they could literally bring the licensee's business to a halt, specific contractual provisions should be included in the license agreement prohibiting their use. Although the substance of this warranty is important, it is as equally important to discuss the subject with the licensor to determine whether it routinely utilizes disabling devices in its software;

• Third Party Software. That the licensor has specifically identified in an exhibit to the agreement all third party software to be delivered by the licensor to the licensee in connection with the licensed software. In many instances, the licensor may have incorporated software from various third parties into its product. The third party licensors may require the licensee to be bound to their own terms conditions and to potentially pay separate license fees for the use of their software. One leading vendor makes no mention in its form license agreement that it will be delivering literally dozens of third party applications with its software. Each application requires the licensee to accept a different set of third party terms and conditions. The presence of these third party applications is not disclosed to the licensee until the agreement has been signed and the software delivered. To avoid such surprises, the licensor should be under an affirmative obligation to specifically identify each item of third party software in an exhibit to the license agreement; and

• Authority. That the licensor has sufficient authority to enter into the license agreement and grant the rights provided in the agreement to the licensee.

• Litigation. That there is no pending litigation involving Vendor that may impair or interfere with licensee's right to use the product.

In addition to the foregoing, four additional points should be kept in mind when reviewing warranty provisions in license agreements. First, beware of very general disclaimer language that could undermine or potentially conflict with express warranties provided elsewhere in the agreement. It is not uncommon to find vendor form agreements with one or two express warranties and then find a general disclaimer provision that states the software is "provided without warranties of any kind" or that the software is "provided as-is." These types of general disclaimers directly conflict with any express warranties provided in the agreement and should be specifically qualified as shown in the example revision to our vendor form agreement below.

The second issue to bear in mind is the growing trend by many vendors to incorporate third party software, particularly open source software, into their applications. This is done to expedite development time, reduce cost, and for other considerations. In addition to the warranty described above regarding third party applications, the licensee should consider including language in the agreement requiring the licensor to assign or "pass through" to the licensee any warranties the licensor received from those third parties. Specifically, the licensor will have entered into license agreements with each of the third party licensors. Those license agreements may, and likely will, contain warranties that can be passed through to the licensee. For example, "To the extent permissible, Licensor hereby assigns to Customer any warranties made to Licensor by any Third Party Licensors." This is a no-cost act by licensor, but is a valuable asset to licensee.

The third issue is the avoidance of exclusive remedies. Most vendor form agreements include language similar to the following: "In the event of a breach of warranty, Customer's sole and exclusive remedy and Vendor's sole and exclusive liability shall be for Vendor to use reasonable efforts to repair the defective software." There are a number of problems presented by this approach. Foremost among them is the fact that there is no time limit within which the repair must be made. If a critical defect exists in the software that renders it unusable, this language places no limit on the length of time the licensor can take to identify and repair the defect. It may take a week. It may take six months. In the meantime, the licensee is left with a piece of software it cannot use. The preferred approach to such provisions is to delete them in their entirety. The licensee should have whatever rights are available to it under the agreement in the event the licensor breaches a warranty. If the provision cannot be deleted, it should be strictly qualified to require the licensor to provide a remedy within a defined period of time (e.g., thirty days).

Finally, the "scope" of the warranties should be carefully reviewed to ensure they cover all aspects of the software being licensed and services to be performed. Consider the warranty provided in Section 7.1 of the vendor form agreement. This warranty is limited to the "Licensed Software." As discussed in Chapter 3, the definition of this term must be revised to ensure it includes future releases and versions of the software.

All defined terms in vendor- provided warranties should be reviewed for similar discrepancies.

Example Revision:

7. Limited Warranty.

   • 7.1 Licensed Software. Vendor warrants that the Licensed Software shall perform substantially in accordance with the requirements of this Agreement and, solely to the extent not inconsistent, the documentation for the greater of (i) a period of one (1) year ninety (90) days after the date of Acceptance Reference Date or (ii) the period during which Customer purchases support from Vendor (the "Initial Warranty Period"). Customer shall provide written notice of any warranty failure to Vendor not less than five (5) days prior to the end of the Initial Warranty Period. Such notice shall specify with particularity the nature of any such failure. Vendor shall not be responsible for any errors or nonconformities in the Licensed Software resulting from Customer's misuse, negligence, failure to use the Licensed Software in conformance with this Agreement or modification of the Licensed Software by Customer.

   • 7.2 Services. Vendor warrants that all services provided by Vendor to Customer under this Agreement shall be performed in a workmanlike manner.

   • 7.3 ^[4] Viruses and Disabling Mechanisms. Vendor shall use commercially reasonable measures to screen the Licensed Software to avoid introducing any virus or other destructive programming that are designed (i) to permit unauthorized access or use by third parties to the software installed on Customer's systems, or (ii) to disable or damage Customer's systems. Vendor shall not insert into the Licensed Software any code or other device that would have the effect of disabling or otherwise shutting down all or any portion of the Licensed Software. Vendor shall not invoke such code or other device at any time, including upon expiration or termination of this Agreement for any reason.

   • 7.4 Infringement. To the best of Vendor's knowledge, Customer's permitted use of the Licensed Software will not infringe the intellectual property rights of any third party.

   • 7.5 No Litigation. Vendor further warrants there is no pending or threatened litigation that would have a material adverse impact on its performance under this Agreement.

   • 7.6 Authority. Vendor has the full power, capacity and authority to enter into and perform this Agreement and to make the grant of rights contained herein.

   • 7.7 Compliance with Applicable Law. Vendor warrants that the services provided under this Agreement and Customer's permitted use of the Licensed Software shall comply with applicable federal, state, and local laws and regulations.

   • 7.8 Third Party Software. In the event Vendor provides any third party software (the "Third Party Software") to Customer in connection with this Agreement, the following shall apply: (1) Vendor shall specifically identify in writing all Third Party Software in Exhibit B; (2) Vendor shall attach to Exhibit B written copies of all third party license agreements applicable to Customer; and (3) Vendor warrants that (i) it has the right to license any Third Party Software licensed to Customer under this Agreement; (ii) to the best of Vendor's knowledge, the Third Party Software does not, and the use of the Third Party Software by Customer as contemplated by this Agreement, will not infringe any intellectual property rights of any third party; and (iii) unless specifically provided otherwise herein, Customer shall have no obligation to pay any third party any fees, royalties, or other payments for Customer's use of any Third Party Software in accordance with the terms of this Agreement. Vendor shall support and maintain all such Third Party Software to the same extent as the Licensed Software.

8. Disclaimer of Warranties. EXCEPT AS PROVIDED IN SECTION7, VENDOR EXPRESSLY DISCLAIMS ALL OTHER WARRANTIES, EXPRESS AND IMPLIED, INCLUDING, BUT NOT LIMITED TO, THE IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. VENDOR DOES NOT WARRANT THAT THE PRODUCTS WILL MEET CUSTOMER'S REQUIREMENTS, THAT THE LICENSED SOFTWARE IS COMPATIBLE WITH ANY PARTICULAR HARDWARE OR SOFTWARE PLATFORM, OR THAT THE OPERATION OF THE LICENSED SOFTWARE WILL BE UNINTERRUPTED OR ERROR-FREE, OR THAT DEFECTS IN THE LICENSED SOFTWARE WILL BE CORRECTED. THE ENTIRE RISK AS TO THE RESULTS AND PERFORMANCE OF THE LICENSED SOFTWARE IS ASSUMED BY CUSTOMER. FURTHERMORE, EXCEPT AS PROVIDED IN SECTION 7, VENDOR DOES NOT WARRANT OR MAKE ANY REPRESENTATION REGARDING THE USE OR THE RESULTS OF THE USE OF THE LICENSED SOFTWARE OR RELATED DOCUMENTATION IN TERMS OF THEIR CORRECTNESS, ACCURACY, QUALITY, RELIABILITY, APPROPRIATENESS FOR A PARTICULAR TASK OR APPLICATION, CURRENTNESS, OR OTHERWISE. NO ORAL OR WRITTEN INFORMATION OR ADVICE GIVEN BY VENDOR OR VENDOR'S AUTHORIZED REPRESENTATIVES SHALL CREATE A WARRANTY OR IN ANY WAY INCREASE THE SCOPE OF WARRANTIES PROVIDED IN THIS AGREEMENT.

^[1]See discussion of "Specifications" in Chapter 4.

^[2]See discussion of acceptance testing in Chapter 4.

^[3]See discussion of indemnity protections in this Chapter.

^[4]Sections 7.3 through 7.8 are example additional warranties that may be added to vendor form license agreements.