Don’t Use License Agreements for Software as a Service

Most IT contract drafters know the difference between a software license agreement and a technology services contract. In a license, the recipient gets rights to copy and use a software application, while in a services contract, the recipient gets a service, like tech support or IT consulting. But software as a service (SaaS) seems to throw a wrench into the gears. Which is it? Fortunately, the new landscape isn’t actually all that confusing (or all that new). SaaS agreements are services contracts, pure and simple. They don’t call for software licenses.

The confusion, of course, stems from the central role of “software” in software as a service. You can cut through the confusion by asking what the customer will do with the software. If the customer puts a copy of a software application on a computer—downloads it, installs it from a disk, etc.—the deal calls for a license. Copyright law gives the software’s owner a monopoly over the right to copy it (to “reproduce” it), so the customer needs a copyright license to make a copy and put it on a computer. But in a SaaS deal, the customer doesn’t put software on a computer, or copy it at all. The software sits on the vendor’s computer and the customer merely accesses it via the Internet. With no copies, copyright plays no role in the transaction, so the customer doesn’t need a copyright license. Rather, the customer needs a simple promise: “During the term of this Agreement, Vendor will provide the System to Customer.”

In other words, the customer gets a service in a SaaS deal, not software. The vendor just uses software to provide the service. The vendor operates like an Internet service provider (ISP). Earthlink and Comcast and other ISP’s use millions of dollars of software to give their customers Internet access. But they don’t give their customers copies of that software. Rather, they provide a subscription to the service made possible by that software.

The distinction has implications for several clauses in a SaaS agreement:

  • The Main Transactional Clause: The customer should get a subscription, not a software license. The customer gets a right “to receive the Service” or “to use the System” so long as the subscription lasts. Of course, you can describe the vendor’s offering as “a license to the Service,” and lots of companies do. But that suggests some kind of copyright license, and it’s hard to predict what a court will do with it if the parties get into litigation. You’ll write clearer contracts—and keep things clearer in your own head—if you avoid licensing language. (See the notes below for sample SaaS transactional clauses.)
  • Maintenance: You don’t need it! In a maintenance clause, the vendor agrees to fix problems with installed software and to send updates and upgrades, so the customer’s copy doesn’t fall behind those of other customers. In a SaaS deal, the customer doesn’t have a copy. The vendor keeps the software, and the vendor’s promise to provide it as a service already involves maintaining it, by definition. (But see below re SLA’s.) Plus, the customer has no copy to fall behind other customers’ copies and so no need for updates and upgrades. When the vendor updates the software on its computers, all customers benefit (in almost all cases).
  • SLA: You should consider a service level agreement (SLA) for a SaaS contract. Most SLA’s address time-frames for fixing errors or minimum performance standards—speed, latency, etc.—or both. (See the notes below for sample SLA’s.)
  • IP Indemnities: SaaS customers generally don’t risk suits about copyright infringement, including open source suits, because they’re not copying any software. So they usually don’t need indemnities against copyright suits. Of course, the flip-side is that vendors don’t face much risk if they grant copyright indemnities. Patent indemnities, however, can play a key role in SaaS contracts because the customer could get dragged into a patent suit, even without copying the software. Some vendors grant patent indemnities only, others grant broad IP indemnities, and still others grant no indemnity at all. (See the notes below for sample indemnity clauses.)
  • Data Management & Security: Data management and security play a more important role in SaaS deals than in most software licenses. The customer’s sensitive data generally sits on the vendor’s computers, along with the software, rather than on the customer’s computers. That’s why many SaaS contracts include a data clause, addressing the vendor’s obligations for managing data and for keeping it secure. (Be sure not to use an NDA for data security! See my recent post on NDA’s vs. data security clauses. And see the notes below for sample data clauses.)

Of course, your deal may involve both SaaS and installed software. A SaaS vendor may provide its main offering online but also give customers a software application to install on their computers—something that helps the computer use data from the online service, for instance. Don’t let that confuse you. What you need there is a small software license agreement wrapped into the larger services contract. The license and its supporting terms should address the installed application only, not the software the vendor keeps on its own computers and uses to run the service.

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Notes & Resources:

  • For sample clauses, see the following resources on the Tech Contracts Chalkboard Contract Forms & Resources page: (a)  “Online Terms of Service, Software as a Service” downloadable form, particularly the transactional clause in Subsection 2(a); (b) “Indemnity” downloadable form; (c) and “Data Management & Security” downloadable form.
  • The Tech Contracts Handbook addresses: (a) SaaS transactional clauses in Chapter I.F; (b) SLA’s in Chapter II.B; (c) indemnity in Chapter II.K; and (d) data management and security in Chapter II.I.

© 2011 by David W. Tollen. All rights reserved.

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13 Responses to Don’t Use License Agreements for Software as a Service

  1. Pingback: SaaS: Software License or Service Agreement? Start with Copyright | Mirsky & Company, PLLC

  2. Pingback: How to Protect Yourself with a Software Services Agreement | Internet Lawyer - Internet Attorney - Internet Law Firm Texas

  3. Pingback: You need to fix your SaaS License Agreement « goodcounsel | legal representation made simple

  4. Scott says:

    What about 365(n) and SaaS? If you call it a right and not a license, you may lose certain rights if the provider goes bankrupt.

    • David Tollen says:

      Scott, good question. Section 365(n) is for IP licenses. It won’t work in a SaaS agreement. To put it another way, I very much doubt that mistakenly calling a SaaS subscription a “license” would trigger 365(n). (The slight risk, however, is another reason SaaS vendors should not use the word “license.”)

      So if a SaaS vendor goes bankrupt, the customer is out of luck — unless it’s gotten some kind of SaaS escrow or backup provider. I don’t think there’s any rescue available from 365(n).

  5. Pingback: software subscription or perpetual license…? Still not sure? | LizziBeth's Legalish Theories On Life And Law

  6. XV says:

    What would be the big downside of granting both a license and having some sort of service component? Just the fact that there does not need to be upkeep of the software? At first, treating the contract as a subscription made sense, but upon further reflection, I am trying to pin down the true practical benefits of paradigmatically favoring the transaction as services-based versus license-based.

  7. Pingback: Don’t Use License Agreements for Software as a Service | burntbutteredtoast

  8. sstrohbehn says:

    Interesting article, but how do you square this with the ruling in MAI Systems Corp. v. Peak Computer, Inc., 991 F.2d 511 (9th Cir. 1993) or the more recent Comedy Central and Warner BRos. v. WTV Systems cases? Don’t some, if not potentially all SaaS services call for loading of part or all of the software into the end-user’s RAM, thereby constituting a copy for purposes of copyright law requiring a license to avoid infringement? And if it’s possible, what’s the harm in including licensing language to be sure the SaaS provider’s IP is protected?

    Thanks

    • David Tollen says:

      Good question, but I don’t think it’s right that many or all SaaS services call for loading software onto the end-user’s computer. In most cases, the customer just views screens produced by the software and sends instructions, without getting a copy. If the customer does get a copy of some software, like something needed to interface with the SaaS system, that should be licensed, as the last paragraph of the post points out. But that doesn’t mean the whole SaaS system calls for a license. I think that for the part not downloaded, the vendor’s better off being quite clear that it’s NOT giving an IP license, or any copies.

      In Warners Bros v. WTV, the defendant wasn’t an end-user but rather a distributor (without a license to distribute, publicly perform, etc.). So I don’t think it tells us a lot about end-user rights. (I don’t know the MAI case, though.)

  9. Bob Smith says:

    Does using the word “license” rather than “service”, and generally how the contract language is written, have any effect on the applicability of sales taxes? Given that services generally are not taxed but canned software (licenses) are, would the contractual characterization of the transaction matter?

    • David Tollen says:

      Bob, state sales tax laws vary, so it’s hard to give a universal answer. In general, I suspect there’s a risk you could turn a non-taxable service transaction into a taxable license by mischaracterizing a SaaS subscription as a software license.

      I’m not a tax expert, though, and I’ve never run into this issue. Any tax lawyers out there?

  10. Pingback: What to pick in SaaS: EULA, SLA or ToS - TermsFeed

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