Introduction
During the review and finalisation of any IT contracts, the intellectual property (IP) clauses are often the subjects of focus by the contracting parties. This is understandably so, given that IP rights can be said to be the cornerstone of most IT contracts. In the context of an IT contract, the relevant IP rights would be the IP rights in the software or computer system to be delivered to the customers. Hence, IP-related clauses can have an impact on the right to use a particular software as well as affect the ability of a customer to own the entirety or a part of the deliverables from the vendor.
In this article, we attempt to dissect the IP-related clauses in an IT contract, with the objective of helping companies, whether you are the customer or the service provider, to better understand the nuances of these IP clauses.
Ownership of Intellectual Property Rights
From our experience, we often hear customers expressing interest to own the IP rights in the deliverables. From the customer’s perspective, it makes perfect sense that since they are already paying for the deliverables, they should rightfully have ownership over the subject matter of what is paid for. A complete ownership of the IP rights in the deliverables is however more often than not impossible (unless the contract is one for the development of a new software and even then, there may be a caveat to IP ownership depending on the method of development), as the service providers are usually offering only a licence to their software or providing software-as-a-service. Relinquishing their ownership in the underlying software will disrupt the entire business model of the service providers and affect the service providers’ ability to continue granting licence to the very same software to its other paying customers.
As such, it is important for the service providers to first explain to the customers the term of its delivery of services, helping the customers to understand that they will be granted a licence to use the underlying software instead of having an ownership over the deliverables. If there are customisation to the software pursuant to the customers’ request or requirement, then perhaps carve-outs can be introduced in the IT contract to distinguish foreground IPs and background IPs, and for the customers to have ownership over the foreground IPs generated pursuant to the customisation work requested by the customers.
Licensing of Intellectual Property Rights
As explained above, in most IT contracts, the IP rights in the underlying software to be delivered to the customers are subject to a licence to use, granted by the service providers (or the software principals, through End User Licence Agreements or EULAs) to the customers. It is thus important for in-house legal reviewing the contracts to ensure that the licensing terms align with the customers’ / companies’ intended usage of the software or deliverables.
Some software deliverables are subject to annual licence subscription requiring the customers to pay for the licensing fees on annual basis, failing which the subscription can be terminated or suspended despite the duration of the IT contract still being intact. The licence may also be subject to certain authorised use limitations such as restriction on the number of active users or maximum processing capacity in a month or a year. It is also very common for the licence to be limited to the entity that subscribes to the software only, without extending to its other related companies although the customers may have originally intended for the software deliverables to be for group-wide usage.
In-house legal should work with the end users within the organisation to ensure that the licensing terms of the deliverables are well-suited for the end users’ requirement or intended usage.
Warranties on Intellectual Property
The customers’ ability to use and continue using the software or deliverables is essential, be it through ownership over the IP rights in the software deliverables or a licence to use thereof. As such, IT contracts will almost without fail require the service providers to offer warranties in relation to the service providers’ rights or authorities to grant licence to the software deliverables, or warranties that the software deliverables do not infringe upon third parties’ IP rights.
In our experience, service providers are typically in a comfortable position to offer these warranties in relation to IPs. Some of the more reputable software principals or providers may have even conducted IP clearances or searches in the countries that they are operating in to ensure that their offerings indeed do not infringe upon third party. Where the service providers are only reselling the software however, they may not be in a position to give warranties on non-infringement of third parties’ IP rights and may require the customers to rely directly on the warranties offered by the software principals under the applicable EULAs.
Indemnity on Intellectual Property
An IP indemnity goes pretty much hand-in-hand with the IP warranties expounded above. Service providers are usually expected to indemnify the customers for any damages that the customers may suffer due to IP infringement claim from third parties resulting from or caused by the software deliverables being infringing on third parties’ IP rights. Such infringement claim can adversely affect the customers’ rights to continued usage of the software deliverables and thus it is well within expectation that customers should be indemnified as such.
Similarly, while service providers normally do not object to offering IP indemnity, it may be conditional upon the customers agreeing to undertake a few obligations themselves. We have commonly seen service providers requiring customers to (i) provide due notice of the IP infringement claim as soon as the claim comes to the knowledge of the customers; (ii) giving up and relinquishing control of the defence of the infringement claim to the service providers; (iii) undertake not to engage the claimant or plaintiff in negotiating or agreeing upon a settlement of the claim; and (iv) rendering assistance to the service providers in defending the claim.
Additionally, some service providers may also impose exceptions to IP indemnities where under certain circumstances, the service providers will not have an obligation to indemnify. Some of these exceptions may include where the subject matter of the IP infringement claim is the portion of the software deliverables customised based on the customers’ requirements, where the alleged infringement is caused by the customers’ failure to update the software according to the service providers’ directions or where the customers had used the software deliverables in contravention of the applicable manuals or terms of use.
Intellectual Property Escrow
Lastly, some customers may also require an escrow clause to be present in the IT contract, to subject the source code of the software deliverables to an escrow. The purpose of the escrow is to offer a fail-safe, allowing customers access to the underlying source code of the software deliverables in certain events that will trigger a release of the source code. These events will normally entail the software principals or service providers ceasing their business operations, or where the version of the software has been made obsolescence.
When there is an escrow release triggering event, the customers will need to have the rights to use and modify the source code of the software so released, so that they can continue to maintain the software on their own. A software escrow is essential when the software deliverable is mission-critical to the customers’ business operation.
Conclusion
IP-related clauses in an IT contract require careful drafting and structuring. Depending on the business requirement of a customer, as well as the commercialisation model of a service provider, the way the IP-related clauses will be presented can differ drastically from contract to contract. Ideally, the lawyers handling the review and finalisation of these IT contracts should be well-versed in both IT contract drafting and IP laws in order to ensure that the commercial interests of both the customers and the service providers are well protected.
Whether you are a service provider looking to onboard a new customer, or you are looking to outsource certain IT services to an external service provider, the Technology Practice Group at Halim Hong & Quek has the relevant expertise to assist. The Technology Practice Group frequently represent service providers and customers alike in their IT projects, and will certainly be able to address the legal needs in this aspect. If you have any enquiries, please feel free to reach out to the partners at the Technology Practice Group.
About the authors
Lo Khai Yi
Partner
Co-Head of Technology Practice Group
Technology, Media & Telecommunications (“TMT”), Technology
Acquisition and Outsourcing, Telecommunication Licensing and
Acquisition, Cybersecurity
ky.lo@hhq.com.my.
.
Ong Johnson
Partner
Head of Technology Practice Group
Technology, Media & Telecommunications (“TMT”),
Fintech, TMT Disputes, TMT Competition, Regulatory
and Compliance
johnson.ong@hhq.com.my
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