In recent years, technology companies have increasingly shifted from selling one-time software products to subscription-based business models, particularly when the products are being deployed as Software-as-a-Service (“SaaS”). This transition is driven by the allure of predictable revenue streams and the appeal to consumers of spreading out costs through monthly, quarterly, or annual subscriptions, rather than paying a large upfront sum. While these models offer financial flexibility and lowered commitment for consumers, they often come with a significant catch: hefty early termination fees.
Many subscription-based software agreements, particularly those for SaaS, include clauses that impose penalties for early termination. These fees can range from 50% to 70% of the remaining subscription period, effectively discouraging consumers from ending their contracts prematurely.
The rationale behind such high early termination fees is clear — these fees are often justified from a commercial perspective, as providing SaaS involves significant investments in infrastructure, development, and onboarding. Also, SaaS providers frequently offer customized integration of their software with customer systems and discounted pricing for long-term commitments. Thus, early termination fees help recoup these costs and ensure that consumers who benefit from discounts and perks fulfill their contractual obligations.
However, these high early termination fees are increasingly coming under scrutiny. A recent lawsuit filed by the U.S. Department of Justice against Adobe highlights the potential TMT litigation risks. In June 2024, the Federal Trade Commission (“FTC”) accused Adobe of deceiving consumers by imposing hefty early termination fees and making it difficult to cancel subscriptions. The Department of Justice emphasizes that such high early termination fees can deter consumers from terminating their subscriptions, raising significant legal concerns.
Although this lawsuit is within the jurisdiction of the United States, its implications are likely to resonate globally, including in Malaysia and the broader Asia-Pacific region, where similar subscription models are prevalent. Given the rapid growth of technology companies and the increasing complexity of TMT litigation, general counsels must be vigilant about the terms and conditions in their software agreements.
In Malaysia and the broader APAC region, many technology companies adopt similar subscription models with comparable early termination clauses. It is not uncommon to see early termination fees ranging from 50% to 70% of the remaining subscription period – some companies have even demanded full payment of the remaining period in the event of early termination. While these fees can be justified from a commercial perspective, helping to recoup significant investments and ensure contractual obligations are met, they also pose substantial risks of TMT litigation.
Balancing early termination fees and defending against litigation requires careful attention. Here are five key insights for general counsels and companies:
- 1. General Legal Position of Contractual Clauses in Malaysia: Malaysian law upholds the freedom of contract, meaning courts are generally reluctant to interfere with commercially negotiated terms. Parties are expected to adhere to the agreed terms, including compensation stipulated in early termination clauses, provided these agreements result from thorough, arm’s-length negotiations.
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- 2. Enforcement of Early Termination Clauses: Early termination clauses and penalty clauses in software contracts are generally recognized and enforced. To enforce an early termination clause, the enforcing party must demonstrate (i) there is a breach of contract, and (ii) the contract contains a clause specifying a sum to be paid upon breach. If these elements are established, the company is entitled to receive a sum not exceeding the amount stipulated in the contract irrespective of whether actual damage or loss is proven.
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- 3. Challenging the Reasonableness of the Compensation Sum: The full sum specified in an early termination clause may not always be enforceable. If the breaching party can prove the compensation sum is unreasonable or disproportionate to the damages suffered, the courts may revise the awarded damages. For instance, requiring compensation payment for the entire remaining subscription period could be deemed unconscionable and disproportionate to the damages suffered by the company.
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- 4. Justification of Early Termination Clauses: Companies should ensure that early termination fees genuinely reflect reasonable and proportionate losses. While proving actual losses is not a required legal burden to enforce the early termination clause, however, being prepared to justify the compensation sum can protect against challenges to its reasonableness.
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- 5. Clear and Well-Negotiated Clauses: A clear and well-negotiated early termination clause is always crucial. Malaysian courts are unlikely to interfere with clauses that have been properly negotiated and willingly agreed upon by both parties, therefore, a well-documented negotiation process helps ensure enforceability and mitigates arguments that these early termination clauses were hidden or not disclosed.
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In conclusion, while early termination fees in software subscription agreements can serve important commercial purposes, they also pose significant TMT litigation risks. By understanding and addressing these risks, general counsels can better navigate the complex landscape of SaaS agreements and protect their companies from potential legal challenges.
If you need help with software agreements or any form of TMT litigation dispute, please reach out to us. Our team of legal professionals is ready to advise and assist you with navigating these complex issues and ensuring that your business is well-protected.
About the authors
Ong Johnson
Partner
Head of Technology Practice Group
Transactions and Dispute Resolution, Technology,
Media & Telecommunications, Intellectual Property,
Fintech, Privacy and Cybersecurity
johnson.ong@hhq.com.my
.
Lo Khai Yi
Partner
Co-Head of Technology Practice Group
Technology, Media & Telecommunications, Intellectual
Property, Corporate/M&A, Projects and Infrastructure,
Privacy and Cybersecurity
ky.lo@hhq.com.my.
.
Nicole Shieh E-Lyn
Associate
Technology & Corporate Practice Group
Technology, media & Telecommunications, Transactions and
Dispute Resolution, Fintech, Privacy and Cybersecurity
nicole.shieh@hhq.com.my
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