We are often asked by users of mission-critical software whether they should purchase the software, or merely license it from the vendor. Here is some guidance and options.
Ownership of software
Ownership of the Software is the securest position a licensee can occupy. Ownership on the face of it, presents little risk of unauthorised adaptation or copying of the software or it getting into the hands of competitors. Often, a licensee buys the software out of the company (as an asset) as opposed to the licensee buying the vendor’s business (by way of a sale of business) or company (by way of a sale of shares). Where it buys the software out of the company, it is often a module, or a standalone software product, where the vendor owns lots of different software products.
The only downside to this is that the license is exposed to a level of risk of “loss of intellectual capacity” by the licensor to maintain the software if critical personnel leave the company or die. This is why there is a trend at the moment to “acqui-hire” start-ups – which is when a big company buys a smaller company just to get its employees.
Licensing of software
There are essentially three different types of licensing arrangements when it comes to proprietary software (as opposed to open source software):
- a non-exclusive source code license (enables the licensee to make changes to the software without infringing any copyright in the software);
- a non-exclusive object code licence (precludes the licensee from making changes to the software); and
- an exclusive licence of either (where the licensee has the rights in terms of the Copyright Act to take action against third parties for copyright infringement in its own name. This is because the licensee’s right of action as exclusive licensee exists concurrently with the licensor’s right of action as the copyright owner. However, the software remains an asset of the licensor.)
The downside of a license is that where the software is valuable, a license sometimes incentivises the licensor to breach the contract rather than carry on licensing the software to the licensee.
Licensing of software: “real” or “personal” right?
A license or “right to use” software is either a “personal right” or a “real right”. Our courts have not yet decided whether a software license confers a personal right or a real right on the licensee. A personal right is “weaker” than a real right (when viewed from the licensees perspective).
The importance of the distinction is not academic: It often becomes very apparent and important where the licensee is liquidated.
If the right to use the software under a license is a personal right, a liquidator may be entitled to sell the software to a third party (even a competitor of the licensee) when liquidating the assets of the company in which the software is included. If the license agreement confers a personal right on the licensee, the License Agreement is not effective against third parties who are not party to the contract. This means that the Liquidator is entitled to ignore the License Agrement and the encumbrances on the software (the License Agreement) and the new owner would not have to carry on licensing the software to the licensee.
On the other hand, if the rights created under the License Agreement are real rights, they are effective against third parties who are not a party to the contract. This means the Liquidator would be obliged to sell the software subject to its encumbrances (the License Agreement) and the new owner would have to carry on licensing the software the licensee.
Some people say that exclusive licenses lean more in the direction of conferring real rights whereas a non-exclusive license leans more in the direction of conferring personal rights.
Remember that our courts have not decided on this issue yet.
What is the practical effect of this?
If the licensor breaches the License Agreement, the licensee would have an election to either claim specific performance or damages. Where the software is critical to the business of the licensee, no amount of money by way of a damages will compensate the licensee for non performance or breach of contract by the licensor, for whatever reason. It will also impact on the licensee’s right to claim specific performance under the contract in the event of a liquidation. Why? A claim for specific performance is always subject to the ability and willingness of the licensor to perform. Where the licensor cannot perform or will not perform, in practice, no court or any other forum would order specific performance because to do so would be academic. And the alternative? Damages.
Contrast this to an ownership scenario, where your risk is really limited to maintenance of the software.
Various questions flow from the above:
- Can the parties agree that a license confers a real right? No. This is a question of law.
- Can a personal right be converted to a real right by some process? For example, a procedure similar to the conversion of a personal right of servitude over land to a real right of servitude over land by registration of the right against the title deed in the Deeds Office? It seems not.
- Can the licensor give the licensee an option to purchase the software? There is nothing preventing the parties from agreeing that in the event of the licensor committing an act of insolvency in terms of section 8 of the Insolvency Act, or being technically or commercially or factually insolvent, that there would be a deemed offer in favour of the licensee.
Under the deemed offer, the licensee is deemed to have made an offer to purchase either the software or the business of the licensee and all its assets (including the software) out of the company on the day preceding any liquidation application. However, in order not to fall foul of our insolvency laws, the sale must not be “unfairly prejudicial” to other creditors. This means that the licensee should pay a “fair value” for the software.
Some people suggest that a fair value one that comprises the total of all liabilities payable by the licensor to all its creditors. But what if the value of the liablities (for example R500,000) was less than the value of the software (for example, R2m)? In this scenario, the shareholders in the licensor company would most certainly agree to the sale.
Options for Critical Software
What options then does the licensee have?
- Exclusive, failing which non- exclusive source code license with or without an option to purchase (for fair value);
- Exclusive, failing which non- exclusive object code license with or without an option to purchase (for fair value);
- Purchase the software from another company – where the licensor would put the software in a separate company with no debtors and creditors and then sell it to the licensee . There would be no reason for that company to be liquidated as it has no creditors or debtors;
- Purchase the company (an “aqui-hire” – if you want the staff);
- Purchase the software from the vendor for fair value and pay the purchase price in one go;
- Purchase the software with payments in instalments. In a worse case scenario, on liquidation, the Liquidator could come after the licensee for the balance of the purchase price. If the licensee paid fair value for the software, there is no reason why the sale should be attacked as no one was prejudiced.
The license would be accompanied by a support and maintenance agreement.
These are some of the options which the licensee needs to consider.
Given the uncertainty in our law whether a license is a real or personal right, and given the risk scenarios set out above, the best case scenario seems to be that the licensee should purchase the software and obtain ownership of the copyright and conclude a maintenance agreement with the licensor (as a service provider). Where the purchasing of the software is not possible, the licensee has been been presented with other options for it to consider. Before making your decision, we do suggest that you consult one of our attorneys and explain your specific circumstances to him.