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As computer systems and software become more complex and difficult to maintain, companies of all sizes have taken to outsourcing some or all of their information technology infrastructure. Information technology (IT) outsourcing, an option at one time available to only the largest companies, has in recent years become a possibility for even small and midsize businesses. Application service providers (ASPs) now offer, in exchange for a periodic fee, to take over the installation, maintenance and provisioning of software applications for companies, freeing them of the need to make large expenditures on hardware, software and support personnel. The ASP model effectively allows a user to purchase access to software and hardware instead of having to license and purchase them in the traditional fashion. This access is usually provided remotely over a wide area network such as the Internet. While a strong case can be made for engaging the services of ASPs, users must also exercise caution in entering into relationships with them. A lot is at stake when a company decides to permit a third party to handle its sensitive business processes and information. ASPs offer benefits to businesses of every size. Small and new businesses with limited resources can replace a single large capital expenditure with manageable monthly payments, and can use ASPs to get their IT functions up and running in record time. Midsize companies find that ASPs enable them to compete with larger players by providing them with reasonably priced access to the same high-performance, high-cost systems used by the leaders. Even large corporations use ASPs to get around the shortage of qualified IT personnel and to obtain rapid implementation of new applications. Outsourcing IT services to an ASP can enable any company to focus on its core competencies while benefiting from the services of a provider that is exclusively focused on computer systems, networks and software. The ASP model also presents serious challenges. As with any agreement with an outside vendor, care must be taken to contemplate the possibility of nonperformance. The ASP may go out of business or may lose its license to provide one or more applications. The service provided may be unacceptable, either because of a deficiency in the ASP’s servers, or problems with the network, or both. The ASP may be unable to provide the required level of technical support and help desk services. Upgrades and updates may be badly implemented, causing disruptions to service or data loss. Any of these problems could have a serious, adverse effect on the operation of a user’s business. THE ASP SERVICE AGREEMENT By carefully constructing its service agreement with the ASP, a company can reduce the threat posed by an ASP relationship gone bad. Certain provisions designed to address these situations and to protect the ongoing operation of the user’s business should be included in the ASP service agreement. Any ASP service agreement should clearly identify such specifics as the required services, pricing, available support and the expected performance standards to be met. The agreement should then explicitly set out the consequences of the ASP’s failure to meet those standards. When nonperformance or another breach occurs, the parties should know what remedies are available. Several types of remedies are usually found in ASP service agreements, including the right to receive fee credits or liquidated damages, to receive additional services and to terminate the relationship. Termination is the most commonly used remedy for ASP nonperformance, so its consequences must be closely examined and clearly described in the agreement. From the user’s perspective, the most important remedy is the right to terminate the ASP service agreement with little or no notice, depending on the severity of the problem. In most cases, the ASP has a fixed number of days within which to cure the deficiencies before termination is effective. The user should be aware of the difficulties that may result from having to terminate an ASP relationship and either retain another ASP or bring the IT function back in-house. The relationship with the terminated ASP is likely to be strained. Transition services, including data downloading and conversion, may be impossible to obtain absent a provision in the agreement explicitly requiring them. Some or all of the required applications may be unavailable from other ASPs or software vendors. This is most often the case when the ASP is also the developer and vendor of the software product being used. Even assuming that the needed applications are available from another source, the user must expect some downtime in connection with the transition to a new provider. This can be especially problematic when a user has become dependent on one or more mission-critical applications in connection with internal operations or servicing customers. The user will likely also need to deal with the fact that the terminated ASP may have one or more copies of the user’s data following termination. It is therefore good practice for a user to include a provision requiring the ASP to cooperate with the user, its replacement ASP and other third parties in making the transition as efficient and cost-effective as possible. Some ASP agreements also provide for a refund of fees and some form of liquidated damages if the user is forced to terminate the ASP service agreement for cause. From the ASP’s perspective, the most important remedy is the right to suspend or terminate service for nonpayment by the user. Some clients of ASPs retain them in order to solve cash-flow problems. Thus, the ASP must ensure that it is being paid on time for its services. Some agreements provide for the suspension of service on very short notice in the event of nonpayment; the user should look out for such a provision in negotiating a service agreement. CONVERSION RIGHT One remedy that is not commonly offered by ASPs, but is more and more frequently requested by users, is what is referred to as a conversion right. This remedy usually permits a user, when an associated trigger occurs, to convert the ASP service license to an end-user license. Thus, a user exercising such a conversion right may bring the hosting of the application in-house or, alternatively, it may engage a third party to host the application for the user. In order for this remedy to be built into the ASP service agreement, the ASP must be an authorized reseller of the software products it provides to the user. The reseller agreement must permit the ASP to license the products to the user as a typical paid-up licensee rather than as an ASP subscriber. If the ASP does not hold such a license, a possible fallback would require the ASP to attempt to obtain this right for the user at the time of the trigger. This may be possible in view of the ASP’s existing relationship with the software vendor(s), although most ASPs will be unwilling or unable to obtain the rights at the later time, especially if the deal is relatively small or if it is not critically important to the ASP. Although the conversion right may be helpful to the user that is not receiving its bargained-for service from its ASP, it is not without its difficulties. Again, although the user may be able to obtain rights to use software as a direct licensee, it may be giving up any user interfaces or other integration-related developments created by the original ASP. Similarly, once the use has been converted from a subscription-based ASP model to a more standard end-user license, the user becomes responsible for maintaining the product on its servers unless it can obtain suitable hosting and/or maintenance services from another party. Yet another problem is the capital expenditure that may be required to convert the license — an expense the user presumably sought to avoid by engaging the ASP in the first place. Finally, there is the possibility that an ASP in good standing with a software vendor at the time the service agreement is entered into may not be in good standing at the time of a requested conversion, or may otherwise be unable or unwilling to fulfill its commitment to obtain a paid-up license to the product for the user. There are various ways to deal with the allocation of costs in connection with the exercise of a conversion right. The agreement may allow the user to credit some portion of the monthly subscription fee toward the purchase of an end-user license in the event of conversion. In addition or alternatively, the user may pay an incremental amount above the standard monthly subscription fee in order to obtain the right to convert. Some agreements allow the user to apply some or all of the additional fee toward the purchase of a license. In any event, ASPs may wish to permit the conversion right to be exercisable only after a specified number of months of service. DATA PROTECTION The ASP service agreement should protect and guarantee access to the user’s data. First, the parties should establish a method of, and a schedule for, backing up the data. Provision for storage of the backup media in a remote location away from the ASP’s servers should be included in the plan. The user should consider requiring that it be designated as one of the custodians of backed-up data. The data should be stored in a recognizable standard format or be easily convertible into such a format. This will enable the data to be used by other applications and in other environments should the company need to adopt the use of one or more new applications or to switch to another ASP. In addition to the problem of continued access to the data, ownership of the data should be addressed. The user should require that it owns any data submitted to the ASP as well as any data generated through the use of the ASP’s applications by the user’s employees and agents. In addition, the user will want to acquire ownership of any data produced or generated by the ASP specifically for the user under the service agreement. If the ASP is to create any specific content, modifications, integration applications or user interfaces for the user, the user should try to obtain a license for continued use of these customizations even if the ASP relationship terminates. It is even more preferable for users to assert ownership of custom developments. The ASP may require the user to grant a license to such developments back to the ASP for use on behalf of other clients. In that event, the user should require that the developments not be provided by the ASP to a competitor. In addition, the parties should provide for remedies in the event that intellectual property infringement claims are made. At minimum, the user should be indemnified for any claim by a third party that a product provided by an ASP infringes that third party’s rights. The user should ensure that any confidential company information, specifically including information about the company’s customers, remains confidential after termination, regardless of the reason or means of termination. The service agreement should prohibit the ASP from disclosing the existence or terms of the relationship between the ASP and the user, or the fact of the termination. By building protections into a service agreement, customers can go a long way toward minimizing the adverse effects of an unsuccessful relationship. Tom Knox is a partner, Chuck Lobsenz a counsel and Rebecca Shwayder an associate in the McLean, Va., office of Washington, D.C.’s ShawPittman. Knox represents emerging growth clients in connection with technology transactions and corporate matters. Lobsenz represents clients in connection with technology transactions and intellectual property matters. Shwayder represents clients in corporate transactions and technology matters.

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