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Today, many software vendors are undergoing a transformation. Motivated by developments as diverse as the availability of the Internet, improvements to bandwidth and network technology, changes to software revenue recognition guidelines, and changing ideas about software shelf life, many software licensors have been switching to application service provider business models during the last few years. When a software licensor changes into an ASP, several intellectual property and related commercial issues arise. Knowing what they are will help you to prepare your client for the transition. Licensing business models — models that involve selling copies of software for users to install and run on their own computer systems — present many obstacles. First, software often becomes outdated quickly, sometimes only months after its installation. Also, software maintenance and end user support on customer premises continues to be expensive and introduces unknown configuration and environmental issues into the technological picture. Finally, having to renegotiate license agreements for upgrades makes it difficult for newly public software vendors to predict their revenue accurately to report to the capital markets. Companies can circumvent these obstacles by providing software resources as a service, not a product. ASPs allow users to log on remotely, usually through an Internet protocol implementation, and use software that is run on the computer servers of the ASP, maintained by the ASP, and automatically updated as the product matures. But switching from an independent software vendor model to an ASP model is not without its own set of legal obstacles. To understand some of the issues involved in this transition, it is important to understand what happens, from an intellectual property perspective, when an end user contracts with a licensor for the right to use software. LICENSES VS. SERVICE AGREEMENTS Although software also is protected by patent, trade secret and trademark law, the main rubric of software protection stems from copyright law, which gives the author of a work such as a computer program the right to prevent others from reproducing, distributing, publicly performing, publicly displaying or preparing derivative works based on the computer program. Although copyright law does not explicitly give software creators the exclusive right to “use” their work, it is nevertheless the main source of protection against software piracy, because using a computer program requires making at least one copy, albeit transitory, in a computer’s memory, and making backup copies to avoid the loss of information. End user licenses specify the terms of software’s use. These licenses generally restrict use to a certain number of computers, sites, concurrent users, named users or servers. The copyright owner has the right to so restrict its software’s use because it bargains for these restrictions in exchange for granting the user the right to make a copy of the software that will reside on the user’s computer. On the other hand, use of an ASP’s software arguably does not implicate any of the rights that software creators enjoy as a result of copyright law. Although the same transitory copies must be made, they are made and located on the ASP’s computers, and thus, theoretically, it is the ASP and not the user who is making them. Think of it as the difference between buying a copy of a DVD and paying for a ticket to a film. The former involves obtaining a copy to be held in your possession; the latter is a service. No one would suggest that a movie ticket is a copyright license. Because use of an ASP’s software does not implicate copyright law, many ASP agreements are written as services agreements, not licenses. This can benefit the ASP in many ways. Negotiating end user licenses can be arduous. Licensing clauses and terms tend to trigger review by the customers intellectual property counsel, whereas services agreements often do not trigger review by outside counsel at all. Intellectual property counsel who review end user licenses almost always ask for provisions granting things like source code escrow, warranty and sublicensing rights; services agreements may not trigger these comments. Granted, an ASP agreement is a complex services agreement, one that is likely to include detailed provisions about service levels (uptime, data capacity, latency, etc.) and escalation procedures (response time, error classification). But legally, it is likely to be less complex and generate lower legal fees from outside counsel than a license agreement. THIRD-PARTY INFRINGEMENT An ASP’s computer servers usually store data and materials generated by the customer using the ASP’s software. This means that a customer can cause the ASP to make copies of materials that the customer provides — something that introduces the possibility of infringing on third parties’ intellectual property rights. For instance, an ASP may provide a video editing application, and the customer may provide the materials to be edited by uploading them via the Web. The customer wants to create a commercial using the image of Marilyn Monroe, and uses the famous skirt billowing shot from “The Seven Year Itch.” This photo is the subject of a copyright that the ASP user probably doesn’t own. Because the customer, not the ASP, selects and edits the materials, the ASP cannot effectively police whether any of the materials, or the editing of them, infringes third-party rights. Similarly, if an ASP provides mailing list generation services, the ASP will not be able to police where the names came from, or whether the ASP’s customers are using the lists legally. One of the ASP’s customers may provide a mailing list that was gathered from a Web site with a privacy policy preventing mail solicitations. In each of these cases, even though the ASP is not generating the activities that may be unlawful, the ASP may be subject to vicarious liability or named in a lawsuit regarding the activity. Most ASPs respond to this by taking two approaches: a business approach and a legal approach. The business approach is to create a set of policies regarding the ASP’s services. These policies typically restrict users from delivering infringing, illegal or misappropriated materials via the ASP, or from using the ASP’s services for unlawful purposes. Some policies also restrict activities that may be legal, but not desirable, such as using the ASP to spam (send unsolicited e-mail), transmit adult content or racist or sexist language, or make commercial solicitations. Some ASPs develop detailed policies that, by contract, require customers to comply or risk termination of service. Others, without preparing any detailed policies, reserve the right to refuse services or remove material to prevent legal exposure. The legal approach involves including in the ASP contracts terms that require the customer to indemnify the ASP for any legal problems that result from data or materials that the customer has selected or provided. Because most customers do not want to take on unlimited liability, these provisions can be tedious and sensitive to negotiate. Nevertheless, most ASP contracts contain them. CUSTOMER DATA What about the customer’s intellectual property? Because customers rely on their ASP to make backups and provide security for the data resident on the ASP’s computer servers, in their ASP services agreements, customers expect promises about security and restrictions on the use of their data. Most ASPs don’t mind doing this, but some ASPs generate revenue by mining their customers’ data. In this case, the non-disclosure and non-use provisions of ASP services agreements — the provisions that relate to trade secret protection — need to be carefully crafted. Also, so that its customers will not be caught unaware while reviewing the ASP services agreement, an ASP should inform its customers of the ASP’s intentions regarding the use of customer data during the sales process. PRICING, PRICING, PRICING In light of the previously-described concerns involved in going from end user licenses to ASP services agreements, you may be surprised to learn that the most difficult and important difference between the two is not the license, but the money. Unlike end user licenses, ASP agreements never have simple, one-time, up-front “buyout” fees that give perpetual access to the software. Fees in ASP services agreements correspond to the value and expense of ongoing services — whether priced monthly, per transaction or per user. If, for instance, an ASP provides a secure messaging product, and charges based on the number of messages sent or received by the customer, the ASP might provide its attorney with a term sheet with the following fees: Initial Payment: $150,000 Transactions Fee: 0-100,000 $1 100,001-500,000 $.75 over 500,000 $.50 So that you can draft the ASP agreement to include clear financial terms, have your ASP client provide you with answers to the following questions: � When is the initial payment due? � How often are the transaction fees paid? � Is the initial payment recoup-able against transaction fees? If so, what happens if the fees are not recouped? A refund? A credit? � Will transactions be measured instantaneously or will they need to be reported in arrears? � Will you invoice for the fees? If so, what are the payment terms? � Are the tiers measured cumulatively? For instance, if there are 150,000 transactions, do they all cost $.75, or are the first $100,000 billed at $1? (Examples are sometimes useful here.) ASP/CUSTOMER DIVORCES Whenever a customer has to stop using technology because the license or services contract for its use ends, there are costs and headaches for the customer in making the transition to a new technology. In an ASP arrangement, these headaches are magnified. When a customer ends its relationship with an ASP, because the ASP has possession of the customer’s data, the ASP and the customer must coordinate the transition of data back to the customer’s system. For this reason, many ASP services agreements contain more detailed “divorce” provisions on the transition or conversion of data from the ASP back to the customer, or to the customer’s new ASP. As we have seen, moving to the ASP model likely will result in some significant differences in the drafting and negotiation of your client’s sales agreements. To be sure that your software client maintains an optimal strategic position, you should encourage your client to re-tool its sales agreements with the transformations of the ASP model in mind. Heather Meeker is a partner at Wilson Sonsini Goodrich & Rosatiin San Francisco, where she serves as a member of the firm’s Technology Transactions Group and specializes in software and technology licensing. She also is an adjunct professor at Hastings College of Law, and the author of a textbook titled “A Primer on Intellectual Property Licensing.” E-mail: [email protected].

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