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The hallmark of every franchise system is uniformity of appearance, selection and service. Franchise systems have become increasingly dependent upon the acquisition and utilization of data in the execution of the daily operations of company-owned and franchised units to ensure uniformity and measure performance, particularly unit level economics. For example, restaurant chains typically employ point-of-sale systems to track customer orders and inventory. POS systems typically feature an electronic polling capability by which the franchisor can obtain information concerning each restaurant’s sales activity, such as average ticket price, mix of menu items sold, selling price and inventory levels. The resulting information is useful in forecasting purchasing requirements, ascertaining the effects of seasonality, determining holiday spending patterns and the like. Unit level operating data and trends are of primary importance in strategic planning for franchise systems. For example, franchisors will analyze such data to prepare impact studies, determine whether a specific market has been saturated or determine whether to spin off a concept or acquire a complimentary or competing concept. Thus, it is important that franchisors ensure that all system outlets have the right to utilize, and are utilizing, the software designated by the franchisor. This article examines the issues that franchisors should consider when acquiring mission-critical software to ensure that the maximum benefits of the software are obtained on a systemwide level. MAKE OR BUY? One of the first issues to consider is whether to develop the software in-house or contract for the development with an outside vendor. There are obvious benefits and disadvantages associated with either approach. For instance, advantages associated with in-house development include control over development, flexibility to introduce changes to the source code, and the opportunity to control costs. Disadvantages include project creep (changing or expanding the scope of development), tying up of IT resources, and lack of experience in designing, building and integrating software with existing systems. Contracting with an outside vendor brings the advantages of experience, a fresh approach to the view of the franchise system, and the ability to devote greater human resources to the project. Disadvantages include greater cost and a loss of control over the development process. This article focuses on the issues associated with employing an outside developer, which is the more likely option for most franchisors. DEVELOPMENT CONUNDRUM The first issue that a franchisor must address is whether to commission the development of a new software package or have a vendor customize an existing commercially available application. This decision will affect both the price and ownership of the resulting software. For instance, if the franchisor commissions the development of a new software package by a third party, there is a greater likelihood that the franchisor will own all of the intellectual property rights associated with the software. It is important to note that source code to software is subject to copyright protection, and the copyright will vest in the developer in the absence of an assignment from the developer to the franchisor. While this may seem counterintuitive, it is important to include a provision in the development agreement by which the developer assigns all of its rights in the source code to the franchisor to ensure that the franchisor owns the entire right, title and interest in the source code. The result will generally be somewhat different if the franchisor decides to have existing application software customized pursuant to its requirements. It is clear that the base application is and will continue to be owned by the vendor. However, there exists the opportunity for the franchisor to bargain for ownership of, or barring that, exclusive rights in, the customized portion of the application in order that the franchisor is not effectively subsidizing development of particular improvements which can then be licensed to its competitors. In either new development or customization, the franchisor must clearly and expressly delineate the desired specifications or functional requirements of the software and ensure that the specifications are integrated into the underlying agreement between the franchisor and its vendor. USE RESTRICTIONS, SCALABILITY In the event that the franchisor will not take title to the system, counsel for the franchisor must pay particular attention to any restrictions on its use of the system. In drafting the license agreement, the franchisor should pay careful attention to whether the grant under the license is a systemwide grant and, if so, whether systemwide usage includes usage by franchisees. Moreover, the franchisor should consider whether there are any restrictions on use of the software in any after-acquired chain or any chain that the franchisor may spin off. If the license contains any such use restrictions, the franchisor must understand that it will be required to pay additional license fees to the extent that it later desires to expand its usage of the software. Scalability — the ability to increase the usage of the software — is also important. The franchisor must have confidence not only that the software is capable of being implemented on a systemwide basis, but also that the system can accommodate the growth of the system, whether through the opening of additional company-owned or franchised units or through the acquisition of one or more additional chains. Given this goal, it is imperative that the franchisor obtain certain representations and warranties from the developer. REPRESENTATIONS, WARRANTIES A franchisor may seek two different sets of representations and warranties: those dealing with “legal” issues such as title, non-infringement and the like, and those dealing with performance characteristics of the software. Generally, vendors attempt to expressly disclaim warranties of merchantability, fitness, title and non-infringement on the basis that the vendor should not be put in the position of being an insurer of the franchisor’s business. Nonetheless, factors such as the size and scope of the project, the leverage of the franchisor and the competition for the work will influence a developer’s willingness to make appropriate representations and warranties. The franchisor should obtain a representation that the software will function in accordance with the agreed functional requirements or specifications. In addition, the franchisor will want to know that the software is free from defects that will affect performance. It is important to note that most vendors will refuse to represent and warrant that software is free from all defects. However, the vendor should be willing to stand behind its work product and warrant that the software is free from defects that will substantially affect performance. In certain instances, franchisors seek to upgrade from existing software due to slow response times. As a result, a franchisor would, when investing in a new software system, want to ensure that its investment is not for naught. Accordingly, the franchisor should bargain for a warranty that the software will not function in an unreasonably slow fashion; i.e., that the software will accept a transmission from and communicate a response within a commercially reasonable time. In addition, a franchisor should insist that the vendor identify the number of transactions that the software is designed to process in a specified period of time. These warranties should comport with the specifications for the system. An additional concern for franchisors is crippling their franchise system by an import of a virus that is distributed to company-owned units and franchised units employing the software. Thus, it is incumbent upon the franchisor to insist upon an anti-virus warranty. While a franchisor will want to obtain an unequivocal warranty that the software does not contain any viruses and the like, at a minimum, the vendor should be willing to warrant that it has used the latest commercially available tools to discern whether the software is afflicted with any viruses. DERIVATIVE WORKS Franchisors must also recognize that their software packages must be able to adapt to the growth and demands of the franchise system. Thus, the franchisor must consider whether it desires to obtain the right to modify the software or to create derivative works. This will not be an issue in cases where the franchisor has title to the software. The franchisor need only select the appropriate vendor for the task. If, however, the franchisor licenses the software, the franchisor should bargain for modification rights at the outset if it thinks that it wants to control the modification process. Of course, should the vendor grant modification rights, the franchisor should be prepared for the vendor to disclaim maintenance and support obligations in the event that the franchisor exercises its modification rights. The purchase of any mission-critical software package is an important step for any franchisor, particularly when the software will be used on a systemwide basis. This article has described certain issues that the franchisor must carefully consider in negotiating the software acquisition agreement. However, there are many other important issues to consider such as the nature and extent of training, which party will be responsible for installation, what acceptance testing procedures will be used, indemnification, limitations of liability and more. Of course, the franchisor should carefully consider whether the vendor has a sufficient track record to undertake a project of the size and scope being contemplated. Finally, the franchisor should perform adequate due diligence to make certain that the vendor is in sound financial shape and should insist, in cases where the software is being licensed, that the source code for the software be placed in escrow so that it may be accessed by the franchisor on the happening of a stated event. Edward J. DeMarco Jr. is a partner in the business and finance department of Ballard Spahr Andrews & Ingersoll (www.ballardspahr.com) and a past chairman of the franchise law committee of the business law section of the Philadelphia Bar Association. 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