A software audit is a right of review often sought by licensors. A software audit typically entails the licensor hiring a third-party auditor whose job is to undertake an independent examination of the licensee’s compliance with the terms of the license. Software audits have become prevalent, so much so that companies offering “audit management software” have proliferated in recent years. This is likely a response to market indicators showing that the software audit industry will grow demonstrably by 2025.
Unsurprisingly, software audits are more frequently becoming a point of contention in litigation throughout the emerging technology space. For instance, in one of the largest patent disputes this decade, a California court was asked to order a software audit to determine how the licensee/patentee was using the software’s source code. The subject of this column is another recent case involving a dispute over a licensee’s refusal to allow a software audit which was designed to determine the licensee’s compliance with its use of the license keys. See Master Tax LLC v. Ultimate Software Group Inc., No. 2:18-cv-01463-DLR (D. Ariz. Aug. 31, 2018).
The licensor requested provisional relief requiring the licensee to both preserve all materials that could be subject to a software audit, and directing the licensee to submit to an audit within a matter of weeks. The licensor prevailed on all aspects of its provisional relief application, which is a testament to the importance of the software audit right, particularly as the downside risk often contemplates the licensee violating the terms of the license right before it concludes, and precluding the licensor from confirming such violations occurred.
Plaintiff Master Tax LLC develops and licenses software that assists employers in paying and filing multi-jurisdictional taxes (the software). In 2007, Master Tax and Defendant Ultimate Software Group (Ultimate) executed a license (the license) wherein Master Tax granted Ultimate a non-exclusive license to two copies of the software. The license also included manuals and user assistance materials for use in administering payroll tax figures for Ultimate’s customers.
Section 12 of the license permitted Master Tax to, at its own expenses, perform an annual audit of the “product,” which is defined therein as the software, jointly with the “media, the user guides and manuals for use with the software, and all related MasterTax [sic] materials, now existing or thereafter created[.]”
The license ended on May 31, 2018. Anticipating the termination, Ultimate started requesting new “license keys” (alphanumeric codes required to operate the software) for fewer clients—this resulted in a concomitant reduction in the license fee. However, in April 2018, Master Tax noticed that Ultimate reverted to utilizing a previous license key which had the capacity to process more data for more Ultimate clients. Consequently, Ultimate was paying a lower fee relative to the customers it was able to serve with the older license key.
Master Tax requested an audit, which Ultimate refused. Master Tax filed the instant action on May 14, 2018, alleging that Ultimate breached Section 12 of the license by refusing to permit an audit. Master Tax then filed for a temporary restraining order (TRO) seeking the preservation of certain Ultimate documents and other electronically stored information relevant to the audit, and separately for a preliminary injunction requiring Ultimate to allow an audit.
The parties failed to resolve the dispute informally, and the court issued a preliminary injunction compelling Ultimate to preserve materials that could be pertinent to the audit. The parties again failed to resolve the dispute, requiring the court to intervene and issue another order on the TRO and preliminary injunction.
To obtain a preliminary injunction, Master Tax had to establish: (1) it was likely to succeed on the merits; (2) suffer irreparable harm absent injunctive relief; (3) the balance of equities tips in the applicant’s favor; and (4) an injunction was in the public interest.
The court found that Master Tax had satisfied the four-factor test and granted the preliminary injunction against Ultimate, thereby requiring it to submit to an audit of the software within 14 days. First, the court held that Master Tax was likely to succeed on its breach of contract claim because the license allowed it to conduct an audit without providing a justification, and that the only limitations imposed on Master Tax were reasonable notice and to pay the expenses of the audit.
Moreover, the court construed the definition of product to encompass the materials sought by Master Tax. Specifically, the definition covered “all related MasterTax materials, now existing or hereinafter created[.]” Consequently, Master Tax was entitled to materials such as scripts, logs and reports that could reveal the scope and nature of Ultimate’s use of the old and new license keys. In addition, the court rejected Ultimate’s argument that confidential information could be “swept up” by audit, as the relevant provision of the license did not limit the information culled from an audit to non-confidential information.
Second, the court held that Master Tax would suffer irreparable harm inasmuch as its suspicions that Ultimate had either misused the software or misappropriated its confidential information could not yet be confirmed so as to allow Master Tax to file a formal complaint against Ultimate that sought more than just provisional relief. Given that the parties had fairly negotiated an audit provision into the license, Master Tax made sure that it had redress in the event that it suspected Ultimate had been misusing the software.
This redress would be mooted in the absence of an injunction, as, while the previous order required preservation of the materials, it did not in turn confer on Master Tax a right to monitor compliance with said order. This was needed as a necessary component of any fair implementation of the audit provision in the license, and therefore was subject to redress via injunctive relief.
Third, the court held that the balance of the equities tilted in favor of Master Tax, as Ultimate had likely breached the license. Finally, it held that the public interest “would be served by holding parties accountable to their contractual obligations.” The court gave Master Tax a week to submit a revised preliminary injunction order that covered its audit rights.
After Ultimate objected to Master Tax’s proposed order, Ultimate also appealed the order to the U.S. Court of Appeals for the Ninth Circuit and moved to stay its enforcement pending the resolution of the appeal. The District Court granted the motion to stay on grounds that Master Tax could possibly retain its audit right even absent the order, as the first preliminary injunction order ordered Ultimate to preserve the materials for audit, which by extension preserved Master Tax’s audit right. On Dec. 5, the Ninth Circuit heard oral argument.
Richard Raysman is a partner at Holland & Knight and Peter Brown is the principal at Peter Brown & Associates. They are co-authors of “Computer Law: Drafting and Negotiating Forms and Agreements” (Law Journal Press).