Different types of software license agreements
During the due diligence, the legal relationships of the company to be acquired are examined, whereby attention is also paid to existing software license agreements. A distinction can be made between these according to, among other things, the role in which the target company acts, i.e. whether it is the IT provider or the IT user. The target company is the IT provider if it sells the software on the market (1st case). Vice versa, the target company is the IT user if it merely acquires the corresponding software on the market and uses it itself (2nd case). In the 1st case – i.e. if the target company is an IT provider – the review in the due diligence primarily focuses on whether the company has acquired the most extensive rights possible to the software. In addition, the license agreements with the customers are also examined. This software is called the “out-licensed software”. In the 2nd case, where the target company is the IT user of the software licensed from a third party, the software is called the “in-licensed software”.
There are other forms of distinction: In legal terms, for example, a distinction could be made between software purchase and software rental. The difference lies in whether the software is provided for a limited or unlimited period of time in return for payment. If it is for an unlimited period, it is referred to as software purchase. If, on the other hand, the transfer is for a limited period, it is referred to as software rental. Incidentally, the virtual provision of software, for example as “Software-as-a-Service”, also known as SaaS for short, is similar to software rental.
The examination of license agreements in due diligence
When examining a license agreement as part of due diligence, it first has to be categorized under the types of license agreements just mentioned: First of all, it must be reviewed whether the software is in-licensed or out-licensed. If it is out-licensed, it must be clarified who is its owner, or what exactly entitles the target company to license out the software. If the company acts as owner or as distributor, separate contractual relationships probably exist in this respect. In addition, in the case of license agreements, the scope and the consideration of the licensing are of interest. Subsequently, the license agreements should be checked for unusual or surprising provisions. Therefore, it is always advisable to have the due diligence conducted by an experienced lawyer who is able to identify which clauses are unusual for the type of contract presented. When examining license agreements, particular attention should be paid to terms and periods of notice. This provides information on how long the customers or the target company are bound to the license agreements.
Depending on whether the software will be used further after the transaction or not, long terms with long periods of notice or short terms with short periods of notice are favorable. In this respect, the intended future use of the software must always be taken into account. If the purchaser wishes to integrate the target company into an already existing group, he will have to consider the question how to proceed with the respective software, i.e. whether it is to be retained or abandoned. If, for example, the purchaser wishes to use a customer management system throughout the group, the customer management system previously used by the target company will become redundant and must be able to be terminated as quickly as possible. In such a case, long contract terms would delay the integration of the target company into the existing group.
Finally, license agreements should also be examined in the due diligence process to determine whether they contain so-called “change-of-control clauses”. Change-of-control clauses are agreements for the event that the ownership structure of the target company changes. If this occurs, it triggers a specific legal consequence. If such a “change-of-control clause” exists in the license agreement in question, it must be examined whether the planned transaction meets the change-of-control requirements. If not, the clause is irrelevant to the transaction. If, however, the clause is relevant, the threatened legal consequences must be examined. Typical legal consequences are termination rights for the other party, as well as certain notification obligations, if applicable.
Consideration in the SPA
In the SPA, under the heading “Seller Guarantees”, a warranty should be included in which the seller guarantees that the target company has only entered into the license agreements expressly listed in an annex to the SPA. This provides the purchaser with certainty as to the existing license agreements.
Furthermore, the buyer should obtain a guarantee that the license agreements are not terminated and that the respective contractual partners have not yet threatened or announced any termination. If the license agreements were only examined on a random basis in the due diligence, the purchaser could consider having certain minimum terms or maximum notice periods guaranteed. Comparable clauses can often be found in the guarantees in the “Material Agreements” section and are thus already covered where applicable.
With respect to the change-of-control clauses identified above, the buyer might consider having the seller guarantee in the SPA that the license agreements do not contain change-of-control clauses. However, a guarantee only provides protection as long as the purchaser has no positive knowledge of the change-of-control clauses. If in one or more license agreements change-of-control clauses are discovered in the due diligence, it must be determined how important the respective license agreements are for the company. If the license agreements are essential for the business operations, it is recommended to obtain a waiver of the licensor’s right at an early stage. However, since the parties to an M&A transaction have an interest in keeping the transaction secret for as long as possible, agreeing a waiver before signing is often out of the question. In this case, the declaration of the licensor’s waiver must at least be included in the SPA as a closing condition or closing action. A purchase price reduction may also be considered in the event that the waiver cannot be obtained and the licensor declares its termination. In addition, further remedies should be considered, depending on the respective constellation, the interests of the parties and the underlying contractual situation.