Charting a Course in Unknown Waters (Part 2 of 2)
 
January 10, 2001
 

In part 1 of this article, which appeared in the last issue, Mr. Venema described some of the issues he encountered and resolved in assisting a client (Buyer) enter an agreement with a company (Seller) to develop a Web-based, hosted computer network for use by the client’s affiliated doctors. The network, which the agreement refers to as the “System,” features several applications that allow users to complete various routine tasks, and to communicate with each other, more quickly and efficiently than do the current paper-based systems. These tasks include filing patient claims directly with insurance companies, ordering prescription drugs, and requesting and obtaining patient lab reports. The System also provides access, via the Internet, to “content” created by various third parties concerning such things as medical procedures and other protocols.

Trip Insurance (a/k/a Warranties and System Support)

Although Columbus probably had no trip insurance, modern voyagers will not leave port without it. The analogous provision in the agreement is the warranty provision.

Contracts involving intellectual property present issues to consider when drafting the warranty section that are unnecessary for more conventional agreements concerning the sale of goods and services. Moreover, if an agreement involves not only the use of intellectual property, but also the development of intellectual property, the agreement should distinguish between critical failures and others of less importance, which will most assuredly arise.

Following Our Own Course

Intellectual property agreements are inherently about using someone else’s ideas. It is extremely important, therefore, to ensure that the party seeking to license the intellectual property has the requisite authority to do so. The agreement must provide for situations where that authority is challenged by a third party. Our agreement provides that the use of the System will not infringe on the intellectual property of another. It further provides that if an infringement is alleged, Seller will defend the action, as specified in the agreement, and will be responsible for any damages.

Ensuring Arrival at the Destination

Warranties also address whether the software or system performs all of its essential functions. The agreement provides that any deficiencies in the System that are discovered after it has been paid for are addressed using an “Error Correction Procedure,” pursuant to which Seller will use all commercially reasonable means to correct the deficiency. If a “Material Error” remains after exhaustion of the procedure, then Buyer may terminate the agreement and, if desired, purchase the source code (discussed in detail below) and related documentation for a discounted fee. The ability of Buyer to purchase the source code for the System at a discounted price creates a significant incentive for Seller to correct the error.

Because of the critical nature of Buyer’s business, the agreement provides that Seller must respond to breaches of this warranty 24 hours a day, 7 days a week. Nevertheless, not all failures are the same, and so the agreement provides for a different response depending on whether the failure is critical to the operation of the System. Thus, the warranty provision is flexible and the required response depends on the nature and importance of problem at issue.

The duration of the various warranties was heavily negotiated and was affected by the commitments the host made concerning maintenance of the System.

No technology-related agreement can be considered complete without extensive Y2K-related warranties. The warranty and related language in the agreement that is required for Y2K is extensive and does not expire until 2002, in order to ensure that the System has sufficient running time to test it during operation in the 21st century.

Paying for the Trip

It’s no accident that much of the Western Hemisphere speaks Spanish, even though Christopher Columbus was Italian. The gold of the Spanish king and queen had a considerable long-term effect on the impact of Columbus’s voyage.

In drafting the agreement, we recognized that during the development process the most direct and powerful means by which Buyer could influence the process was to withhold payment. Accordingly, the agreement provides that payments are made only when Buyer concludes that specified Milestones have been reached. A small percentage of the total price was paid upon execution of the agreement. Additional payments are due upon completion of preliminary testing, upon training of Buyer’s personnel, upon delivery of documentation, and upon completion of acceptance testing. The final payment is due only after the System is ready for use by all authorized users.

Obviously, as is the case with any agreement, the more a buyer’s obligation to pay is delayed, the more influence the buyer will continue to have over the seller.

The Completed Map

By the time he returned from his first voyage to the New World, Columbus had collected the information necessary to make subsequent trips much easier and safer, even though he still thought he had found an alternate route to India. He understood the value of this information and protected it accordingly.

Information on How to Get There

When the System is complete there will likewise be a considerable amount of information that describes how the System operates. Although it may be somewhat inaccurate and incomplete, this information is nonetheless extremely valuable. Such items include: source code, object code and other documentation. A program’s “source code” is a written description of the program written in normal text, while the “object code” is a manifestation of the program that only a computer can read. Users typically have access to only the object code, because with the source code an informed person can recreate or modify the software without the help of the original developer. The “other documentation” is information that would be helpful to a person attempting to use the source code, including technical information and information concerning other software that is included as part of the software, such as contact information with the developers of that included software.

Since Buyer will be so dependent on the proper functioning of the System, the agreement had to provide for the possibility that Seller might become unable to perform, because of incompetency, insolvency, or some other reason. If Seller were to go bankrupt or, for whatever reason, were to refuse to cooperate or to become unable to cooperate, then Buyer may need or want to modify or repair the System.

Initially, like Columbus with his charts, Seller was unwilling either to reveal all of the information about the System, or to create a situation where the information might be revealed. Seller felt that the source code, in particular, was a valuable trade secret, which Seller did not want to disclose. Buyer, on the other hand, persuaded Seller that it needed to have at least access to the source code in order to protect the investment Buyer was making in the development of the System.

The compromise the parties reached is the usual one: we agreed that Seller would escrow the source code with a third party who would agree to hold it unless certain specified events occur, such as the insolvency or bankruptcy of Seller, or Seller’s material breach of its support obligation. If one or more of the specified events occurs, then the third-party escrow agent would provide Buyer with the escrowed information. In this way, Seller was able to protect its valuable information, while Buyer is able to get the information if its necessary.

Information About the Trip

The applications that are part of the System will generate a tremendous amount of useful information about patients, their prescription drugs, and their medical insurance, among other things. This information is a valuable asset that will be created by the Registered Users and Subscribers, as they use the System that was developed by Seller and paid for by Buyer. Accordingly, the agreement needed to address the rights of the various parties to this information. Because this agreement involved medical treatment and patients, the parties also had to consider a variety of federal and state laws that affect what information may be released to third parties. In any agreement, however, the parties should provide for how the accumulated database can be profitably shared and should, most assuredly, manage this valuable intangible asset carefully.

Conclusion

Businesses increasingly find that their business transactions are no longer single sales, but ongoing, mutually beneficial, cooperative relationships. As companies increasingly find themselves in these new and unknown waters, it becomes necessary to find the courage of Columbus, to embark into the unknown with vision and creativity.