Geoffrey G. Gussis, Esq. is the author of Website Development Agreements: A Guide to Planning and Drafting , which was recently reprinted in Bowne Publishing’s “The Best in Ecommerce Law”. Geoffrey represents high-tech companies on a variety of matters and can be reached at [email protected] or at (888) 831-0197.
Introduction
In this economic environment, most web developers would do just about anything for a long-term website development relationship with a stable Fortune 500 company. The business model shakeout in the online arena combined with the general economic deterioration of the global economy has left the web development industry scrambling for the few high-tech projects that are available. Unfortunately, purchasers are keenly aware that the balance of power has shifted and that their financial resources can provide them with significant bargaining power on price as well as in structuring the legal terms that govern the development relationship. The key for web developers in this market is to aggressively close deals while ensuring that their development agreements provide adequate legal protection and a minimum of liability exposure. With a flexible development agreement, web developers can increase the number of deals consummated while addressing purchaser concerns in a timely fashion. This article discusses some of the key sticking points that often arise in negotiations between purchasers and developers.
At the outset, website developers should make sure that they are organized in an entity that can minimize liability exposure. Web developers often choose corporations or limited liability companies, which can help limit liability. If a developer is signing an agreement in a personal capacity a client may be able to sue the developer personally if the deal goes bad. While forming limited liability entities is a relatively simple procedure in most states, developers should make sure that they “observe the formalities” of the entity that they form. These formalities include holding meetings of directors or members, observing annual meetings and bylaws and keeping the finances of the principals separate from those of the limited liability entity.
Website developers should also make sure that they have a handle on their intellectual property assets. First, developers should make sure that they own all of the intellectual property that they intend to integrate into a development project or have obtained the right to sub-license it to clients. Although much of the intellectual property (primarily copyrights in the web development scenario) will be created during the relationship, web developers often reuse significant portions of code in each project.
Web developers should ensure that they have secured their relationships with any subcontractors that may work on development projects. These subcontractors often contribute intellectual property, and clients will want to obtain these rights as well. Failure to address preexisting intellectual property issues will result in potential claims by purchasers and developers for breach of contract and infringement. Ideally, website developers will have standard agreements in place for clients and subcontractors prior to entering into negotiations. These standard forms can accelerate the business deal and avoid having to work with a client’s standard agreement or worse, with the purchaser’s attorney.
There is nothing more important to web developers than prompt payment for services rendered. Many purchasers will want to tie payment to vague or arbitrary standards. Web developers should avoid these provisions at all costs. Payment should not be left to the client’s discretion or conditioned upon the completion of arbitrary deadlines. Instead, web developers should insist on payment in stages based on clearly defined acceptance testing procedures. Once a web developer has delivered a piece of the project and it conforms to the agreement’s specifications (see below), the website developer should receive partial payment. This process should continue with the final payment being made after the project is fully completed. Most sophisticated developers are familiar with this type of payment structure. Web developers should also negotiate for an initial payment prior to commencing work to provide some economic security and commit the purchaser to the successful completion of the deal.
Limit Exposure
Web developers should ensure that their agreement effectively limits their liability exposure. This can be achieved through a combination of contractual limitations that purchasers of web development services often leave out of their standard agreements. Most purchasers, however, will accept provisions that limit liability as they are common in the industry. A typical development agreement should include not only a limit on the total dollar amount of liability (usually the total cost of the services under the development agreement), but also a limitation on the specific damages that a purchaser of services can recover. In addition, web developers may want to consider a contractual provision that requires that the purchaser exercise any legal remedies within a certain number of years after the development is completed. This will provide extra protection to the developer and also ensure that any issues are brought to light as quickly as possible so that they can be addressed in a timely fashion.
Warranties for web developers follow a simple rule: less warranties mean more developer protection. While savvy purchasers of web development services will demand certain warranties, web developers can often channel and limit these warranties to ensure that they are not unnecessarily exposed to vague standards and specifications. In addition to disclaiming the implied warranties, such as the warranty of merchantability and the warranty of fitness for a particular purpose, developers should also put strict limits on performance warranties. Some purchasers ask for an absolute warranty that the development deliverables will “conform to specifications” that are included in an attached exhibit. Developers should make sure that the exhibit clearly shows the hardware/software configuration that the developer will use to create the environment. The developer should limit performance warranties so that they apply only to the deliverables as they were delivered. Finally, if applicable, the developer should insert provisions to nullify the warranties should the purchaser modify the deliverables (except as provided for in the agreement) or use the deliverables outside of the scope of the specifications.
Most purchasers of web development services will want at least some level of indemnification in their contract. Indemnification provisions protect parties against potential third party claims that may arise out during the performance of a contractual relationship. The intellectual property indemnification is one of the most requested in the high-tech context. Basically, purchasers want to make sure that the will be made whole if they are sued based on deliverables they receive. For example, a purchaser will not want to deal with a third party who later claims that the software the purchaser is using infringes on their rights. Provided that a developer has strong controls over its intellectual property (see Section 1 above), this indemnification should not be a problem. Be forewarned that savvy purchasers will also want the indemnification obligation carved out of the limitation of liability provisions. The rationale behind this normally acceptable demand is that a purchaser should not be limited in recovering from the developer because of the developer’s infringing use of the intellectual property of another. Purchasers often ask for broader indemnities based on an agreement’s extensive warranty section, but developers should steer clear of both broad warranties and indemnification provisions to limit liability exposure.
Give Rights to the Purchaser But Keep What You Need
Section 1 covered preexisting intellectual property, but development relationships typically result in the creation of intellectual property. Typically, the development agreement includes a provision requiring that the developer assign all of their rights in the development deliverables to the purchaser. Often this is coupled with “work made for hire” provisions. Unless the developer seeks to retain ownership and license the deliverables, the foregoing provisions are normally acceptable to developers. Many developers, however, forget to retain rights to reusable code that is developed through the relationship. In many cases, purchasers will not have a problem licensing this code back to the developer with the right to sub-license it in future projects. However, some purchasers do not want any of the intellectual property used again, mainly out of a concern that a developer will sell the same system to a competitor. These issues should be distinguished from the reusable code that the developer maintains from the inception of the relationship – the preexisting intellectual property discussed in Section 1.
Specify, Specify, Specify
In many development relationships, a development company responds to a Request for Proposals (RFP for short) and provides detailed specifications and cost estimates as part of bidding on a project. These documents are often incorporated and referred to from the development agreement, and intertwined with the agreement’s warranty provisions (see Section 4). While a developer may be tempted to provide scant detail in a specifications exhibit, this strategy often backfires in actual practice. Purchasers who receive defective deliverables often turn around and point the finger at the developer, accusing them of creating a system that does meet their expectations. A better solution is for the developer and the purchaser to clearly delineate the scope of the system with particularity. If the system is supposed to operate on a specific hardware and software platform, the specifications should clearly indicate the combination. The drafting of a detailed specifications exhibit often uncovers areas that the parties did not anticipate, and can reduce the level of uncertainty involved significantly.
Get Credit
Developers often want to use a purchaser’s corporate name and trademarks to generate more business. To be safe, negotiate for a provision in advance to secure rights to use trademarks and corporate names solely for promotional purposes and within a range of specified uses (on the developer’s website, in press releases, etc.). Purchasers may want to approve any promotional materials in advance and developers should be amenable to negotiating such a provision.
Consider Insurance
In the early days of the Internet boom, insurance companies were largely oblivious to the Internet and the novel legal and liability issues it presented. Today, the situation is completely different. Major insurance companies now write policies that protect against losses relating to online operations, including intellectual property infringement. In addition, developers should consider errors and omissions policies. While insurance may be expensive, it often gives developers more leeway in agreeing to certain warranties and indemnification provisions.
Keep Records and Put It in Writing
After the euphoria of closing a big deal wears off, parties often dispense with formalities. In addition to securing a copy of the development agreement and storing it in a safe place, developers should make sure that they keep records of important client contacts. Comprehensive development agreements have detailed provisions which require that notices of defaults be sent to specific parties. These provisions should be followed and a paper trail should be maintained by a project manager. This will ensure that the developer will not lose track of important issues, and also can assist in dispute resolution should the relationship go sour.
These are just some of the important issues that developers should consider when entering into contractual relationships. Developers can gain a significant competitive advantage by dealing with them in advance and streamlining the negotiation process with the purchasers of their services.