Sublicensing considerations in software contracts

Sublicensing has become increasingly prevalent against the backdrop featuring a diverse IPR spectrum that subsists in a licensed work, a variety of business models and use cases (internal use, production/testing environment, (non)commercial use, etc.), complex organisational structures of the involved entities, multiple proprietary interests, geographical scope and so on. Sublicensing may carry the risk of diluting the value of the licensed work, but it also has the  potential to  increase the licensor’s return. Skilful drafting of head licences and sublicences is key in avoiding potential pitfalls.

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Licensor’s considerations

The licensor is usually the primary originator (not necessarily the owner!) of the licensed/sublicensed work. The Licensor’s major concerns relate to safeguarding the proprietary and commercial interests stemming from the work,  including adequate compensation and control of the use of work. These concerns are usually addressed either by a sublicensing approval mechanism or pre-emptive sublicensing restrictions embedded in a head licence.

Approval may problematic because: (i) it involves carrying out due diligence and vetting the respective sublicensee, which may not always be feasible; and (ii) it shifts the burden of compliance monitoring from licensee to the licensor; and (iii) unless qualified or conditioned, it effectively “signs off” on the sublicensing arrangement, which may in certain circumstances mean a waiver of a right to dispute its validity or scope.

Pre-emptive sublicensing restrictions are more common and may include such provisions as: 

(i) A requirement of a written sublicence,  whose terms are consistent with the original licence (licensor may require a copy of  each sublicensing agreement,  or even include a model sublicence agreement within the head licence); 

(ii) The Licensee’s full liability for the acts or omissions of a sublicensee or, alternatively, licensee’s joint and severable liability with its sublicensees for any breach of the licence. The licensee should be required to furnish the licensor with notice if it becomes aware that the sublicensee has breached the sublicence agreement; 

(iii) An acknowledgement by the licensee that a  breach of the sublicence is treated as a breach of a licence.  The licence agreement may include the licensor’s right to enforce a sublicence (see also Contracts (Rights of Third Parties) Act 1999, which creates exceptions to the usual rules on contract privity and licensor can rely on such statutory rules to impose obligations directly against sublicensee); 

(iv) Audit rights for the licensor, which may be the licensor’s only way to verify that the sublicensed work is not misused and/or infringed and that royalties are adequately calculated; 

(v) Regarding the effect of sublicence termination: (a) Does the licensed work have to be returned or destroyed at termination?; (b) When the original licence terminates, does the sublicence terminate in tandem or does it become a direct licence (see VLM Holdings, where the High Court held that the sublicence survived the termination of the head licence, causing the licensor to be in breach of a separate licence of the same software that it had granted to a third party on an exclusive basis).

It is in the licensor’s interest to ensure that the sublicence is not granted to a competitor. Licensor may want to place express restrictions on the third parties that may become sublicensees, such as a limitation to only allow it for parties having a direct contractual relationship with the licensee, only to affiliates of the licensee, only to a specified number of third parties or only to parties preapproved by the licensor. Another approach is to restrict sublicensing by listing types of companies, or even specific entities, to which no sublicence can be granted.

The licensor’s compensation may take different forms and methods: (i) equally shared royalties; (ii) an upfront lump sum;  or (iii) per each sublicensed copy. Special attention must be given to those arrangements where the licensee receives a cross-licence from its sublicensee.

The licensor should always seek the availability of equitable remedies in both licensing and sublicensing agreements, because the infringement of digital works can proliferate virtually  instantly and on a very large scale. If the parties decide to include an arbitration clause, the licensor should ensure that an exception is included to allow for injunctive relief.

Licensee/sublicensor

The licensee/sublicensor wears both licensor and licensee hats being the middleman, having a direct contractual relationship with both the licensor and sublicensee. 

First, the  licensee has to consider whether the agreement with the licensor needs to contain a right to sublicense.  If so, it is important to expressly state such right, because implied sublicensing might not be possible or at least uncertain, depending on a jurisdiction and licence exclusivity. Blanket prohibitions on sublicensing can be particularly problematic where the licensor or licensee is part of a group of companies. 

As explained above, in most scenarios the licensor will want to limit and restrict sublicensing or condition it on an express, prior written approval. If the licensor’s approval to sublicensing is mandatory, licensee should require that such consent can be withheld only on a reasonable basis and not arbitrarily. 

If the licensor chooses to impose express restrictions and limitations on sublicensing, a licensee, in turn, should ensure that these limitations are clear, specific and broad enough to allow for all intended sublicensing scenarios. The licensing clause (and sublicensing permission) should be explicit regarding licence exclusivity, geographical application, term and licensed rights, including: 

- The right to make a reasonable number of copies to fully exercise all rights under the licence agreement (including for backup and archival purposes), adapt, customize, configure, extend, localize, translate and/or enhance; 

- Permit licensee’s third party contractors, agents and outsourcers to install, use and access the work (directly or remotely); 

- Move or transfer software licences from any device or platform to any other device or platform; 

- Install and use the licensed software for development, testing, disaster recovery and high availability purposes and, as needed, to migrate to new versions.

Further, the licensee should seek the following: (i) A warranty (coupled with an indemnification) from the licensor that the licensed product does not infringe or misappropriate the IPR of any third party and does not include any unauthorised materials or information; (ii) that the licensor has all the necessary rights to license the work and to allow subsequent sublicensing thereof (including the right to grant further sublicences, if applicable);  and (iii) that no claim is pending or threatened against the licensor or its suppliers alleging that the licensed product infringes the IPR of any third party.

Sublicensee’s perspective

The sublicensee’s primary concern is to ensure the full enjoyment of the licensed product without incurring any liability arising from the acts of the upstream licensors. Understanding what obligations are being imposed within the licensing chains with multiple tiers tends to be a complicated endeavour.

In a perfect world, the sublicensee should seek a warranty from the licensee/sublicensor that no IP claims are pending and the licensee/sublicensor has all necessary rights to grant a sublicense for the use as anticipated in the sublicensing agreement. If there is a claim, the sublicensor should be required to indemnify for any claims arising from such technology, even if sublicensor is not the one who developed it and undertook no due diligence.  It is important for the end user, because there may be no other recourse due to absence of privity with the original licence.

However, if the middleman is a reseller/paying agent/mere conduit, the sublicensee may not have any leverage to negotiate sublicensing terms, which are usually simply passed down from the original licensor. But, at the very least, sublicensee should seek to specify that its rights are not contingent on the  licensor’s receipt of payment from the reseller and that payment in full to the reseller is deemed to be payment in full to the licensor.

The sublicensee may want to consider entering into a stand-by licence with the licensor pursuant to which upon a termination of a head licence, sublicensee would receive a direct licence from the licensor. Sublicensor should be asked to contractually commit to good faith cooperation with sublicensee’s effort to obtain stand-by licence agreement.

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