White SW Computer Law Intellectual Property, Information Technology & Telecommunications Newsletter - June 2006

When a software developer is engaged to build a custom program, or enhancements to an existing program, the customer should ensure that their software development agreement includes provisions allowing it to have access to the source code.

The intellectual property rights in a software program (including source code) are not necessarily always owned by or available to be used by the customer, despite the fact that they have paid a software developer to build it on their behalf.

Without access to the source code, a customer will be hampered in its efforts to maintain, or further develop the program, which may in turn impact on its ability to deliver a service to its clients. Maintenance is particularly important in the event that security defects are discovered in the software or underlying operating system, which is not an uncommon occurence.

In addition, if a software developer owns the intellectual property rights in the program, it may be able to sell or licence the program to third parties, which could include the customer’s competitors.

A recent matter¹⁾ heard by the New South Wales Supreme Court centered on a Software Development and Support Agreement (“the Agreement”) that had been terminated by the software developer. The customer and the developer were in dispute in relation to the ownership of the intellectual property rights in various programs developed for the customer and whether the developer was under an obligation to supply the source code for the programs to the customer.

Legal proceedings were commenced by the customer to establish its alleged ownership of the copyright in the computer programs developed for it under the Agreement.

The customer was a supplier of management products to the hospitality industry, including computer software programs that integrate data from liquid measuring devices with point of sale, stock control and accounting systems.

The developer had developed a new release of an earlier version of the customer’s software (written by previous software developers) and had maintained the software over a number of years, including error correction, customisations and enhancements.

The developer had commenced development of a further new release of the software, but this new release had not yet been completed.

The Agreement did not detail which parts, if any, of the source code were to be made available to the customer. The Agreement also did not contain a requirement that the parties enter into an escrow agreement, requiring the source code to be lodged with an escrow agent.

Under an escrow agreement, a customer may gain access to the source code in the circumstances agreed to by both parties. The developer has the security of knowing the source code will not be otherwise released to the customer. The customer also benefits because it knows that if the specified circumstances occur, commonly this would be the developer becoming insolvent, the developer cannot withhold or delay access to the source code.

The Agreement provided for an initial term followed by successive periods of 12 months, unless either party provided written notice to the contrary. The software developer gave notice in November 2006 terminating the agreement from January 2007.

As a preliminary step, before the matter proceeded to trial, the customer made an interlocutory application to the Court requesting the Court to order that the developer provide it with a copy of the source code for a number of specified programs so that it could maintain same. The developer opposed the request.

Before the Court would make such orders, it had to consider:

1. Did the customer’s claims raise a serious matter to be tried?
2. Did the customer’s claims have a reasonable prospect of success at trial?
3. Where the balance of convenience falls. To decide this, the Court has to consider what effects the granting of an injunction will have on both parties, and in particular whether to grant one would cause hardship to the developer or to refuse one would cause hardship to the customer.

It is generally more difficult to obtain orders that go further than the preservation of the status quo by requiring a party to take some new positive step or undo what he has done in the past. If such orders are wrongly granted the party who receives the initial benefit of such orders ordinarily has to pay damages to the party against whom such orders were granted. Those damages can be very substantial.

In this case, the Court decided that the customer did have a serious matter to be tried, with a reasonable prospect of success. It also considered that the balance of convenience favoured the customer and ordered that source code for both the old (VB6) and the new software (C++) be delivered up to the customer. Of particular relevance to this issue was the Developer’s offer to license the source code to the customer for the sum of approximately $190,000 and that the customer offered director’s guarantees in the sum of $190,000 to cover any damages that might be suffered by the release of the source code to it.

In deciding this, the Court formed the view that the customer was likely to suffer damages because without access to the source code, the customer:

1. could not provide clear advice to its clients as to the development pathway and timetable for release of the new version of the software
2. could not provide support, maintenance, customisation and error correction to its clients to a level which is commercially expected.
3. could be expected to suffer significant direct losses, the continuing loss of clients and substantial damage to its reputation.

The matter has not yet been decided by the Court, but this interlocutory proceeding illustrates the potential expense and inconvenience of litigation which can arise without clearly defined access to source code either in an agreement or through an escrow arrangement.

When considering a disaster plan for your business, one factor that you should consider is how your business could be affected if one of your suppliers terminates an agreement, or otherwise ceases supply and how well your agreements have been drafted to allow you to trade on uninterrupted (including access to all the necessary source code)