Taft Chicago partner Marcus Harris will be a featured speaker for Pemeco Consulting’s webinar, “SaaS Contract Negotiations: A Winning Playbook,” on April 27. The webinar will provide insights on the typical negotiation cycle, key contract terms, how to build a strong bargaining position, and how to master negotiation strategies. 

For more information or to register, click here.

Harris has established one of the country’s leading practices devoted to drafting and negotiating Enterprise Software related license, implementation, and SaaS agreements, as well as litigating failed software implementations in courts and before arbitration panels across the country. He is one of the foremost attorneys in the country representing government entities, distributors, and manufacturers in recovering damages arising from failed Enterprise Resource Planning (ERP) software implementations.

Section 365(n) of the United States Bankruptcy Code (11 U.S.C. Title 11) protects the rights of intellectual property (IP) non-debtor licensees.  Section 365 of the Bankruptcy Code allows a debtor –in-possession, or a trustee (e.g., a software vendor) to: (a) assume, (b) assign, or (c) reject certain executory contracts – which would typically include software licenses.  A debtor in possession’s decision to assume, assign, or reject an executory contract is subject to court approval, certain deadlines and other requirements detain Section 365 of the Bankruptcy Code.  Section 365(n) is a carve-out to that broad right that allows a non-debtor counterparty (e.g., a licensee in a software license) the right to either accept the rejection of the license or continue performing under the contract for the duration of the term of that license. 

If the software vendor assumes a contract despite the bankruptcy, both parties can continue to perform their obligations as if nothing had happened.  If the software vendor assigns a contract, the assignee will perform the software vendor’s obligations under the license.  However, if the software vendor rejects the license, the licensee can either accept the rejection or retain its contracted-for rights and continue to use the software for the remainder of the term of the contract.

However, in the context of a software license, the licensee may not be able to continue to use the software without access to the source code and without the assistance of the licensor. Given the unique nature of software licensing agreements, licensees must assess the risks of a vendor going bankrupt, understand the rights and remedies afforded under 365(n), and implement strategies for gaining access to source code to continue to maintain the software. 

Key Points in Drafting Software License Agreements:

  • License Should Be Explicitly Subject to 365(n): The software license agreement needs to include language that it is subject to Section 365(n) of the Bankruptcy Code.  While not dispositive, explicit language makes the intent of the parties clear.
  • Source Code Escrow: Because licensees only retain rights that exist at the time of the bankruptcy, licensees need to make sure that the software license agreement includes the right to access source code and any associated support and maintenance rights to use that source code.  Robust source code escrow agreements and carefully drafted escrow provisions are critical to retaining maximum flexibility and use of the software on a going forward basis – even if the software vendor goes bankrupt.  Having continued access to the software, but no means to maintain or update it, does little good.
  • Separate Licensee Fees from Other Fees:  License agreements often contain payment obligations for (among other things) support, professional services, software development, maintenance, and customizations that are not associated with the license grant.  If these fees are bundled together, a licensee may be obligated to continue to pay fees for services not provided – just to continue to access and use the software.  Delineating licensee fees from other fees minimizes this risk.

Carefully drafting license agreements to account for the potential of a software vendor bankruptcy is critical to achieving maximum flexibility in using licensed software and minimizing business disruption.

Join Taft partner Marcus Harris and associate Nick Brankle for a complimentary webinar on April 20, 2023, at 12:30 PM EST / 11:30 AM CST. Harris and Brankle will provide tips to avoid a digital transformation relationship trainwreck. This includes how to manage risk, spot vendor red flags, avoid litigation, and negotiate software contracts. 

This webinar is pending approval for 1 hour of CLE credit in the following states: Indiana, Illinois, Kentucky, Minnesota, and Ohio. 

Register here.

ERP software continues evolving, and digital transformation remains as relevant as ever for modern commercial enterprises. Keeping up-to-date is essential for your business. Post-COVID, there have been non-stop developments in ERP software trends, pushing IT leaders to reprioritize constantly. Here is a breakdown of the latest ERP trends we expect to see in 2023:

  • Cloud ERP
    • Upon initial thought, cloud may not be the first cutting-edge trend individuals think of when looking forward to 2023. Companies continue to move to the cloud due to its perceived flexibility, lower cost, and supposed ease of implementation. The cloud allows integration, composability, and customization, allowing businesses to scale as needed. Cloud ERPs also help lay the foundation for a broader transformation strategy.
  • Digital Transformation
    • Digital technology is now frequently used to improve and facilitate daily operations. Digital technology can help an organization improve competitiveness, increase employee productivity, boost revenue, and improve communication and overall customer service. In addition, AI tech and advanced analytics are becoming key considerations in digital transformation. Artificial intelligence capabilities are embedded into ERP systems to help with the demand and need for personalization. Many ERP vendors now offer machine learning capabilities within their ERP software.
  • Personalization
    • ERP platforms now offer “low-code” analytics that businesses can use for easier customization and configuration. ERP software vendors now provide products tailored to the specific needs of organizations. In the past, complex scripting languages and difficulties in software development made it costly and time-consuming to provide true customization. The integration of AI-based user interfaces like chatbots that assist with customer information stored in the ERP platform are becoming more common.
  • Mobile ERP
    • 2022 was the year of significant strides in mobile support of cloud-based ERP systems. That trend will continue into 2023. Businesses will continue using fully integrated cloud-based ERP systems, allowing employees to access real-time documentation from remote locations on mobile devices.

As organizations continue acknowledging and appreciating the new wave of ERP trends, flexibility and adaptability are crucial. While mainstream cloud adoption will continue, we expect ongoing legal issues with cloud contracts and digital transformations. To compete in today’s marketplace, organizations should continue to ensure their ERP software takes advantage of cutting-edge functionality and personalization.

With so many companies switching to a cloud solution, it is difficult to imagine it any other way than good. However, that is far from the truth.

Cloud ERP is unquestionably great for vendors. It shortens the sales cycles, decreases contract negotiations, and above all increases software vendor profits. For vendors it results in a consistent revenue stream. Because of the perpetual nature of cloud payments, the cost of cloud solutions for customers over the long term is much higher than traditional on-premise solutions – and the profits for vendors can be exponentially higher.

For customers, the ease of implementation, lower support costs, and the reduced need for IT resources are all valid selling points. But the reality is that the cloud is overhyped, and has substantive risks and disadvantages. While the cloud has been hyped as “next generation” and “best practice,” there are a number of traps awaiting the unwary or the rushed.

Most ERP software packages being sold as cloud platforms were not designed as native cloud platforms, and they are not ready for “prime time.” In the rush to grab recurring revenue and push the cloud’s advantages, many software companies reverse-engineered their products for cloud adoption to get on the profit bandwagon. The practical effect is that while you may be gaining some more advanced technologies in the cloud,  you may be giving up sophisticated functionality that was stronger in your on premise environment. You also may be stuck with decreased functionality because of the inability to modify or customize a cloud solution.

Many ERP vendors exert enormous pressure on their customers to migrate to the cloud, even if doing so might not be in the customer’s best interest. Oracle, for example, notoriously provided sales reps with higher commissions to sell cloud solutions over on-premise solutions in an effort to get customers to migrate.

It is extremely important not to get caught up in the hype about cloud migration. Despite what a sales team or account executive will tell you, it’s not an appropriate solution for every ERP user.

  • Don’t underestimate the costs. There are both hard and soft costs in migrating to the cloud. The hard costs are obvious, although we are seeing clients underestimate the downstream expense. The soft costs are more difficult because they involve a change management strategy that could take a year or more to roll-out depending on the size of the organization and the complexity of its ERP system.
  • Specify security responsibilities in the contract. Since the user will not be operating or controlling the cloud infrastructure, the contract must specify in great detail the obligations and responsibilities of each party to maintain the security of the data being stored. It’s one thing if a user’s employee forgets their tablet with access to your ERP system on a bus; it’s another thing entirely if the cloud files are breached due to lax protections or security by the software vendor. The provider must ensure the safety of the data, protect it from being corrupted, hacked, or otherwise accessed without authorization, and have experts on hand to react immediately if something goes wrong.
  • Ensure there is an out. It is vital to be able to step away from the contract when a problem appears and cannot be resolved to your satisfaction. Another deal breaker should be contract language that fails to protect against cost overruns and completion delays – all too common with ERP.

The bottom line is that the cloud offers many advantages, but it is not a magic potion. You are often giving up robust customized functionality for more generalized but sophisticated technology – and paying more for it over time. Understand what you are getting into, and make sure you can get out of it with minimal business disruption and cost.

From modernizing business processes, accelerating workflows, and increased profitability, there are plenty of upsides to an ERP software implementation or full scale digital transformation. However, there are many things that can go wrong during and after the implementation process that can result in an implementation train wreck. In the cases we litigate on behalf of ERP customers victimized by software failures, the reason for the failure almost always lies squarely with the ERP vendor or integrator.

Failure can take a multitude of forms, from not realizing expected business benefits, blown budgets, extended timelines, and the failure of deliverables to conform to agreed upon specifications.  At the other end of the spectrum are production stoppages, massive loss of revenue and even business failure.  The most common reasons we see for failed software implementations and digital transformations include the following:

  • The ERP Vendor Oversells the Software: It is common for ERP vendors to overpromise and under deliver the ERP software’s functionality and exaggerate the software’s fit for a customer’s business needs. Despite a customer’s best efforts to evaluate and select an ERP system, ERP vendors often engage in puffery and misrepresentations to meet sales quotas. When this happens, customers are often so far into an implementation project they feel compelled to pay for expensive customizations to try to save a software solution that is riddled with extensive gaps in functionality.
  • The Customer is Provided With an Unrealistic Budget or Timeline: In order to close a deal, ERP vendors often grossly underestimate the cost of the implementation or the time it will take to get to “go-live.” This results in missed deadlines and the customer paying more to complete the implementation than is necessary.
  • Inadequate Project Management: ERP vendors often take shortcuts on project management or fail to devote adequate project management resources to a project because of resource constraints. This results in part-time project management or remote project management that is rarely successful.
  • Failure to Sufficiently Test the Software: The lack of adequate ERP vendor project management resources can lead the ERP vendor to take shortcuts on critical project management tasks like conducting proper testing and dry-runs prior to go-live. Going live in a production environment with untested or under tested software can have disastrous results.
  • Inadequate User Training: ERP vendors often fail to properly train users in how to use the software and fail to train users using real data and real transactions. Without proper training, users are ill-equipped to use the software in a production environment.
  • Inadequate Vendor Resources: ERP vendors always commit to providing a seasoned team of ERP consultants with deep industry experience. The reality can be very different. We often see ERP vendors assign consulting neophytes to projects that not only lack industry experience but are unfamiliar with the software product being implemented. There is often a revolving door of consultants on a project with each new person requiring redundant training to get up to speed on the implementation project. Often ERP vendors and integrators will use a customer’s implementation project as a training ground for new consultants.
  • Integration Shortcuts: ERP vendors sometimes under-test the system to intentionally conceal defects to meet milestone and deliverable deadlines. Often this results in a failure to perform proper integration testing to determine if the ERP system can interface with other non-ERP systems on which a customer might depend.

Overall, a digital transformation or ERP implementation can transform your business positively and provide long-term benefits. It is crucial to evaluate the business objectives your organization wants to achieve, understand the implementation/integration process, and use attorneys with extensive software experience to negotiate your vendor contracts to minimize the likelihood that you are the victim of an ERP train wreck.

Oversold and misrepresented software, missed deadlines, inexperienced consultants, and budget overruns are all common occurrences in a digital transformation. The reality is that as a customer, the odds of a successful ERP implementation, or digital transformation, are stacked against you.

When clients come to us in the midst of an ERP or digital transformation train wreck, they are overwhelmed and frustrated. Many times they are convinced they have a case, and want to sue their ERP vendor. Our response is almost always the same: “have you done everything you can – within reason – to make sure that the project can’t be saved?” We counsel our clients to spend what it takes and to devote the time that is necessary to “right side” the project so that they can get a functional product.

Litigation should be the last option, and only considered after you have exhausted all other efforts. But sometimes that’s just not possible. If the vendor is incompetent, the software project is excessively over-budget, the software is inoperable, or the functionality was misrepresented, then no amount of time or money may be able to save the project. If that’s the case, litigation may be a viable option.

If you choose to litigate, understand that the contracts for software and associated services will heavily favor the vendor. The limitations of liability, warranties, and remedies will all benefit the vendor to the customer’s detriment. As a customer, you may have little recourse to recover damages, and much of the responsibility for the failed implementation will be placed on you.  Vendors – especially top-tier vendors, will vigorously defend lawsuits. They hire large law firms with teams of lawyers to defend them. They employ tactics designed to increase the cost and the duration of litigation. Some vendors bend over backwards to protect their salespeople and their commissions.

There’s more:

If you financed your deal, the financing arrangement adds another level of complexity to the lawsuit. If there are multiple vendors, things get even more complicated. If you have withheld payment because of poor performance, it is likely you will face a countersuit

So, is filing a lawsuit against your ERP vendor the best course of action? It can be. But it needs to make sense. Litigating because the software didn’t work the way you expected, or because the project cost more than estimated rarely forms the basis for successful litigation. The failure needs to be objective and identifiable. If there was a misrepresentation, it needs be substantive. If the vendor fraudulently induced you to enter into a contract, the circumstances of the fraud must be pleaded with specificity. And, the failure and/or the misrepresentation needs to have caused damage in excess of the fees it will take to bring the lawsuit. Spending $500,000 in legal fees to recover $100,000 in legal fees rarely makes sense. If you are litigating against a sophisticated vendor, expect that vendor to aggressively defend the lawsuit. You need to be prepared to spend at least the amount you spent on the software and the implementation.

We make our living recovering damages from customers who have been victimized by failed ERP implementations and digital transformations. The process is expensive, difficult and uncertain, but sometimes it is the only option that you have.

While the ERP contract negotiation process is dependent on the facts of the particular transaction, all negotiations have a similar process and a similar trajectory. The cost of the software and implementation, the importance of the software being licensed, the number of vendors, and the risk presented by the technology will all impact the length and difficulty of the contract negotiation process.

  1. Dollar Amount of the Deal. Smaller sized deals usually demand less of an investment in attorney time and attorney review than larger sized deals. There is also the issue of risk; smaller deals usually (though not always) present less risk to the company in terms of implementation failure. For the most part, it is fair to say that a $5 million deal will usually require more review than a $5,000 deal. The economics also need to make sense. It typically does not make sense to spend $40,000 in legal fees to substantively review and negotiate a $5,000 deal.
  2. Appetite for Risk. Your company’s appetite for risk will influence both the depth and scope of review and the modifications you make to the contracts. The nature of the software and the amount of money spent on that software are often directly related to risk aversion. A $5,000 single-sign-on software product is fundamentally different than a full scale ERP package costing millions of dollars. The warranties, limitations of liability, remedies for breach, and indemnity obligations will all be negotiated differently depending on the risk presented by the deal.
  3. Negotiation Strategy. Asking for concessions on issues that may be less important to you allows you to concede on them in exchange for larger more important concessions later. Simultaneously negotiating with two vendors maximizes your leverage and helps you obtain better pricing and legal concessions. Keep in mind that this strategy increases the costs of the contract negotiation. Understanding your leverage is key to being able to successfully negotiate with any ERP vendor. If you are in an important industry, licensing a new product, or spending a significant amount of money (from the vendor’s perspective), you will have more leverage and obtain more concessions. Having a legal team with deep industry experience that knows what to ask for and how to ask for it is critical.
  4. Contract Terms Seem Simple – Until They Are Not. It is important to have a realistic understanding of how long it takes to negotiate your contracts with your ERP vendor. What looks like a simple three-page order form, often ends up being hundreds of pages long due to the incorporation by reference of URLs in the order form. These URLs often point to additional and more substantive terms and conditions that govern the relationship. This increases complexity and can substantially increase review time.
  5. Timeline. As attorneys, we conduct an initial review of the contracts to determine risks. We then highlight those risks, summarize strategies for mitigating or eliminating those risks and have a conference call with the client to finalize our changes to the contract and develop a negotiation strategy. We then send the marked up contract back to the vendor. The vendor then reviews our proposed changes and provides a marked up response.  This is usually followed by conference calls and exchanges of additional drafts of the marked up contracts. The client/customer should reasonably budget at least one month for a moderately complex contract negotiation. A multi-million-dollar transaction could take significantly more time.

The worst strategy is to rush through the contract negotiation process to get promised pricing discounts. Bringing an important deal to your attorneys at the last minute is not in your best interest. Understanding the contract negotiation process and allocating the proper amount of time to the negotiation allows your attorneys to do their jobs and protect you. Taking a measured and methodical approach to the negotiation process usually results in an end product that serves you well.

There are lots of ways a digital transformation can go wrong, even with a negotiated contract that spells out in detail what the software vendor and integrator will do, when they will do it, and what they will be paid. This is even more true during a recession. As we have repeatedly said on this blog, implementing software solely because you want the latest and greatest technology almost guarantees failure. The project has to be tied to a business case. Digital transformations that do not add value to the business simply do not make sense. Projects that add value are more likely to have executive and employee buy-in, and are less likely to be postponed or cut during a recession. Even with a strong business case, success is not guaranteed. Recessions put additional pressure on digital transformations.

Below are some signs that you may be headed for an “ERP train wreck.”

  • The Vendor Doesn’t Understand Your Business or Industry: Often vendors use projects as a training ground for incompetent or inexperienced consultants. These consultants may not understand the unique requirements of your business or industry. Sometimes they don’t understand the software they are tasked with implementing. If you were promised the “A team,” but provided with the “D team” because the vendor had more important customers, you could be in serious trouble.
  • The Vendor Misses Deadlines and Milestones: Digital transformations and ERP implementation are challenging. While changes in scope and pushing back deadlines are not uncommon, a vendor repeatedly missing agreed upon deadlines is a sign your project is not going well.
  • Project Status Reports Are Not Provided or Are Incomprehensible: Regular status reports are sometimes the only way a customer can get an understanding of the health of a project, upcoming deadlines, and open action items. If the vendor is not providing status reports, it is a red flag. At the same time, if the status reports hide information, are difficult to understand, or don’t provide meaningful information, your project could be headed for failure and you many not even know.
  • Deliverables Don’t Meet Agreed Upon Requirements: Requirements for deliverables should be agreed upon and documented both in reasonable detail and in a functional design document. While it’s not unusual for a customer to reject a deliverable because of non-compliance with agreed-upon specifications, repeated failure by the vendor to provide deliverables that meet specifications is not normal.

Digital transformations and ERP implementation projects are difficult. Often, one-sided contracts shift responsibility for success to the customer and don’t provide a clear path for managing the project. Without a clear business case, and executive and employee buy-in, the likelihood of success is dim. During a recession all of this becomes amplified. Budget cuts, project delays, and suspensions are more common. Proper change management, project governance, and a clear business case are absolutely critical to a successful digital transformation.