In an appearance before the Denver City Council’s Governance Committee in February of this year, Denver’s Chief Information Officer, Scott Cardenas, explained that the city of Denver would be paying additional license fees to Oracle as a result of breaching the scope of its license agreement. The cost to Denver’s tax payers: nearly $4 million.
Local CBS reporter, Brian Maas, obtained hundreds of pages of emails between the city and Oracle indicating that the city’s breach of the Oracle license would require a license payment to Oracle in excess of $10 million. Oracle was apparently willing to settle the breach for $3 million.
Oracle and the city subsequently entered into a 5-year software license contract increasing the city’s payments to Oracle for 2017 from $1 million to nearly $4 million. City spokesperson, Jenny Schiavone, characterized the new license as replacing the city’s outdated licensing model, right-sizing the contract and modernizing the city’s service structure. To Ms. Schiavone, the issue was business as usual. Don’t believe it.
Software audits are common practice in the ERP industry and Oracle has a reputation for aggressive enforcement. Software sales people, in a drive to meet their quotas, love non-compliance issues and are willing to leverage one-sided audit provisions, threats of lawsuits and threats of penalties to extract fees from customers that have exceeded the scope of their license.
While ERP vendor software audits are common, the city of Denver’s resolution is uncommon in that it was publicized. Further, the resolution could have been easily avoided.
You never have as much leverage with a software vendor as you do before you sign a contract. Once you have signed, most incentives the ERP vender had to work with you to lower fees and provide discounts are long gone. You need to use this leverage to negotiate terms that give you the ability to effectively deal with aggressive enforcement and threats of additional fees.
- License Grant: The license grant is the heart of any ERP software transaction. You need to ensure that you draft the license grant so that it covers both your anticipated use of the software as well as unanticipated uses of the software, changing business needs and future growth. The city of Denver’s assertion that the increase in fees was due to an outdated license model is an excuse for a poorly drafted and negotiated license grant. The city’s attorneys should have drafted the scope of the license grant to account for the city’s future use to minimize the likelihood of a breach and the payment of fines and penalties. While it is difficult to predict how you might use the software in the future, it is imperative that the ERP software contract have language that allows you the flexibility to purchase additional users at a discount, change licensing model or amend the grant to allow for new or unexpected uses with minimal fees.
- Future Options: A future option is essentially a discount on future users or licenses that is negotiated in advance and held out by the vendor for an agreed upon period. The future option should be drafted broadly enough to apply to any additional uses or expansion of use discovered during an audit.
- Audit Provision: The audit provision is the section of the ERP software contract that allows your vendor to gain access to your system to verify that your use is within the scope allowed by the license grant. Most ERP customers pay little attention to this language, and the city of Denver probably did too. The language in the audit provision needs to be drafted to allow you to reasonably challenge the ERP vendor’s findings and take advantage of any negotiated discounts. It needs to be drafted so that you have control over the audit provision so as to reduce costs, expenses and burdens. For example, having a team of software auditors arrive at the end of the month or year, take over your system and view your confidential information or your customer’s confidential information to verify compliance with the ERP software contract would be problematic. Similarly, an ERP vendor requiring you to pay for the audit itself would be unreasonable. Special attention needs to be paid to the audit provision language.
As an ERP customer, it is your responsibility to understand the scope of your software license contract and to be in compliance with that agreement. It is also your responsibility to draft and negotiate software contracts that allow you reasonable flexibility in the use of the software to minimize the likelihood that an audit will result in unexpected fees or allegations of breach. If the city of Denver had negotiated a better ERP software contract, paid more attention to the scope if its software license agreement with Oracle, understood how it was using its software, and used experienced ERP software licensing attorneys, Denver’s taxpayers could have avoided paying millions of dollars unnecessarily.