How To Avoid The Pitfalls Of Computer Contracts

If your hardware or software package doesn't live up to expectations, you may have a legal problem.

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Not long ago, one of my small business clients walked into my law office with a copy of a contract he'd signed for a software package for his new computer. "The damn program doesn't do what it's supposed to do," he said, "and I want you to enforce the warranty clause in my contract. I'm ready to go to court to make these bastards live up to their promises."

He handed over the contract for me to read, and a few minutes later I broke the bad news to him: He had almost no case. The contract he'd signed had some general language about how the software vendor agreed to provide an "accounts receivable, accounts payable, general ledger, and payroll package." But there were no program specifications, nor did the contract say exactly what the program was supposed to accomplish. The warranty was almost worthless, and I had to tell my client that litigation wasn't likely to recover his investment.

The problem my client faces has become increasingly common, especially as more small companies switch to using computers in their operations. Right now there are over 500 court cases involving computer transactions, and that's only a small percentage of the number of actual disputes. By the end of the decade, the roster of court cases will probably reach 5,000 -- again, just a small percentage of the actual number of problems. Moreover, the major cause of these disputes isn't dissatisfaction with the equipment, but rather with the contracts that govern the sometimes complicated relationship between buyer and seller.

Few small business buyers -- and few lawyers -- really know what to look for in the fine print of the contracts they sign when they buy a computer or software package. As a result, their vendors are often able to create a lopsided negotiating situation that gives the seller a great deal more protection than the buyer. It's hard to predict where problems will actually arise, of course, but I have found that there are several major pitfalls that a buyer should be prepared to deal with in negotiating the terms of any computer transaction.

Licensing or purchase agreement. This part of a contract tells you exactly what you're purchasing. In a software contract it may read: "Vendor has granted user a nonexclusive and nontransferable license to use the application software. All programs remain the property of the vendor."

This is reasonable, since there have been cases where a business has taken the software and gone into competition with the software vendor. The clause simply means you're only buying the right to use the software -- it's not your property.

Both software and hardware contracts usually contain an additional limitation on the location or locations at which the equipment may be used. From the vendor's point of view, it's a reasonable way to protect their exposure under their warranty, and to protect their interest under certain financing arrangements. What may not be reasonable are their terms should your company move from one location to another.

Vendors should not severely limit a company in this respect, since growth is good for both of them and growth often requires a move. If your contract has no terms relating to moving the equipment, try to insert terms you both can live with. If the terms are there, but are heavily weighted on the vendor's side, try to modify them according to your particular circumstances.

Risk of loss. Every contract should contain a risk-of-loss clause that clearly places the transportation risk upon the vendor. I've seen some contracts that make the purchaser responsible for the equipment as soon as it leaves the manufacturer. That's unreasonable.

The vendors, after all, ship hundreds of items each day. They're the ones who pack the equipment. They choose the carrier. Let them worry about insuring the shipment, and let them bill you for the charges.

Merger or integration clause: Simply stated, this clause tells you the extent of your agreement with the vendor and what written documents apply to the agreement. Here's a typical clause:

Customer understands that it has read this agreement, and it is in agreement with all the terms and conditions herein. It agrees to be bound by the terms and that it is the complete and exclusive statement of contract between customer and vendor, and that no verbal or other written communication supersedes this agreement.

That's backwards as far as you're concerned as the purchaser. What about the sales literature the vendor distributes? The correspondence between you? The oral commitments made during negotiations? The owner's manual? All of this should be integrated into the final contract.

Let's say you have a problem and take the matter to court, and to prove your point you're depending on a letter you received a week before the contract was signed. If you signed that merger clause, you cannot introduce that letter in court. Nor can you point to claims made in sales literature or cite promises made verbally by a salesman.

The best contract for you would have no merger clause at all. The second-best contract would specify and attach all of the items we've mentioned here. Then the merger clause would include them automatically. The least desirable contract, of course, would have a merger clause with no outside documentation attached.

Time of delivery agreement. We've all been through promises-of-delivery-date problems, and you'll find that vendors will often avoid being pinned down. These promises mean little unless they're included in the contract.

If your business will suffer loss in a delivery delay, you should seek to include a liquidated-damages clause specifying the amount the vendor will owe you for each day of delay. Although successfully negotiating a liquidated-damages clause is difficult, I've seen them included in computer contracts.

These agreements are enforceable, and they should guarantee you the attention your order deserves. It's an effective way of becoming the "squeaky wheel" without the necessity of daily phone calls and letters to find out where your equipment is.

Limitation of liability. This is a controversial item in computer contracts, and one that can cost your business a great deal of money if it's not handled properly.

A North Carolina software vendor's contract is a good example of how these clauses read: "(Vendor) agrees it shall correct any deficiencies or errors in said software systems or programs... but (vendor) shall have no further direct or consequential liability to the buyer because of any such errors or deficiencies."

Hardware manufacturers cover themselves with the same blanket. One contract reads: "(Vendor) shall not be liable for any damage caused by delay in shipment, installation, or furnishing of equipment or services."

These clauses put the burden of a vendor's potential mistakes squarely on your shoulders. When you buy a computer, you're putting almost your entire business into its circuits and programs. If the system malfunctions and data is lost or repairs are delayed, it can have a devastating financial effect on your business.

A properly drawn contract (from the viewpoint of the purchaser) will include a warranty clause. And a good warranty will require the vendor to repair or replace the hardware and "de-bug" the software over a certain time period. However, most warranty clauses that I've seen state that the vendor is not responsible for the harm done by the delay or failure. This total absence of liability may seem unreasonable, but these clauses have been maintained legally for some time.

Changes are coming, with many lawsuits challenging limitation-of-liability clauses. A Massachusetts furniture company is suing Data General Corp. for losses incurred from an alleged failure, plus the cost of doing work the computer failed to do.

An Arizona court awarded damages to a computer purchaser in a similar case, but the award was reversed on appeal -- based on the contract language.

But it's still an uphill battle. A purchaser should try to eliminate this limitation-of-liability clause from a computer contract, or at least soften its effect by trying to include a limit on the amount of damages for which the vendor could be liable in case of a costly failure.

Leasing agreements. Because of the staggering cost of larger computer systems, most purchases are made through some sort of lease or lease-purchase agreement with a third-party leasing company. This is a plus for companies that can't afford the cash outlay but need a computer.

But what happens if the vendor breaches his contract? Or fails to perform under the warranty? You have paid the vendor with money borrowed from a leasing company, and the leasing company wants its payments on schedule. If this potential situation isn't clarified in your contract, your company is left with no bargaining power and a computer that doesn't work.

I'm currently involved in such a case. A company purchased an additional drive for its computer -- $20,000 worth of equipment -- from a systems house, and financed the transaction through a leasing company.

The drive never functioned properly, and the purchaser is refusing to pay on the lease until the unit is replaced or repaired. Enter the manufacturer of the drive. He claims that the drive works fine, and is threatening to sue the systems house for nonpayment. The leasing company is getting impatient with the nonpaying purchaser. While all this yelling is going on, the real loser is the company that bought the drive. It has an obligation to pay for something that doesn't work.

The company could have protected itself by covering such a situation in its lease agreement with the leasing company and in its contract with the systems house. The two agreements can work together to spell out what happens if the equipment fails to operate and the warranty isn't honored. Of course, the customer, the vendor, and the leasing company must agree to compatible provisions.

The key, then, is to negotiate hard for contract terms that benefit your company when you're planning that new computer or adding to an existing system. It not only puts pressure on the vendor, but it also makes things easier if you ever end up in court over a problem.

As long as all contract signers know what that computer is "supposed to do," you may not have to visit my office and tell me it isn't doing it.