The End of the Software Reseller Model?

A common sales channel for software proprietors/vendors to get their software to market is via resellers. However that sales model, or at least certain aspects of it, will now bring greater commercial risk for those vendors as a result of the recent case of Computer Associates UK Ltd v Software Incubator Limited.

In this long-awaited decision, the Court of Justice of the European Union (CJEU) has ruled that the supply of software by electronic means, where it is supplied together with the grant of a perpetual licence, falls within the definition of the sale of goods (rather than the sale of services) for the purposes of the Commercial Agents (Council Directive) 1993 (the Regulations), irrespective of whether the software is supplied on a tangible medium such as a CD or by electronic download.

Why does the ruling matter?

The CJEU’s judgment has significant implications for the software industry generally, and the reseller business model in particular, because resellers selling software via a perpetual licence can now benefit from the rights granted to commercial agents under the Regulations. Significantly, these rights include the right to compensation or an indemnity payment upon termination of the agency relationship in most circumstances. If an agent (for which now read “reseller”) has their agency agreement terminated (with only a few exceptions, for example where termination is due to the agent’s serious breach of contract) or the agency has come to an end either because of the ill health of or retirement of the agent, then the agent will have a right to bring a claim against their “principal” (in this case, the software proprietor/vendor) for compensation or (if the agency agreement provides for it) an indemnity payment. Compensation is generally calculated by reference to the value of the agency to a hypothetical purchaser; an indemnity payment is capped at one year’s average annual remuneration over the last 5 years of the contract. As such, indemnity payments are usually preferable for the principal.

In addition to the right to compensation or an indemnity payment, the reseller is also entitled under the Regulations to all commissions earned up to the date of termination, commission on sales made after termination that the agent generated as a result of their efforts during the agency (a.k.a. pipeline commission), and a notice period of up to 3 months (depending on the length of the agency contract).

As a result of the CJEU’s judgment, businesses who engage resellers to distribute their software that is made available electronically via a perpetual licence will need to take measures to quantify and mitigate their potential exposure to compensation payments upon termination. This can be done by urgently reviewing their reseller/agency contracts and relationships so as to mitigate risk and also by looking into the use of different sales channels.

What did the judgement not cover?

However various outstanding questions remain following the CJEU’s judgment:

1. The judgment did not provide any clarity on how software-as-a-service (SaaS) might be treated. Such software may now be considered goods (given that software can be classified as a good regardless of the medium in which it is supplied). However it is also arguable that software which is centrally hosted and accessed by a customer but not downloaded, and which is accessible on a subscription basis only (i.e. not perpetual), will fall outside of the ruling. If this is the case, one effect of this judgment is that we may see software companies move further away from licensing models comprising one payment for a perpetual licence, towards SaaS models, as a means to avoid making compensation payments to their resellers in the event of termination.
2. The judgment relates solely to the Regulations and therefore does not consider wider legislation governing the supply of goods (such as the Sale of Goods Act 1979) under which, at present, software must be sold or hired on physical media to constitute goods.

Is it the end of the reseller model?

Finally, it is worth noting that this case was referred to the CJEU by the UK’s Supreme Court prior to the end of the Brexit transition period, and the Supreme Court have yet to apply the ruling in practice. Although the Regulations remain in force in the UK post-Brexit, it was the view of the Court of Appeal that any such extension of the Regulations should be done by the UK Parliament, not the CJEU. Now that the UK has left the EU, the Supreme Court might be asked to look again at this issue before too long.

So whilst this might not quite be the end of the reseller model, it will inevitably bring about plenty of changes in the sales channels used to distribute software.

What can we do to help?

James Sarjantson and Thomas Taylor in LCF Law’s Commercial team have significant experience of advising IT businesses on their trading and contractual arrangements; Charles Abraham in LCF Law’s Disputes team has significant experience in dealing with agency disputes. As such, LCF Law are uniquely capable of providing rounded and commercial advice on this issue. Please therefore contact any of:

James Sarjantson on 0113 201 0401 – ku.oc1701681519.fcl@1701681519nostn1701681519ajras1701681519j1701681519, Charles Abraham on 0113 201 0405 - ku.oc1701681519.fcl@1701681519mahar1701681519bac1701681519, or Thomas Taylor on 0113 204 0407 – ku.oc1701681519.fcl@1701681519rolya1701681519tt1701681519.