Selling a business? Guidance on offering transitional services

Many large corporates have centralised IT services with group licenses for their key software. So what happens when a division or group company is divested?

This situation occurred with one Belgian chemicals company. A PeopleSoft license acquired only 8 months earlier had to be urgently repurchased at list price again (over €8m) when one of the main divisions was divested to a buyer. Nothing had been provided for in the commercial arrangements.
In hindsight, it’s clear that a license bought in one company name does not transition over to another corporate owner – even where the people, office premises and other facilities do not change.

For many major divestments e.g. in financial services and insurance where portfolios of policies and customers are being sold, the teams put in place ‘Transitional Services Agreements’ or ‘Transition Services Agreements’ (TSAs). These are intended to accommodate continued and uninterrupted running, following closing, until such time as the buyer can establish a wholly new infrastructure: that can often take 18 months to 2 years.

But the planning around such transitional services is often weak with, in particular, possible software licensing claims rarely addressed.

The danger is that both sellers and buyers are almost exclusively focussed on the due diligence based on the running of the business pre-sale (is there any present litigation or claims?) and for this to be repeated in the form of warranties at the moment of closing.

So the sellers can truthfully state that the target business is fully licensed. And the buyers accept this. But 3 months after the heat of the closing, there may be a dawning realisation that the apparent software compliance has been upended because of the change of identity in the user of the software. In short, the licenses, being personal and non-assignable, do not extend to the new user.

Even where TSAs are used for the seller itself to supply continuing IT services to the buyer, the fact that the programs are then executed by or for the benefit of the buyer (a third party to the license contracts) means that such licenses are nugatory.

The danger is of an audit then initiated by a savvy software vendor (IBM, SAP, Microsoft, Informatica or Oracle). Such software audits may take months and will typically utilise Deloitte, Ernst & Young, KPMG or PricewaterhouseCoopers all of whom have mandates from the software vendors to carry out these specialised audits. Oracle use its own License Management Services division (LMS) based in Romania.

From this, an ‘Effective License Position’ is produced often disclosing a licensing shortfall. And, this is generally only remediated at close to list price, 2-years back support and other penalties. Claims can spiral if for instance the transitional services are supplied from a virtualised network.
In short, a fully compliant target company is, by virtue only of the change of control, converted into business possibly exposed to substantial un-provisioned liabilities.

Some TSAs correctly recognise the possibility of migration costs being charged to the acquirer with this explicitly covering any additional software license fees or costs for novations. However, demands following software audits on a customer fully dependent on legacy software might end up being 5-10 times more than the amount that could, in other circumstances, be negotiated.

Memery Crystal Comment

There is no right or wrong as to who should bear the costs. But sellers and buyers need to consider early on ideally in Heads of Terms any software licensing impact. This should address the period, after closing, when any services are to be supplied by the seller to the buyer, and then, separately, the costs of licensing once the transition ends and all services and licenses are to have migrated over.

It’s key that the risk of penalties and under-licensing are addressed, financial provisions assessed and there is a clear understanding as to who then pays.

Critically, there needs to be a looking ahead to the compliance position of the target business for the time after closing – not simply due diligence looking at the position as at exchange of contracts.