Software Liability Explained

Software liability is an increasingly important area for every software development company and team. At its core, software liability is about protecting users from damages caused by software issues.

As more software is in use than ever before, there’s a lot of ways that software — and its manufacturers — could be held responsible for certain actions or inactions. Indeed, even the rise of cyber insecurity globally could fall into this murky area.

This article describes important information regarding software liability, including:

• Types of software liability
• Why liability is important
• Related documents
• Insurance

Of course, software manufacturers must know how to mitigate the risks associated with software liability, so we’ll will discuss this at the end of the article.  

What is Software Liability?

Software liability is the legal responsibility of software manufacturing companies on any issues related to the software they develop. And that's why it's so interesting to your leadership. There are many scenarios where software manufacturing companies can be held liable for damages caused by software. For example:

• Bugs in the code
• Security issues
• Intellectual property violations

How much responsibility falls on the software companies usually depends on the specific terms outlined in contracts, the laws of the region, and how the software is being used.

(Related reading: CISO thinking on software liability.)

The Importance of Software Liability

To operate efficiently and accurately today, businesses depend on various software systems. A failure or glitch in any software they use can cause major incidents like service outages and data losses, causing severe financial and reputational damage to the business.

Another angle is one of security. Any security vulnerability in the software can make companies and their clients victims of sensitive data losses, causing them to face lawsuits that can penalize the business. 

And that doesn’t include one major area: defects in software that can lead to physical damage. For example, software often directly controls or interacts with physical systems, particularly in manufacturing and healthcare, and even in the mundane operations of a regular office. For example:

• Software errors can cause machinery to malfunction, leading to workplace accidents or the creation of low-quality, faulty products.
• Likewise, errors in medical software can lead to incorrect diagnostics and even provide wrong treatment to patients. 

Thus, it is important to know about the fundamentals of software liability and how it can save companies and clients from software that does not prioritize software security and quality over its development and deployment. Also, software companies need to know how to face such cases and what can be done to cover the financial and reputational damages.

(Related reading: the software engineer role & common DevOps roles.)

Types of software liabilities

Software-related issues such as bugs in the code, security loopholes, and low-quality design can harm the business and its clients in many ways. Depending on the types of risk to the clients and the business, there are several types of software liabilities. 

Neglect of software quality standards

This is when a person or entity can prove that given software is not up to the standard the manufacturer claims—and the manufacturer has not included reasonable care in the areas of the software's design, development, testing, or maintenance.

In that case, the manufacturer can be charged with negligence and provide compensation to the client in court.

Damages from defective software

Software liability applies to damages from defective software, such as:

• Physical damages caused by software systems. (If your software supports physical systems, this is possible.)
• Security vulnerabilities that can cause losses or harm.

Failure to comply with regulatory standards

Sometimes companies have to face legal and financial penalties because of violations of industry-specific regulations, such as security and data privacy regulations of the software they use.

(Related reading: regulatory compliance.)

Violations of intellectual property (IP)

If software copies or uses code, designs, or ideas already protected by copyright or patent laws without proper permission, the software manufacturer could face legal consequences for intellectual property rights infringement.

Breach of contract

When the software manufacturer promises to provide technical support for some functionalities in the system but fails to provide them, this is a breach of contract. That means the manufacturer fell out of compliance with the legal contract. As such, the manufacturer is liable and could be fined or face other legal consequences for this breach. 

Misrepresentation or fraud

When a software company deliberately makes untrue statements about its software's capabilities or hides its flaws and limitations, it could be held responsible for misrepresenting its product or committing fraud.

Documents related to software liability

As liability is a legal issue, at its core, several documents may come into play before, during, or even after your use of software.

Among much documentation that comes from software companies, you’ll typically see software liability statements. The ‘limitation of liability statement’ clearly outlines the limitations of the software provider's responsibilities. Reading and understanding these statements before purchasing or using the software is critical for users to avoid unexpected consequences. 

End User License Agreement (EULA)

The EULA is the common document that defines legal contact between the user and the software. It includes the limitations on liability statement, including information such as:

• The description of the types of damages the company is held responsible or not responsible for.
• Liabilities on third-party applications.

(Read about third-party risk management.)

General Terms

The General Terms document includes the terms and conditions (T&C) related to limitations on liability, privacy and security terms, user restrictions, insurance policies related to software liability, warranties, etc.

Clients can use this document as evidence against the company during any term breaches. 

Warranty documents

The warranty documents specify if the software guarantees to perform as expected, over which time period (when does the warranty end) and the actions that can be taken if the software fails to meet the warranty terms, including repair, replacement, or refund. 

Privacy policy

This document typically includes the types of user information the software collects and how they are used, addressing the relevant data protection and privacy laws.

It can also include statements of software liability when a data breach occurs due to the software. 

User manuals

The user manual describes the correct functionalities of the software and/or any standard practices the company follows to ensure its quality. If a user encounters any misbehavior or deviations from the statements in the manual, they can use this as proof of correct software behavior.

Software liability insurances

Having software liability insurance is critical for any software development business. There are several such insurances — some are mandatory to have. The key software liability insurance covers various aspects of software liability issues. 

Technology Errors & Omissions Insurance (Professional Liability Insurance)

This insurance can help pay the legal expenses of client lawsuits. It covers software liability issues, including negligence, contract breaches, software errors, and mistakes. The general terms document includes the amount limits of the insurance, aggregate limits, and applicable scenarios.

Commercial General Liability Insurance

This is not directly related to software liability. However, it covers bodily injuries or property damage due to business operations which also can be caused by software failures. Users can get coverage in one of two ways:

• Claim-based, whenever they make a claim regardless of the event time.
• Occurrence-based, which covers any event even after the policy expiration.

Cyber Liability Insurance

This is an important policy in software liability that covers damages due to cyberattacks, data breaches, and electronic business operations. Organizations can claim costs related to:

• Lawsuits
• Data recovery efforts
• Reputational damage management

(Read our cyber insurance explainer.)

Workers Compensation Insurance

In some countries, worker compensation insurance is a mandatory insurance that every software development company must purchase and be covered under. This insurance covers medical expenses associated with work-related damages, including damages due to software failures. 

Intellectual Property Insurance

If a software company is found guilty of intellectual property infringement, this insurance helps cover the costs associated with the claim, such as legal fees.

How to manage software liability risk

Liability risks can be reduced if the software development companies demonstrate their commitment to avoid liability issues for their clients, competitors, and the general public. Thus, it is important to know how businesses can manage and mitigate the risks associated with software liability. 

You’ll also want to know what your risk tolerance or risk appetite is — knowing that, at an organizational level, can make a lot of these decisions a bit easier.

Maintain software quality standards

Software manufacturers should conduct regular and continuous quality assurance (QA) practices to ensure their software is up to — and remains up to — the standards they claim. This includes conducting:

• Regular performance, stress, and load testing to ensure the software behaves as expected in various load conditions.
• Regular unit testing to ensure the code is bug-free.

Scan for security vulnerabilities & review security regularly

Check the security of your code before releasing to production: this means you can find known security vulnerabilities before exposing them to production environments.

Also, regularly review the established security procedures to identify any places where security controls are lacking. With these two practices, you can significantly reduce the risks of cyberattacks and data breaches. 

Adhere to applicable compliance laws

It is always a best practice to ensure compliance against general and industry-related regulations, for example. Medical software must comply with HIPAA regulations and implement the necessary security controls to comply with SOC and other cybersecurity and data protection laws. 

(Related reading: ISO 27001 for InfoSec.)

Obtain necessary insurance

As described earlier, the software manufacturer must obtain the related insurance in order to manage the legal costs, response and reinstatement.

Outline clear contract terms

Always review these items with your company’s legal team: the terms and conditions clauses, the limitations on liability statements, warranties, and other related liability clauses. This ensures no inappropriate or unclear items are included inadvertently that may cause the software company any unnecessary financial liability. 

Provide comprehensive documentation

Document every functionality of the software and the standards and practices followed throughout the development and deployment process. This includes the testing procedures and coding standards followed.

This practice helps maintain the set realistic expectations and reputation among the clients. 

Don’t take liability lightly

As you have learned throughout this article, various software liability issues can cause software manufacturers financial and reputational damages. Liability statements should be clearly defined in the appropriate documents and obtain the appropriate insurance for financial protection against lawsuits.

Finally, companies must follow the risk management strategies described in the article to demonstrate their commitment to avoiding software liability issues.