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The server should reject sessions as the grace period has past and yes you do need an RDS license server and once the server VDAs communicate to it it will allow connections again. Also understand that while you can install user and device CALs on an RDS license server but a RDS session host server can only be set to use a user or device CAL and not both

That's what I thought, that we need an RDS license server. I asked our app team specifically to verify the same but they said they can access the applications through citrix. That's what confused me. Thanks @Johnny Ma for the info.

A surprise software audit will surprise your app team and their budget!