Volume 21, No. 3
Spring 2010
Committee Cochairs
Erick Howard
Shartsis Friese LLP
San Francisco, CA
ehoward@sflaw.com
John P. Hutchins
Troutman Sanders LLP
Atlanta, GA
john.hutchins@troutmansanders.com
Coke Morgan Stewart
Kaye Scholer
Washington, D.C.
coke.stewart@kayescholer.com
Newsletter Editors
Editor in Chief
Steve Gardner
Kilpatrick Stockton LLP
Winston-Salem, NC
sgardner@KilpatrickStockton.com
Editor at Large
Brad Lyerla
Marshall Gerstein & Borun LLP
Chicago, IL
blyerla@marshallip.com
Young Lawyer Oriented Editor
Elaine Y. Chow
K&L Gates LLP
San Francisco, CA
elaine.chow@klgates.com
Litigation Tips Editor
Douglas N. Masters
Loeb & Loeb
Chicago, IL
dmasters@loeb.com
Editor at Large
David L. Marcus
Comcast Cable Communications
Philadelphia, PA
David_Marcus@Comcast.com
Published by the Intellectual Property Litigation Committee of the ABA Section of Litigation © 2010 American Bar Association, All Rights Reserved
This Issue: Indemnity Issues in IP Litigation
Contractual Indemnity Obligations
for Patent Infringement Claims
By Virginia DeMarchi
C
ontractual indemnity provisions
allocating the risk of infringement
of intellectual property rights
are increasingly common in commercial
agreements. Typically, these provisions
take the following form: “A will indemnify B against any claim that Product or
Service supplied by A infringes another’s
patent, copyright, trademark, or other
intellectual property right.” This obligation
is generally contingent on B’s promptly
notifying A of any such infringement
claim and granting A control of the defense.1 A’s agreement to indemnify B may
be accompanied by an express agreement
also to defend B against the infringement
claims, although in the absence of an
express agreement, the obligation to
defend or to pay the costs of defense may
nevertheless be implied by operation of
state law.2
The decision whether to accept the
defense of claim for which defense and
indemnity is (or may be) owed needs to
be made early in the case.3 An indemnitor
who delays may lose the opportunity to
control the defense of the action, and it
will be bound by any determinations made
in the action for which it improperly declined to provide a defense.4 For this reason,
it is necessary for a potential indemnitor
Continued on page 19
Indemnification Clauses in
Software Licensing Agreements
Associate Editor
Jason Hicks
By Ted Borris
Art Director
Tamara Nowak
Intellectual Property Litigation (ISSN 1936-7619) is
published quarterly by the Committee on Intellectual
Property Litigation, Section of Litigation, American
Bar Association, 321 N. Clark Street, Chicago,
IL 60654. The views expressed within do not
necessarily reflect the views of the American
Bar Association, the Section of Litigation, or
the Committee on Intellectual Property
Litigation. © 2010 American Bar Association
www.abanet.org/litigation/committees/
intellectual
Y
our client is attempting to license
software to a willing customer.
Like any good software company, your client has a software licensing
agreement filled with clauses that attempt
to protect your client from unnecessary liability, thanks to your skilled and
experienced draftsmanship. It includes
warranties that are mostly limitations on
warranties; restrictions on damages that
would require a judge to perform a judicial
“Where’s Waldo” to find something for
which your client is actually responsible;
a forum selection clause that ensures that
your client’s brother will try any litigation and that her cousins will make up the
entire jury pool; and no less than three
clauses that will prevent the customer
from telling anyone that he has any connection to your client whatsoever.
In 90 percent of licensing opportunities,
your client’s customer simply signs the software licensing agreement without reading any
Continued on page 21
1 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
Message from the Chairs
A
s trial lawyers, it’s our duty to
zealously advocate our clients’
positions. But we also have a duty
to counsel our clients when their position is wrong or weak and help them see
the value of compromise. There is also
another duty that good lawyers perform,
whether the rules of ethics actually require
it or not: the duty to help clients avoid in
the future the circumstances that resulted
in litigation in the first place. Performing
these duties well, especially the last one,
requires an understanding of how clients
got into the situations they were in when
they first came to you for help. Many
of those situations were the result of a
contract, and understanding the nuances of
contracts—particularly those touching on
intellectual property issues—is at the heart
of an intellectual property litigator’s value
to clients.
This issue focuses on one of the trickier
subjects that just about every contract or
relationship involving intellectual property
affects—indemnification. The authors of
the articles contained in this issue treat
indemnification in a variety of contexts,
including software licenses, patents, and
the Uniform Commercial Code. Knowing what indemnification obligations arise
under the law—without the necessity of a
contract—and what requires the parties’
agreement are key when advising clients
how to protect themselves in the future, as
well as in understanding how a client got
into trouble in the first place. The articles
in this issue will better equip you for that
understanding, and more. We hope you
enjoy reading this issue of our awardwinning newsletter!
Our Committee has so much going
on, it’s hard to keep up with it all. If
you’re not involved already, we want
you to get involved. Please reach out to
one of us, and we’ll help connect you to
one of our many active Subcommittees,
which are working on projects ranging from a database of best practices in
injunctive relief proceedings in jurisdictions around the country to reviving our
e-Newsletter, IP Remedies, which we’re
planning to relaunch soon. Check out
our webpage at www.abanet.org/litigation/
committees/intellectual for more information and let us know where you’d like
to lend a hand.
Contact Erick C. Howard, Shartsis
Friese LLP, ehoward@sflaw.com; Coke
Morgan Stewart, Kaye Scholer LLP,
coke.stewart@kayescholer.com; or John
Hutchins, Troutman Sanders LLP, john.
hutchins@troutmansanders.com for more
information.
We look forward to helping you take
advantage of the many benefits and opportunities the Committee has to offer. l
The Benefits of Membership
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Go to www.abanet.org/litigation
2 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
The Buck Stops Where? Avenues to
Indemnification in the Copyright Context
By Joseph Petersen and Ashford Tucker
O
ver the past decade, we have witnessed a revolution in the manner
in which media are distributed to
the public. Not long ago, if you wanted
to rent a hit movie and hear the latest pop
sensation, you would have made your
way to the local video store and capped
your trip with a stop at the neighborhood
record store. Today, with the development
of high-speed Internet connectivity and
the multitude of sites distributing digital
media on the Web, that same content can
be had with the click of a mouse.
Given the ease of distributing digital
media, it is no surprise that suppliers of
digital content, both at the wholesale and
retail levels, are multiplying. However,
one constant in the ever-shifting business
models and players is the issue of where
such parties may turn when faced with a
charge of copyright infringement in the
content they sell. In such circumstances,
often the first question asked by the defendant distributor is whether responsibility for
the infringement can be passed to the party
from whom the distributor obtained the allegedly infringing content. The answer lies
in principles of copyright indemnification
which, despite the ever-changing business
landscape, remain largely unchanged from
the pre-Internet age.
The Copyright Act itself is silent on
the issue of indemnification. Lacking a
clear indication from Congress as to the
scope of indemnification in the copyright
context, courts reliably recognize only two
avenues to indemnity: a right granted by
agreement and, possibly, a right granted by
state statute.
The ramifications of this are twofold.
First, distributors of content should make
sure that they have secured written indemnification agreements with their suppliers.
Second, distributors should take steps to
ensure that the indemnifying party has
the financial means to stand behind its
indemnification (or has obtained suitable
insurance covering the activities of the
distributor). If a distributor’s contractual
partner lacks the financial wherewithal to
stand behind its indemnity, the distributor
may have to shoulder the obligation to the
claimant by itself with no viable recourse
against the party whose actions may have
given rise to the liability in the first place.
Indemnity under an Agreement
Courts have long upheld indemnity agreements in the copyright context. Issues
may arise, however, when a party seeking
indemnification either actively participates
in the conduct giving rise to liability or
has knowledge of the infringement and attempts to pass liability to another pursuant
to an indemnification agreement. In such
circumstances, courts have sometimes refused to give effect to the indemnification
agreement, invoking the rule that a party
claiming indemnification must demonstrate that it committed no wrong.
For example, in Olan Mills, Inc. v.
Linn Photo Co., the Eighth Circuit held an
indemnification agreement unenforceable
because it did “not constitute a good faith
effort to avoid copyright infringement.”1
In Olan Mills, a photography studio sued
a photograph developer for reproducing
copyrighted photos that bore a copyright
notice. To gather evidence, the studio
hired a third-party investigator who posed
as a customer and paid the developer to
make copies of the studio’s photos. Prior
to filling the order, the developer required
that the investigator sign the developer’s
standard customer agreement expressly
holding the developer harmless for any
liability arising from the copying.
Relying on the fact that the studio made
repeated demands upon the developer to
cease infringing on the developer’s copyrights, the court stated that the developer
had actual notice of its infringement and
accordingly “could not reasonably rely
on its indemnification agreement.”2 The
court also noted that the developer created its indemnity agreement “in an effort
to circumvent liability for its infringing
conduct.”3 Accordingly, the court denied
the developer the benefit of the indemnity
it had obtained from the investigator.
Similarly, in Mary Ellen Enterprises v.
Camex, Inc., the Eighth Circuit rejected a
party’s indemnification claim based on a
finding that the party seeking indemnification was partially at fault because it had notice that the plaintiff claimed a copyright in
the work at issue and yet failed to confirm
that the plaintiff assented to the distribution
of her work. The decision in Mary Ellen
was premised on a broad reading of the
Eighth Circuit’s earlier decision in Olan
Mills, which the Mary Ellen court cited for
the proposition that an “infringer cannot
rely on [an] indemnification agreement because [the] copyrighted work [was] clearly
marked with [a] copyright notice.”4
Olan Mills and Mary Ellen may well
constitute the high-water mark of judicial
reluctance to enforce indemnification
agreements upon a finding of fault of the
party seeking indemnity. It is not clear
whether the approach followed in these
cases will be adopted in other circuits. Nor
is it clear whether these cases are applicable to the digital sphere where the sheer
volume of works may make the diligence
demanded by the Mary Ellen court impractical, if not cost-prohibitive.
However, taken together, they suggest
that, in particular circumstances, a distributor of content may wish to consider taking
steps beyond accepting a supplier’s representation, backed by a written indemnification agreement, that it has the right to commercially exploit a given work. Specifically,
if the distributor has an objective reason to
question whether the supplier in fact has the
rights it claims to have, the prudent course
may be for the distributor to make an independent determination of the status with
the ultimate rights holder as indicated in the
work’s copyright notice (if any).
Indemnity Without Agreements: State
Statutes as Substantive Sources
Parties seeking indemnity in the copyright
context without the benefit of a written
indemnification agreement are on less
certain footing. Claims for copyright indemnification under state common law are
generally not successful. Courts, concluding that the scope of copyright indemnification is a question of federal, not state,
3 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
law, routinely dismiss state common-law
claims for indemnification and its typical
companion, contribution.5
As to whether a right to copyright indemnification exists as a matter of federal
law, courts have likewise been reluctant to
find such a right. Courts begin by asking
whether such a right may be found either
implicitly or explicitly in the Copyright
Act or under federal common law. To date,
courts have essentially answered both
questions in the negative.
First, it appears well established that
the Copyright Act creates no independent
right to indemnification.6 Second, courts
typically find that copyright indemnification presents no unique federal interests
that warrant a judicial declaration that
copyright indemnification forms a part of
federal common law.7
Accordingly, a claimant seeking
copyright indemnification in the absence
A claimant seeking
indemnification in the
absence of a written
agreement faces
an uphill battle.
of a written agreement faces an uphill
battle at best. However, claimants have
been successful when they were fortunate
enough to locate a state statute on which
to base an indemnification claim. In those
circumstances, courts analyze whether
the specific state statute is preempted by
the Copyright Act. If they conclude that
it is not preempted, the claimant will be
permitted to proceed with its indemnification claim even in the absence of a written
agreement.
For example, in Dolori Fabrics, Inc. v.
The Limited, Inc., a retailer of women’s
dresses found liable for copyright infringement sought indemnification from the
manufacturer of the infringing goods.8 The
court found no enforceable contract of
indemnification between the retailer and
the manufacturer. Nonetheless, the court
concluded that the New York Uniform
Commercial Code provided the retailer
with a right to indemnification. Specifically, the court held that section 2-312(3) of
the New York Uniform Commercial Code,
which provides a warranty of noninfringement with respect to goods obtained from a
merchant who regularly deals in like goods,
covers copyright infringement claims.
Similarly, in Frank Betz Assocs. v.
Signature Homes, after being sued by an
architecture firm for selling infringing
house plans, the defendant home builder
filed claims for indemnity against the
source of the infringing plans.9 While the
court rejected the common-law claim for
indemnity, it found that the home builder’s
claim for indemnity under a Tennessee consumer protection statute was not preempted
by the Copyright Act and thus survived a
summary judgment motion.
In short, courts routinely reject claims
for indemnification under the Copyright
Act or federal or state common law
(as distinct from claims under written
indemnification agreements). However,
state statutes may present a viable
avenue to indemnification in circumstances where there is no written indemnification agreement.
Conclusion
It may come as a surprise that a party’s
right to seek indemnification is relatively
circumscribed in the copyright context.
The best avenue for a party seeking
copyright indemnity is a clear, unequivocal agreement governing the indemnitorindemnitee relationship from a financially
solvent or adequately insured counterparty.
A party seeking indemnification without
the benefit of a written agreement should
thoroughly research whether there is a
state statutory basis for an indemnification
or like claim. If there is no written agreement and no viable statutory authority for
indemnification, the party contemplating
an indemnification claim may well decide
that the pursuit of indemnification would
amount to little more than throwing good
money after bad. l
Joseph Petersen is a partner with
Kilpatrick Stockton LLP’s Trademark and
Copyright practice group in the firm’s
New York office. His practice focuses on
copyright and trademark issues arising in
the digital media and technology industries. He may be reached at JPetersen@
kilpatrickstockton.com. Ashford Tucker
is an associate with Kilpatrick Stockton
LLP’s Trademark and Copyright practice
group in the firm’s New York office. He
may be reached at AsTucker@kilpatrickstockton.com.
Endnotes
1. 23 F.3d 1345, 1348 (8th Cir. 1994).
2. Id.
3. Id.
4. 68 F.3d 1065, 1072 (8th Cir. 1995).
5. See, e.g., Lehman Bros., Inc. v. Wu, 294
F. Supp. 2d 504 (S.D.N.Y. 2003) (rejecting
claim for contribution under New York state
law because the issue of whether contribution
is available in connection with a federal
statutory scheme is governed exclusively by
federal law); but see Foley v. Luster, 249 F.3d
1281, 1286 (11th Cir. 2001) (applying general
principles of preemption doctrine to state
common-law indemnity claim in copyright
context); 3 Melville B. Nimmer & David
Nimmer, Nimmer on Copyright § 12.04[C]
[4][b] (Matthew Bender, rev. ed.) (“The
absence of a constitutional bar is not the same
as there being a substantive right to bring the
claim. Thus, the question remains whether
substantive law authorizes such a claim for
indemnification to go forward.”).
6. See Frank Betz Assocs. v. Signature
Homes, 2009 WL 2151304, at *3
(“[F]ederal courts are reluctant to find a right
of indemnification in the statutory terms of the
Copyright Act.”); Elektra Entm’t Group Inc. v.
Santangelo, 2008 WL 461536, at *2 (S.D.N.Y.
Feb. 15, 2008) (“no [rights to indemnity or
contribution] exist under . . . the Copyright
Act”); Zero Tolerance Entm’t, Inc. v. Ferguson,
254 F.R.D. 123, 126 (C.D. Cal. 2008)
(“[C]ourts have held that no right to
indemnification or contribution exists under
. . . the Copyright Act.”); Pure Country
Weavers, Inc. v. Bristar, Inc., 410 F. Supp.
2d 439, 448 (W.D.N.C. 2006) (“[N]o right of
indemnification was affirmatively created . . . in
the Copyright Act.”).
7. See Frank Betz Assocs., 2009 WL
2151304, at *3 (federal courts reluctant to
find indemnity a “limited situation in which
it is appropriate to formulate federal common
law”); Elektra Entertainment Group, 2008
WL 461536, at *2 (“no [rights to indemnity
or contribution] exist under federal common
law”); Zero Tolerance Entertainment, 254
F.R.D. at 126 (“courts have held that no right to
indemnification or contribution exists under . . .
federal common law”); Pure Country Weavers,
410 F. Supp. 2d at 448 (“this is not one of the
limited situations in which the Court should
formulate federal common law to create such a
right [to indemnification]”).
8. 662 F. Supp. 1347, 1358 (S.D.N.Y. 1987).
9. 2009 WL 2151304 (M.D. Tenn. July 13,
2009).
4 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
Can I Settle Now? Determining the Existence
of a “Rightful Claim” of Patent Infringement
By Christopher M. Arena and Chad A. Rutkowski
P
ity the patent defendant who
was sued just for using or selling a product made by one of its
vendors. It did not design the product. It
did not manufacture the product. It does
not specialize in the vendor’s industry
and thus is probably not generally aware
of the patent landscape in that industry. It
likely did not have either the incentive or
the know-how to undertake an expensive
freedom-to-operate analysis. And now it
is facing the long slog through a litigation
that will assuredly cost it in the six figures
(if not seven figures, as is often the case)
in legal bills, not to mention the internal
administrative resources needed to assist
litigation counsel. If it wins, it will have
spent that money simply to continue what
it had been doing, namely selling someone
else’s product. These are costs that the typical buyer did not factor in when it reached
agreement on the purchase price of the
product at issue. It thought it was buying a
product, not a lawsuit.
Pity that patent defendant all the more
if it does not have a written contract with
the vendor containing a clear indemnification provision. Without such a provision,
our patent defendant is subject to the
tender mercies of the implied warranty
against infringement, and its attendant
indemnity provision, under the Uniform
Commercial Code (UCC). In addition
to having several unique prerequisites to
indemnification, including that the seller
must be a merchant regularly dealing
in such goods and that the infringement
claim must exist at the time of delivery
of the goods, indemnity claims under
UCC section 2-312(2) are “infrequently
litigated.”1 Add to this the fact that UCC
claims are governed by state law and thus
subject to whatever specific gloss the
courts of each individual state care to put
on it, it is hard to give that patent defendant any assurance that it will not be stuck
with the loss. This uncertainty in turn may
have an impact on the patent defendant’s
ability to reach a reasonable settlement
with the patentee.
The Indemnitee Does Not Have to
Take the Case to Verdict
A body of case law is developing, however, that is bringing some needed clarity
to at least one prerequisite for indemnity
under the UCC—the requirement that the
claim of infringement be “rightful.” UCC
section 2-312(2) provides as follows:
Unless otherwise agreed, a seller
that is a merchant regularly dealing
in goods of the kind warrants that
the goods shall be delivered free
of the rightful claim of any third
person by way of infringement or
the like but a buyer that furnishes
specifications to the seller must hold
the seller harmless against any such
claim that arises out of compliance
with the specifications. (emphasis
added)
Thus, in order for the potential indemnitee to prove its claim of indemnity, it
has to demonstrate that it was liable for
a “rightful claim” of infringement. This
is easy enough if the infringement claim
was actually adjudicated and a verdict
of infringement issued against it. In that
case, ironically, it wins by losing. But
what if it wants to settle a claim? Is a
patent defendant condemned to long,
expensive discovery and a long, expensive trial?
The answer to this question has been
“no” for some time. The Federal Circuit
in Cover v. Hydramatic Packing Co., Inc.,
rejected an argument that a verdict of
patent infringement was necessary before
entitlement to indemnity under section
2-312(2) could be established. To find otherwise “would not lead to judicious public
policy inasmuch as parties would eschew
settlement and be forced to go to trial to
discern whether a ‘rightful claim’ exists
under federal patent law.”2 The Federal
Circuit, however, came to this conclusion
in the context of a preemption analysis
and thus did not define the parameters of
what constitutes a rightful claim. Even if it
had, such an opinion would be persuasive
precedent only, because UCC interpretation is a state court, not a federal court,
responsibility.
The Indemnitee Does Not Have
Carte Blanche to Settle
Cover has, nonetheless, proven influential
in both state court decisions and with federal district courts charged with interpreting state law. Cover left open, however,
the question of under which circumstances
an indemnitee may settle a case with a patent plaintiff short of a verdict. A tension
is created here, for the following reason:
Although courts wish to encourage settlements, from the indemnitor’s perspective,
it ought not be obligated to reimburse an
indemnitee that made a “volunteer” payment. Otherwise, the indemnitee could
“give away the store” and simply settle
frivolous patent infringement claims
knowing that it was spending the indemnitor’s money.
In recognition of this competing interest, courts have rejected arguments from
indemnitees that the mere filing of a lawsuit
sufficiently establishes the rightfulness of
the claim or that a rightful claim can be
established if the indemnitee had a “reasonable belief that the alleged infringement
will be upheld” at the time of the settlement.3 In trying to strike that balance, however, courts have not been very precise in
identifying how the rightfulness of a claim
will be measured. One district court has
written, “If claims of patent infringement
are seen as marks on a continuum, whatever
a ‘rightful claim’ is would fall somewhere
between purely frivolous claims, at one
end, and claims where liability has been
proven, at the other.”4 Any seasoned litigator knows, however, that there is a vast gulf
between purely frivolous claims and adjudicated successful claims when it comes to
analyzing whether a case is one that should
be settled.
Further complicating the matter is the
fact that some courts have also found that
indemnification for costs of litigation is
5 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
appropriate even when the claim is adjudicated in the indemnitee/patent defendant’s
favor. That is, a claim need not be adjudicated in favor of the patent owner to constitute a rightful claim; it is possible that
a patentee’s claim is rightful even where
the patentee loses. All that is necessary for
demonstrating that a claim is rightful in
these jurisdictions is a demonstration that
the claim was non-frivolous and had an
adverse effect on the buyer’s ability to use
the purchased goods.5
The policy behind the section 2-312(2)
indemnification provision is to provide
a ready means of enforcing the warranty against infringement. When a buyer
bargains for a certain price to purchase
the subject good, it is doing so without the
expectation that it will have to pay a hidden litigation cost on top of the purchase
price just to secure the right to use what it
bought. If such a “right of use” fee is necessary, it should be explicitly contracted
for between the parties. Thus, where the
infringement claim casts a “substantial
shadow” over the buyer’s use of the product, regardless of the ultimate outcome of
the claim, the warranty of noninfringement
has been breached. Courts analyzing section 2-312(2) in this fashion borrow from
the more substantial precedent regarding
the warranty of good title, UCC section
2-312(1), under which a buyer is deemed
to have the right to be free from the worry
that use of his bargained-for property will
subject him to lawsuits.6 Where the indemnitee has to engage in litigation to buy
that peace, reimbursement by the seller is
normally appropriate to restore the benefit
of the bargain to the buyer.7
Settlement Can Be Reached Before
Claim Construction
So when, exactly, can an indemnitee in a
patent case buy that peace? The United
States District Court for the Northern District of California, in Phoenix Solutions,
Inc. v. Sony Electronics, Inc., was recently
confronted with the issue of “how far a
patent infringement case must proceed in
order to establish a rightful infringement
claim . . . .” 8 In that case Sony Electronics, Inc., was sued by a patentee claiming
to hold a patent covering Sony’s use of an
interactive voice recognition system on
Sony’s customer service phone lines. Sony
had contracted with another company, Edify Corporation (later bought out by Intervoice), to provide the software necessary
to enable interactive voice recognition on
the system. Sony litigated the case for 11
months but settled prior to claim construction. Sony asserted by way of defense both
that the patentee’s claims were invalid and
that Sony did not infringe.
Prior to settling with the patentee, Sony
filed a third-party complaint against Edify/
Intervoice for indemnification under California’s version of UCC section 2-312(2),
California Commercial Code section
2312(2). Edify/Intervoice moved for summary judgment, claiming, inter alia, that
the patentee’s claims were not rightful in
light of Sony’s invalidity and noninfringement positions, which Sony effectively
abandoned by settling prior to claim
construction. Edify/Intervoice asserted that
claim construction was required at a bare
minimum in light of the impact the court’s
construction of disputed terms would have
on Sony’s defense positions.
The court rejected the argument that
claim construction was per se necessary
to determine whether a patent claim was
rightful. Although the mere filing of litigation did not itself demonstrate a non-frivolous, rightful claim, claim construction
was not necessary to engage in an evaluative inquiry into the merits of the claim
itself. Because the terms of the settlement
indicated that Sony undertook such an
evaluative exercise, enough evidence was
presented for Sony’s claim to survive summary judgment. Thus, the court rejected
adoption of any specific milestone in
patent litigation before a determination
of rightfulness could be made, suggesting
that an indemnitee/patent defendant need
not await any specific milestone before
exploring settlement with the patentee.
Conclusion
Ultimately, the determination of whether
an indemnitee settled a rightful claim of
patent infringement will ordinarily be a
fact question requiring jury determination. The buyer will need to establish that
a breach of the warranty of noninfringement occurred, which in turn will require
evidence that the underlying patent claim
was non-frivolous and threatened to have
an impact on the buyer’s ability to use the
purchased goods. This is not the same as
establishing actual liability for patent infringement, though. In fact, the indemnitee
should argue that it is not even necessary
for the patentee’s claim to be successful before the breach of warranty can be
established. It is only necessary that a nonfrivolous claim affected the benefit of the
bargain it thought it had reached, and imposed a hidden cost that was not reflected
in the purchase price of the subject good.
Moreover, the indemnitee is not obligated to incur the expense associated with
specific milestones in a patent case, such as
claim construction or the close of discovery, before it can safely consider settlement.
Rather, the indemnitee needs to gather
sufficient evidence to perform an evaluative process of the risk involved by the
claim and the impact the claim will have
on the indemnitee’s use of the good. This
might reasonably occur once infringement
contentions are served, but it could theoretically be sooner. In fact, one can foresee an
indemnitee settling before litigation is filed,
such as when an indemnitee receives an offer to license from a patentee with detailed
claim charts. Future cases will decide how
far back courts are willing to go before a
determination of whether a claim is rightful
can reasonably be made. What is certain
is that a body of case law is finally being
developed on this subject, offering more
guidance for the future. l
Christopher M. Arena is a partner at
Woodcock Washburn LLP in Atlanta. He
may be reached at carena@woodcock.
com. Chad A. Rutkowski is an associate at Woodcock Washburn LLP in
Philadelphia. He may be reached at
crutkowski@woodcock.com.
Endnotes
1. Sun Coast Merch. Corp. v. Myron Corp.,
922 A.2d 782, 795 (N.J. App. 2007).
2. Cover v. Hydramatic Packing Co., Inc.,
83 F.3d 1390, 1394 (Fed. Cir. 1996).
3. See 84 Lumber Co. v. MRK Techs., Ltd.,
145 F.Supp.2d 675 (W.D. Pa. 2001).
4. Id.
5. See, e.g., Pac. Sunwear of Cal., Inc. v.
Olaes Enters,, Inc., 84 Cal. Rptr. 3d 182 (Cal.
App. Dep’t Super. Ct. 2008).
6. See, e.g., Pacific Sunwear, 84 Cal. Rptr.
3d 182; Sun Coast Merchandise, 922 A.2d 782.
7. It should be noted that although the
policy is discussed here, and in the case law, in
terms of what is fair to the buyer, the section
2-312(2) indemnification is bilateral in the
sense that the buyer may have to indemnify
the seller for infringement claims arising out
of the seller’s conformance with the buyer’s
specifications.
8. 637 F. Supp. 2d 683, 697 (N.D. Cal.
2009).
6 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
The Basics of Indemnification
By G. Ross Allen
I
ndemnification is a contractual assurance relieving a party from the risk of
financial loss if an issue arises relating
to the party’s rights under a license agreement. An indemnity clause is one of the
most important sections in an intellectual
property transaction, yet its importance is
often overlooked.
Indemnification encourages diligence
by allocating responsibility to the party in
the best position to know potential risks
faced by its technology. In the case of intellectual property, the licensor generally has
conducted due diligence by determining
what other related technologies exist and
conformed its research and development
process accordingly. Thus, the licensor is
best positioned to determine whether its
technology potentially infringes a third
party’s rights and should assume some
responsibility for the risk of infringement.
Further, indemnification provides a contractual remedy for the licensee in the event
it is later sued in connection with using or
manufacturing the licensor’s product.
Implied Indemnification under the UCC
An indemnification obligation arises
only when a situation mandates or when
expressly provided. When a licensing
agreement does not contain an indemnity
clause, state contract laws—most adopting
the Uniform Commercial Code (UCC)—
will govern if the licensor regularly deals
in licensed goods. In intellectual property
transactions, it is highly unlikely that
corporations will enter into contracts with
merchants acting outside their normal
course of business. Thus, states’ versions
of the UCC will often apply.
Under UCC section 2-312, absent agreement otherwise, the licensor warrants that
the goods will be delivered free of the rightful claim of any third person. Essentially,
this means the licensor promises that its
technology does not violate the intellectual
property rights of others. If allegations of
infringement arise, the official comments
to section 2-312 instruct that the licensee’s
remedy arises immediately upon notice of
an infringement claim. A claim is “rightful”
under section 2-312 if it constitutes a “nonfrivolous claim of infringement that has any
significant and adverse effect, through the
prospect of litigation or otherwise, on the
buyer’s ability to make use of the purchased
goods.”1 The licensee, however, does not
lose its potential claims of indemnification
against a licensor by denying infringement
when answering a third party’s infringement complaint.2
When a licensing
agreement does not
contain an indemnity
clause, state contract
laws will govern.
UCC section 2-607 requires the licensee
to inform the licensor within a reasonable
time after the licensee discovers or should
have discovered a breach of the agreement. When infringement is alleged, the
licensee must notify the licensor within a
reasonable time after receiving notice of
the litigation. If the licensee fails to notify
the licensor, the licensee risks being barred
from any remedy or liability established
by the litigation. Thus, the licensee must
establish a notice procedure providing
timely notice of a claim or liability so that
the licensor can properly defend against
the claim or liability. The adequacy of
a license’s notice process is sometimes
contested when the licensor refuses to indemnify it. Therefore, the notice procedure
must provide notice within a reasonable
time to the licensor, or the licensee will
risk being barred from asserting indemnification. Further, although a licensor has
the right to take control of litigation under
section 2-607, it is not required to do so. If
the licensor does not retain control, the licensee will need to proceed with litigation
over the infringement allegations, incur the
costs of its defense, and later seek recovery
from the licensor for its expenses.
Drafting Indemnity Clauses
Generally
In most instances, parties choose to draft
indemnity clauses modifying or supplementing the governing state’s version of
the UCC to clarify and preserve issues
unique to intellectual property transactions
and to minimize future disputes. Each
party must consider the possible ramifications of indemnification when drafting
indemnity clauses. The scope of indemnification is a primary concern for all
parties. Two main issues arise in considering the scope of indemnification: (1) what
is the desired extent of the indemnification, and (2) what limitations should be
included.
The extent of the indemnification
includes whether the licensor warrants
against direct infringement, contributory
infringement, or inducement. The extent
also includes what types of damages and
fees will be covered by the indemnity
clause. For example, whether a licensor
must assume the risk of liability when
a licensee is later accused of contributory infringement in supplying a licensed
technology to a third party will depend
on the express language of the indemnity
clause. In determining the correct extent
of indemnification, a party’s concerns may
vary depending on whether the party is the
licensee or the licensor.
Limitations that parties tend to focus on
when drafting indemnity clauses include
territorial limitations and limitations on the
amount of liability assumed by the licensor.
Territorial issues often arise when parties
commonly do business outside the United
States. Parties should consider whether the
licensor will warrant only against the rights
of third parties held in the United States
and not in foreign jurisdictions. Parties
doing business internationally may require
indemnity provisions that encompass warranties against third-party rights in many
jurisdictions. With foreign transactions, parties should consider whether the indemnification will be limited to only the countries
where the technology will be used. For
instance, a licensee doing business in both
the United States and Japan would not want
7 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
an agreement limited to warranting against
third-party rights only in the United States.
Parties must, however, ensure that the
indemnification will be enforceable in the
applicable jurisdictions. And the licensor
will want to make sure it has researched
the existing technology and intellectual
property in all territories covered under the
agreement.
Whether to include a cap on the amount
of liability is another important limitation
for parties to consider. Parties may wish
to limit the amount a licensor indemnifies
to the amount supplied by the licensing
agreement. Alternatively, the parties may
choose a cap based on state law or apportion liabilities based on a party’s benefit
from the agreement. These territorial
limitations and limitations on the amount
of liability provide clarity and can help
eliminate future disagreement over an
indemnity clause’s scope if infringement
allegations arise.
Considerations for Each Party
Several recurring issues arise based on
whether a party is the licensee or the licensor. Counsel must take special precautions
depending on which side counsel is representing and what the client’s interests are.
Concerns for the Licensee
The licensee faces several unique issues
regarding indemnity clauses. The licensee
must assess the possible ramifications
associated with entering into a licensing
agreement and negotiate an indemnity
clause accordingly. The licensee should
investigate the licensor’s financial situation. The licensor must be sufficiently
able to meet its indemnity obligations in
the case that infringement allegations later
arise. Similarly, the licensee will want to
determine any legal actions the licensor
is currently involved with, as well as past
litigation, especially actions involving the
licensed technology.
The licensee should also negotiate
whether sublicenses are covered by the indemnity clause. This will have a substantial impact on future sublicensing negotiations because the sublicensee will want
to be protected from the rights of third
parties, as well. A strong argument can
be made that the indemnification should
cover the sublicensee because the licensor
ultimately reaps the royalty benefits from
the sublicensee’s use.
Further, the licensee will want to speci-
fy what types of damages the licensor will
accept responsibility for. For instance, the
indemnity clause may allocate responsibility for both direct and indirect damages on
the licensor. The licensee may also want to
negotiate whether the licensor will assume
responsibility for associated defense costs,
investigation expenses, discovery costs,
and attorney fees.
Concerns for the Licensor
The licensor’s goal will be to minimize the
risks associated with licensing its technology. Thus, the licensor will want to specify
a period of time for the licensee to provide
notice of any infringement allegations. The
agreement may provide that if the licensee
fails to give notice within the specified period, the licensee risks being barred from
seeking indemnification or risks having to
pay for some portion of its defense. The
procedure and time requirements should
be clearly stated to prevent ambiguities
about each party’s obligations.
The procedure and
time requirements
should be clearly
stated to prevent
ambiguities about
each party’s
obligations.
The licensor will also want to consider
what its obligations for infringement
claims will be if the licensee combines the
licensed technology with a third party’s
technology. The licensor may want to
carve out exceptions to indemnification
where infringement would not have occurred but for the combination or where
there is a reasonable noninfringing alternative combination available. The licensor
should limit its liability to indemnify only
claims arising from its technology and not
the entire infringing combination.
Further, the licensor must determine
whether it will control litigation and
settlement if the licensee is later sued.
This can entail choosing counsel and
litigation strategies. It is important to
specify who controls litigation, because
the licensor and licensee likely have differing interests in how these issues are
handled. The licensee may want to retain
control over defending any infringement
suits. In such cases, the licensor will
need to determine how the expenses of
defending a suit will be handled. The
license may provide that expenses are
charged against royalties owed under
the agreement or that expenses will be
shared by the parties. Regardless, the
licensor should clarify in detail how litigation and associated expenses will be
handled. Similarly, if the licensor desires
to control the defense, it will want to
state that the licensee must cooperate in
any defense efforts regarding the technology. Because a licensor will want to
minimize its responsibility, the licensor
will also want to include a provision that
the licensee has a duty to mitigate.
Conclusion
Intellectual property indemnification is an
important consideration for parties entering
into licensing arrangements. While state
contract law generally protects the licensee
in most jurisdictions, the licensee and the licensor will want to expand or modify these
provisions to define explicitly the protections and obligations for each party. Parties
should focus on the scope of indemnification, including the extent of protection and
any limitations. In doing so, each party
faces several unique concerns. Both parties
must thoroughly assess the ramifications
for all possible scenarios and negotiate an
indemnity clause that adequately incorporates each party’s risks and obligations. A
clear, unambiguous indemnity clause will
help eliminate future disputes in the event
infringement allegations arise. l
G. Ross Allen is an associate at
Townsend and Townsend and Crew LLP
in Palo Alto, California, specializing in
intellectual property litigation. He may be
reached at grallen@townsend.com.
Endnotes
1. Pac. Sunwear of Calif. v. Olaes Enters., Inc.,
84 Cal. Rptr. 3d 182, 194 (Cal. Ct. App. 2008).
2. See Phoenix Solutions, Inc. v. Sony Elecs.,
Inc., 637 F. Supp. 2d 683 (N.D. Cal. 2009).
8 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
Drafting and Negotiating Defense and
Indemnification Provisions
By Robert E. Rudnick and Andrew M. Grodin
S
ales agreements and licenses may
be the driving force for a significant number of companies generating revenue today, but management
of certain liability risk and protection for
clients down the road depends on properly
drafted intellectual property (IP) defense
and indemnification provisions. Whether
as outside counsel drafting a license
agreement for a client or as an in-house
attorney looking to update an employer’s
standard sales and services agreements,
practitioners often overlook IP defense
and indemnification clauses until it is too
late. Particular industry customs and the
concerns of important customers play
a large role in shaping IP defense and
indemnification provisions in purchase and
license agreements. However, proactive
private practitioners and in-house counsel
should use these provisions to manage
their clients’ risk of liability by narrowing and carefully drafting and negotiating
these often glanced-over provisions.
This article addresses important considerations for reasonably narrowing defense
and indemnification provisions alone, as
well as in combination with corresponding
representations and warranties provisions.
In most circumstances, considerations for
IP defense and indemnification provisions in purchase agreements for the sale
of goods are equally applicable to license
agreements for services, technology, and
software. Accordingly, throughout this
article, the term “seller” denotes a seller of
goods or services or a licensor of technology or software. Likewise, the term
“buyer” is used for a corresponding buyer
of goods or services or the licensee of
technology or software.
IP defense and indemnification issues addressed in this article relate to IP
generally—patents, trademarks, copyrights,
and trade secrets, associated with the sale of
goods and services or licenses of technology and software. However, the primary
focus is on provisions that limit liability in
patent infringement lawsuits. The larger
litigation defense costs and complex issues
in play in patent litigations usually dwarf
those in other types of IP actions. While
liability for copyright infringement or trade
secret misappropriation actions is often successfully avoided or managed by corporate
policies prohibiting intentional malicious
acts, patent infringement actions often arise
without the intentional acts of copying or
the like by the seller and therefore require
greater attention in the drafting of IP defense and indemnification provisions.
While it is not possible or even highly
probable that all of a seller’s risk can be
eliminated in the context of a business
transaction, the risk can at least be man-
Practitioners often
overlook IP defense
and indemnification
clauses until it
is too late.
aged and minimized. This is particularly
true because boilerplate IP defense and
indemnification provisions are typically
overly broad in favor of protecting the
buyer or licensee. The following sections
highlight important issues to be considered
by a seller for reasonably narrowing these
provisions that are applicable in most industries for managing the seller’s inherent
exposure to liability associated with the
sale of goods or the licensing of intellectual property.
Defense and Indemnification—
General Terms and Triggers
A well-constructed IP defense and indemnification provision should clearly set forth
the terms, scope, and breadth of a seller’s
defense and indemnification obligations,
and include the events and conditions that
trigger such obligations. For example,
language for a boilerplate IP defense and
indemnification provision may include:
Seller will defend, indemnify, and
hold Buyer harmless against a
third-party action, suit, or proceeding (“Claim”) against Buyer to the
extent such Claim is based upon an
allegation that a Product, as of its
delivery date under this Agreement,
infringes a valid United States patent
or copyright or misappropriates a
third party’s trade secret.
This seemingly innocuous provision
creates potential liability in the form of
an unbounded indemnification and hold
harmless statement that may include lost
profits or business interruption damages.
On the other hand, this same example
limits the triggering event that creates the
seller’s defense and indemnity obligation. It also limits the type and geographic
scope of the defense and indemnity, which
are addressed in greater detail below.
As evident in the above example, a critical element is the term that creates or triggers a seller’s defense and indemnification
obligations. A well-drafted provision must
clearly state whether a seller’s obligation
is triggered by the filing of a complaint,
the receipt of a letter alleging infringement, or merely offering a patent license.
The seller’s counsel should advocate
that the triggering event be limited to the
filing of a claim, lawsuit, or proceeding.
The seller can then also determine, case
by case, whether to step in and defend or
indemnify for mere allegations of infringement or offers to license. Such a decision
often depends on the seller’s business
relationship with the buyer, as well as the
perceived stature and merit of the patent
and the party alleging infringement.
In contrast, a buyer’s goal is to minimize the resources it would have to expend in dealing with a third-party patentee
alleging infringement. By requiring the
9 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
Combination Exclusions
Products are often used as components integrated into a larger system by the
buyer. Simply supplying a single component without knowing how it will be used
in a system can create significant liability and hardship for a seller when the buyer
seeks defense and indemnification from all its component suppliers in response
to a patent infringement lawsuit brought against its system. To manage such risk,
component manufacturers often include combination exclusions in their IP defense and indemnification obligations. A combination exclusion may state that the
“Seller shall have no defense or indemnity obligation for a Seller-furnished product that has been used with or combined with hardware or software not furnished
by Seller.”
Blanket combination exclusions may be problematic for products specifically
designed to operate with other products not supplied by the seller, e.g., software
designed to operate with a computer or a memory component designed to operate with a microprocessor or microcontroller. Accordingly, the scope and extent
of combination exclusions can and should be tailored to the particular products
licensed or sold. Factors to consider in drafting combination exclusions include
whether the product is a staple good in commerce, the use of the product as a
stand-alone item, the licenses held by the seller from other third parties regarding the use of the product, and the ability of the buyer to modify or customize the
purchased product for use with its particular product.
seller’s defense and indemnification obligation to trigger early, e.g., upon receipt of
a letter or other communication, the buyer
effectively diverts a potential problem directly to the seller, with little expenditure
of resources. It is typical for a purchase
agreement or license agreement to create
the seller’s IP defense and indemnification obligation based on the filing of an
action, a claim, or a proceeding. However,
recently we have seen buyers more aggressively seeking contract language in
which a seller’s IP defense and indemnity
obligation is triggered by an allegation of
infringement, particularly in market segments with patent troll activity.
Defense and Indemnification—
Separate but Related Obligations
Historically, for certain industry segments,
protection afforded buyers of goods from
third-party patent infringement was in the
form of IP indemnification only. In the
last decade, sales and license agreements
have extended the sellers’ obligations to
include both defense and indemnification obligations. Of late, it is not unusual
for such agreements to create obligations for the seller to defend, indemnify,
and hold the buyer harmless. Each of
these separate, but related, obligations
increases the seller’s exposure to liability.
Although industry custom may dictate
this arrangement, deciding whether to tie
one’s defense obligation to the obligation
to indemnify should be critically evaluated. The two obligations are completely
separate, yet they are often combined.
Indemnification does not merely create a
“pay the way” obligation for the seller. In
assuming a level of risk, the seller must
be able to determine and contract for the
amount of involvement it wishes to undertake in a claim for IP infringement made
against a buyer.
A prudent way to provide specific limitations to the seller’s defense and separate
indemnity obligations is to substitute the
blanket statement to “defend, indemnify,
and hold the buyer harmless” with the
following:
Seller will defend, at its expense, a
third-party action, suit, or proceeding against Buyer (“Claim”) to the
extent such Claim is based upon an
allegation that a Product, as of its
delivery date under this Agreement,
infringes a valid United States patent
or copyright or misappropriates a
third party’s trade secret. Seller will
indemnify Buyer for any judgments,
settlements and reasonable attorney
fees resulting from a Claim as provided in this Section.
The seller should also consider making
its defense and indemnification obligations
conditioned on the buyer promptly notifying the seller of the claim in writing once
the buyer is aware of the claim; the buyer
giving the seller sole authority and control
of the defense or settlement of the claim;
or the buyer providing all information and
assistance requested by the seller to handle
the defense or settlement of the claim.
Important Defense and
Indemnification Exceptions
Sellers should consider explicit exceptions
to their defense and indemnification obligations. Examples of limiting or obviating
exceptions to the creation of an obligation
include exclusions for a product that has
been modified by someone other than the
seller, a product that has been modified by
the seller in accordance with the buyer’s
specifications or instructions, and a claim
of infringement based on the buyer’s
other products or third-party products. In
association with these exceptions, sellers
should also consider obtaining a reverse
defense and indemnification obligation
from buyers. A reverse obligation could
include, for example, an agreement to
defend the seller against third-party
claims, judgments, or settlements and to
reimburse attorney fees resulting from a
claim against the seller’s product that has
been modified by someone other than the
seller or a product that has been modified by the seller in accordance with the
buyer’s specifications or instructions. The
seller should also consider expressly limiting or excluding liability when the alleged
infringement results from the negligence
or willful misconduct of the buyer.
Hold Harmless and Limitation of
Liability Provisions
Because it has become common for
defense and indemnification provisions
to hold buyers harmless from IP infringement, sellers are now facing large potential
damages including the buyer’s lost profits,
business interruption expenses, and other
consequential damages. Hold harmless
provisions should be evaluated to impose
reasonable limitations; otherwise, the
seller could be responsible for more than
it bargained for. The purpose of a seller
holding a buyer harmless against IP
10 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
infringement allegations is to ensure that
the buyer is placed in the same position
that it would have been in absent the infringement allegation, not to ensure that its
potential profits are protected. To manage
this risk, the scope of the IP defense and
indemnification hold harmless provision
should have well-defined limitations of liability to exclude lost profits and indirect,
consequential, incidental, and business
interruption expenses.
It is in a seller’s interest to include a
limitation of liability disclaimer following
IP defense and indemnification provisions
that states, for example:
No Other Remedies Regarding
Infringements—The foregoing
states Seller’s entire liability and
Buyer’s sole and exclusive remedy
with respect to any infringement or
misappropriation of any intellectual
property rights of any other party.
Likewise, a seller should make it clear
that any indemnification obligations are
limited to the amount finally awarded by a
court or agreed to in a settlement.
In addition to excluding certain types
of damages, it may also be reasonable for
sellers to consider a limitation of liability
provision that sets a cap on its liability. It
is quite common in the licensing of offthe-shelf software products, for example,
to cap liability at the price paid by a buyer
for use of the software. In other industries,
it is common to set a liability cap at a multiple of the sale or transaction price.
Geographic Limitations on Defense
and Indemnity Obligations
Another consideration in drafting IP
defense and indemnification clauses is
specific geographic scope restrictions.
For example, if a product is sold to a
buyer in the United States for use in the
United States, the contractual IP defense
and indemnification should reasonably be
limited to infringement of United States
intellectual property, e.g., U.S. patents in
U.S. courts. If a buyer ships the received
product overseas for use in its factory in
the United Kingdom, the seller should not
have to defend or indemnify against thirdparty infringement allegations arising in
the United Kingdom regarding infringement of a U.K. patent.
Geographic limitations may further
help eliminate the seller’s obligation to
defend against some oddball infringement allegations made by third parties.
For example, a third party may attempt
to allege that a buyer’s use of the product
in the United States, in some fashion,
infringes the third party’s foreign patent.
Although there is little chance that a U.S.
court would find that it has jurisdiction
over infringement of foreign patents, a
seller with an unbounded duty to defend
and indemnify could still be required to
expend resources and incur unnecessary
outside counsel expense merely to respond
to the meritless allegations in a foreign
on a linear depreciation monthly
over a (X) year useful life, in which
case Buyer will return to Seller the
Product and cease all use of it.
Such provisions, with the possible
exception of the refund, are likewise advantageous for the buyer. These provisions
allow the buyer to maintain functionality
of the purchased good by using the substitute product without the headache of being
subject to a full patent infringement action
that diverts significant resources from the
buyer’s business.
To mitigate or terminate the impact of IP
infringement claims, a seller should consider
provisions that explicitly allow the seller to
substitute a modified noninfringing product
or service that provides the necessary
functionality for the buyer.
court or otherwise. Geographic limitations
would provide the seller with a graceful
way to decline to defend and indemnify in
such instances without disrupting important business relations.
Remedial Measures: Noninfringing
Substitutes or Modified Goods
To mitigate or terminate the impact of
IP infringement claims, a seller should
consider provisions that explicitly allow
the seller to substitute a modified noninfringing product or service that provides
the necessary functionality for the buyer.
For example, the seller may wish to add a
provision that includes one or more of the
following obligations:
Seller, at its own expense and option
may: (1) procure for Buyer the right
to continue use of the Product; (2)
replace the Product with a noninfringing product; or (3) refund to
Buyer a pro-rated portion of the applicable Fees for the Product based
Coordinating Defense
and Indemnification with
Representations and Warranties
Narrow IP defense and indemnification
provisions can easily be undone by the
inclusion of broad representations or warranties due to the conflicts the two create.
For example, the standard Uniform Commercial Code (UCC) provisions that have
been adopted under the laws of virtually
all states state that in any contract for the
sale of goods, it is inherent that the seller
warrant against infringement of a thirdparty’s property rights.1 Such implicit
rights trump the narrow provisions of a
carefully drafted IP defense and indemnification provision. Fortunately, most
reasonably sophisticated sales agreements
appropriately and explicitly disclaim such
UCC warranties. However, all too often, in
addition to disclaiming such UCC warranties, many carefully and not-so-carefully
drafted IP defense and indemnification
provisions have little or no value when the
contract itself further includes an explicit
11 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
warranty against IP infringement.2 In such
instances, a buyer may seek indemnification from a seller under either or both of
these provisions. Accordingly, any restrictions on the seller’s potential liability set
out in the IP defense and indemnification
provisions will be rendered moot in view
of the provided blanket representation and
warranty against patent infringement with
no limitations.
From the seller’s perspective, it is
therefore prudent to refuse to include a
representation or warranty against IP infringement if a well-structured IP defense
and indemnification section is included
in the agreement. During negotiations,
to the extent such provisions are discussed, the seller’s counsel may argue
that the warranty against IP infringement
is unnecessary for two reasons: (1) The
IP defense and indemnification provisions set forth the extent of the buyer’s IP
indemnification, and the warranty against
patent infringement therefore provides
an unnecessary second cause of action
under the agreement; and (2) of a more
practical nature, it is not possible for the
seller to evaluate every third-party patent
in force to make such a representation
and warranty, even after an extensive patent clearance study has been performed.
Finally, to the extent that a buyer still demands that a representation and warranty
against patent infringement be included,
it is wise to include such a provision
with the explicit statement that the sole
remedy for breach of this representation
and warranty is provided under the patent
indemnification section.
The purpose of a well-drafted arm’s
length defense and indemnification provision is not to afford the buyer or seller the
opportunity to take advantage of the other;
rather, it is an opportunity to apportion
appropriate risk inherent in any sale or
license. This can be accomplished by employing some of the practice tips discussed
in this article with the understanding that
no matter how many scenarios are considered, there is always a risk of the unknown
that cannot be contracted away. l
Robert E. Rudnick is a director at
Gibbons P.C. in Newark, New Jersey. He
may be reached at rrudnick@gibbonslaw.
com. Andrew M. Grodin is an associate at
Gibbons P.C. in Newark, New Jersey. He may
be reached at agrodin@gibbonslaw.com.
Endnotes
1. Section 2-312 (2) of the UCC states:
“Unless otherwise agreed, a seller that is a
merchant regularly dealing in goods of the kind
warrants that the goods shall be delivered free
of the rightful claim of any third person by
way of infringement or the like but a buyer that
furnishes specifications to the seller must hold
the seller harmless against any such claim that
arises out of compliance with the specifications.”
Section 2-312 (3) of the UCC states: “A
warranty under this section may be disclaimed
or modified only by specific language or by
circumstances that give the buyer reason to
know that the seller does not claim title, that
the seller is purporting to sell only the right or
title as the seller or a third person may have, or
that the seller is selling subject to any claims of
infringement or the like.”
2. It should be noted that because a finding
of infringement would constitute a direct breach
of the warranties in the agreement between the
buyer and seller, a buyer would potentially have
a direct claim for breach of contract against the
seller, separate and apart from the claim raised by
a third party asserting a claim of infringement. A
carefully crafted IP defense and indemnification
provision should therefore make indemnification
the sole and exclusive remedy for the breach of
contract, thereby cutting off any additional claims
between the buyer and the seller.
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12 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
Sharing the Risk: Patent Infringement Liability
Indemnification and Insurance
By Kim Cauthorn, Tom Britven, and Tamara Turek
I
ncreasingly, the targets of patent
infringement suits are large entities
selling or using the allegedly infringing
product.1 Often, the suit is related to use of
a product, component, or technology supplied by a third party. To shift the financial
risk of such suits, the large entity customer
typically seeks indemnification against
claims of patent infringement from the
supplier/original equipment manufacturer.
More recently, some large entities in the
telecommunications, software, and financial services sectors have begun requiring
their suppliers to carry patent infringement
liability insurance.
However, there are unique issues
regarding the use of patent infringement
liability insurance in such situations. Insurance policies covering patent infringement liability are not widely available; can
be expensive (in relation to the value of
the supply contract); can contain a number
of exclusions; and typically will not
automatically cover customers without an
endorsement or unless the customers have
been added as named insureds.
Another challenge lies in valuing a
potential claim to determine how much
insurance is proper to provide adequate
protection to its customer and itself. Valuation is especially challenging in light of
recent case law that relates to defining the
applicable revenues from which infringement damages should be calculated.2 Of
particular importance are situations where
there is a question of whether the supplied
component or technology is a direct or contributing cause of the alleged infringement.
This article discusses how both the
large entities and their suppliers can address these issues at the contract negotiation stage to manage patent infringement
liability risk more effectively.
The Risks
The trend in patent litigation has been for
patent holders to assert their patent rights
against the entity selling the allegedly
infringing product3 or the entity combining components into a single product.
In today’s high tech economy, it is not
unusual for an entity to combine hundreds,
if not thousands, of components from different suppliers into a single product—for
example, a smart phone. Another dynamic
is the uncertainty surrounding the proper
methodologies for calculating damages
for patent infringement.4 Not surprisingly,
downstream entities want their suppliers to assume the liability for any patent
infringement claims made against them.
or settlement, such provisions typically
do not cover customer loss of revenue or
damage to downstream customer relationships caused by the infringement action.
Moreover, suppliers generally do not
assume infringement risk for components
that are modified by the customer or are
combined in unanticipated ways with
other components sold by the customer.
Suppliers with sufficient negotiating
The trend in patent litigation has been for
patent holders to assert their patent rights
against the entity selling the allegedly
infringing product or the entity combining
components into a single product.
However, an indemnification obligation
is only as strong as the financial ability of
the indemnifying party to honor it and the
indemnitee’s ability to enforce the indemnitor’s obligation. Given that defending a
patent infringement action can cost several
million dollars, the supplier may not have
the resources to cover the defense costs,
much less any damage award or settlement
that may follow. The supplier also runs
the risk that all or several of its customers will be sued by the same patent holder
for infringement in the same or related
actions.5 If the supplier has many customers that it is obligated to indemnify, it may
find itself financially unable to honor all of
its obligations. Further, the supplier may
be so financially constrained that it is not
in a position to develop a design to avoid
further infringement.
Even if the supplier is able to honor its
contractual indemnity for the litigation
costs and any resulting damage award
leverage may contractually limit their
liability to a percentage of the cost of
the goods or components sold under the
agreement. With more goods and components supplied from overseas, especially
Asia, it may be difficult for the customer
to enforce an indemnification obligation
or even to identify or locate the original
supplier.
Managing indemnification risks is a
challenge. For entities such as big box
retailers, consumer electronics manufacturers, and telecommunications providers, it is not always realistic to do a credit
check or perform extensive financial due
diligence on the potentially hundreds or
thousands of their suppliers or original
equipment manufacturers. Likewise, while
it is wise for customers to conduct due
diligence on their suppliers or original
equipment manufacturers to ensure that
they own or have licensed the necessary
intellectual property covering the supplied
13 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
The U.S. Market for Patent
Infringement Liability Insurance
Insurance coverage for patent risk has been developing since at least the early
1980s. The Lloyd’s of London insurance market has been underwriting patent
risk for non-U.S. companies since the early 1980s and has been in and out of the
U.S. market since 1998. Intellectual Property Insurance Services Corp. (IPISC), a
managing general agency based in Louisville, Kentucky, has been offering patent
coverage in the United States since the late 1980s. Some large carriers and reinsurers have, in isolated instances, provided catastrophic coverage for patent infringement liability risk or provided excess coverage where patent infringement liability
risk coverage is part of an integrated risk program.
A limited number of carriers currently offer patent infringement liability insurance to U.S. companies. As of January 2010, IPISC was the only U.S. carrier
offering stand-alone patent infringement liability insurance. Allied World/Darwin
selectively offers an endorsement of up to $1 million of coverage for patent infringement liability risk on its Tech//404 policy form. Lloyd’s, through SAMIAN
Underwriting Limited, may reenter the U.S. market sometime in 2010 to offer
patent infringement liability coverage to U.S.-based companies. ThinkRisk, a new
U.S.-based insurance underwriting agency, may offer patent coverage as part of its
modular coverage for media, technology, advertising, privacy, and network security risks at some point. Patent infringement insurance buyers must therefore stay
abreast of current market offerings, including availability and terms of coverage.
products, customers may lack the time
or resources to do so. And, if it is the
combination of components that allegedly
infringes rather than any single component, such due diligence would not be
particularly helpful.
For other types of risk, customers often
contractually require their suppliers to
carry insurance. Examples include general
liability coverage, workers compensation,
and errors and omissions coverage. As the
risk of liability for patent infringement has
increased, some entities are now requiring
their suppliers to carry patent infringement liability insurance either in lieu of,
or in addition to, providing indemnification. However, there are often unrealistic
expectations regarding availability, scope
of coverage, limits of indemnity, and the
cost of coverage.
Patent Infringement Liability
Insurance
Process
Liability insurance underwriters focus on
three primary questions when conducting
their underwriting analysis:
1. Will the insured be sued and therefore make a claim on the policy?
2. If so, what will it cost the insurer to
resolve the claim?
3. How long will it take to resolve the
claim?
Underwriting patent infringement
liability risk is particularly challenging
because there is insufficient actuarial data
available to address these three questions.
The challenge is compounded when the
underwriter must consider such questions
in the context of contractual arrangements
between suppliers and customers. While
there is not yet a uniform underwriting
process or model, underwriters typically
require either a search by patent counsel
showing that the product to be insured
does not infringe on any existing patents
or payment of an underwriting fee (typically a few thousand dollars) to conduct its
own analysis.
In addition to a noninfringement
analysis, the insurance application typically requests the following categories of
information:
• Relevant products made or sold by
the applicant
• Relevant patents on the products
held by the applicant
• An explanation of how the patents
were developed or obtained
• The applicant’s financial information
• The applicant’s patent risk management policies and practices
• The applicant’s patent dispute history
If the applicant is a supplier or original
equipment manufacturer and wants others,
such as its customers, listed as additional
insured parties or seeks to cover its patent
infringement liability indemnification obligations with the insurance, the applicant
will also need to provide the following:
• Information about such entities
• A description of what is being
supplied to such entities
• A description of how the entities
will be using or selling what is
supplied to them
• The contractual arrangements with
such entities
Pricing
Given the complexity of the underwriting process, uncertainty, and potential
high-dollar liability related to a patent
infringement suit, such insurance can be
expensive. This is especially true when the
underwriter is analyzing the risk of both
the customer, which often has the larger
base from which damages may be calculated, and the supplier. Therefore, the cost
of the insurance must be weighed against
the benefits of having the coverage.
The premium for such insurance is
usually calculated on a rate-on-line basis.
For patent infringement liability policies,
premium rate-on-line typically falls in
the 1 percent to 10 percent range. As an
example, a 1 percent rate-on-line for a
limit of indemnity of $1 million would
be a $10,000 premium. Most specialty
line patent policies include a self-insured
retention and a co-insurance. The selfinsured retention works like a deductible
but does not count against the policy
limit. The co-insurance counts against
the policy limit and can be anywhere
from 5 percent to 20 percent. This is the
portion of the legal expenses or damage
award that must be paid by the insured.
In addition to other factors, the premium
is priced against the self-insured retention and the co-insurance percentage. If
the applicant is willing to retain more
risk (a higher self-insured retention), the
premium typically decreases. Likewise, if
14 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
the insurer carries more risk, the premium
typically increases.
Form, Conditions, Exclusions, and Claims
Insurance policies that cover the thirdparty risk of the policy holder being
accused of patent infringement are usually
referred to as defensive or infringement
liability policies. The policy will cover
legal defense costs and/or damages and
settlement.6 However, these are typically
claims-made indemnity policies that
include legal defense expenses within the
policy limits. For example, if a $4 million
policy is purchased and $4 million is spent
on defense, there is nothing remaining to
cover damages or settlement. Moreover,
for there to be coverage, the claim must
be made during the policy period, which
typically is one year. These policies also
can be broadened to cover trademark
and copyright infringement liability risk.
Some carriers allow endorsements to these
policies that cover the insured’s contractual patent infringement liability indemnification obligations to customers and
others and that list indemnified parties as
additional insureds.
Obtaining the appropriate scope of
coverage is particularly important when
customers are added as additional insured parties or when a contractual patent
infringement liability endorsement is
requested. The carrier will request a very
specific description of the products to be
covered against claims of patent infringement. If the supplier is providing a component part or a material that will go into a
product sold by the customer, descriptions
of both the component part or material and
the finished product should be provided to
the carrier.
Policy definitions vary among carriers.
For example, a “claim” may be defined to
require initiated legal action in one policy
form but only the threat of legal action in
another policy form. This distinction can
be particularly important in the context of
warning letters. For example, if a supplier
has purchased patent insurance covering
a customer and the customer receives a
warning letter, the cost to retain counsel
to review and respond to the letter may
or may not be covered or count against
the self-insured retention, depending on
how “claim” is defined. “Prior acts” may
be defined such that if a claim is made
for infringement that allegedly began two
years before the policy’s inception date,
the claim either will be denied or the carrier will not cover any damages accruing
prior to the policy’s inception date. Some
policies also require a waiting period
before any claim can be brought against
the policy.
Patent insurance policies also typically
exclude willful infringement and nonintellectual property causes of action.
However, some policies cover legal defense
expenses to defend against such claims.
option in those situations where the customer is requiring the supplier to purchase
the insurance and to list the customer as an
additional insured or where the insurance
stands behind the seller’s indemnification
obligation to the customer.
A second option is for the customer to
add patent infringement liability coverage
to its vendor insurance programs. Vendor
insurance programs are programs sponsored by large entity customers to offer
Obtaining the appropriate scope of coverage
is particularly important when customers
are added as additional insured parties or
when a contractual patent infringement
liability endorsement is requested.
Policy requirements for claim submission, approval, and management vary.
Some carriers require a third-party legal
opinion that the insured has a reasonable
probability of successfully defending
the claim before the insurer will accept
the claim. Most carriers allow choice of
counsel but require settlement consent. In
situations where the supplier has agreed
to indemnify its customer and is using the
insurance to stand behind the indemnification obligation, care should be taken
to avoid conflict in the language of the
insuring agreement and the language of
the indemnification agreement as it relates
to the control of the litigation.
How to Use Patent Insurance to
Address the Risks
If customers require their suppliers to
carry patent insurance or the suppliers
are considering using patent insurance
as a backstop to contractual indemnification obligations to customers, suppliers
may find that the cost of the coverage is
too high compared with the value of the
contract. In such situations, there may be
some more cost-effective options.
As a first option, the parties can share
the cost of the policy. This is a viable
cost-effective, required insurance coverage to the vendors with whom they do
business. If the customer has decided that
it will require all or a significant number
of its vendors to purchase patent insurance and if the customer is large enough to
already have a vendor insurance program in place, it likely has the necessary
relationship with insurance carriers to add
patent insurance to the program. Accessing insurance through such a program is
likely to be more cost effective than each
supplier obtaining the same coverage on
an ad hoc basis.
Third, the supplier providing the
indemnification can spread out the cost
by purchasing a broad policy that not
only covers it against any claims of patent
infringement but also extends the coverage to any entity it contractually agrees to
indemnify.
A fourth option is for the customer to
carry a policy that applies only in those
situations where the supplier has not indemnified the customer, the supplier cannot honor its indemnification obligation, or
the indemnification does not apply or only
partially applies. Such insurance fills a risk
gap that big box retailers and media, technology, and telecommunications providers
15 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
in particular are experiencing.
A fifth option is to purchase insurance that will apply only in the event the
liability exceeds a fixed amount where, for
example, the indemnification is capped or
there is a limitation of liability. However,
the supplier/customer contract should
be drafted so it is clear the insurance is
intended to be excess to the fixed amount
or liability cap. This is especially important if the contract also contains a patent
insurance requirement. The flip side of
this option is to purchase insurance in the
amount of the capped liability where the
insurance applies when the indemnified
party requests indemnification, but only up
to the capped amount.
Assuming insurance is not discussed
when the contract is negotiated and an
indemnification demand is made, the
customer and/or supplier may have coverage, or at least partial coverage, under
other existing insurance policies such as
commercial general liability insurance or
technology errors and omissions professional liability insurance. Some errors and
omissions policies, especially for technology and software companies, provide
coverage for patent infringement liability
by endorsement. However, these claims
must relate to the policy holder’s professional services activities, and the limits for
patent infringement liability are generally
no higher than $1 million.
Conclusion
The cost of litigating patent infringement
suits is high and shows no signs of decreasing. The risk that customers will be sued for
patent infringement continues to increase.
The potential for high damage awards
poses a very real threat to customers and to
the suppliers providing indemnification to
them. Patent insurance in lieu of, or in combination with, patent infringement liability
indemnification can be a useful risk-sharing
tool. However, such a tool cannot be used
unless carefully considered and obtained in
a timely manner. l
Kim Cauthorn is a director at Duff &
Phelps. She may be reached at kwimberly
.cauthorn@duffandphelps.com. Tom
Britven is a managing director at Duff
& Phelps. He may be reached at thomas
.britven@duffandphelps.com. Tamara
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Turek is a vice president at Duff &
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.turek@duffandphelps.com. All reside in
Houston, Texas.
Endnotes
1. For purposes of this article, such entities
will be referred to as “customers.”
2. See, e.g., i4i Ltd. P’ship v. Microsoft Corp.,
Case No. 2009-1504 (Fed. Cir. Dec. 22, 2009);
Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301
(Fed Cir. 2009); Cornell Univ. v. Hewlett Packard
Co., 609 F. Supp. 2d 279 (N.D.N.Y. 2009).
3. Although a full discussion is beyond the
scope of this article, a related reason for targeting
the larger downstream entity may be the impact of
the Supreme Court’s holding in Quanta Computer
v. LG Electronics. While limited by Quanta to one
bite at the license “apple,” the patent holder can
pick where on the apple it chooses to bite, i.e., the
entity it chooses to target. See Quanta Computer v.
LG Elecs., 128 S. Ct. 2109 (2008).
4. Case law addressing the applicable
revenues and profits on which calculation of
infringement damages should be based is still
developing. See, e.g., i4i Ltd. Partnership, No.
2009-1504 ($290 million damages award and
injunction affirmed); Lucent Technologies,
580 F.3d 1301 ($357 million damages award
reversed); Cornell University, 609 F. Supp. 2d 279
(court granted defendant’s motion for judgment
as a matter of law because it held the record
showed plaintiff did not prove entitlement to
entire market value of defendant’s products).
5. An example can be found in webMethods,
Inc.’s 2004 Form 10-K Annual Report: “On
March 30, 2004, we entered into a settlement
agreement with a private company that had made
claims against five of our customers, whom we had
agreed to indemnify, at least in part, for business
reasons against infringement claims relating to
our products. The private company claimed that
those customers’ implementation of application
integration systems and methods supported by
certain of our products allegedly infringed a
U.S. patent. The private company did not make
infringement claims directly against webMethods
or claim that any of our products infringed that
patent. Under the settlement agreement, we paid
$2.25 million to the private company in April 2004
to secure a complete release of all claims against
the five customers, and we obtained a license to
that patent that we can pass through to our past,
present and future customers with respect to their
use of webMethods’ products.” webMethods, Inc.,
SEC Form 10-K Annual Report for fiscal year
ended Mar. 31, 2004, at 25.
6. Patent infringement liability policies cover
third-party losses only; therefore, such policies will
not cover the accused infringer’s lost revenue or
lost customer relationships. It may be possible to
obtain a separate insurance policy to insure such
first-party losses.
16 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
Res Judicata: Patent Indemnitee Beware!
By Kenneth L. Dorsney
I
ndemnification plays an important
role in the assignment or licensing of
patents and the sale of goods. Patent
litigation is expensive, consuming, and
perilous. Indemnification clauses thus
have emerged as a key component in the
transfer of property and patent rights.
Like similar contractual rights, though,
the mere existence of the right does not
necessarily confer the unequivocal power
to exercise the right. Initial protection does
not always guarantee a later recovery. An
indemnitee’s action or, as in the case of
res judicata, a failure to act might preclude
the contractual recovery first envisioned.
A patent indemnitee should tread lightly in
litigation to prevent the preclusive nature
of a final judgment.
Indemnification in Patent
Infringement
Patent indemnification is like other forms
of contractual indemnification whereby
one party to the transaction agrees to protect the other party against claims arising
from use of the patented technology or
the goods purchased. One type of protection often embodied in an indemnification
clause relates to the defense of claims for
direct infringement, contributory infringement, and inducement of infringement, including the payment of associated attorney
fees and costs.
assuming entry of the indemnitor in an
action for patent infringement, either as a
named defendant, as a requirement of the
contract, or by agreement of the parties,
the indemnitee’s claim might be timely
earlier2 and, if not litigated in the action,
might be barred by res judicata.
Res judicata3 prevents parties from
litigating issues that were, or could have
been, raised in a prior action.4 “The
doctrine serves to ‘relieve parties of the
cost and vexation of multiple lawsuits,
conserve judicial resources, and, by
preventing inconsistent decisions, encourage reliance on adjudication.’”5 The
doctrine applies “if (1) the prior decision
was rendered by a forum with competent
A patent indemnitee
should tread lightly in
litigation to prevent
the preclusive nature
of a final judgment.
Notice and the Party Indemnitor
“Generally, in the absence of a specific
provision in the indemnity agreement,
there is no requirement to notify the
indemnitor to come in and defend as a
condition precedent to recovery.”1 It is frequently the case, however, that the indemnitor is named in the infringement action
or the indemnitee either provides notice
or has an express duty and gives notice of
the action, and, as a result, the indemnitor
enters as a party.
Res Judicata and the Preclusive
Nature of Consent Judgments
A claim for indemnification is generally
not timely until a final judgment is reached
on the underlying claim giving rise to the
right to be indemnified. However,
jurisdiction; (2) the prior decision was
a final decision on the merits; and (3)
the same cause of action and the same
parties or their privies were involved in
both cases.”6
As a general rule, a consent judgment
operates with the same res judicata finality
given to a judgment entered on the merits
in an adversarial proceeding.7 Implicit
in this rule is the recognition that a judgment entered by the consent of the parties,
although based on an agreement, is a final
adjudication by a court that produces the
same result as if the merits of the action had
been fully litigated.8 Unless a party specifically reserves its rights within a consent
judgment to relitigate an issue at a later
time, a court can give preclusive effect to
the language of a consent judgment.9
The Case of Peregrine Financial
An example of the harm that might befall
an unwary indemnitee in a patent infringement action involving the indemnitor is
Peregrine Financial.10 Peregrine Financial
Group, a commodities brokerage firm,
and TradeMaven L.L.C., a developer and
licensor of commodity trading software,
entered into a license granting Peregrine
the right to use TradeMaven’s software.
The agreement contained a provision
indemnifying Peregrine against patent
infringement, including attorney fees and
costs incurred in defense of the action.
In July 2005, Trading Technologies,
Inc., initiated a patent infringement action
against Peregrine and TradeMaven alleging that the software TradeMaven licensed
to Peregrine infringed Trading Technologies’ proprietary patent rights. Although
Peregrine maintained that it had received
assurances from TradeMaven during the
litigation that TradeMaven would indemnify Peregrine for the defense of the
action, Peregrine did not file a claim in the
litigation against TradeMaven for indemnification.
On January 30, 2006, TradeMaven
entered into a settlement agreement with
Trading Technologies whereby TradeMaven admitted infringement and agreed to
the payment of a settlement. Peregrine was
not a party to the settlement agreement. Instead, Peregrine disapproved of the settlement by letter to TradeMaven’s counsel
and continued to litigate and incur defense
expenses. The letter stated, “TradeMaven
is obligated to indemnify [Peregrine] for
any claims against it for infringement.
These obligations are continuing.”
On March 15, 2006, Peregrine entered
into settlement agreement of its own with
Trading Technologies. TradeMaven was
not a party to this settlement agreement.
That same day, however, TradeMaven
amended its own settlement agreement.
Although there was some disagreement,
TradeMaven contended that it agreed to
pay an additional sum in exchange for
Trading Technologies executing a general
17 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
release in favor of Peregrine. Peregrine
disputed this assertion.
In conjunction with the settlement
agreements, all three of the parties agreed
to a consent judgment, which the court
entered on March 23, 2006. The final paragraph of the consent judgment provided
that “[e]ach party shall bear its own costs
and attorneys’ fees.”
Shortly thereafter, on May 23, 2006,
Peregrine’s counsel again sent a letter to
TradeMaven’s counsel regarding indemnity and seeking to resolve the matter of
Peregrine’s expenses for defending the
litigation in the amount of $416,081.22.
TradeMaven did not pay the claim. Peregrine then initiated an action for indemnification to recover its defense expenses.
TradeMaven asserted res judicata as an
affirmative defense and moved for summary judgment based on the language of
the consent judgment.
patent litigation and the action to recover
on the claim for indemnity. Peregrine
also contended at oral argument that
even if it could have brought its claim
for indemnification in the patent litigation, it was not required to do so because
its cause of action had not yet accrued.
Further, Peregrine invoked principles of
equity to assert that TradeMaven should
not be permitted to avoid its contractual
obligation to indemnify because it had
given assurances during the litigation
that it would do so. In defense, TradeMaven relied on the last sentence of the
consent judgment whereby each of the
parties agreed to “bear its own costs and
attorneys’ fees.”
The appeals court was not persuaded
by Peregrine’s arguments. Instead, it
found that Peregrine’s claim for indemnification arose out of “the same incident,
events, transaction, circumstances, or
Because Peregrine could have brought its
claim for indemnification in the patent
litigation, the trial court did not err when it
granted summary judgment on TradeMaven’s
affirmative defense of res judicata.
Following a hearing on the issue, the
lower court granted TradeMaven’s motion
for summary judgment. Peregrine moved
for reconsideration, which was denied,
and then appealed. On appeal, the parties
agreed that there is identity of parties between the patent litigation and the action
for indemnification and that the consent
judgment constituted a final judgment.
The only res judicata factor at issue was
whether there was identity of the causes of
action.
Peregrine maintained that because it
did not bring any claims in the patent litigation against TradeMaven arising out
of TradeMaven’s contractual obligation
to indemnify Peregrine, there was no
identity of causes of action between the
other factual nebula as the patent litigation”; thus, “identity of causes of action”
existed between the two cases. Consequently, because Peregrine could have
brought its claim for indemnification in
the patent litigation, the trial court did not
err when it granted summary judgment
on TradeMaven’s affirmative defense of
res judicata.
Conclusion
An indemnitee having secured a contractual
right to recover for the expense of a patent infringement lawsuit should carefully
consider the ramifications of any negotiated
settlement or judgment where the indemnitor
was involved in the action. At a minimum,
Peregrine Financial serves as warning that
any potentially limiting language should
be carefully scrutinized and that an express
reservation of rights to bring a later action
for indemnification should be included in the
language of a consent judgment. l
Kenneth (Ken) L. Dorsney is a patent attorney and of counsel with the law
firm of Elliott Greenleaf in Wilmington,
Delaware. He can be reached at kld@
elliottgreenleaf.com.
Endnotes
1. Crystal River Enters. v. Nasi, 399 So. 2d
77, 78 (Fla. 5th DCA 1981).
2. See Wilson v. City of Chicago, 120 F.3d
681, 685 (7th Cir. 1997) (plaintiff entitled to
bring an indemnification claim against the
municipality before a judgment is final against
its employee).
3. “[A]s a general matter, the law of
the regional circuit applies to issues of res
judicata and collateral estoppels.” Dana v. E.S.
Originals, Inc., 342 F.3d 1320, 1327 (Fed.
Cir. 2003) (Dyk, J., concurring) (citing Media
Techs. Licensing, LLC v. Upper Deck Co., 334
F.3d 1366, 1369 (Fed. Cir. 2003); but see id.
(Federal Circuit law applies to the res judicata
effect of a consent judgment on the issues of
patent validity and infringement.) (discussing
Foster v. Hallco Mfg. Co., 947 F.2d 469 (Fed.
Cir. 1991)).
4. The preclusive nature of final
adjudication is generally referred to as “res
judicata.” Analyzing the doctrine further
reveals that res judicata embraces two
preclusive concepts: “issue preclusion” and
“claim preclusion.” Issue preclusion refers to
matters that where actually litigated; whereas
claim preclusion refers to matters that should
have been raised in an earlier action. Carson v.
Dep’t of Energy, 398 F.3d 1369, 1375 n.8 (Fed.
Cir. 2005) (citing Migra v. Warren City Sch.
Dist. Bd. of Ed., 465 U.S. 75, 77 n.1 (1984)).
5. Id. at 1375 (quoting Allen v. McCurry,
449 U.S. 90, 94 (1980)).
6. Id. (discussing claim preclusion and
citing Peartree v. U.S. Postal Serv., 66 M.S.P.R.
332, 337 (1995)).
7. Epic Metals Corp. v. H.H. Robertson Co.,
870 F.2d 1574, 1576 (Fed. Cir. 1989) (applying
Third Circuit law).
8. See id. (citing Interdynamics, Inc. v.
Firma Wolf, 653 F.2d 93, 96–97 (3d Cir.), cert.
denied, 454 U.S. 1092 (1981)).
9. “[Parties] may expressly reserve in a
consent judgment the right to relitigate some
or all issues that would have otherwise been
barred between the same parties.” Epic, 870
F.2d at 1576 (citations omitted).
10. Peregrine Fin. Group, Inc. v.
TradeMaven, L.L.C., 909 N.E. 2d 837 (Ill.
App. 2009).
18 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
Contractual Indemnity
Obligations
Continued from page 1
to evaluate the existence and scope of its
indemnification obligation immediately
upon receiving notice of a claim.
Intellectual property indemnity provisions present unique challenges for the
potential indemnitor in cases of patent
infringement. First, it may be difficult in
patent cases to assess whether a particular
claim triggers an indemnity obligation.
The typical complaint for patent infringement alleges only the existence of a particular patent; ownership by the plaintiff;
infringement by the defendant by means
of making, using, selling, offering to sell,
or importing widgets that embody the patented invention; and the relief requested.5
The patent-in-suit may contain dozens of
claims and many columns of description,
but nothing requires the plaintiff to disclose in the complaint which claims of the
patent are asserted against the defendant
or to explain how the defendant infringes.
As a result, when a lawsuit is filed, neither
the defendant nor the supplier/potential
indemnitor may be able to tell for sure
whether the infringement claim is within
the scope of the indemnity obligation. Often the supplier will need to undertake its
own independent infringement analysis to
determine whether the product or service
that is the subject of indemnity obligation
is likely to be accused of infringing the
patent-in-suit.
Second, even when the plaintiff’s
contentions are known, the supplier and
its customer may dispute whether the
supplier’s product or service triggers the
indemnity provision. The asserted claims
of the patent-in-suit may be directed to
multistep methods or multicomponent
systems. The supplier may have provided
only a single component that is used in
only one part of the defendant’s accused
process or that is combined with many
other components in the defendant’s
accused system. In this situation, the supplier may argue that it owes no indemnity
for patent infringement because it has
supplied nothing that, by itself, infringes
any claim of the patent-in-suit.6 Some contracts anticipate this problem by providing
for indemnity from claims arising from a
combination of the supplier’s product or
service with other products or services, but
only where such a combination is “approved” or “authorized” by the supplier.
Such a provision, however, may result
in the supplier contractually assuming
responsibility for liability and damages for
an infringing system or method for which
it supplies a relatively minor component.
Efforts to mitigate this result include limiting the supplier/indemnitor’s exposure
to some specified maximum amount or
limiting its responsibility “to the extent”
the supplied component contributes to the
infringement, leaving the problem of how
to apportion responsibility among contributing components for later resolution in an
it by such suppliers as a result of any
claims RFR might make against the suppliers. RFR then sued Rex-Hide, Century’s
main supplier. Rex-Hide filed a third-party
complaint against Century for indemnification against RFR’s claim, and Century
in turn filed a cross-claim against RFR for
indemnification pursuant to the parties’
settlement agreement. The Federal Circuit
affirmed the district court’s conclusion
that “RFR’s duty to indemnify Century
and Century’s duty to indemnify Rex-Hide
‘creates a circular indemnity that extinguishes RFR’s patent-infringement claims
against Rex-Hide.’”8 This case highlights
the importance of the care required in
drafting indemnity provisions, as well as
Often the supplier will need to undertake its
own independent infringement analysis to
determine whether the product or service that
is the subject of indemnity obligation is likely
to be accused of infringing the patent-in-suit.
action to enforce the indemnity obligation.
Third, indemnity obligations can be
recursive—e.g., A may owe indemnity
to B for widgets supplied by A, while C
may owe indemnity to A for computer
chips provided by C and included in A’s
widgets, and so forth—potentially requiring examination of different contracts for
indemnity and evaluation of the interplay
between them. In a recent unpublished
decision, the Federal Circuit reviewed a
curious collection of indemnity obligations among three parties that created a
circular indemnity obligation. In RFR
Industries, Inc. v. Rex-Hide Industries,
Inc.,7 the patent holder, RFR, sued Century
Steps, Inc., for infringement of patents on
a rubber filler used in railway systems. As
part of the settlement of their dispute, RFR
reserved its right to sue Century’s suppliers for infringement but agreed to indemnify Century from any claim made against
the impact those provisions can have on
the outcome of the action itself.
Fourth, even when the duty to defend
and indemnify is undisputed, fulfillment
of the duty may be complicated by the
existence of actual or potential conflicts
of interest between the supplier and the
defendant in the action. Patent infringement cases provide ample fodder for
such conflicts at different stages of the
proceedings. For example, during claim
construction, it is not difficult to imagine a situation in which a disputed claim
term, if construed one way, might read
on the supplier’s widget but, if construed
another way, might instead read on some
other aspect of the defendant’s system not
provided by the supplier. The supplier, if
required to defend the claim, will be in the
position of having to advocate on behalf of
the defendant a claim construction adverse
to its own interests. Similar conflicts can
19 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
arise with respect to the issue of infringement, where one theory may implicate
the supplier and another may not, and the
supplier and the defendant will have correspondingly different interests.
Where there is a conflict of interest, the
supplier may be excused from the requirement to defend the claim and may be relieved of the usual consequences of failing
to provide a defense, i.e., the supplier will
not be bound by determinations against the
defendant as to which the defendant and
supplier have a conflict, and the supplier
can later contest whether the defendant
To establish willful
infringement, a patent
holder must show
that the accused
infringer was
objectively reckless.
was properly held liable. As explained in
the Restatement (Second) of Judgments,
“When, because of conflict of interest
between the indemnitee and indemnitor, the indemnitor cannot properly take
over the defense of the indemnitee, the
situation is one of justified refusal by the
indemnitor to defend the action.”9 Some
states, however, hold that if the indemnity
contract imposes a duty to defend, the
supplier/indemnitor cannot rely on the
conflict to escape this obligation. Instead,
the supplier must either retain independent
counsel for the defendant or reimburse
the defendant for the costs of retaining
counsel of its own choosing.10 Either the
defendant or the supplier may bring an
action for declaratory judgment regarding
the existence of a duty to defend the claim,
the underlying indemnification obligation, or both.11 A few states even require
the supplier/indemnitor to intervene as a
party in the action so that its interests can
be determined at the same time as the underlying liability.12 Because conflicts can
arise at various points during the course
of a patent infringement action and may
be difficult to anticipate, the existence and
implications of potential conflicts need to
be reevaluated periodically.
Even when the interests of the supplier/
indemnitor and the defendant/indemnitee
are aligned, the defense provided by the
indemnitor may fall short of what the
defendant would do if handling the action
on its own. For example, the defendant
may have patents of its own that could
be asserted as counterclaims for patent
infringement against the plaintiff. Under
the typical intellectual property indemnity provision, the supplier would have
no obligation to bring (and pay for) those
counterclaims.
Finally, claims of willful patent
infringement and inducement of infringement deserve separate consideration, as
they likely are not susceptible of indemnification at all. To establish willful
infringement, a patent holder must show
that the accused infringer was objectively
reckless, i.e., that the accused infringer
acted despite an objectively high likelihood that its actions constituted infringement of a valid patent.13 A claim for
inducement of infringement requires a
patent holder to prove that the alleged
inducer knew of the patent, knowingly induced the infringing acts, and possessed
a specific intent to encourage another’s
infringement of the patent.14 Indemnification of losses resulting from willful or
intentional violations of law is generally
prohibited as contrary to public policy.15
Defense of such claims, however, may
not be prohibited, and if the supplier
has a duty to defend or indemnify other
claims, such as claims of direct infringement or contributory infringement, the
supplier will likely be required to provide
a defense of the action as whole, subject
to allocation of costs associated solely
with the claims for which there is no
obligation to defend or indemnify. l
Virginia DeMarchi is a partner at
Fenwick & West LLP, in Mountain View,
California. She may be reached at
vdemarchi@fenwick.com.
Endnotes
1. Where notice and opportunity to defend
are not expressly provided for in the contract
between A and B, they will usually be implied by
operation of state law. See, e.g., Cal. Civ. Code
§ 2778(6) (judgment against indemnitee is only
presumptive evidence of indemnitor’s obligation
if indemnitor not provided reasonable notice and
opportunity to control defense).
2. See, e.g., Cal. Civ. Code § 2778(3), (4)
(“An indemnity against claims . . . embraces
the costs of defense against such claims . . .”;
“The person indemnifying is bound, on request
of the person indemnified, to defend actions or
proceedings brought against the latter in respect
to the matters embraced by the indemnity. . . .”).
3. See Lockwood Int’l B.V. v. Volm Bag Co.,
273 F.3d 741, 746 (7th Cir. 2001) (“The insured
needs a defense before he knows whether the claim
that has been made against him is covered by the
policy, assuming there is doubt on the question.”).
4. See VanKirk v. Green Constr. Co., 195 W.
Va. 714, 721–22, 466 S.E.2d 782, 789–90 (W. Va.
1995) (holding that if notice and an opportunity to
assume the defense are provided, an indemnitor
who declines to assume the defense will not be
permitted to dispute the indemnitee’s liability to
the plaintiff).
5. See Fed. R. Civ. P., App. XII, Form 18.
6. See, e.g., Microsoft Corp. v. CSIRO, 2007
U.S. Dist. LEXIS 91550 *10 (E.D. Tex. Dec.
13, 2007) (“CSIRO concedes that Marvell only
makes a component of the end product and
therefore does not and cannot directly infringe.”).
7. 222 F. App’x 973 (Fed. Cir. 2007)
(unpublished).
8. Id. at 975–76.
9. Restatement (Second) of Judgments
§ 57, cmt. c, at 83 (1980).
10. See, e.g., Am. Motorists Ins. Co. v. Trane
Co., 544 F. Supp. 669, 686 (W.D. Wis. 1982),
aff’d 718 F.2d 842 (7th Cir. 1983); U.S. Fid. and
Guar. Co. v. Louis A. Roser Co., 585 F.2d 932,
939 (8th Cir. 1978).
11. See, e.g., MetroPCS Wireless, Inc. v.
Telecomms. Sys., Inc., 2009 U.S. Dist. LEXIS
97884 (D. Md. Oct. 20, 2009).
12. See City of Columbus v. Alden E. Stilson
& Assocs., 90 Ohio App. 3d 608, 616, 630 N.E.2d
59, 64–65 (1993).
13. In re Seagate Technology, LLC, 497 F.3d
1360, 1374 (Fed. Cir. 2007).
14. DSU Med. Corp. v. JMS Co., 471 F.3d
1293, 1304–5 (Fed. Cir. 2006) (en banc in
relevant part).
15. See, e.g., Cal. Civ. Code § 1668 (“All
contracts which have for their object, directly or
indirectly, to exempt any one from responsibility
for his own fraud, or willful injury to the person or
property of another, or violation of law, whether
willful or negligent, are against the policy of the
law.”). In the context of insurance coverage, a
number of courts have found that an insured could
not be indemnified for claims of inducement of
infringement or willful infringement. See, e.g.,
Mez Indus., Inc. v. Pac. Nat’l Ins. Co., 76 Cal. App.
4th 856 (1999) (inducement); Carlson Marketing
Group, Inc., 517 F. Supp. 2d 1089 (D. Minn. 2007)
(willfulness).
20 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
Indemnification Clauses
in Software Licensing
Continued from page 1
of these clauses. It may come as a surprise to
some lawyers, but most software customers
are more concerned about how the software
will help them and how much it will cost
them than about whether the contract would
prevent them from hiring employees of the
software vendor.
However, it’s the other 10 percent that
ensured that your children received an
Xbox 360 this year, complete with the
newest version of Call of Duty. Those 10
percent of software customers don’t sign
on the dotted line without a vetting process; they hire their own counsel/detective
to dissect your client’s licensing agreement like a fifth-grade science project.
Your client responds by calling you.
The resulting process, a negotiation of the
legal terms of a software licensing agreement,
is now as American as filling in UCLA versus
Louisville in the fourth round of March Madness brackets. Depending upon the typical
sales cycle for the products that are the subject
of the agreement, the purchase price, and
other factors, the process can take as little as
one five-minute phone call or as long as 12
months. Your job, of course, is to bring the
process to conclusion as quickly and smoothly
as possible, balancing your ethical duty to
defend your client zealously with your client’s
need to collect the contract’s down payment
before the end of the fiscal year.
Software licensing agreements inevitably contain many clauses that become the
frequent subject of negotiation, some mentioned above. However, one clause that is
often the source of many billable hours is
the infringement indemnification clause.
This article examines the provisions that
are often included in infringement indemnification clauses within software licensing agreements and that could lead to
unintended liability. This article provides
practitioners with typical examples of
these issues, along with potential compromises that can be used to resolve the issues
in a mutually acceptable manner. Issue 1: Scope Creep
Most software companies today do not license only the software that is exclusively
manufactured by them. Rather, successful
companies often package their applications with third-party products to offer
clients turnkey solutions. Vendors may include sales of servers, processors, laptops,
and other hardware. In addition, they may
offer third-party software applications,
some of which are embedded into your client’s applications and some of which are
“bolt-on” applications that are listed in the
agreement and operate hand-in-hand with
your client’s applications.
Software companies generally accept
the responsibility of defending, indemnifying, and holding their customers harmless
against infringement claims resulting from
the use of their proprietary software applications. However, software companies
have a more general reluctance to agree to
similar protections for third-party applications. The reasons for this dichotomy are
simple. First, software companies have no
control over how third-party applications
are designed and whether the third parties
that designed them used industry-standard
methods of preventing developers from
producing infringing material. Second, if
an infringement of a third-party application
occurs, they have no ability to design a fix.
Third, software companies typically have
low profit margins related to third-party
applications, choosing instead to focus their
earnings on the sale of their own applications. Fourth, many third-party vendors,
particularly large, well-known companies,
offer little or no protection in the event of
an infringement, thus greatly limiting a
reseller’s recourse if the third-party application runs into an infringement issue.
Nonetheless, in drafting a clause
that gives a customer protection against
infringement, occasionally contract drafters inadvertently fail to limit the clause’s
protections to the company’s proprietary
applications. This often occurs because the
definition of “software” within the clause
fails to exclude third-party applications
and, in fact, is often defined as “any software applications listed on the attached
licensing schedule,” or similar wording,
which captures both third-party embedded
applications, as well as any third-party
“bolt-ons” or operating systems listed on
the purchase schedule. Not to belabor the
point, but contract drafters don’t intend
this result; rather, it results because the issue is not foremost in the drafters’ minds.
To resolve this issue, one should ensure
that the indemnification clause offer
protection only against infringement of
the client’s “Software” and then define
“Software” to mean the client’s “proprietary software applications listed on the
licensing schedule, but not any third-party
applications, embedded or otherwise.”
Of course, a savvy customer’s counsel will notice this definition and reject
it outright. Given that the customer is
usually not in privity of contract with the
applicable third parties and is paying your
client for the third-party applications, why
should the customer accept full responsibility for any infringement?
Fortunately, there are multiple compromises available; in fact, negotiation on this
point may be among the most interesting
parts of any software license agreement
negotiation. First, your client could offer to
pass through any infringement indemnities
or warranties it may receive from thirdparty vendors, subject to the terms of any
applicable third-party licensing agreement
to which your client is a party. Second, your
client can agree to make reasonable efforts
to enforce any indemnities or warranties
it receives from third parties, on behalf of
your client’s customer. Third, your client can propose to work directly with the
third-party vendors in the event of an infringement, making reasonable attempts to
resolve the issues. Fourth, you can suggest
any combination of the first three.
All four of the above suggestions will
subject a vendor to little, if any, further potential liability in the event of an infringement issue. At most, the vendor may need
to apply some elbow grease in working
with the third parties, something that would
likely occur anyway, assuming the vendor
licenses third-party applications to many
customers and will therefore need to resolve the issue in some manner. However, if
a customer’s counsel refuses to accept any
alternative solutions because it doesn’t offer
significant protection beyond “reasonable
effort” assurances, and if your client is willing to assume some risk, counsel and the
vendor may decide that it’s worth the risk to
take the following steps:
1. Review the purchase schedule to
determine which third-party applications will be sublicensed to the customer, both embedded and “bolt-on”
applications.
21 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
will have high market-based incentives to resolve infringement issues,
as well as the means to do so.
Other Issues
Any indemnity clause will present software license agreement attorneys with a
host of additional potential points of negotiation. Here are some additional major
points that attorneys often debate.
Control of the Litigation
Assuming a software vendor has agreed to indemnify a customer against liability
for infringement, the vendor would prefer that the customer not simply defend the
claim on its own, then send the bill to the vendor. Rather, the vendor should demand
control of the litigation. A typical clause reads, more or less: “[Vendor] shall be
entitled to control the defense of the litigation.” Given that the vendor has agreed to
take responsibility for the results of the infringement claim, the customer and the
customer’s attorney should be willing to take second chair during any litigation.
Reasonable Assistance from the Customer
Inclusion of a provision requiring the software licensee to provide reasonable assistance in defense of the claim is not controversial; in fact, customers should want
to agree to provide this. The question, rather, is whether the vendor should agree
to pay for this assistance or whether the customer’s assistance largesse should
also cover the costs. There is no standard answer to this question. However, if the
vendor has reasonable limits on liability and remedies, it is not out of the realm of
possibility for the vendor to assume this risk also.
Indemnity Conditions
For infringement claims, software license agreements virtually always include
provisions that act as conditions for receiving the benefit of the indemnity clause.
The reason for these conditions is that vendors have less responsibility if, somehow, the customer’s failure to act reasonably led to the claim. Such conditions
often include the following:
• The customer shall not be entitled to the indemnity if the customer failed to install
the most recent version of the software and such version would have eliminated the
issue.
• The customer shall not be entitled to the indemnity if the customer used the
software with unauthorized products (such as unapproved hardware or operating
systems) or in an unauthorized fashion (for example, the software’s documentation limited its use to the banking industry, and the customer used the software for
medical billing), and such unauthorized use caused the alleged infringement.
Both of these potential indemnity conditions create some points of negotiation. For
example, for the second condition, one point that customers frequently request is for
an exception to the condition where the vendor endorsed the use of the software in a
manner not authorized by its documentation. Nonetheless, infringement indemnity
clauses in most software license agreements include some form of these exceptions.
2. Review the vendor’s licensing agreements with the licensors of such
third-party applications.
3. If your client’s third-party licensing agreements include reasonable
protections against infringement
liability, the risk of offering protections for such third-party applications to the customers will be
equally limited.
4. If the third-party licensing agreements offer limited or no protection,
then your client should avoid including protections for such applications,
unless your client understands and
accepts the risk, and such third-party
applications are manufactured by
major national software vendors that
By taking these steps, your client will
be reassured that it will meet this quarter’s
sales targets, without assuming unreasonable infringement risk. However, practitioners must also consider this question: What
if the client’s software is alleged to infringe
against some third-party material, despite
efforts to remove liability for third-party
applications from the equation? Will the
company have to file for chapter 11 due to
commitments to customers? The following
steps help resolve this challenge.
Issue 2: Remedies for Infringement
Although you did a good job limiting
your client’s indemnification obligation
to your client’s proprietary software,
your client may face an infringement suit
nonetheless. There are businesses that
have, as their main purpose, to acquire
patents at an inexpensive price, often as
part of a bankruptcy sale, to sue companies for patent infringement. For this
reason, defense of patent infringement
claims have become a common “cost
of doing business” for many software
companies.
Because an infringement suit is a realistic possibility in the software industry,
attorneys representing software companies scrupulously draft remedy provisions within infringement clauses. Most
software companies include a provision
in their infringement clauses that provides
one or more the following as a remedy,
usually at the choice of the vendor:
• The vendor may reengineer the software in a manner that removes the
infringing material, without material
loss of functionality.
• The vendor may replace the software
with noninfringing software without
material loss of functionality.
• The vendor may terminate the agreement and refund the software license
fee, according to some reasonable
depreciation scale representing the
projected life of the software.
The above combination of remedies is
fairly typical in the software industry. It
allows the vendor flexibility to adjust the
remedy, depending on the ease of replacing the product, the availability of equally
22 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
functional alternative products, and other
factors. One common variation involves
the inclusion of a requirement that the
vendor make reasonable efforts to perform the first and second remedies before
resorting to the third, to ensure that the
vendor is trying to fix the problem before
“punting” and simply returning a portion
of the customer’s fees.
As one can imagine, the remedy provisions within an infringement clause are often
heavily negotiated and present many options
for compromise, such as the following:
• Altering the termination remedy
such that the depreciation limitation
is either extended to up to 10 years,
or perhaps removed. It is not advisable to agree to remove the clause,
except as a last resort to resolve the
issue, because the result would be
that your client would be required to
refund 100 percent of the applicable
fees even if the customer received
many years of use of the product.
• Allowing the possibility of a refund
of other fees beyond software licensing fees, such as maintenance fees,
software implementation fees, and
software installation fees.
• Including a provision that permits
the customer and the vendor to
negotiate in good faith whether reengineering, replacement, or termination will be the remedy in the event
of a determination of infringement.
It is better to avoid this clause if
your client is the software vendor
because your client may need the
flexibility to resolve the issue for a
host of customers as a class rather
than customer by customer.
Inclusion of some combination of the
reengineering, replacement, and termination remedies above will protect your client
from unreasonable remedies in the event
of an injunction or some infringement
determination that makes it impracticable
for your client’s customer to continue to
use the unmodified software, even if some
level of negotiation of these provisions
occurs. However, these remedy limitations
do not ensure that there is no ultimate limit
on your client’s liability in the event of an
infringement. Drafters of software contracts
who represent vendors should consider
including the ultimate protections against
excessive liability discussed next.
Limitations on Infringement Liability
A persistently negotiated issue in software
licensing agreements is the limitation
on liability. One challenge, however, is
the connection between limitations on
liability clauses and infringement indemnity clauses.
Many software customers, along with
their savvy attorneys, recognize that
any limitation on liability for infringement may eviscerate the infringement
clause completely. If a software licensing
agreement limits liability to, for example,
software fees paid, the software company
may choose, at least theoretically, simply
to refund a portion of a total contract value
rather than fix the problem. This decision
would be cold comfort to a customer that
has implemented the vendor’s software
throughout its organization, because a
refund of the fees would not resolve the
burden of uninstalling software, installing
a new product, training its employees on
the new product, transferring data to the
new product, and adjusting the organization to the differences between the old
product and the new.
At the same time, software vendors do
not want to open liability on all contracts
to such an extreme that any infringement
claim could cause them to go into chapter
11. They would rather, as with the other
potential risks in the contract, have the
infringement liability limited in a manner that connects it to fees paid by the
customer (i.e., the benefit received by the
vendor).
For this reason, it has become common
in the software industry for vendors and
customers to negotiate a compromise, such
as the following:
• Extension of the contract’s standard
limitation on liability to some multiple, perhaps 200 or 300 percent, of
fees paid.
• Inclusion of a special limitation of
liability, applicable to infringement
claims only, at a set amount, such
as $500,000 or $1,000,000, or some
other amount based upon the value
of the contract, the intended life of
the software, and other factors.
• With regard to infringement indemnity clauses, removal of the standard disclaimers of consequential
damages, special damages, and the
like, generally contained in software
licensing agreements.
If your client is a software vendor,
however, you will find that occasionally customers simply won’t accept any
limitation of liability for infringement.
These customers tend to believe, arguably
correctly, that they had no involvement in
the creation of the issue, so they should
have no responsibility for fixing it. If,
during a negotiation, a customer will accept no compromise, it is incumbent upon
the vendor’s counsel to:
• Ensure that the client make its decision with the full understanding of the
meaning of “unlimited liability” for
infringement claims.
• Have the client evaluate the products
for potential risks to determine whether
the potential liability is somewhat in
check. For example, is the product an
older product, perhaps on legacy technology? Does the client have a patent
on the product? Does a competitor
have a patent on software with similar
features and functions?
If you represent a vendor, and you and
your client take both of these steps, you
can best mitigate the potential risk, in the
unlikely event that a third party files a
claim that causes the need for this mitigation and your client has agreed to remove
the limitation of liability’s applicability to
infringement claims.
Conclusion
Any attorney who has spent more than
a few months in the business of negotiating software license agreements has
confronted issues regarding the intellectual property rights indemnity. Given
the potential stakes, it is most important
for attorneys to satisfy themselves of the
results of any negotiation, as well as to
tailor the clause to meet the needs and
wants of their clients. Ultimately, there
are infinite possible issues that can result
from a discussion over an infringement
indemnity clause, and attorneys must follow their ethics obligations, their clients’
wishes, and their own judgment and
experience to ensure that the clause will
protect their clients in the event of litigation and not create a litigation trap. l
Ted Borris is the assistant general
counsel of Quadramed Corporation in
Reston, Virginia. He may be reached at
Ted.Borris@QuadraMed.com.
23 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
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In This Issue...
Contractual Indemnity Obligations for Patent Infringement Claims
By Virginia DeMarchi. ............................................................................................. 1
Indemnification Clauses in Software Licensing Agreements
By Ted Borris ......................................................................................................... 1
The Buck Stops Where? Avenues to Indemnification in the Copyright
Context
By Joseph Petersen and Ashford Tucker .............................................................. 3
Can I Settle Now? Determining the Existence of a “Rightful Claim” of
Patent Infringement
By Christopher M. Arena and Chad A. Rutkowski.................................................. 5
The Basics of Indemnification
By G. Ross Allen ................................................................................................... 7
Drafting and Negotiating Defense and Indemnification Provisions
By Robert E. Rudnick and Andrew M. Grodin ....................................................... 9
Sharing the Risk: Patent Infringement Liability Indemnification and
Insurance
By Kim Cauthorn, Tom Britven, and Tamara Turek .............................................. 13
Res Judicata: Patent Indemnitee Beware!
By Kenneth L. Dorsney ....................................................................................... 17
24 Published in Intellectual Property Litigation, Volume 21, Number 3, Spring 2010 © 2010 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be
copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.