Patent Indemnification Provisionsmedia.straffordpub.com/products/patent-indemnification...2010/07/22...

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Patent Indemnification Provisions

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Negotiating Indemnification Clauses to Allocate Patent Infringement Risk

A Live 90-Minute Teleconference/Webinar with Interactive Q&A

Today's panel features:Thomas J. Scott, Jr., Partner, Goodwin Procter, Washington, D.C.Laurie S. Hane, Partner, Morrison & Foerster LLP, San Francisco

Robert S Bramson Principal Bramson & Pressman Conshohocken PaRobert S. Bramson, Principal, Bramson & Pressman, Conshohocken, Pa.

Thursday, July 22, 2010

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©Bramson & Pressman 2010

Bramson | Pressman

Patent Indemnity Clauses

for

Vendor Products and Services

By Robert S. Bramson


Bramson | Pressman

Patent Indemnity Clauses

for

Vendor Products and Services

What are the issues?

Should there be an indemnity? o What if both vendor and customer contribute to the infringement? o What is the nature and extent of the infringement? o Should liability be shared?

How to address the disproportionate revenues of vendor and customer? o The $10 component of $1,000 product? o How is this affected by Lucent v. Gateway, 580 F.3d 1301 (Fed. Cir. 2009)?

Should vendor’s liability have a cap? o How much? o How determined?

What is the role of the financial strength of vendor v. customer? o Should the vendor “indemnify and defend” or indemnify only?

Should the customer relinquish to the vendor control of its financial exposure? Applicability of insurance?

Scope of the indemnity? o What is excluded?

Political issues between the IP lawyers and vendor’s sales staff in getting the deal done. Drafting issues – clarity and completeness

Everything is negotiable!


When is Indemnity Applicable?

A Product o Sold for resale o Component of consumer product ASIC in a cellphone

o Component of non-consumer system, e.g. wireless router Made and sold by A for $500 each, totaling $5MM Incorporated by B in telcom system sold for $100MM C operates the system, with $5B per year in revenues

A Manufacturing System o Product is manufacturing system o Product is a component of a manufacturing system

A makes component, sold for $1MM B incorporates component in system, sold for $100M C uses system to make widgets with annual sales of $2B

A Manufacturing Process o A is catalyst in manufacturing process o A process or service is provided

Semiconductor “fab” Pharmaceutical contract manufacturer

Outsourced service o Telecommunications service


What is the Infringement?

Product or Process is:

Itself direct infringement Non-staple element which is a contributory infringement Element of co-infringement, e.g. claim specifies A+B; vendor sells A, not B, to customer No infringement by Vendor per se, but infringement by active inducement o E.g. Infringing method functionality is latent in A’s product. A advises B how to turn on

functionality. B practices the infringing method.

There may be an exception to indemnity, when the infringing product was made

to the customer’s specifications. Who designed the infringing product?

Product design is:

Completely vendor’s – indemnity is proper Customer’s as to some or all infringing components - shared indemnity may be proper Designed by vendor to customer’s specs – indemnity may not be proper

Where does Vendor’s Indemnification Obligation to Customer Come From?

As a matter of law; UCC §2-312(3) o Can be negated

As a matter of contract o Indemnity can be broad, narrow or share


Customer Issues in Indemnification

• Should vendor indemnify and defend”? Does customer want vendor to control customer’s potential liability? Does vendor have the financial strength to support the indemnity and

defense?

• Is customer unwilling to relinquish control of litigation? o Solution – shared loss? How much? 50/50?

• Does vendor have a patent defense insurance policy? o What are its limits? o How will it apply if multiple vendor customers are sued? The policy limit applies to all suits! Caveat: Most patent defense policies are “claims made”!

What is indemnified? o Damages o Attorney’s fees o Injunction o Lost profits o Lost customers/business

Should there be liability sharing between vendor and customer? o What are reasonable caps on vendor’s liability?

What are comparative negotiating positions of the parties? Has a “freedom to operate” analysis been done? How common is patent litigation is in the industry? What are vendor’s obligations to obtain a paid-up license or provide a design-around?

o If design-around, will it meet the performance specifications of the replaced product? Will the cost be comparable to the replaced product??


Vendor Issues in Indemnification

Relationship of vendor’s revenues/profits to customer’s revenues/profits o What is a fair risk sharing? o What is a reasonable cap?

What about joint and several liability if Vendor and Customer are both infringers? o What if customer is financially weak? o Insurance?

Who pays? Should customer contribute? Coverage? Limits? Liability sharing with other customers?

Sales Department view of IP Lawyers killing good deals o Political vs. substantive aspects

Dealing with joint and several liability when vendor and customer are both defendants and infringers?

o What is the effect of the cap?


Elements of the Indemnification Clause

Notice to indemnitor of infringement Indemnified parties o Include customers of indemnitee

Payment of assessed damages, costs and attorney fees Right/obligation to defend o Counsel of indemnitor’s choice

Right of indemnitee to approve counsel? o Right of customer to defend

Does customer then indemnify vendor? Does vendor share costs?

o Obligation to provide assistance Right to settle at expense of indemnitor Right to take license from patent owner Right to substitute “equivalent” non-infringing product/component o Quality o Price

Same price as substituted product This is usually missing from indemnification clauses

Cap on indemnity o Limit to vendor’s sales to customer or a fraction thereof o Limit to coverage of patent infringement defense insurance policy

Sharing the liability/indemnity Insurance Limitation of Liability o This clause is standard, but usually excludes punitive damages, which may be assessed in

exceptional cases or in the event of willfulness

Waiver of Warranty o It is usual to waive implied warranties, including the implied warranty of freedom from

infringement, UCC § 2-312(3), which is replaced by the indemnification clause


When Technology and Patents Only are Licensed

My experience is that there is no indemnification o There could/should be a basis for seeking indemnification, if the licensor is licensing a

detailed product design, as with IP circuit designs

o The UCC will not apply, because there will not be a product “sale” However, there may be reps and warranties of: o “no infringement” – this is unlikely to be given by the licensor o “to the best of licensor’s knowledge, no known infringement” – this is more likely and

should give rise to an indemnification, but limited to licensor’s knowledge, so likely not

valuable. This would be a poorly written representation, because it leaves unresolved

whether licensor should have done a freedom to operate analysis.

o “to the best of licensor’s knowledge, no known infringement, but limited to a freedom to operate analysis which has been shared with the licensee” – whether there is an

indemnification must be negotiated, but it will usually be quite limited

o “to the best of licensor’s knowledge, no known infringement, with no investigation having been made or required to be made” – indemnification limited to breach of the

representation is appropriate, but is not likely to be meaningful


BRAMSON | PRESSMAN

PATENT INDEMNITY AND RELATED CLAUSES

I. INDEMNIFICATION BY VENDOR FOR IP INFRINGEMENT1.

a. Vendor shall: i. defend Customer and its Affiliates with respect to any claim

asserted or suit brought by a third person and alleging that the manufacture, sale, importation, use or disposition by Customer, the Affiliates or any of their customers of a Product2, a component of the Product, equipment incorporating the Product or a process utilizing the Product, directly or indirectly infringes any IP3 of the third person (“Claim”); and

ii. indemnify4 Customer with respect to all damages, costs and expenses incurred by or assessed against Customer with respect to a Claim and its settlement.

Provided, however, that the term “Claim” and therefore Vendor’s

obligations in subparagraphs I(a) and (b) shall not apply to any claim or suit as to IP:

A. for which:

1. the Product is a component of equipment alleged to

infringe the IP or is utilized in a process alleged to infringe the IP; and

1 In some instances, a product is made to the specifications of the Customer. UCC § 2-312(3) specifies that

a “buyer who furnishes specifications to the seller must hold the seller harmless against any such claim which arises out of compliance with the specifications.” If that is the case, counsel for the Vendor must consider including an explicit reciprocal indemnification from the Customer. Obviously, the waiver of warranty of paragraph IV cuts both ways and would waive any implied warranty by the Customer unless there is an express Indemnification by the Customer. To complicate life, there may be a basic product designed by the Vendor with specific modifications to the Customer’s specifications, but whose features contribute to the infringement? 2 In some instances, the Vendor may provide a service for which indemnification is sought by the Customer. For example, a contract manufacturer may have exposure for patent infringement for a process it uses to produce a drug for a pharmaceutical company. Or a wireless carrier may contract out the handling of prepaid cell phone calls. In these situations, the language of the indemnity clause will have to be modified accordingly. 3 “IP” may be defined as patents, copyrights, trade secrets, mask works, design patents, etc. The specific definition will be tailored to the contract. Typically IP includes at least patents and trade secrets. 4 This clause doesn’t include “hold harmless,” because that term is generally held to be identical to “indemnify.”

See Adams, A Manual of Style for Contract Drafting, 2d Edition, §12.134.

http://www.law.cornell.edu/ucc/2/2-103.html#Buyer_2-103


2. the Product cannot reasonably be considered to infringe

the IP, directly, contributorily or by active inducement;5 or

B. which applies to features designed by Vendor to Customer’s specifications.6

b. If Vendor fails to assume the defense of any Claim within fifteen (15) calendar days after receipt of notice of the Claim, Customer shall (upon notice to Vendor) have the right to undertake, at Vendor’s expense, the defense, compromise or settlement of the Claim on behalf of and for the account and risk of Vendor, subject to paragraph III(b).

c. If Vendor assumes the defense of the Claim, it shall keep Customer reasonably informed of the progress of the defense, compromise or settlement and permit Customer to participate in the suit in an advisory capacity.

d. [Optional]7 If Customer wishes to assume the defense and control of the Claim and Vendor is not a party to the Claim8, Customer may:

i. upon notice to Vendor, elect to control the defense of the suit and

defend the suit with counsel of Customer’s choice; and

ii. if Customer elects to assume the defense and control, Customer shall consult with Vendor’s counsel as to all significant decisions.

If Customer makes the election of subparagraph (d)(i), Vendor and Customer shall share the costs of Customer’s counsel and any damages assessed in the suit or payments required to be made in

5 The “provided, however,” clause addresses the situation in which a product or process of the Customer includes the Vendor’s “Product” or its use, but the alleged infringement cannot reasonably be considered to be based, in whole or in part, on the Product. In that situation, it is reasonable for the Customer to assume all risks associated with the alleged infringement. 6 This is the standard exception of UCC § 2-312(3). 7 If Customer’s potential liability is large and Vendor is financially shaky or small or has a modest Policy, if any, the Customer will want to retain control of the Claim, so that Customer is master of its destiny. 8 Vendor can agree to Customer’s control if Vendor is also a party to the claim, but it becomes more complex when

both parties’ liability is subject to the control of one party.


any settlement thereof on a [50-50]9 basis, subject to the cap of paragraph III(b) as to Vendor’s liability.

e. The obligations of Vendor under paragraph I(a) are conditioned upon Customer providing Vendor with: i. prompt written notice of the Claim10;

ii. full authority to (A) settle or defend the Claim, at the option of

Vendor, with counsel of Vendor’s choosing, so long as settlement does not impose liability on Customer to the third person, and (B) control the defense of the Claim; and

iii. at Customer’s expense, reasonable cooperation and assistance in

the defense of the Claim.

f. In connection with any Claim, at Vendor’s option and expense, Vendor may, at any time, and shall, if a Product is held to infringe and the use or sale of the Product is enjoined: i. procure for Customer and its customer(s) the right to continue all

acts in relation to the Product; or

ii. if procurement of rights is not a reasonable or viable option, replace the Product with a non-infringing alternative with performance and pricing that is (A) at least equal to the performance and pricing of the Product and (B) approved in writing by Customer, which approval shall not be withheld unreasonably.

g. [Optional] Vendor’s liability to Customer under paragraph I(a) shall be

limited to the coverage of the Policy.

II. [Optional] INSURANCE11. During the term of this Agreement, Vendor shall, at its expense, obtain and maintain an Intellectual Property Infringement Defense Policy (the Policy”). The Policy shall: a. Be placed with an insurer and have terms reasonably acceptable to

Customer; 9 This is just one possibility and the agreed “split” must be negotiated. 10 UCC §2-607(3)(b) specifies that a buyer must inform a Seller, within a reasonable time, if an infringement suit has been filed. Otherwise, the buyer is barred from receiving indemnification. 11

For a detailed discussion of insurance issues, see Gauntlett, IP Attorney’s Handbook for Insurance Coverage in Intellectual Property Disputes, American Bar Association, and Gauntlett, Insurance Coverage of Intellectual Property Assets, Aspen Publishers.


b. Insure the payment of all legal fees, expenses, costs and damages in

connection with the defense of any Claim against Vendor or Customer;

c. Have policy limits of at least Twenty Five Million Dollars

($25,000,000)12;

d. Name Customer as an additional insured; and

e. Provide that it cannot be canceled or not renewed without at least thirty (30) days prior notice to Customer.

On the Effective Date, Vendor shall provide Customer with a copy of the Policy and a Certificate of Insurance reflecting all of the terms set forth above.

III. LIMITATIONS OF LIABILITY.

a. Vendor shall not have any liability to Customer for incidental, consequential or punitive13 damages related to any Claim, including without limitation liability for claims for lost profits or revenues.

b. Vendor’s total liability to Customer under paragraph I [Indemnification Clause] shall be limited to the lesser of (i) the amounts paid by Customer under this Agreement from the Effective Date to the date of its termination for all allegedly infringing Products14 or (ii) Y Dollars ($Y)15.

12 The amount will vary. The author has been advised by an industry expert that $25 million is the maximum amount for which this type of insurance coverage is available, although higher amounts of “cover” will be available in some circumstances. 13 In patent cases, the court may award attorneys’ fees “in exceptional cases,” 35 U.S.C ¶285. Also, the court may award multiple damages for willfulness, 35 U.S.C ¶284; In re Seagate Technology, 497 F.3d 1360 (Fed. Cir. 2007). 14

This is often a maximum exposure. Lower sums have been common in the author’s experience. 15

The amount will vary with the applicable Product and circumstances and is highly negotiable. Some important considerations are (i) the perceived risk of an infringement claim, (ii) what is standard in the industry (if that can be


c. Each party acknowledges that the limitations of liability in paragraph

III(b) reflect the allocation of risk agreed by the parties and Customer acknowledges that Vendor would not have entered into this Agreement without such limitations of liability.

IV. WAIVER OF WARRANTY16. Except as set forth in paragraphs I and

[Reps and Warranties], Vendor makes no express or implied representations or warranties to Customer, including without limitation warranties of merchantability and fitness for a particular purpose17.

determined), (iii) the relative negotiating strength of the parties and (iv) pressure by the sales department on the legal department to get the sale completed. 16 The use of this “waiver of warranty” provision negates the implied warranty of UCC §2-312(3) and limits the Customer to the express warranties set forth in the Indemnification clause. The negation of warranties must be “conspicuous,” UCC §2-316(2). 17

If the Agreement includes warranties of merchantability and/or fitness, this clause would be modified accordingly.

CoverBramson handout with footnotes

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