Litigation Issues

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 Associate Editor Jason Hicks 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
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
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 anothers patent, copyright, trademark, or other intellectual property right. This obligation is generally contingent on Bs promptly notifying A of any such infringement claim and granting A control of the defense.1 As 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

By Ted Borris
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 Wheres Waldo to find something for
which your client is actually responsible; a forum selection clause that ensures that your clients 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 clients 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

s trial lawyers, its 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 contractsparticularly those touching on intellectual property issuesis at the heart of an intellectual property litigators value to clients. This issue focuses on one of the trickier
subjects that just about every contract or relationship involving intellectual property affectsindemnification. 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 lawwithout the necessity of a contractand 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, its hard to keep up with it all. If youre not involved already, we want you to get involved. Please reach out to
one of us, and well 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 were planning to relaunch soon. Check out our webpage at www.abanet.org/litigation/ committees/intellectual for more information and let us know where youd 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
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The Buck Stops Where? Avenues to Indemnification in the Copyright Context

By Joseph Petersen and Ashford Tucker
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 distributors 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 studios photos. Prior to filling the order, the developer required that the investigator sign the developers 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 developers 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
partys 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 Circuits 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 suppliers 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 works 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,
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 womens 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 builders 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.
is an associate with Kilpatrick Stockton LLPs Trademark and Copyright practice group in the firms 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 Entmt 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 Entmt, 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).
Conclusion
It may come as a surprise that a partys 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 LLPs Trademark and Copyright practice group in the firms 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
Can I Settle Now? Determining the Existence of a Rightful Claim of Patent Infringement
By Christopher M. Arena and Chad A. Rutkowski
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 vendors 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 elses 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 defendants 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 UCCthe 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 indemnitors 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 indemnitors 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
appropriate even when the claim is adjudicated in the indemnitee/patent defendants 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 patentees 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 buyers 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 buyers 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 Sonys use of an interactive voice recognition system on Sonys 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 patentees 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 Californias version of UCC section 2-312(2), California Commercial Code section 2312(2). Edify/Intervoice moved for summary judgment, claiming, inter alia, that the patentees claims were not rightful in light of Sonys 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 courts construction of disputed terms would have on Sonys 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 Sonys 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.
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 indemnitees 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. Dept 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 sellers conformance with the buyers specifications. 8. 637 F. Supp. 2d 683, 697 (N.D. Cal. 2009).
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 buyers 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 patentees claim to be successful before the breach of warranty can be
The Basics of Indemnification

By G. Ross Allen
ndemnification is a contractual assurance relieving a party from the risk of financial loss if an issue arises relating to the partys 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 partys 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 licensors product.
significant and adverse effect, through the prospect of litigation or otherwise, on the buyers 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 partys infringement complaint.2
Drafting Indemnity Clauses Generally

In most instances, parties choose to draft indemnity clauses modifying or supplementing the governing states 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 partys 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
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 licenses 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.
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 lawsmost 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 licensees 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
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 partys 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 clauses scope if infringement allegations arise.
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 licensors 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 partys obligations.
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 clients 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 licensors 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 sublicensees use. Further, the licensee will want to speci-
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.
The procedure and time requirements should be clearly stated to prevent ambiguities about each partys 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 partys 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
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 partys 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).
Drafting and Negotiating Defense and Indemnification Provisions

By Robert E. Rudnick and Andrew M. Grodin
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 employers 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 generallypatents, 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 sellers risk can be eliminated in the context of a business transaction, the risk can at least be man-
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 partys 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 sellers 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 sellers defense and indemnification obligations. A well-drafted provision must clearly state whether a sellers obligation is triggered by the filing of a complaint, the receipt of a letter alleging infringement, or merely offering a patent license. The sellers 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 sellers business relationship with the buyer, as well as the perceived stature and merit of the patent and the party alleging infringement. In contrast, a buyers goal is to minimize the resources it would have to expend in dealing with a third-party patentee alleging infringement. By requiring the
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 sellers 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 sellers defense and indemnification obligations,
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.
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 buyers specifications or instructions, and a claim of infringement based on the buyers 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 sellers 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 buyers 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.
sellers 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 sellers 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 sellers 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 sellers exposure to liability. Although industry custom may dictate this arrangement, deciding whether to tie ones 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 sellers 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 partys trade secret. Seller will indemnify Buyer for any judgments, settlements and reasonable attorney
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 buyers 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
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 sellers interest to include a limitation of liability disclaimer following IP defense and indemnification provisions that states, for example: No Other Remedies Regarding InfringementsThe foregoing states Sellers entire liability and Buyers 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.
defend against some oddball infringement allegations made by third parties. For example, a third party may attempt to allege that a buyers use of the product in the United States, in some fashion, infringes the third partys 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 buyers 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.
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 thirdpartys 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
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 sellers obligation to
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
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 sellers 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 sellers 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 sellers 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 buyers 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 arms 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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Sharing the Risk: Patent Infringement Liability Indemnification and Insurance

By Kim Cauthorn, Tom Britven, and Tamara Turek
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.
unusual for an entity to combine hundreds, if not thousands, of components from different suppliers into a single productfor 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 indemnitees ability to enforce the indemnitors 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
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 todays high tech economy, it is not
The U.S. Market for Patent Infringement Liability Insurance

Insurance coverage for patent risk has been developing since at least the early 1980s. The Lloyds 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. Lloyds, 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.
An explanation of how the patents were developed or obtained The applicants financial information The applicants patent risk management policies and practices The applicants 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
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.
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
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?
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 insureds 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 policys inception date,
the claim either will be denied or the carrier will not cover any damages accruing prior to the policys 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 sellers 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. 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
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
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 holders professional services activities, and the limits for patent infringement liability are generally no higher than $1 million.
Turek is a vice president at Duff & Phelps. She may be reached at tamara .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. Pship 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 Courts 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 defendants motion for judgment as a matter of law because it held the record showed plaintiff did not prove entitlement to entire market value of defendants products). 5. An example can be found in webMethods, Inc.s 2004 Form 10-K Annual Report: On March30, 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 infringers lost revenue or lost customer relationships. It may be possible to obtain a separate insurance policy to insure such first-party losses.
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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Res Judicata: Patent Indemnitee Beware!

By Kenneth L. Dorsney
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 indemnitees 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.
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 indemnitees 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
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 TradeMavens 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 TradeMavens 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
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.
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. 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
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,
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, Peregrines counsel again sent a letter to TradeMavens counsel regarding indemnity and seeking to resolve the matter of Peregrines 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 Peregrines arguments. Instead, it found that Peregrines claim for indemnification arose out of the same incident, events, transaction, circumstances, or
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. Dept 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, 9697 (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).
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 TradeMavens affirmative defense of res judicata.
Following a hearing on the issue, the lower court granted TradeMavens 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 TradeMavens 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 TradeMavens 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
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 plaintiffs contentions are known, the supplier and its customer may dispute whether the suppliers 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 defendants accused process or that is combined with many other components in the defendants 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 suppliers 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/indemnitors 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, Centurys main supplier. Rex-Hide filed a third-party complaint against Century for indemnification against RFRs 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 courts conclusion that RFRs duty to indemnify Century and Centurys duty to indemnify Rex-Hide creates a circular indemnity that extinguishes RFRs 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 recursivee.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 As widgets, and so forthpotentially 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 Centurys 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 suppliers widget but, if construed another way, might instead read on some other aspect of the defendants 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
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 anothers 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 indemnitors 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 Intl 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, 72122, 466 S.E.2d 782, 78990 (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 indemnitees 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. Appx 973 (Fed. Cir. 2007) (unpublished). 8. Id. at 97576. 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), affd 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, 6465 (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, 13045 (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. Natl Ins. Co., 76 Cal. App. 4th 856 (1999) (inducement); Carlson Marketing Group, Inc., 517 F. Supp. 2d 1089 (D. Minn. 2007) (willfulness).
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, its 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 dont sign on the dotted line without a vetting process; they hire their own counsel/detective to dissect your clients 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 clients need to collect the contracts 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 clients applications and some of which are bolt-on applications that are listed in the agreement and operate hand-in-hand with your clients 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 resellers 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 clauses protections to the companys 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 dont 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 clients Software and then define Software to mean the clients proprietary software applications listed on the licensing schedule, but not any third-party applications, embedded or otherwise. Of course, a savvy customers 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 clients 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 customers counsel refuses to accept any alternative solutions because it doesnt offer significant protection beyond reasonable effort assurances, and if your client is willing to assume some risk, counsel and the vendor may decide that its 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.
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 customers 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 customers 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 customers 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 softwares 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.
will have high market-based incentives to resolve infringement issues, as well as the means to do so. By taking these steps, your client will be reassured that it will meet this quarters sales targets, without assuming unreasonable infringement risk. However, practitioners must also consider this question: What if the clients 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 clients indemnification obligation to your clients 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
2. Review the vendors licensing agreements with the licensors of such third-party applications. 3. If your clients 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
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 customers 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 clients 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 clients 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 vendors 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 contracts 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 wont 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 vendors 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 liabilitys 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.
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In This Issue...
Contractual Indemnity Obligations for Patent Infringement Claims Indemnification Clauses in Software Licensing Agreements
By Virginia DeMarchi. ............................................................................................. 1 By Ted Borris ......................................................................................................... 1
The Buck Stops Where? Avenues to Indemnification in the Copyright Context Can I Settle Now? Determining the Existence of a Rightful Claim of Patent Infringement The Basics of Indemnification
By Joseph Petersen and Ashford Tucker .............................................................. 3
By Christopher M. Arena and Chad A. Rutkowski.................................................. 5 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 Res Judicata: Patent Indemnitee Beware!
By Kim Cauthorn, Tom Britven, and Tamara Turek .............................................. 13 By Kenneth L. Dorsney ....................................................................................... 17

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Volume 21, No.

This Issue: Indemnity Issues in IP Litigation

Contractual Indemnity Obligations for Patent Infringement Claims

Indemnification Clauses in Software Licensing Agreements

Message from the Chairs

The Benefits of Membership

Reach Your Potential

The Buck Stops Where? Avenues to Indemnification in the Copyright Context

Indemnity under an Agreement

Indemnity Without Agreements: State Statutes as Substantive Sources

The Indemnitee Does Not Have to Take the Case to Verdict

The Indemnitee Does Not Have Carte Blanche to Settle

Settlement Can Be Reached Before Claim Construction

The Basics of Indemnification

Drafting Indemnity Clauses Generally

Implied Indemnification under the UCC

Considerations for Each Party

Drafting and Negotiating Defense and Indemnification Provisions

Defense and Indemnification General Terms and Triggers

Important Defense and Indemnification Exceptions

Defense and Indemnification Separate but Related Obligations

Hold Harmless and Limitation of Liability Provisions

Coordinating Defense and Indemnification with Representations and Warranties

Geographic Limitations on Defense and Indemnity Obligations

Remedial Measures: Noninfringing Substitutes or Modified Goods

The Benefits of Membership

You Bring the Lunch We Bring the CLE

Sharing the Risk: Patent Infringement Liability Indemnification and Insurance

The U.S. Market for Patent Infringement Liability Insurance

Patent Infringement Liability Insurance

How to Use Patent Insurance to Address the Risks

ababooks.org . . . the source you trust for practical legal information.

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Res Judicata: Patent Indemnitee Beware!

The Case of Peregrine Financial

Indemnification in Patent Infringement

Notice and the Party Indemnitor

Res Judicata and the Preclusive Nature of Consent Judgments

Contractual Indemnity Obligations

Indemnification Clauses in Software Licensing

Issue 1: Scope Creep

Issue 2: Remedies for Infringement

Nonprofit Organization U.S. Postage PAID American Bar Association

AmericanBar Association 321 N. Clark Street Chicago, IL60654-7598

By Joseph Petersen and Ashford Tucker .............................................................. 3

By Christopher M. Arena and Chad A. Rutkowski.................................................. 5 By G. Ross Allen ................................................................................................... 7

Drafting and Negotiating Defense and Indemnification Provisions

By Robert E. Rudnick and Andrew M. Grodin ....................................................... 9

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