Monday, May 27, 2013

Intellectual property indemnification versus a warranty of non-infringement – what’s the difference?

Indemnities are used to protect against 3rd party claims for injury or damage caused to the third party by one of the parties to the agreement. Warranties are to make sure that certain facts are true or certain behaviors will continue for the term of the agreement. Both normally will be specified to survive the termination or expiration of the agreement.

Intellectual property indemnifications will normally require that the infringing party defend against the third party claim (thereby assuming the cost of the defense). They will also require the infringing party to pay any damages awarded. There may also be an issue of who controls the defense of the claim. Suppliers are normally concerned that if a Buyer controls the defense it will set a precedent for other potential lawsuits. Buyer’s may be concerned with Supplier’s controlling the defense, especially if the Supplier has limited assets as a bad defense could require the buyer to pay any damages over and above what could be recovered from the supplier. Indemnifications will require the infringing party to try to remedy the infringement. The structure and order of the remedies available to the infringing party are one of the most important aspects of the indemnification. The first issue is when does the infringing party need to take action to remedy the infringement? If it’s only after they have been found by a court of law to be infringing, that’s too late as it can interrupt the supply chain. If it’s when a claim is brought, it’s usually too soon as the claim may not have merit. The second major issue is the precedence between remedies. Remedies that would be the lowest cost for the buyer are usually the most expensive for the supplier and vice versa. I’ve seen IP indemnity remedies where they require the supplier to provide the first of the list that is practicable (meaning capable of being done), and list:
1.Obtain for Buyer the right to continue to use and sell the Product.
2. Modify the Product so it is non-infringing.
3. Replace the Products with non-infringing ones that comply with the Agreement; or
4. at Buyer's request, accept the cancellation of infringing Products without Buyer having any cancellation liability and the return of the infringing Products at Supplier’s expense and refund any amount paid.
With this language it the Buyer did not request #4, the infringement would not have been remedies and it would be a breach. IP Indemnities are normally carved out of the limitation of liability for several reasons. First, they are a third party claim, not a claim by one of the parties to the agreement and the limitation should be only for claims between the parties to the agreement. A second reason to carve the IP indemnification from the limitation of liability is under many intellectual property laws if there is willful infringement of another part’s IP rights a court may award penalties. If you didn’t carve the IP indemnification out of the limitation of liability and a penalty was ordered, the Buyer cold wind up being limited to only the direct damage awarded and have to pay the penalty portion of the award.

A warranty of non-infringement provides you with significantly less protection than if you include both the IP Indemnity and warranty. A breach of the warranty only provides for damages and does not force the Supplier to remedy the infringement. It may be cheaper for them to pay the damages and walk away from the problem. If the Buyer is sued directly for the infringement, the buyer will need to defend against the claim, pay the claim and seek to recover both their costs and any damages paid as a claim of breach of the warranty of non-infringement. The recovery under warranty will be limited under the limitation of liability as to the types of damages that may be claimed and there may be financial limits on the amount the supplier is liable to pay. If you have a financial cap on liability all of your costs to defend, and damages paid would be against that cap providing you with a reduced amount you could recover for the damages the buyer sustained. If you had to litigate to get recovery for breach of warranty, those costs would also be counted against the limitation.

In supplier proposals and negotiations I look for what I call “red flags”. These are early warning signs that there might be a problem that may require walking away from a deal, changing suppliers, or identifying a need to establish alternative sources. When I have a supplier that doesn’t want to provide an Intellectual Property Indemnity and only wants to provide a warranty of non-infringement, that’s a personal red flag for me. It tells me that they don’t have significant confidence in their product or service being non-infringing. If they don’t have significant confidence in that, it tells me that I shouldn’t have confidence in their product being non-infringing and that they will do the right thing for my company in the event an infringement claim is brought based upon their product.

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