January 1, 2001

Table of Contents

Introduction

As in many areas of contractual dealings, indemnification is often a divisive issue in the sale or licensing of intellectual property, particularly those involving patents. Before one party pays significant monies to another for a patent or patent license, the paying party seeks to have the compensated party hold it harmless in the event of any loss or damage resulting from the subject patent. From the perspective of a Licensee, indemnification is necessary to ensure it is acquiring proper title to, and the ability to fully use, a valid patent. To a Licensor, though, the indemnification obligation imposes a security pledge that can be very costly in the event of a difficult-to-foresee indemnification damage claim. Contractual parties often have competing and conflicting views on the necessity of an indemnification clause, let alone on the scope of the indemnification.

Money adds fuel to this inherent tension. Contracts having patent indemnification clauses, for example, frequently involve the exchange of large sums of money. The spending party naturally negotiates for a full security in return for its large payments. The party potentially receiving the riches, often being more focused upon its monetary gain to be had than upon the assumption of an indemnification obligation, may be tempted to sign off as an Indemnitor to an "all inclusive," comprehensive, limitless patent indemnity clause to hold and save harmless the paying party Indemnitee from all losses or damages related to the exploited patent. After all, why let the detail of contract language get in the way of that healthy payday?

I suggest that the potential Indemnitor give pause to the fine print of indemnification, especially since agreeing to a indemnification obligation is not the first or only recourse. Before one signs on the bottom line to be an Indemnitor, alternatives to the weighty indemnification covenant should be considered and exploration should be taken of ways to limit the scope of the indemnity obligation. Although we need not be unmindful of the Indemnitee's legitimate needs born from its acquisition payments, our focus hereinafter is more directed upon on the Indemnitor's contractual interests. This sensitivity to the potential Indemnitor's position is offered as actually promoting the overall availability of technology transfers by eliminating or restricting undue impediments to technology owners allowing others to exploit their patents.

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The Nature Of Indemnity

First, let us consider the nature of what we are confronting.

Contractual indemnity is an agreement to save harmless another from a liability, loss, or damage. It is an assurance by which one party (the Indemnitor) undertakes to secure another (the Indemnitee) against an anticipated loss or to prevent the other party from suffering the legal consequences of an act or forbearance. Under an identification provision of a contract, one party normally agrees to bear or reimburse all costs, expenses, legal fees, and related damages owed or paid by another party.

A party to a contract may offer to indemnify another from some specified action or non-action on its part, from a breach of any of its obligations, or from a liability, loss, or damage relating to property rights transferred in the contract. Indemnity provisions may be in favor of one party only, as is the case where a seller indemnifies a purchaser from claims of product liability, or they may be made mutual wherein both parties to a contract agree to indemnify the other, such as, for example, for any breach of their respective obligations in the contract.

Indemnity agreements are sought in many types of situations, such as in health, safety, or environmental matters, and especially with regard to the accuracy of representations and warranties as to facts or conditions; and in contemplation of possible contingencies or consequences.

It is normal for a paying party to want to be held harmless from challenges to the ownership, validity, or ability to exploit the subject matter involved and from any liability, loss, or damage related to, or arising from, the exploited subject matter. On the other hand, it is rare that the responding compensated party willingly accepts the role of a surety. Resolution of this conflict is by negotiated compromise at the risk of losing the contemplated transaction.

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Patent Indemnity Issues Arises In Many Contexts

The concept of patent indemnification often becomes an issue in business merger and acquisition agreements, asset purchase agreements, business entity formation agreements, patent licensing or cross-licensing agreements, joint venture agreements, technology sharing or consultation agreements, institutional research and development agreements, sales and distribution agreements, franchise agreements, and in governmental contracts.

A patent indemnity clause in an agreement usually has a direct bearing upon the price or compensation structure of the agreement. Indeed, the presence of an indemnification agreement can facilitate the sale of an asset at the particular price at which it was sold .

An obligation of patent indemnity can be placed on any party to an agreement. Every party, however, has the power to refuse such an undertaking, and often one or both parties will seek a final agreement where there is an expressed disclaimer or denial of any obligation of indemnity to the other. Ultimately, the nature of the transaction involved, the money at stake, and the competing interests and bargaining power of the parties are the significant factors in determining whether a party will obligate itself to indemnify another.

In any event, the parties will need to assess the likelihood of a damaging patent indemnification event and its cost. Factors bearing upon this determination will include the level of competition in the field of the patent to be exploited, the history of patent litigation in that field, the ability of competitors to fund litigation, the closeness of the exploited patent to potentially conflicting patents, whether the exploited patent can dominant a market with high profits which is likely to attract competition and litigation, and whether a damage award could be massive.

With this background in mind, let us consider two common situations where patent indemnity agreements are vigorously sought.

The first is where a Purchaser seeks to acquire the assets or business of a Seller, often for millions, if not tens or hundreds of millions, of dollars.

The second is where a Licensor (the owner) is willing to allow another (the Licensee) to use its patents or technology, still at a significant compensation to the Licensor.

A. Patent Indemnification in Purchase Agreements

Patent indemnification commonly occurs in situations where a Purchaser pays a large sum of money to obtain the patent assets or patent-based business of a Seller. The Seller's interest in seeking a high purchase price for any patent to be sold usually triggers a corresponding competing interest of the Purchaser to obtain a Seller's indemnity undertaking that any purchased patent truly meets the Purchaser's inherent expectations as to title, validity, and ability to exploit.

In the common Purchase Agreement scenario, the style of crafting a written obligation of patent indemnity may vary. Regardless of how one sets forth the indemnity clause though, keep a watchful eye for the terms "indemnify", "defend", and "save and hold harmless".

A direct approach to a broad and encompassing indemnity clause might read:

"Indemnification. Seller shall, upon demand, indemnify, defend, save and hold harmless the Purchaser, its directors, officers, employees, agents,affiliates, and sub-licensees from and against any and all liabilities, costs, claims, damages, losses, fees or expenses (including, but not limited to, reasonable attorney fees and investigation fees or expenses), demands, judgments, and awards related to, or arising out of, or incurred in connection with (a) any manufacture, use, or sale or other disposition by Purchaser of any product or process of the "Sold Patents", and (b) any material breach of any representation, warranty, covenant, or agreement of the Seller to Purchaser."

Contracts may also impose an indemnification obligation in an indirect manner. In this approach, there is usually a preliminary stating of a comprehensive list of Seller's "Representations" or "Warranties" concerning the patents involved in the sale and the related issues of fact upon which the purchase price is based. The contract then later provides for a broad "Indemnification" provision whereby the Seller fully indemnifies the Purchaser for any breach of, inaccuracy of, or loss arising from the "Representations" or Warranties".

An example of this indirect style is set forth below. Pay particular attention to the bold print language of the Seller's list of "Representations and Warranties" because it later sets up a broad and comprehensive scope of potential patent indemnification.

Representations and Warranties:
I. Patents And Intellectual Property. Schedule "A" attached hereto contains a complete and accurate list and summary description of all Patents and all Intellectual Property Assets and other proprietary rights owned or possessed by Seller necessary to conduct its business.

(1) Seller is the owner of all rights, title, and interest in and to each of the Patents and Intellectual Property Assets and other proprietary rights listed at Schedule "A" attached hereto, free and clear of all liens, security interests, charges, encumbrances, equities, and other adverse claims, and has the unfettered right to use with same without payment to or permission from a third party.

(2) All of the Patents listed at Schedule "A" are currently in compliance with formal legal requirements including payment of filing, examination, and maintenance fees and proofs of working or use, are valid and enforceable, and are not subject to any maintenance fees or taxes or actions falling due within ninety days after the Closing.

(3) No Patent has been or is now involved in any interference, reissue, reexamination, or opposition proceeding, nor is there any potentially interfering patent or patent application of any third party.

(4) No Patent is infringed or has been challenged or threatened in any way. None of the products manufactured and sold, nor any process or know-how used by Seller infringes or is alleged to infringe any patent or other proprietary right of any other Person.

(5) All products made, used, or sold under the Patents have been marked with the proper patent notice.

(6) Seller is not infringing upon or otherwise acting adversely to any copyrights, trademarks, trademark rights, service marks, service names, trade names, patents, patent rights, licenses, trade secrets or other proprietary rights owned by any other person or persons, and there is no claim or action by any such person pending, or to the knowledge of Seller threatened, with respect thereto.

In addition to the foregoing, the Purchaser may even add a blanket "all-encompassing" clause of "Disclosure", which on its face may not even mention "patents", but due to the nature of the transaction sets up an obligation of patent indemnity. For example, a contract clause concerning "Disclosure", with like bold print "be careful of" language, may provide:

Disclosure. No representations or warranties made by Seller contained in this Agreement, nor any materials or documents furnished by Seller to Purchaser whether or not part of Purchaser's prior due diligence examination, nor any statement or certificate furnished or to be furnished by Seller to Purchaser or its representatives in connection herewith or pursuant hereto, contains or will contain any untrue statement of a material fact, or omits or will omit to state any material fact required to make the statements herein or therein contained not misleading or necessary in order to provide a prospective purchaser of the business of the Seller with adequate information as to Seller and its condition (financial and otherwise), properties, assets, liabilities, business, and prospects, and Seller has disclosed to Purchaser in writing all material adverse facts known to them relating to the same. All documents and materials ever furnished to Purchaser by Seller at any time, and from time to time, are hereby incorporated herein by reference, as if all such documents and materials were attached hereto as Schedule "B", and all of which are included in the representations and warranties contained in this Agreement.

Having stated a preliminary broad scope of Seller "Representations and Warranties", the Purchaser using an indirect style of crafting the patent indemnity obligation then advances the second stating, such as the following, which places upon Seller a broad obligation to indemnify:

Indemnification. Seller hereby indemnifies and agrees to hold Purchaser harmless from, against, and in respect of, and shall, on demand, reimburse Purchaser for any and all losses, liabilities or damages suffered or incurred by Purchaser (a) by reason of any untrue representation, breach of warranty or non-fulfillment of any covenant by Seller contained herein or in any certificate, document or instrument delivered to Purchaser pursuant hereto or in connection herewith or (b) which would not have been suffered or incurred if such representation were true and not breached or if such covenant were fully performed.

Finally, expect a "survival" clause to further cement Purchaser's insistence of a Seller's obligation of indemnity:

Nature and Survival of Representations and Warranties. Each statement, representation, warranty, indemnity, covenant and agreement made by Seller in this Agreement or in any document, certificate, or other instrument delivered by or on behalf of Seller pursuant to this Agreement or in connection herewith shall survive the Closing.

B. Patent Indemnification In Licensing Agreements

In illustrating the second situation of a patent license where a Licensor allows a Licensee to use its patent, set forth below is an alternative example of a direct approach to a broad encompassing indemnification.

Indemnification

1. Losses Defined.

For purposes of this Agreement, the term "Loss" or "Losses" shall mean each and all of the following items, namely, claims, losses, liabilities, damages, fines, penalties, costs and expenses (including, without limitation, interest which may be imposed in connection therewith), expenses of investigation, reasonable fees and disbursements of attorneys, counsel, and other experts, and the cost to the person seeking indemnification (the "Indemnitee") of any funds expended by reason of the occurrence of any of the events enumerated below, as a case may be, or incurred in imposition thereof or in enforcing the provisions of this Agreement, without giving effect to any insurance reimbursement or tax savings which may inure to the Indemnitee.

2. Indemnification By Licensor.

To the maximum extent permitted by applicable law, Licensor shall indemnify Licensee (and its stockholders, directors, officers, employees, agents, representatives, affiliates, customers, and any person claiming by or through any of them), pay on demand and protect, defend, save and hold harmless Licensee from and against, on an after tax basis, any and all "Losses" arising out of or resulting from:

(a) any breach of any of the representations or warranties made by Licensor in this Agreement,

(b) any failure by Licensor to perform any of its covenants or agreements contained in this Agreement;

(c) infringement, predicated on manufacture, use, or sale of the "Licensed Patent" herein, of any third party patent;

(d) manufacture of the "Licensed Patent";

(e) design defects in the "Licensed Patent";

(f) misappropriation or infringement by Licensor of the trade secrets of any party; as a result of information conveyed by Licensor to Licensee,or employed by Licensor in development of the "Licensed Patent"; and

(g) copyright infringement arising out of any material published by Licensor.

A patent license, similar to a purchase agreement, could also approach the indemnification obligation in an indirect way employing "Representation" and "Warranty" provisions backed by an indemnification covenant. In each case, the party paying wants indemnification from the compensated party.

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Costs and Risks of Patent Indemnity

Such burdensome contractual provisions proposed above seem entirely justifiable in the mind of the Purchaser given the high purchase price involved. They also appear most reasonable to the Licensee given the compensation to the Licensor and the contemplated effort of exploitation the Licensee intends to employ.

Nevertheless, regardless of the context, a commitment to indemnify another party can be a very costly undertaking of uncertain risk. Given a "damaging event", not only can the final substantive determination of "what the liability, loss, or damage is" be expensive, but also the very procedural process to determine it can be high-priced.

Addressing the substantive cost first, a finding of patent infringement may lead to a staggering amount of damages. Multi-million dollar judgments are common.

In the United States, for example, patent damages are to be "adequate to compensate for the infringement but in no event less than a reasonable royalty for the use made of the invention by the infringer, together with interest and costs as fixed by the court". Thus, patent damages are measured to compensate the patent owner whose rights have been infringed. Further, if "damages are not found by a jury, the court shall assess them" and "in either event the court may increase the damages up to three times the amount found or assessed". A U.S Court, in its discretion, is importantly free to triple patent damages based upon the circumstances of the case. Increased damages are common where the infringement was knowingly willful or in wanton disregard of the patentee's rights.

Still further, the U.S. Court "in exceptional cases may award reasonable attorney fees to the prevailing party". Willful infringement or the bad faith conduct in litigation is a sufficient basis for finding a case exceptional.

Also expensive is the procedural cost to determine what the liability, loss, or damage is. The American Intellectual Property Law Association (AIPLA) periodically conducts and publishes a comprehensive survey on the economic aspects of U.S. intellectual property law. The AIPLA Report Of Economic Survey 2001 reports that the "median" American estimated cost of patent litigation, for a matter having greater than one million dollars and less than twenty five million dollars at risk, was nearly $800,000.00 through the "end of discovery" stage of the litigation and nearly $1,500,000.00 inclusive of all stages of the litigation. For patent matters having more than twenty five million dollars at risk, the "median" estimated costs of American patent litigation was over $1,500,000,00 through the "end of discovery" stage of the litigation and nearly $3,000,000.00 inclusive of all costs of the litigation.

The costly, protracted, and consuming process of patent litigation reflects the fact that the patent litigants have procedural due process and substantive right involving many legal issues. The parties usually extensively litigate the proper interpretation of the patent claims and the coverage of the properly interpreted claims upon the accused product or process, and may likewise explore numerous issues affecting the validity of the patent claims, all prior to even reaching the question of damage assessment. Initially, the jurisdiction and proper court venue for the legal action may be contested. The file history of the patent at issue will be extensively studied as supplemented by additional prior art searches to find applicable art beyond that cited by the Patent Examiner. Plaintiffs may request temporary or preliminary injunctive relief. Discovery demands to produce documents, answer written interrogatories, admit statements of fact and law applied to facts, and to take discovery and evidence depositions of witness and expert testimony are likely to be comprehensive. Prior to a liability trial, the litigants can be expected to file motions for summary judgment on issues of infringement and patent validity. Indeed, there are no shortages of issues to a patent litigation.

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Practical Alternatives To Undertaking Patent Indemnity

Fortunately, there are alternatives for the potential Indemnitor to explore when confronted with a compelling demand to undertake a potentially costly, comprehensive covenant of patent indemnity. Even so, when all is said and done, if significant monies are paid to the Indemnitor, the availability of several of the alternatives are usually correspondingly restricted by the transactional equities and bargaining power of the Indemnitee. Several alternatives to full patent indemnity are discussed below.

A. Limit Representations and Warranties

Although a warranty of good title and against claims of infringement may arise from the statutory law of a particular jurisdiction or the nature of the transaction involved, the same might be excluded or modified by specific contractual language or by the circumstances of the transaction.

A Seller or Licensor of a patent often represents and warrants "to the best of its knowledge and belief" that it is the owner of the entire right, title, and interest in and to the exploited subject matter, that it has the right and power to make the subject transfer or license grant, that there are no other agreements with any other party in conflict with such a making, and that it knows of no prior art that would invalidate the patents. Such warranties are appropriate and consistent with a general warranty of title and fitness for the purpose for which the exploited subject matter is conveyed. Beyond this, however, representations and warranties should be carefully considered.

All "Representations" and "Warranties" should be carefully reviewed to make sure they do not have an undue, limitless scope. Frequently, such provisions are limited to the present knowledge of the Indemnitor. For example,

"To the best of Seller's knowledge, Seller represents and warrants that the products and/or methods embodied in the "Patents Sold" and the "Related Property Sold" do not infringe any patents or other property right owned by a third party."

Better yet, a party could warrant that, "to the best of the party's knowledge", the sold or licensed subject matter does not infringe a specified patent or patents of a country in force on the date of the execution of the agreement, rather than "any" patent.

One should also keep in mind that "Representations" and "Warranties" can be expressed in many ways. An alternative formulation can be a most effective way to limit indemnity. Consider such a limiting potential when the subject matter of a "Representation" or "Warranty" is stated:

  1. in terms of being accurately described,

  2. in terms of the existence of one or more historical facts,

  3. in terms of the subject matter being in conformance with a specified condition or standard,

  4. in terms of there being full disclosure of the subject matter for assessment by another,

  5. in terms of the results to be obtained, or

  6. in terms of the suitability of the subject matter to meet the requirements of the recipient.

An alternative format of expression can be used to avoid a "blanket" warranty, backed by the obligation of indemnification, against the sold or licensed subject matter infringing "any" patent or "third party" right. The Seller or Lessor would therefore do well to avoid such absolutes by employing a different style of expressing the "Representations" and "Warranties".

The giving of a comprehensive warranty that the exploited subject matter is valid and does not infringe any other patent or third party right is risky for many reasons.

First, both the technical fields of patent coverage and the extent of conceivable prior art are each vast. Truly, any searching of prior art suffers from the need of trying to focus upon the matter at hand from the great volume of prior technical art being explored.

Further, there is no universal way of correctly classifying the myriad areas of art technology consistently. Searching a particular "classification" category of a patent database will likely reveal numerous "teachings" of art.

Further, different people normally describe things differently, let alone differently by reason of translation.

Further, different people also have differing understandings of what a particular term of language may mean.

The differing use, perception, and confusion of language reportedly dates back to the fall of the Tower Of Babel. The art of linguistics has been alive ever since. There can exist a great variance in how people identify, describe, and define their inventions. The active patent of a third party may avoid detection in the great mass of patent or prior art literature due to a subtle change in language avoiding a patent searcher's inquiry criteria.

Moreover, patents are only one source of technical literature, and patent rights can be affected by the claimed subject matter of a patent being shown or described in any type of public printed publication, in any language, anywhere in the world, more than one year prior to the patent application's filing or priority date. The additional prior art areas or statutory patent bars of on sale or commercial activity and public use by others may also present formidable challenges to patent validity.

Add further the consideration that patent validity can be affected by other statutory conditions to the patent grant such as the fulfillment of duties of good faith and candor during the patent prosecution, or compliance with written description, enablement, and best mode requirements.

It would also be a Herculean task to render an authoritative prior art "clearance" opinion in an attempt to eliminate patent infringement risks for a contemplated product or process. Even a monumental opinion may still prove illusory because patents may issue to the public years after their applications were filed. While pending, patent applications may enjoy secrecy from public disclosure, particularly during the first 18 months of their filing dates. In any event, the "opinion that counts" is the Court of final jurisdiction from which there is no appeal. Reasonable minds can and do differ. One should expect there to be enough room for interpretation, speculation, and uncertainty when it comes to assessing the risk of a patent indemnification claim arising or the cost it will bring.

All of the above reasons serve as a constant reminder to a Seller or Lessor to limit and restrict the scope of representations and warranties concerning any patent to be exploited.

B. Better Yet, Negate Representations and Warranties

Expressly denying a broad scope of patent indemnity hits the nail squarely on the head. One can outright deny the existence of a patent indemnity obligation. For example:

"Any covenant herein by Licensor shall not be construed or implied to warrant and represent that products made under the "Licensed Patent" will meet any safety, performance or other standards, whether imposed by any instrumentality of government or otherwise. Licensor makes no representations, extends no warranties of any kind, either express or implied, and assumes no responsibilities whatever with respect to manufacture, use, sale, or other disposition by Licensee of products made or methods employed under the "Licensed Patent."

Even more fundamental, a pro-active Licensor may seek an aggressive negotiation position by not just denying an obligation of indemnity, but rather seeking to impose the indemnification upon the Licensee. For example:

"Licensee will fully indemnify and save and hold harmless Licensor against all product liability or consequential damage claims, liabilities, demands, damages, expenses, or losses arising out of any manufacture, use, or sale or other disposition by Licensee of any product made under the "Licensed Patent."

C. Due Diligence Investigations and Cooperation

Let us keep in mind that both parties to a contract transaction have the same opportunity to learn of and discover the merits or demerits of the subject matter to be exploited. Mutual cooperation and disclosure can place the contracting parties on an equal footing with like access to information and prior art from which all may thoroughly examine, study, and make up their own minds on the validity, scope, commercial utility, and risks of the subject matter to be exploited.

Likewise, all parties have the ability to investigate the potential rights of others. A would-be Indemnitor might refuse to undertake an indemnity obligation on the basis that the Indemnitee is equally capable of investigating and assessing the scope of risk of infringing a third party's rights before agreeing to the subject transaction. Better than telling the contrary party to do it alone, a party may offer to fully participate and cooperate in a mutual approach to such an endeavor.

Regardless, all parties are responsible for their own "due diligence" investigation into the existence, validity, and value of the exploited subject matter and the potential for costly damaging event.

There are numerous "due diligence checklists" for patent transactions which set forth myriad tasks needing careful assessment. Among the tasks, a party will need to:

  1. identify all patents and pending applications, domestic and foreign, to be licensed or transferred, including obtaining copies of their prosecution histories;

  2. determine whether continuation, continuation-in-part, international or foreign country counter-part applications, or new filing applications can be timely filed based upon the patent assets;

  3. verify the current existence and remaining term of the patents and applications to be exploited;

  4. verify the current title holder and parties in interest of the patent assets, including checking for security interests, financing agreements, collateral assignments, and encumbrances;

  5. identify any opposition , reexamination, interference, reissue, or other inter-parties or post grant proceedings affecting the patent assets;

  6. identify all patent licenses, contracts, settlements or other agreements pertaining to the patent assets;

  7. obtain all prior art searches, reports, and opinions concerning the validity of the patents, the infringement of the patents by others, or an infringement of third party patents by the products or process of the patent assets; and

  8. obtain copies of any patent dispute correspondence, cease and desist letters, letters alleging infringement, warning letters, legal notices, lawsuits, complete litigation histories, judgments, and settlement agreements of the patent assets.

Yes, even basic "due diligence" for a patent transaction is a large work assignment.

Once the parties know what they are dealing with in terms of the subject matter to be transferred or exploited, further "due diligence" can be extended to address the proprietary rights of others affecting the patent assets to be exploited. Attempts may be made to search competitor patents and identify potential infringers of the patent assets to be exploited. The investigation may then thoroughly examine a particular patent of a third party for its potential claim coverage over the contemplated product or process of the patent assets to be exploited and whether any modification or changes must be made to avoid infringement

D. Advice of Counsel

Both integral to and supplemental of a "due diligence" investigation is the availability of expert legal counsel. The advice of a competent patent attorney may be obtained to determine whether there is a reasonable basis for a party to believe that its actions do not violate another's patent rights.

The advice of counsel is of great guidance to parties in the review, negotiation, and execution of any patent indemnity agreement. The United States Court of Appeals for the Federal Circuit has identified numerous factors bearing upon the competence of a patent attorney's opinion on the issues of patent validity and infringement. An opinion based on the independent judgment of an experienced patent attorney after study of the prosecution history of the subject patent normally contains a detailed written analysis that compares, "element-by element" and "limitation-by-limitation", the claims of a patent of concern with the potentially infringing product or process.

Importantly, reliance upon the advice of counsel can also prevent a finding of "willful" patent infringement which may result in the "up to triple" enhancement of patent damages.

E. Design-Around, Quality Control, and Specification Restrictions

Careful study of another's patent under the advice of patent counsel may provide the parties with the ability to design around the scope of the protective right or coverage of its patent claims. Often language in a patent claim requires the presence of a particular structural or functional or step "element" as part of the inventive combination. Additionally, such "elements" of the invention may have particular "limitations" placed upon them which must be present in any accused product or process for there to be infringement. Thus, the precise definition of another's patent claim serves as a public notice to others of what must be avoided and what is permitted with respect to the patent. Armed with this information, the parties may be in a position to modify, alter, or substantially change the licensed or transferred product to avoid infringement.

The patent indemnity clause may be written to be conditioned upon or extend only to products made pursuant to an established or specified criteria for the design around modification, alteration or change. The parties may require an adherence to strict specifications, restrictions, and quality control assurances as a pre-condition to any patent indemnity involving the product or process.

F. Base Technology Licensing or Base Component Part Purchase

A patent grants to its owner the right to exclude others from making, using, or selling the invention covered by its patent claims in the territory of the patent right. If a particular patent causes a concern, parties are free to contact the patent owner, directly or through an intermediary maintaining confidentiality, in an attempt to gain permission to use the invention. The permission can come in the form of a patent license grant or an "implied license", such as an implied license to fully use product purchased from the patent owner. Especially when the subject patent matter is merely a component part of what the parties to a patent indemnification agreement intended to exploit, the parties may agree to purchase all such component parts from the patent owner or its licensee to thereby exhaust, under a "first sale doctrine" termination of patent right, the patent owner's exclusivity rights with respect that particular component which is purchased.

G. Insurance

Rather than agreeing to indemnify another for any potential patent infringement, one or both parties might consider trying to obtain appropriate insurance for the exploited subject matter. Insurance is often used in the meager and acquisition context to afford protection for a variety of concerns. For example, agreements commonly provide that one or both parties obtain product liability insurance with respect to the development, manufacture, and sales of licensed or transferred products.

General commercial or business liability insurance policies providing coverage for "advertising injury", "misappropriation of advertising ideas or styles of doing business", and "infringement of slogan or title" usually, but not always, fail to include coverage for patent infringement. However, in 1996, "offers to sell" the patented invention were added to the list of activities constituting U.S. patent infringement and business insurance policy language must be carefully examined to determine whether the scope of "advertising injury" coverage, in fact, provides patent infringement coverage. Important factors may include the relation of the offer to sell and the purchase of the infringing product to any advertisement of a patented product.

A safer practice would be to purchase an insurance policy containing a specific coverage for patent infringement as an alternative to relying upon a covenant of patent indemnification. Patent insurance may now be obtained to cover the costs of enforcing patent rights, defending patent related claims, and for conducting or defending patent infringement litigation.

A patent insurance policy for cost of defense and indemnification loss should avoid ambiguity by expressly covering the statutory violation of patent infringement as one of the defined "enumerated offenses" for which policy coverage is contemplated. Patent infringement "defense" or "liability" insurance policies may greatly vary from one another. The policy should be carefully checked, particularly in its "Definitions" and "Exclusions" sections, for the terms and conditions defining and affecting its scope of furnished coverage.

A "defense" or "liability" patent insurance policy will not protect against all patent loss because any "known loss" or "loss in progress" will likely be excluded from policy coverage. After all, the policy protection is against fortuitous events and not known certainties. For example, a "known loss" is one "where an insured knows, when it purchases a policy, that there is a substantial probability that it will suffer or has already suffered a loss. At that point, the risk ceases to be contingent and becomes a probable or known loss." The principle here is that the policy purchaser should not, with knowledge of an impending loss or substantial probability of loss, foist his known risk upon an Insurer. Similarly, a "loss in progress" clause denies coverage for claims that have been previously discovered or manifested.

Specialty patent insurance products are also available for "pursuit" or "patent enforcement" coverage that pays for the litigation costs of protecting a patent holder's rights and enforcing them against future, or even pre-existing, infringers. Such "offense" policies of "patent infringement abatement" usually provide for a percentage based co-participation by the Insured in the litigation costs. If the litigation successfully produces a damage recovery from the infringer, the Insurer is usually entitled to recover the costs it advanced, and may even obtain a percentage "bonus" or "retainage" share of the recovery.

H. Risk Sharing Agreements

Parties can always agree to allocate the risk of patent infringement between themselves. It is not necessary for one party to bear all risk. A contract can specify the parties' respective percentage obligations to fund litigation and to pay for any liability or loss in the event of a third party patent claim.

I. Suspension, Limitation, or Reversion of Royalties to Fund Legal Proceedings

The parties can also contractually provide that in the event of a claim of patent infringement, royalties or future payments are to be suspended, or reduced in amount, or held in escrow as a reserve to either fund legal proceedings involving the patent infringement or to build a reserve against infringement damages. An escrow account funded by this option could be subject to contractual conditions such as being first applied to funding of a defense of the claim, and if the claim is not successfully defended, the balance applied to pay damages and costs, or settlement or license fees to a third party. Any further monies left over would go to the owner after claim satisfaction.

J. Limited and Conditional Indemnity Covenants

There are many ways to "little by little" limit one's contractual covenants to provide patent indemnity to another.

  1. Maximum Exposure Limitation
    First, set a monetary limit to the indemnity obligation. The indemnity clause can provide a maximum limit or ceiling to the total cost of indemnity obligation undertaken with the indemnity being up to a specified sum at which time the indemnity obligation ceases. Simply adding a statement that "notwithstanding anything to the contrary contained herein, the indemnification liability herein shall not exceed the amount of $ (agreed sum)" can serve as an upper cap to the indemnity obligation.

    Alternatively, an indemnification clause may contain a caveat that the patent indemnity shall be limited up to the amount of the actual monies received by the Indemnitor under the agreement.

  2. Minimal Claim Size
    Conversely, to avoid being embroiled in litigation over frivolous matters or claims of nuisance value, an indemnity undertaking may provide it is only triggered by a claim having at least a minimum amount of potential liability or loss exposure. By establishing a threshold amount of the controversy which gives rise to any assumption of defense or indemnity payments, the party to be indemnified in effect has to cover the first portion of a claim up to the established minimum controversy threshold in a way similar to a common deductible in insurance coverage. Placing a financial interest in limiting indemnity claims upon the person to be indemnified may also prompt the exercising of more care to avoid liability than otherwise might occur.

  3. Avoid "Pay On Demand" Language
    The Indemnitor may seek to contractually limit the obligation to make indemnity payments until a final adjudication of the third party claim by a Court of competent jurisdiction from which no appeal of right exists. Patent litigation can last years. This type of limitation avoids the "pay on demand" language likely to be included in a blanket patent indemnity clause.

  4. Limit The Parties To Be Indemnified
    A party may limit to whom its obligation of indemnity runs. Care should be taken that the obligation to indemnify is only to the direct party signatory to the agreement, and not necessarily to individual parties (such as its officers, directors, employees, agents, representatives, stockholders present or future), or other entities (such as wholly owned, controlled, or affiliated companies, sub-licensees, successors, or receivers).

  5. Limit Indemnification To The Exploited Matter
    Further, the indemnity can be stated not to cover any modifications or changes made to the exploited subject matter. The indemnification could further be restricted to cover only exploited subject matter made in conformance with agreed upon specifications, established criteria or standards, and quality control restrictions.

  6. Limit The Time Period For Indemnification
    Usually an agreement to indemnify always has a clause stating that the indemnification provision survives termination or expiration of the agreement. Otherwise a party could discharge its obligation to indemnify another by simply committing a breach that would terminate the contract including its indemnity obligation. Nevertheless, the survival clause of the indemnity provision should govern only those claims arising from acts or circumstances occurring prior to the agreement termination or expiration.

  7. Limit the Nature of the Liability or Loss
    An indemnity clause can require that any aggravated, punitive, or enhanced damages arising from or caused by any conduct or forbearance of the person to be indemnified be so borne by that person. This is consistent with the Indemnitee being responsible for its own conduct.

    The indemnity obligation can also be conditioned upon the Indemnitee taking steps to mitigate the amount of losses incurred. In this regard, the obligation to indemnify can be stated not to apply to the extent to which any loss would not have arisen but for a voluntary act or omission on the part of the Indemnitee which could reasonably have been avoided without material cost, expense, or business detriment to the Indemnitee. A mitigation clause provides that there is no liability for any damages, losses, liabilities, cost and expenses to the extent that the Indemnitee could have avoided or reduced the same.

  8. Condition Indemnification Upon Timely Notifications and Cooperation
    The patent indemnity obligation can be conditioned upon the indemnified party giving prompt timely written notice to the owner of any third party claim, action, or proceeding, and may be further conditioned upon the Indemnitee fully cooperating with the owner in any defense or settlement of the claim. Such provisions are common and are akin to insurance policies requiring prompt notice of potential claims and timely forwarding of lawsuit papers as a condition of policy coverage.

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Conclusion

Patent indemnification is a thorny issue. Regardless of the amount of money changing hands or the bargaining power of the parties, exploration of alternatives to a comprehensive patent indemnification contract clause can foster the transfer of technology without requiring an undue pledge of security.

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under applicable rules of professional conduct, this content may be regarded as attorney advertising.