Third Party IP Infringement Liability & You: What You, as a Contract Developer, Should Know

A while back I had a post on Contract Drafting for Software Development Agreements. Today's post is a followup, specifically about the issue of Third Party IP Infringement Liability.

If you are someone who offers engineering or design services on a contractor basis, or work for a firm that does, there will almost certainly be a series of clauses in your contract regarding third party IP infringement indemnification. That's a big legalese mouthful, but it is potentially the most expensive part of your agreement, so it should be negotiated carefully.

Essentially, when a service provider indemnifies a client over third party IP infringement claims, the provider is stating that the work-product it delivers doesn't infringe anyone else's copyright, trademarks or patents. Copyright and trademark is pretty easy to cover, as long as you are not using uncredited stock photos or rival company's logos.

Patent infringement is much trickier. There are millions upon millions of patents issued, and as we learned from This American Life, a patent from 1999, predating the first podcast by several years, actually apparently does cover podcasts themselves. As a result, it is very, very hard to know if one is infringing third party patents.

And patent damages can be extraordinary. Many, many multiple times the value of an underlying services contract. This is why you need to be particularly careful when making representations about third party IP infringement. So, from the point of view of a service provider, here are a few ways to limit your exposure (if you are a client, then you will be coming at this from roughly the opposite perspective):

1. Disclaim all third-party IP infringement warranties. If you can get this provision, you probably don't need any further advice, because you are well known in your field and have substantial bargaining power. However, sometimes a client will be willing to accept this condition, so if the initial contract is silent on this issue, this may be the place to start negotiation.

2. Offer third-party IP infringement indemnification only over knowing or negligent violations. Basically, this means that you will not be on the hook for "strict liability" infringement. This is essentially the situation in the podcast story above, where no one had any idea that their techniques fell into the scope of the patent until they were hit with a demand letter. You'll only be on the hook for infringing patents you know about or should have known about. That latter part can get tricky, because then the question is "well should you have known about that?" This inquiry will get into how much of an expert you are in your particular field, how much a particular patent or lawsuit has been in the news, etc. However, it is still a pretty strong standard.

3. Limit your total indemnification liability. This is often the easiest solution. Typically damages under an agreement, no matter what form in which they occur, should have a cap. Often times, however, indemnification liability is specifically exempted from this cap. So, for instance, if there is an liability cap of $1,000,000.00 on an agreement, and you show up to your client's office and blow up a $2,000,000.00 piece of machinery, you are only on the hook for the initial $1M. If, however, indemnification liability is exempted, and it turns out you deliver work that infringes a third party patent, your liability could be limitless. Liability caps commonly used in developer agreements range from a negotiated, fixed price, to the fees paid to the consultant over a given period of time (trailing twelve months, trailing two years), the total fees paid to the consultant, or a multiple of any one of those. Additionally, there should be a sunset provision on this indemnification liability, meaning you will no longer be on the hook for these types of claims two, three, five, etc., years out.

4. Negotiate at what point indemnification liability obligations become active. Some clients will want you to indemnify them for claims as they arise, which means you will be on the hook for every crank and potentially baseless infringement claim your client receives. Other possible solutions include having indemnification obligations become active upon the breach of an IP warranty, i.e., proof that you knowingly delivered infringing IP, after a claim has survived a motion to dismiss, or upon adjudication that IP was actually infringing.

It is very, very important to pay close attention to these provisions when you agree to develop software on a subcontracting basis. More than any other clause, this one can come back to bite you, years later, for enormous sums of money. To put it another way, if you give a client unlimited, strict liability third party IP infringement indemnification, your contract with them is no longer so much of a services contract as it is an insurance contract. Keep in mind, that as a developer makes more and more representations, the developer can argue it is entitled to higher fees, as it is bearing higher risk. The counterpoint is true from the point of view of the client. In any event, it is essential that before the commencement of services both client and service providers have negotiated this issue explicitly, so they understand their mutual responsibilities and obligations to each other.


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