In a world of 1) increasingly smaller windows of time between periods of economic volatility; 2) a measurable shift over the past half century from tangible assets to intangible assets that now account for 85% of the value of the S&P 500; and 3) an increasing trend towards uncapped contractual indemnification between vendors and customers, it is clear that intellectual property infringement exposure for a technology company is a fast-evolving risk. Managing this risk requires proactive collaboration between a company’s general counsel and chief financial officer to win key customer contracts vital to the company’s growth/milestones while also protecting the company’s often delicate balance sheet as it tries to address 1) hypergrowth, 2) market position, 3) cash burn and run rate, and 4) present/future profitability.
What should you think about when negotiating IP infringement indemnifications?
An immediate piece of advice is to make sure that if you agree to indemnify another party (e.g.: vendor or customer), always retain control of the defense…if not, you may lose your ability to seek recoupment from your insurer, which can be the difference between a multi-million $$ impact to the company or not. More importantly, you lose control of litigation that has the potential to affect your company the most.
Sally Bracho, Senior Vice President of Claims & Contracts for ABD Insurance & Financial Services, says “We typically see 3rd party IP infringement carved out from a limitation of liability clause, resulting in a significant risk exposure. While it is understandable that a customer would want protection in the event they are sued for IP infringement based on their use of the vendor’s product, we suggest our clients take all possible steps to limit that risk exposure. For example, attempt to limit the definition of “indemnitees” as a broad definition increases the exposure. If your product is integrated into the customer’s product, try to remove “end users” from the definition to lessen the risk exposure or attempt to limit the exposure to direct damages; indirect damages, such as loss of business if the customer cannot continue to sell the product, can be substantial. A super cap can sometimes be negotiated to avoid uncapped liability. We suggest our clients also pay attention to warranty statements, in addition to the indemnity provisions, as an IP warranty may be carved out from the limitation of liability provision.”
Other non-monetary controls in the contract can limit exposure. Andrew Basile, President of law firm Young Basile, notes, “The indemnifying party should have the right to update the product or service to avoid infringement or to terminate the agreement going forward if an infringement claim is made or appears likely. In other words, there should be an escape hatch. The indemnity should also exclude claims based on combinations of the provider’s product or services with third party offerings if the infringement claim is based on the combination.”
Unlike other types of insurance such as management and professional liability insurance, IP infringement liability insurance can be used to backstop a technology company’s contractional duty to indemnify a customer facing a patent infringement lawsuit for using technology supplied by the technology company.
In the financial services sector, this risk is real and can be exponential if a patent holder seeking to monetize its patents targets several customers of a fintech company. Just look at what happened when several Jack Henry customers were sued by Milestone IP. Or, at what happened when USAA won verdicts totaling over $300M against Mitek customer Wells Fargo over remote deposit capture technology. The good news is insurance is available to protect against such risks. As an example, a fast-growing fintech with plans to go public had several contracts with large financial institutions that included IP infringement indemnities. It was able to spread the cost of the insurance across those contracts to hedge against that financial risk.
While IP infringement indemnification risk is real, this next example highlights why it is important for tech companies to remember they can be sued directly too. A small but growing business communications services provider was forced to agree to high caps on the IP infringement indemnities it provided to three of its larger customers. It insisted it only needed IP insurance specific to those contracts. Fortunately, the company was convinced to purchase broader IP insurance because it was sued directly for patent infringement, unrelated to those contracts. The insurer accepted the claim and was able to assist the insured in resolving the claim quickly and cost-effectively. The additional cost to include coverage to protect the insured against IP infringement claims made directly against it outside of the scope of the three customer contracts was negligible.
At the end of the day, intellectual property as a chassis for our economy but also a source of litigation for all companies in the technology sector is only going one direction. Do your best to balance growth while also managing risk, which can be done with careful attention and negotiation of indemnification to customers/vendors, as well as ever more efficient IP insurance.