The Independent Counsel

Contracts


Seller Beware


BY TOM L. PETERSON

Suppliers of software services are frequently confronted with contract forms that call for a "supplier's indemnity." In these, the client-asks the software firm to "indemnify" against liability that the client might incur if the supplier's software infringes the intellectual property rights of third parties. Similar clauses are often requested of vendors in OEM contracts.

A supplier should understand that an agreement to indemnify is like an agreement to provide free insurance to the client.

Unless limited by specific wording in the clause, an indemnitor is responsible for any and all damages, losses, and expenses and for any protective remedy sought for violation of patent, trademark or other intellectual property rights by the supplier's software.

No insurance is available for such exposure because the existence of all such rights cannot be determined. An insurance company could go broke if it took on this responsibility. Yet suppliers of software services often gamely offer this coverage in complete ignorance of the risks.

The managing partner of a very large Boston firm specializing in intellectual property law recently said, "These indemnity clauses are often only discovered when a lender or venture capital firm or acquiror does its due diligence prior to lending or investing in a software firm. Then, the whole transaction stops while we try to evaluate what the risk might be. The investigation can cost hundreds of thousands of dollars and even then we can only offer a very guarded guess as to what the risks might be...."

The partner went on to say: "There is much anguish when we have to say we can never be sure what might be out there-what third party rights-even in the U.S., because we can't know what patent claims might be in the pipeline, let alone the possibility of imbedded copyright violations. After many hours of research we can probably offer some comfort, but we aren't an insurance company either."

The moral? Don't take a risk if you don't know how big it is. Tell your customer that you are unaware of any violation of third party IP rights affecting the software.

Then, if you must offer an indemnification, but wish to avoid putting the entire future of your company on the line, you might even offer to share the risk with the customer for a limited time, and up to an amount that your company can afford to lose, with the option to try and design around the problem or otherwise take any corrective steps which might work, for a pre-agreed compensation.

Comment: The wise vendor of software or software services will take care to identify any supplier's indemnity clauses before signing a seller-supplied software services agreement. And then start negotiating!

© ASSOCIATION OF INDEPENDENT GENERAL COUNSEL 2004; (all rights reserved). This article is not intended as legal advice. Consult a qualified attorney for assistance concerning a specific issue or problem.