Indemnity Basics for Defendants Sued for Patent Infringement

Ryan Koppelman

Corporate Counsel

01-07-2013

While making a successful indemnity claim can often be a challenge, the cost of defending and settling patent cases can be quite high—and, therefore, an aggressive approach to indemnity can be justified to help defray these costs. As a defendant, there are several indemnity options and numerous strategies for pursuing reimbursement where the product accused of infringement was at least partially outsourced.

Most indemnity claims start with an analysis of any supplier agreements that cover the products accused of infringement. For example, if a company’s website is accused of infringement, agreements with the web developer or hosting company may be relevant. Similarly, if a company’s consumer electronics product is accused, agreements with the component suppliers, the producer of the operating system, or any application developers could all be relevant.

The upside is that the indemnity provisions in such supplier agreements typically impose a duty on the supplier to defend against and pay any claims against its customers. The downside is that the scope of that indemnity is often limited to disclaim indemnity when a supplier’s products are combined or modified. With combined products, the typical agreement seeks to exclude indemnity when infringement is premised on a combination of the vendor’s products with another company’s products. There would be no indemnity if the supplier’s products do not by themselves infringe a patent. In addition, modification by a customer of the vendor’s product that results in infringement is also usually disclaimed.

A good example of these common limitations is found in an agreement between Sun Microsystems and Microsoft Corporation, which was at issue in In re Microsoft Corp. Antitrust Litigation (2003). The agreement related to the use of the Java Runtime Environment (JRE) in Microsoft’s products and provided that: “Sun will defend or settle at its expense any claim brought against Microsoft, Microsoft's distributors, dealers or end-users that alleges that the JRE Software . . . infringes any . . . patent . . .  of any third party in any country in which Microsoft distributes such products . . .” But Sun had no indemnity obligation if: “Any alleged infringement arises from: (i) modifications made to the JRE Software by or on behalf of Microsoft, or (ii) the combination of the JRE Software with any other product, program, or data, to the extent the alleged infringement arises from such combination.”

The limitations regarding combinations and modifications are both present in this example, but the key language here is the phrase “arises from.” This is a common drafting convention, and creative lawyers on either side can likely argue for, and against, the notion that an alleged infringement arises from a modification or combination. Because this issue is subject to potentially considerable dispute, the likelihood of receiving full reimbursement is diminished, but partial reimbursement through settlement of the indemnity claims itself could still be an option in many circumstances.

Another common limitation on indemnity in many supplier agreements is the exclusion for customer-specified or custom-ordered products. For example, pursuant to another litigated indemnity agreement, Sun was under no obligation to indemnify its customer, Eastman Kodak Company, for its use of Java, “(1) if Kodak were to use an altered version of the FCS technology; (2) if Kodak used the FCS technology in combination with non-Sun-provided equipment, or (3) if Sun complied with the designs or specifications established by Kodak.” See Eastman Kodak v. Sun Microsystems (2004).

Indeed, the issue of who controls the design and specifications of a product can even flip the indemnity obligation to the buyer, such that if the seller is sued for patent infringement, the buyer—as the party responsible for dictating the functionality accused of infringement—could potentially be on the hook to indemnify. Accordingly, who designed the product is an issue that needs to be investigated before raising indemnity with suppliers.

If no supplier agreement exists, the Uniform Commercial Code’s implied warranty against infringement provides another option for reimbursement when one is sued for patent infringement, but it also has several notable limits. See UCC § 2-312(3). The code provisions begin with the phrase “unless otherwise agreed,” and thus an enforceable indemnity agreement will likely supersede the UCC warranty, and any express disclaimer would negate it entirely. In addition, it applies to: (i) only merchants, (ii) only goods (not services), (iii) only products from normal stock (not custom goods or ones specified by the buyer), (iv) only infringement of patent claims covering devices or products (not method claims), and (v) only claims brought within four years of the goods being delivered.

The scope of the warranty is also seemingly limited by its terms to a “rightful claim” of infringement, which might suggest that an actual finding of infringement be a prerequisite. The Federal Circuit, however, has rejected that argument as inconsistent with the policy favoring settlement. This leaves open an argument that the warranty should provide for cost of reasonable attorneys’ fees and expenses as well as the cost of a reasonable settlement, though it does not give rise necessarily to a duty to defend.

In light of these rules and potential pitfalls, the following strategies should be considered. All potential indemnity options should be evaluated and timely notice provided to any potential indemnitor. It is helpful to involve the business managers who deal with the supplier to leverage their business relationship with the indemnitor, to determine whether they are a strategic or replaceable supplier, and to follow the status of the ongoing business relationship. If managers are renegotiating the supplier contract or nearing a renegotiation phase, that can affect how, and to what extent, one might push a potential indemnity claim.

In addition, the value of at least partial indemnity should not be underestimated when available. Partial indemnity may be a compromise to any dispute over the scope of indemnity, but it can still positively affect a defendant’s litigation budget. To maximize this potential and the value of the overall claim, the indemnitor should be invited to participate in the settlement process, their approval should be sought for any potential settlement, and they should be asked to at least contribute to any payment. Having separate indemnity counsel may assist with this process by maximizing negotiation leverage as well as avoiding any potential conflicts.

Lastly, if negotiating with the indemnitor for reimbursement fails and the indemnity claim is strong enough, litigation or arbitration against the indemnitor can be considered. Plaintiffs in patent litigation have become more aggressive, so defendants should consider taking aggressive action to defend themselves as well. Proceeding in that direction, however, could potentially disrupt the underlying business relationship, so it is necessary to fully consider the implications. Ultimately, taking these steps will help to maximize potential indemnity claims.

Ryan Koppelman, a partner in the Silicon Valley office of Alston & Bird in Menlo Park, California, focuses his practice on intellectual property matters with a specific focus on patent litigation.