I recently spoke at a CLE at my firm about how to successfully draft key provisions in an intellectual property license and negotiate them. Here is an edited transcript that I post in two pieces. In this first one I offer suggestions about drafting warranties, indemnities and limitations of liability and I also provider some drafting tips. In my 2d post I offer my top-ten considerations when negotiating an IP license.
Warranties, Indemnities and Limitations of Liability
As Heather Meeker points out in her fine book, Technology Licensing A Practitioner’s Guide, warranties, indemnities and limitations of liability send clients and even some lawyers into a mental tailspin. They are most densely written, the furthest removed from the business deal and the most difficult to understand. Yet they are extremely important and it’s best to analyze and negotiate them together or else you might end up agreeing to points that are not important or miss others that are.
Let’s start warranties.
A warranty is a promise that a fact is true. There are three warranties that are typically found in IP transactions: a corporate, performance and a noninfringement warranty. In a corporate warranty the licensor warrants it has the right to enter into the transaction. In a performance warranty involving technology the licensor warrants that the software will perform in accordance with the contract specifications. In a noninfringement warranty the licensor warrants that the IP being licensed does not infringe third-party IP rights.
The remedies for breach of warranty may include requiring the party granting the warranty to remedy the defect. The license may also give the party who suffered a breach the right to terminate and be indemnified.
If you are providing a warranty (as you will in almost all IP licenses) you will want to minimize their number and scope and the remedies in case of breach. Whether you are able to minimize depends on your negotiating leverage and the other party’s risk tolerance.
There are several ways to minimize. Use knowledge and materiality qualifiers and time limitations. A knowledge qualifier states that to best of the warrantor’s knowledge its intellectual property does not infringe 3rd-party rights. A materiality qualifier limits the warranty obligation to only material failures of the IP to conform to contract specifications. A time limitation provides that the warranty obligation ends after a stated time period which in software deals is usually 90 days.
There are also a number of implied warranties present in any IP transaction but typically the IP provider will disclaim them by using conspicuous language. The IP licensee will then be limited to the warranty protection expressly provided in the agreement. In other words what you see is what you get.
An indemnity is like an insurance policy; the indemnifying party acts like an insurer; if something goes wrong that party pays money or corrects the wrong.
Indemnity provisions allocate the risk of loss between the parties. They generally require the indemnifying party to defend, indemnify and hold the indemnified party harmless though indemnification and holding another harmless are usually interpreted to mean the same.
In sophisticated IP transactions indemnities are sought because parties want protection against the substantial costs and damages resulting from third-party IP infringement claims are therefore reluctant to commit without indemnity protection from the other party.
With the growth of IP litigation especially in the patent area indemnification provisions have become much more complex. In other words every time you draft an indemnification agreements in a complex transaction it may be different.
Indemnification agreements commonly divide responsibility based on the party who is ultimately responsible for the infringing conduct; there are a number of ways to draft these responsibility clauses. For instance, if the third-party claim arises from the licensee’s use of software outside the scope of the agreement, you can provide for no indemnification. Again in the software context you can provide for no indemnification if the infringement claim arose from the provider’s compliance with the licensee’s specifications.
In trademark licenses both parties will seek indemnity protection. The licensee will be required to indemnity the licensor against product liability claims arising from products made by the licensee bearing the licensor’s mark. The trademark owner-licensor will be required to indemnify the licensee against infringement claims arising from the use of the licensed mark in accordance with the agreement.
Limitations on Liability
The party indemnifying will often want to cap or limit the dollar amount of the indemnity obligation to reduce its risk or lower the incentive for litigation. In software deals the cap may be the license fee paid by the licensee. A $10,000 cap for example effectively wipes out the indemnity because the plaintiff is not going to sue where the most it can recover is $10,000.
And remember in NY you can’t disclaim liability for gross negligence or willful misconduct.
Finally when thinking about risk allocation, do you want to make it one-sided so that liability falls on the other guy. Or do you want to make the liability for all narrow to reduce the incentive to sue. Whatever option you adopt you need to ask whether the benefit you hope to achieve by the deal is worth that risk you are assuming.
Tips for Effective Drafting
Here are a few tips for effective drafting.
The Internet Has Changed the Meaning of Some of the Words We Use In Licenses
The first is an obvious truism: don’t use a word in your agreement you don’t understand. You might now be thinking I know that; I didn’t wake up at whatever time this am to come here to hear that. But think again; the internet age has created some new definitions.
Here are two examples. In the pre-internet days, TV rights meant distribution of programming content to your TV, maybe even one that had rabbit ears. But a provider of TV programming can now deliver it in a number of ways including by (a) cable; (b) satellite; (c) free streaming; (d) subscription; (e) pay-per-view; (d) video on demand; (f) internet broadband and (g) through your computer via a Slingbox, to name a few. So if you your deal gives you only TV rights you may find yourself in a costly fight trying to determine whether those rights go beyond the traditional means of distribution.
The same for home entertainment products; in the past technology limited your viewing or listening of music and video to your home. But now portable media devices (iPads, tablets, etc.) allow you to be entertained anywhere. So, if you want to license your IP for use on these devices, you should expressly say so.
Suggestions on the Use of Shall
The second tip I also adopt from Heather Meeker’s fine book with respect to the work “shall.” Lawyers love “shall.” They use it in legal documents as a command. I am not going to tell my wife (however much I sometimes might like to) “you shall go to the store tonight.” But you rarely will find an agreement that is without a “shall.”
The problem is that agreements sometime don’t use “shall” all the time. So the agreement might provide: “You shall deliver the source code to Mr. X and you will make it available to Mr. Y.” The obligation with respect to Mr. X is clear but what about with respect to Mr. Y. In other words, are you equally obligated to make the code available to Mr. Y? You probably are but why create any ambiguity. Use “shall” when you are attempting to create a party’s legal obligation and use “will” when the subject is not one of the parties and you are speaking about a future occurrence. For instance, say “the parties shall sign the releases today and the releases will become effective tomorrow.”
Have any other drafting tips you wish to share or any suggestions about warranties, indemnities and limitations of liability. Please pass them on.