Don’t Permit a Patent in Your Indemnity Clause
Do You Want to Read a Contract?
Do you like to read contracts?
Most business people find themselves using the same contract for years or using a template– so what could possibly go wrong?
What is an Indemnity Clause?
Shockingly enough, most people do not like to read the contracts they sign. Contracts can be long and boring. After being an attorney for 20 years and offering flat-rate services for over 3 years, I’ve noticed that even the brightest leaders and entrepreneurs don’t like to read contracts. Even those who do read a contract don’t always understand the full implications of a contract’s wording. Take, for example, this “standard indemnity clause” that is typical of many contracts:
Consultant will indemnify, defend, and hold harmless Client, Client’s parent, subsidiaries and affiliates and each of such parties’ respective parents, subsidiaries, affiliates, present or former directors, officers, employees, representatives, contractors, consultants, agents, successors and assigns (collectively, the “Indemnified Parties”) from and against any and all losses, liabilities, penalties, damages, costs and expenses (including attorneys’ fees and expenses) incurred by or asserted against any of the Indemnified Parties arising out of or based upon (i) any third party claim that any Service, Deliverable, or any part thereof infringe upon or violate any copyright, trademark, trade secret, patent, or any other proprietary right of any person or entity and the basis for such a claim does not rely on any information, material, property or work provided by Client; (ii) any breach or alleged breach of any representation, warranty, covenant or agreement of Consultant or Consultant’s activities hereunder; (iii) any claim, demand or action instituted by Consultant’s employees under workers’ compensation or similar laws or regulations, or (iv) Consultant’s failure to comply with any federal, state or local laws, regulations, requirements, ordinances, codes or orders.
I’m willing to bet your eyes glazed over just reading that…
Revenge of the Indemnity Clause
Long story short, it’s called an indemnity clause and it can come back to royally bite you and your business later on. For more information about indemnity clauses, and what to look out for, read Contract Tip: What is an Indemnity Clause?
If your client asks you to sign a contract that contains this indemnity clause, do you sign it?
When you promise to “indemnify and hold harmless” another party, you are promising to compensate the other party for ALL monetary damages and losses that may have occurred. The paragraph above says that if a claim is made against the Client by any third-party for an alleged infringement of any proprietary right (including patents) that you as the Consultant will reimburse the Client for ALL its damages and losses associated with the claim or allegation. Given the way this paragraph is written, this involves more than you may think:
- You would have to compensate the Client for even false claims of infringement.
- You would have to compensate the Client, whether or not the Client was actually sued.
- You would have to compensate the Client, even when the infringement allegation was completely false (even if it is settled out-of-court).
- You would have to compensate the Client, even if they settle right away.
And, to make things worse, damages and losses could be significantly more than you could possibly guess, such as:
- You would be responsible for costs associated with “completely fixing or replacing” whatever “thing” contains the infringing work, whether a machine, system, materials, inventory, software or whatever.
- You would be responsible for the costs associated with replacing the “thing” that contains the infringing work for all its customers.
- You would be responsible for lost profits associated with the loss of the “thing” that is infringing and/or the potential loss of goodwill associated with negative publicity in the allegation.
- You would be responsible for not just attorneys fees, but court costs and expert witness fees.
There is no limit to potential damages with an indemnity clause.
Can you imagine the pile of money that could be demanded from you and your business, when you combine the two lists above? For example, suppose you developed some key piece of software in an order fulfillment system and that system had to be replaced? Imagine the demands that could be made if the client decided to settle by offering a cash settlement and agreement to replace its system. Then the client had negative publicity and a decline in sales. Even if you felt the allegation was false, the client could seek monetary indemnification against you and your business for all of those issues!
Clearly, a “standard indemnity clause” could literally throw you and your business into bankruptcy, if not handled correctly. So, what does this have to do with patents?
Indemnity Clauses and Patents
Of all the “proprietary rights,” there are two that are most dangerous to you and your business, because they are completely out of your control and potentially unknown to you. The first are any proprietary rights created in contract between your client and some third-party that you are not aware of. This possibility must be excluded from your contract and the indemnity provision. We are not talking about those particulars in this article.
Indemnity clauses and patents can often clash!
The second dangerous proprietary right is patent. If you are not sure, read our article on Patents 101 for a quick brush-up on what a patent is. This is especially important for software developers, consultants, scientists, engineers and similar experts who have a hand in building a product based on specifications provided by the client. In a nutshell, it protects claims about some invention that is considered new, useful and non-obvious at the time the patent was awarded. Since a utility patent can protect claims for up to 20 years, that is an eternity in some industries such as cellular phones, Internet services, software, telecommunications and more.
If your client is going to dictate functional specifications to you, how can you be sure those functional specifications do not infringe on some third-party’s patent? The only way to do this, is to conduct a patent search and/or prior-art search on all the functional elements on the work product you have been tasked to build. This should not be a task for most consultants, and it’s hard to envision any client willing to take on the costs for doing this, which can far exceed the costs for the primary service.
Therefore, a patent is the one proprietary right that should be specifically excluded from an indemnity clause. The party providing the specifications and/or requirements to build a product should be the party that bears the risk in third-party causes of action relating to patent infringement claims.
It pays to hire an attorney to review your contract before you sign it.
Are you not sure about your contract specifics? Our firm has been provides a flat-rate contract review to clients for only $20/page (minimum 5 pages). For this limited review, our attorneys read the contract, making comments and suggestions along the way. Our flat-rate contract review is the singular most popular offering with our firm.