The patent indemnification trap
Before accepting the claims made by IoT suppliers, device makers should be aware of the loopholes and limits that many indemnification clauses contain
By David Muus and Sven Törringer
“We don’t need to worry about patents. Our supplier has obtained the necessary licences and indemnified us.”
We have heard some version of this in countless discussions with companies that make cellular IoT devices.
It’s a comforting message fed to customers by their suppliers – usually a chipset or module vendor. The problem is that it often rests on false assumptions.
Promises are made in sales discussions and sometimes written in a contract or letter. Typically, the supplier says it will cover the customer’s legal costs if the use of a certain component leads to patent issues. This is known as indemnification.
If your company relies on such agreements, there are three things you need to know:
Never take it for granted your supplier has obtained the licences it implies it has.
Loopholes and exclusions may severely limit the costs you can recover.
An indemnity is not a licence. Only licences from patent owners and/or patent pools can provide true peace of mind.
In a previous article, we explained why customers should be sceptical when suppliers claim to hold all the necessary patent licences. If those licences aren’t actually in place, a patent dispute is likely to arise at some point. When it does, worried customers will dig out their indemnity to see how much support they can expect from their supplier.
So, let’s look at the fine print.
What to look for
Indemnities are not a ‘get out of jail free' card. As with any legal promise, the wording matters a great deal. Even a single cleverly drafted limitation may result in significantly less protection than expected.
“subject to the limitations in this IPR Indemnification Statement”
Based on numerous real-world examples seen by our team, standard indemnity clauses contain a bunch of loopholes that, though they appear gaping to us, are unlikely to be detected by those without intellectual property contracts experience.
Some indemnities we have seen include over a dozen limitations, restrictions and obligations that the customer must comply with for the indemnity to apply. Each has the potential to significantly decrease the customer’s protection. The following are just a few of the most common examples.
Is the compensation capped?
Consider the following example clause:
“The six (6) month period preceding the date on which Customer provides written notice to Supplier of an Infringement Claim shall be the “Claim Period” as to that claim. The entire liability of Supplier towards Customer provided in the foregoing paragraph (the Indemnity) for all infringement claims during a Claim Period shall not exceed the aggregate revenue amount Supplier has received during the Claim Period from the Customer for the infringing products received from Supplier.”
This language caps the supplier’s payout as the aggregate revenue the customer has paid the supplier for the six months preceding the written notice of an infringement claim. This is great for the module supplier. But how much protection does it give to an IoT device maker that may have been selling unlicensed products for years?
Many jurisdictions allow patent owners to claim damages stretching back a number of years. So an IoT company could be left footing the bill for a lengthy period of infringement, with the supplier taking responsibility for only a fraction. The customer may also have to figure out how to deal with liabilities from future sales which can also be excluded under some indemnification agreements.
It’s hard to know how much protection you really have unless you have a good sense of how that capped amount stacks up to your potential liabilities. To judge this, you need to know something about the patent landscape in your space. Total costs could greatly exceed the indemnity coverage, particularly if you and your supplier have obtained few of the necessary licences.
Am I giving up too much control?
Indemnifications often specify that they will only apply if the customer gives the supplier sole control of the defence or settlement of the claim. Here’s a typical example:
“Supplier may defend or indemnify the Customer against any Infringement Claim only if the Customer agrees to allow Supplier to have a right to control the defense of the infringement claim.”
A supplier that is footing the bill will naturally expect to control the defence strategy. But this can be more problematic than many realise. Think about the limitations discussed in the previous section. Could these lead to diverging interests between the customer and supplier in how a case is handled? The answer is yes.
A supplier with capped exposure might want to quickly settle a matter – even if the customer’s best interest is in fighting for a more favourable outcome regarding liabilities not covered by the indemnity.
Alternatively, a customer may wish to end the dispute as quickly as possible, hoping to avoid reputational harm, remove distractions and focus on running its business. But a supplier with control over the defence might have other ideas, preferring to drag the case out, either to deter claims against the rest of its customers or simply to delay its obligation to pay out. A supplier with a capped liability may also be less concerned about an extended dispute since its exposure remains limited even if the customer's unlicensed sales continue to accumulate.
Put simply, allowing a third party’s legal and business priorities to take precedence over your own may easily become problematic, especially given the number of ways in which interests can be mis-aligned.
Will my freedom of action be compromised?
“Supplier may defend or indemnify the Customer against any Infringement Claim only if the Customer agrees to take no action to compromise the infringement claim without express written approval of Supplier”
This may look like a reasonable request – after all, the supplier has said it will take care of the costs of any infringement claim. But in practice, this clause puts the customer in a difficult position. There are many situations in which it is in an OEM’s best interest to engage with licensors directly: maybe their indemnification only covers a fraction of their liability and they need to initiate discussions to resolve the remaining liability themselves; or maybe their own customers have encountered legal problems from selling or using unlicensed products and are requiring the OEM to sort things out for them.
Whatever the case, the above language creates a concern that taking any action will result in the loss of protection. To be safe, customers might ask the supplier for permission to engage with licensors. But if they get no reply, they’ll be left with no idea of what to do. This puts them between a rock and a hard place.
Am I relying on a ‘final judgment’ that may never come?
Sometimes, a supplier promises to take certain actions only:
“if an unfavorable and final, non-appealable judgment is rendered against Supplier”
Customers need to know that patent litigation is rarely resolved through a final, non-appealable judgment – meaning there are many situations in which these protections may not apply.
According to some estimates, 95% to 97% of all US patent litigation cases are settled out-of-court. In many jurisdictions, including the United States, defending a patent lawsuit all the way to a non-appealable final judgment involves a significant investment of time and money. It rarely happens because it rarely makes commercial sense.
Accordingly, you should be sceptical about whether promises conditioned on a final judgment will be of any help in a real-world scenario.
What about the other costs to my business?
Customers that are overly focused on what’s right in front of them – the costs that may be covered by the indemnification – can easily miss the bigger picture. Even an indemnification that provides good cover against claims cannot shield a company from the uncertainty and business impact that result from complex patent litigation. The true costs of a multi-year patent dispute can be hard to quantify, extending far beyond legal fees and royalties.
For starters, there may be costs that fall outside the scope of the indemnity, as discussed above. Then there are many additional factors to consider. Will the dispute cause disruption to your supply chain, and knock-on delays in getting products to market? Will you need to obtain new parts that necessitate recalibrating product designs and/or manufacturing processes leading to increased costs? Will customers receive their products in time? Will customer relationships be damaged by all of the above?
A complex legal dispute will also strain internal budgets and use up significant management time, especially if it takes place in a foreign jurisdiction in a far-away time zone. Most executives would prefer to focus on growing the business rather than spend their time on resolving disputes they were led to believe their suppliers would handle.
Could this lead to a dispute with my supplier?
We have also been involved in cases where the customer requests support from its supplier, and the supplier suddenly decides to go quiet. If a customer is left to fend for itself, it may end up having to take its supplier to court to recover losses it believes are covered by the indemnity. But a lawsuit may not be an option – many indemnities require disputes are subject to arbitration first.
In these circumstances, it is worth noting that some of the indemnities we have seen require disputes to be resolved in Hong Kong or Singapore under the laws of those jurisdictions. Initiating a dispute resolution on the other side of the world is no easy task for IoT companies with limited resources and personnel. If the disputed amount is small, then the process itself can cost more than the protection the indemnity offers.
What’s more, even if the customer wins a dispute and receives compensation from its supplier, this will not solve the underlying issue: the obligation to ensure that it has all necessary licenses in place.
Secure real peace of mind
Even the strongest indemnity is not a licence. It is your responsibility and no one else’s to ensure you have the legal right to use technology developed by others in your products.
Without doubt, obtaining key licences yourself provides the greatest level of business certainty. It could also prove to be a competitive advantage if patent suits target your supplier’s unlicensed customers, or the supplier itself.
One option is to seek out a module maker that acknowledges the need for licences and helps its customers obtain them. Nordic Semiconductor, for example, has entered into agreements with the Sisvel Cellular IoT patent pool and others to facilitate licences for its customers.
Regardless of supplier, every company should understand the patent landscape around the technologies in its products and take action to mitigate risks. Key questions to ask include:
Who are the key patent owners?
What are the published royalty rates?
Are there streamlined licensing options like patent pools available?
How much should be provisioned for licensing costs in the bill of materials?
When it comes to cellular IoT, the Sisvel patent pool covering LTE-M and NB-IoT devices is an easy choice for most device makers. It provides a licence to thousands of patents from over 30 patent owners, covering more than 50% of the total patents in the space. The rates start at just $0.08 per device and have been priced to encourage the growth of cellular IoT. This coverage is available through a single, transparent, standardised licence agreement. This means you can obtain fast and easy protection with confidence that your competitors will not receive a better deal.
Ultimately, the decision lies with each IoT business. Some may opt to deal with the Sisvel Cellular IoT pool, others may prefer to negotiate with dozens of patent owners individually. But all companies should think twice before staking their future on a promise from a supplier.
David Muus is head of licensing programmes at Sisvel
Sven Torringer is programme manager of Sisvel Cellular IoT
The content of this Article is for general information only and does not constitute professional or legal advice. You must not rely on the information in the Article as an alternative to seeking advice from an appropriately qualified professional. If you have any specific questions about any such matter, you should consult an appropriately qualified professional.
