Providing Indemnification for Patent Infringement

Cardinal Peak recently had an unfortunate “first”: We chose to walk away from a promising engineering engagement because we couldn’t reach agreement with our customer about an indemnification clause.

Let me give a little background before diving into the issue. “Indemnification” technically is the legal obligation to compensate a business partner for losses that the partner might suffer during the performance of a contract.

To give an example, it’s common for professional services providers such as Cardinal Peak to indemnify our customer in the event of a lawsuit alleging that we copied a third party’s source code into the product we engineered for the customer. In this case, if the third party were to sue the customer for copyright infringement, then Cardinal Peak will be responsible for both the costs of the legal defense, plus the costs of any settlement that would arise. You can read a little more background (albeit with a testing-oriented slant) here.

Not to suggest that we take any financial risk lightly, but we are generally okay with providing this type of indemnity protection to our customers because we control our own actions and we’re confident we won’t behave unprofessionally.

In this case, however, our customer insisted we provide indemnification in the case where we were to unwittingly infringe a third party’s patent. In my view, this is a very risky form of indemnification to offer.

I am aware of too many examples where existing patents cover relatively obvious methods of solving some particular problem. (A portion of our services business involves expert services work in support of patent litigation — so we’re all too familiar with the ugly details, although we can’t speak publically about the cases we’ve worked on.) It seems all too possible that, without any foreknowledge of an existing patent, a competent engineer might independently hit on an already-patented method for solving a problem. And if this were to be the case, the amount of money required to mount even a trivial defense would put a small firm like Cardinal Peak out of business.

There’s also a quirk of the U.S. patent system that is worth pointing out: To my understanding, it is not even theoretically possible to guarantee a priori that you don’t infringe a patent. Even with a complete patent search and the best legal advice, under our system, the only way you can determine infringement is through a jury trial.

So really there’s no way for a firm like Cardinal Peak to be absolutely, 100% certain we don’t infringe a patent.

One way to look at this is that there is inherent financial risk in releasing any high-tech product. The form of risk that first comes to mind is when a high-tech company invests a lot of money in developing a product, just to see it flop when it comes to market.

But market failure isn’t the only form of risk in product development: Liability for unwitting patent infringement is another. (Unfortunately, it seems to be a growing risk!) Just like market risk, patent infringement liability is a risk that should be borne by the company that also stands to reap the rewards from a successful product — and that’s usually not the provider of your engineering services. After all, rarely will the service provider own the intellectual property that results from their work for hire.

I’m not suggesting that Cardinal Peak would never offer indemnification for unwittingly infringing someone’s patent. But there would have to be some upside. It is a risky move for us, and we would want to see some extra return that justifies taking that risk, whether that would be in the form of royalty participation in the product or IP ownership of whatever is developed.

What do you think? This is an issue that my partners and I continue to discuss, so we welcome your comments.

Howdy Pierce is a managing partner of Cardinal Peak, with a technical background in multimedia systems, software engineering and operating systems.