Significance of clause for patent indemnification

By Chandrasekhar Raju, LexOrbis

Patent indemnification is a contractual indemnification where one party to the transaction agrees to protect the other party against claims arising from use of the patented technology or the goods purchased. The protection embodied in a patent indemnification clause often relates to the defence of claims for direct infringement, contributory infringement, and inducement of infringement, including the payment of associated legal fees and costs.

Chandrasekhar RajuManaging associateLexOrbis
Chandrasekhar Raju
Managing associate

Patent infringement litigation has been rising in recent years. Patent infringement suits frequently target large corporations in the telecom, software, and financial service sectors selling or using an allegedly infringing product. Often, the suit is related to use of a product, component or technology supplied by a third party. To shift the financial risk of such suits, the corporation as a purchaser usually seeks indemnification against claims of patent infringement from the seller/original equipment manufacturer. Litigation may involve a patent holder asserting its patent rights against an entity selling the allegedly infringing product or an entity combining several components into a single product.

Purchasers of goods or services should be concerned if there is a risk that the goods or services may bring allegations of patent infringement from a third party patent owner. Although the seller assumes liability for such an eventuality with a patent indemnification provision (such as warranty), whether the purchaser will be fully indemnified is open to question. If a patent infringement suit arises, such warranties may provide only cosmetic relief. To recover damages from the seller, based on a warranty claim, it would first need to be proved that the seller’s products or services infringed the third party’s patent. Then, a subsequent suit may take place between the purchaser and seller where the purchaser would have to prove that the infringement fell within the scope of the warranty.

It is important for a purchaser of goods who seeks an indemnity to follow procedural formalities to safeguard its indemnity right, which includes providing prompt notice to the seller regarding a patent infringement suit and an opportunity to defend. If the purchaser does not notify and unilaterally pursues the case or negotiates a settlement with the third party, the purchaser may risk losing the indemnification or bearing the burden of proving that its actions were reasonable.

The purchaser should also show that it had accepted in good faith the freedom to operate implied in the indemnification provision. If the purchaser chooses to settle with the third party, it may be assumed that the purchaser is liable for the patent infringement. Such situations may become complex if the patent infringement suit alleges that products or services purchased from more than one seller were combined with other components to form the infringing product.

It may be agreed that a patent indemnification clause will not apply if the purchaser makes significant changes to the products purchased from the seller, and a third party sues the purchaser for patent infringement. In the US case of Carter-Wallace Inc v Tambrands Inc, it was concluded that some modification to the products purchased may be made without taking the resulting products outside the indemnity clause.

It is important to negotiate a contract with an indemnification clause against patent infringement with appropriate representations, warranties and contractual undertaking of risk allocation. To address such issues, both the purchaser and the seller need to perform a due diligence study to uncover risks associated with any patents that are essential to implement specific technology.

Patent infringement suits may prevent a purchaser from selling allegedly infringing products in the market. In such cases, the purchaser may lose customers, resulting in a loss of revenue. Further loss may be incurred in replacing the allegedly infringing products. Downstream, customer relationships may be damaged and market share reduced.

Before entering into agreements with patent indemnification clauses, the purchaser needs to assess the risks arising from a third party allegation of patent infringement. The purchaser should identify all patents and pending applications, domestic and foreign, to be licensed or transferred, and obtain copies of their prosecution histories. The purchaser should identify and verify the patent portfolios of competitors, to ascertain the validity and remaining term of their patents and whether new filings or continuation, continuation-in-part, or international or foreign country counterpart applications have been made. Most importantly, the purchaser should conduct a freedom to operate study to identify potential patents related to the technology in any relevant jurisdiction.

Chandrasekhar Raju is a managing associate at LexOrbis.

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