2. Licensor Indemnity Obligations

Under a contractual indemnity provision, one party (the "Indemnitor") agrees to protect another party (the "Indemitee") from claims by third parties arising out of the Indemnitor's conduct. The most common example of this type of provision is the indemnity provided by most vendors to protect their licensees from claims that the licensed software infringes the intellectual property rights of a third party. If the third party sues the licensee claiming the licensee's use of the software infringes its intellectual property rights, the vendor will hire a lawyer to defend the licensee and pay any damages that result from the claim.

a. Intellectual Property Infringement Indemnity

The intellectual property rights indemnity protects against events which do not occur with great frequency. However, it is somewhat like earthquake insurance in that, if there is an infringement claim, the potential costs to the licensee would be significant, and licensee's continued use of the software could be precluded. Consequently, the indemnity provision is extremely important and, despite vendor protestations that they have never had an infringement claim or ever heard of such a claim, this protection should be required from all licensors. This protection has gained even more importance recently as the number of intellectual property infringement actions are on the rise, particularly those relating to patent infringement.

Vendors often try to limit the intellectual property indemnification only to infringement of copyrights. That is not acceptable, as most infringement actions arise out of patent or trade secret rights. The indemnity should extend to infringement claims of any "patent, copyright, trade secret, or other proprietary rights of a third party." The vendor may also try to limit the indemnification to "United States" intellectual property rights and, unless foreign use of the software is anticipated, this limitation is generally acceptable.

Some vendors may insist on certain exceptions to their indemnity obligation. Common and acceptable exception language is as follows: "Notwithstanding anything to the contrary herein, Vendor shall not be responsible under this Section for infringement claims arising from (i) modifications of the Licensed Software by any party other than Vendor or its agents; (ii) specifications provided by Customer for the development of custom programming; and (iii) failure to implement an update to the Licensed Software that would have avoided the infringement." With regard to the last exception, it is important to include the following qualifying language: "(iii) failure to implement an update to the Licensed Software that would have avoided the infringement, provided Vendor has notified Customer in writing that use of the update would have avoided the claim."

In the event licensee's use of the product is prevented by court order, or if the business risks (potential exposure to punitive damages) of continued use of the product are too great for licensee, licensee must have the option to demand that the vendor either (i) procure the rights for continued use of the product by licensee, (ii) replace or modify the product with another system or components of comparable quality and functionality, or (iii) refund all fees, including license and professional service fees, paid by the licensee ^[5]. Many licenses give the vendor the right to choose the remedies described in sections (i) through (iii). These provisions should be modified to give the option to licensee, or at a minimum, require the vendor to use commercially reasonable efforts to accomplish (i) or (ii) before resorting to (iii). One of the most common errors in drafting these types of provisions is the failure to include a specific time frame for the vendor to provide one of the remedies described above. See the example language provided below.

b. Other Vendor Indemnities

In addition to an indemnity for intellectual property infringement, the unique circumstances of a particular transaction may cause the licensee to request other indemnities from the vendor. If the licensee is a healthcare provider or a financial institution and the vendor will have access to non-public patient or customer information in implementing the software, the licensee may require the vendor to indemnify the licensee from any claims arising from the vendor's breach of confidentiality with regard to the patient or customer information. Other common indemnities include the following:

Property Damage. Indemnity from claims arising from damage or destruction of property caused by the vendor.
Personal Injury. Indemnity from claims arising from personal injury claims resulting from the actions of the vendor and its employees.
Employee Compensation Claims. Since the vendor is an independent contractor of the licensee, the licensee should have no liability for compensation, overtime, and other similar claims by the licensor's employees. This indemnity requires the licensor to indemnify the licensee from those claims.

c. Licensee Indemnities

Vendors frequently seek very broad indemnities from their licensees regarding use of their software. The indemnity in Section 10 of the vendor form agreement shows a typical licensee indemnification provision. Note that unlike the vendor indemnities described above, there is no "fault" component in this provision. Specifically, the common thread running through the vendor indemnities described above is that the licensee is being protected from claims that arise because of some fault of the vendor (e.g., the vendor has infringed a third party's intellectual property rights, the vendor has damaged a third party's property, the vendor has injured someone). Compare the indemnity in Section 10 of the form agreement. This provision requires the licensee to protect the vendor from claims - even if the licensee has done nothing wrong, even if the claim arises because of something the vendor has done. This provision requires the licensee to indemnify the vendor for any all claims that may arise from the Licensed Software, regardless of whether the licensee is at fault.

Consider the following examples. A third party sues the licensee and the vendor because the vendor intentionally infringed the third party's intellectual property rights. In that case, Section 10 would require the licensee to hire a lawyer to defend the vendor from its own wrongful conduct and to pay any damages a court may award. Similarly, if a defect in the software causes a third party harm, the licensee must indemnify the vendor from any claims by that third party.

Licensee indemnities that are not based on fault are unfair, unreasonable, and should be strongly resisted. At most, the licensee should indemnify the vendor from the following types of claims: (1) intellectual property provided by the licensee that infringes a third party's intellectual property rights (this is essentially the reciprocal of the standard vendor intellectual property infringement indemnity); (2) licensee's failure to use the software as permitted under the agreement; and (3) licensee's modification of the vendor's software, solely to the extent the infringement claim results from those modifications.

Example Revision:

Indemnification. ^[6]
- 10.1 Customer Indemnification. Customer shall defend, indemnify, and hold Vendor and its directors, officers, agents, employees, members, subsidiaries, and affiliates from and against any claim, action, proceeding, liability, loss, damage, cost, or expense (including, without limitation, attorneys' fees), arising out of or in connection with Customer's failure to use of the Licensed Software as permitted under this Agreement. Vendor shall provide Customer with prompt notice of any such claims, allow the Customer sole control of the defense, and fully cooperate with the Customer in defending the claim.
- 10.2 Vendor Indemnification. ^[7] Vendor, at its own expense (including payment of attorneys fees, expert fees and court costs) shall defend Customer and its directors, officers, agents, employees, subsidiaries and successors in interest against any loss, cost, damage, liability, or expense from any and all third party claims that the License Software infringes any patent, copyright, trade secret, or other proprietary right of a third party and shall indemnify and hold harmless Customer and its directors, officers, agents, employees, subsidiaries and successors in interest from any amounts assessed against them in a resulting judgment or amounts to settle such claims, provided that Customer (a) gives Vendor prompt written notice of any such claim, (b) permits Vendor to control and direct the defense or settlement of any such claim, and (c) provides Vendor all reasonable assistance (at the expense of Vendor) in connection with the defense or settlement of any such claim. If the Licensed Software is, or is likely to be, the subject of an infringement claim, Vendor, at its expense, shall: (i) procure the right to allow Customer to continue to use the Licensed Software; or (ii) modify or replace the Licensed Software or infringing portions thereof to become non-infringing, without loss of material functionality. If Vendor is unable to provide one of the remedies in (i) nor (ii) within forty-five (45) days of notice of the claim (unless such period is extended by Customer), Vendor shall have the right to terminate this Agreement and refund all fees paid hereunder for the Licensed Software, pro-rated on a straight-line basis over a five year term. Notwithstanding the foregoing, Vendor shall have no obligations under this Section solely to the extent any infringement claim is based upon or arising out of (i) any modification or alteration to the Licensed Software not approved by Vendor, (ii) any combination or use of the Licensed Software with products or services not supplied by Vendor or approved in writing by Vendor in advance of such combination, or (iii) use of the Licensed Software not in accordance with the applicable Documentation or outside the scope of the license granted under this Agreement.

^[5]Depending on the size of the transaction and bargaining strength of licensee, licensee should consider requiring the vendor (in addition to refunding the purchase, license and professional service fees paid for the product) to also reimburse licensee for all reasonable costs incurred by licensee associated with having to seek out, negotiate and switch to another vendor.

^[6]Note that we have split the existing indemnification section into two parts: Customer Indemnification and Vendor Indemnification.

^[7]Proposed new section providing a standard vendor indemnity for intellectual property infringement.