I’m So Happy – Keeping the Peace With IP Infringement Clauses

By: Robert V. Hawn, Esq.

Many technology companies generate their revenue by providing their technology, often in the form of software, to customers through licenses, subscriptions, or software as a service platform. As a technology lawyer practicing in Silicon Valley, I work with a number of companies which actively distribute their technology though licensing deals. Their customers, who are almost always licensees or subscribers, require that they are covered if sued by a third party claiming that the licensed technology is owned by that third party. The legal term for a licensor covering its licensee against claims from a third party is indemnification.

As we discussed in my prior blog about how indemnification are triggered , indemnification obligations get triggered by the threat of a lawsuit or an actual claim. Once the threat or claim hits, the licensee is required to do certain things, e.g., provide notice to the licensor. So, what happens next?

Indemnification clauses try to keep everyone happy by striking a balance between two competing interests. The first is the interest of the licensor in trying to minimize its exposure. The second is the interest of the licensee which wants to continue to use what it has paid for. The manner in which these tensions are resolved is often a function of the relative bargaining power of the licensor and the licensee.

Typically, if a claim hits, the licensor will agree to do certain things. First, it may agree to defend the licensee from the claim and hold the licensee harmless from its effects. As part of this obligation, the licensor will outline certain remedies which will be offered to the licensee. The first is that the licensor will try to provide a work-around, and a licensee will often want a commitment that the work-around does not materially reduce the functionality they have paid for. The second is that the licensor will agree to take a license from the third party bringing the claim and pay any royalties or other damages that may result. The third is that the licensor may offer some sort of refund to the licensee, particularly if the licensor is unable to develop a workaround or get a license. The refund may also be coupled with the ability to walk from the deal without a further indemnification obligation.

As mentioned above, the indemnification obligation is often triggered when the licensee receives a threat of a claim or is hit with a claim. There are situations, however, when a licensor may want to trigger the above remedies. This might occur when the licensor believes that a claim may be forthcoming and may want to deal with the issue without having to be involved in expensive litigation. In this situation, indemnification clauses often provide that the licensor can invoke the above remedies to minimize its ultimate liability.

Indemnification provisions often contain other methods to reduce or eliminate a licensor’s liability. Stay tuned, and we’ll discuss that in our next blog.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

Dealing with the Unknown – How Does Indemnification Get Triggered and What Happens Next

By: Robert Hawn

As a start-up lawyer in Silicon Valley, I work with a number of companies that generate revenue through licensing their intellectual property, or access to it. In creating and negotiating licensing agreements, my client, as the licensor, often wants to describe what will happen if someone claiming better rights to the technology my client has licensed sues my client’s customer and tells them to stop using the property my client licensed to their customer. In that case, a customer, who is the licensee, will often look to my client, the licensor, and say, “I paid you so I could use this stuff, so get this other guy off my back.”

The fancy term for a licensor covering its licensee against claims from a third party is indemnification. Although the language used in indemnification provisions is a bit formal and tortuous, the basic ideas are pretty simple. In my prior posts on this subject ( May 18 th and August 3 rd ), I discussed the basic concept around indemnification, and the types of items, from an intellectual property context, that these provisions address. In this blog, let’s look at what happens if an indemnification claim arises.

The first issue is the trigger for the obligation. Indemnification provisions will often describe two different events that will trigger the required tasks for a licensor. Most agreements describe the first event triggering the indemnification obligation as the presence of a claim. Typically, this will occur when the customer receives what lawyers call a “cease and desist” letter. These letters allege that someone else owns the licensed IP, and demands that the customer stop using the IP if the customer does not want to be sued. Often, a cease and desist letter is the opening salvo in an attempt to extract royalties from the customer in exchange for calling off the threatened lawsuit. Related to a cease and desist letter is the filing of an actual lawsuit.

A second trigger could exist. Sometimes a licensor may suspect that its IP may become the subject of a claim from a third party. It may find out because it has received a cease and desist letter, or it becomes known in the industry that an infringement risk has arisen. It may be because the licensor itself has been sued. If so, the licensor may want to take advantage of certain tasks that will allow the licensor to minimize its risk. These risk minimization tasks will be discussed in my next blog.

The second issue is what happens once the obligation gets triggered. Essentially, two separate sets of responses are described. The first response is procedural, and discusses how the claim is going to get managed. The second concerns some of the options the licensor can take if it loses the claim, or it decides it wants to fight it.

There are a small number of key concepts with the procedural response. The first is that the licensee must provide notice of the claim to the licensor. This is really important, because if the licensor doesn’t know about the claim quickly, it can lose some valuable rights. Often, you’ll see clauses that will impact the licensor’s indemnification obligations if the notice is delayed or not sent. The second is that control for the defense of the action must be assigned to one of the parties. Usually, but not always, the licensor gets to take control, but the licensee can allow their attorneys to be involved at the licensee’s expense. The third is that the licensee will often request approval rights over any settlement.

One of the standard issues that gets discussed is what will happen if a licensor can’t beat a claim, or can’t afford to fight a claim and wants to resolve it. Because a licensee will have a strong vested interest in continuing to use the IP, a number of approaches have been developed that often appear to resolve this issue. I’ll discuss those in my next blog.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

Creatively Covering Customers’ Catastrophes: Cover THIS!

By: Robert Hawn

As a San Jose corporate lawyer, many of our clients make their money through software licenses. As part of their deals, a number of risks have to be allocated. As explained in my blog posted on May 18 [ Creatively Covering Customers Catastrophes: The Exciting World of IP Infringement Indemnification ], one major risk is that our client’s customer may get sued for infringement due to the software they have received from our client. To allocate this risk, a process called indemnification is used. Indemnification means that if the customer is sued, the licensor will defend the customer and, if an infringement occurs, agree to cover the customer for any damages. Software licensors will often, but not always, indemnify their customers from this risk.

One issue is what types of intellectual property the indemnification will cover.

Before we dive in, let’s discuss some background. Generally, intellectual property is thought of as falling into four major categories: patents, trademarks, copyrights, and trade secrets. There are others, but we’ll ignore them for now. Each form of intellectual property covers certain items. Although it is a gross overgeneralization, you can think of patents as covering inventions and their improvements, trademarks as symbols of the source of a good or service, copyrights as a creative work, e.g., music, a book, or software, and a trade secret as something that is subject to reasonable efforts to be kept secret and has some economic value.

Typically, an infringement clause will cover all intellectual property, and a clause is often added which says this. Licensors will often, however, attempt to limit the intellectual property to specific categories. The blanket indemnification that is often provided may be unnecessary under certain circumstances. One area concerns territory. For example, if the key technology that is being licensed, whether directly or by incorporation into licensed software, is protected by a patent, and the license limits use to the United States, then there probably isn’t much need to protect the customers from patents granted in other countries. It’s a good idea, where license rights are constrained, particularly to geographic areas, to match the indemnification obligation to those areas.

Another way indemnification can be limited is by corresponding the item licensed with the appropriate intellectual property right. This occurs most often with trademarks. Remember, trademarks are words or symbols that tell the consumer the source of a product or service. If a customer is merely licensing technology that they are going to distribute under their own name, there’s really no reason for that customer to be protected from an infringement claim against the licensor’s trademark, because the customer isn’t going to be using it. On the other hand, if the customer is licensed to use the trademark, such as in a franchise agreement, and the customer is motivated to enter into the deal because of the strength of the mark, you can bet that an infringement indemnification concerning the licensor’s (or franchisor’s) mark will be a key part of the agreement.

A third limitation occurs when an item licensed is composed of intellectual property that comes from third parties. This is very common these days when licensing software, because software often includes “open source” software that is free to developers and free to distribute, but often disclaims any obligations regarding any commitments regarding intellectual property. When this occurs, a licensor will often attempt to exclude any coverage for such software that has been licensed by the licensor and incorporated into its products. This often makes for a very spirited discussion!

In my next blog on the exciting world of intellectual property infringement indemnification, we’ll talk about some of the approaches that can be used if an infringement is expected to, or actually does, occur.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

Crowdfunding: Are you the Right Investor?

If you have always wanted to invest in a start-up business , whether a high tech emerging growth company or a low tech products company, you have no doubt heard of the new SEC rules allowing crowdfunding. Part of the excitement comes from being able to make investment opportunities available through crowdfunding internet portals, and part of the excitement comes from more relaxed investor standards. Let’s take a look at the new regulation, which the SEC has title “Regulation Crowdfunding”. You can find it at https://www.sec.gov/rules/final/2015/33-9974.pdf . My last blog regarding crowdfunding ( click here to read ) focused on the requirements for an issuer. In this blog, I’ll focus on the requirements concerning investors.

Crowdfunding is generally thought of as the use of the Internet by small companies to raise modest amounts of funds from investors. The new regulation allows investments to occur online. Only a broker-dealer or online portal registered with the SEC and a member of the Financial Industry Authority (“FINRA”) or other national securities association registered with the SEC, however, is allowed to offer and sell securities to the investing crowdfunding public. A company can’t offer a crowdfunding opportunity directly. To see if a broker-dealer is properly registered with FINRA, check http://brokercheck.finra.org/ , and to check if a portal is properly registered under FINRA, check http://www.finra.org/about/funding-portals-we-regulate .

Although Regulation Crowdfunding relaxed investor suitability standards, some still exist. The standards limit the amount that can be invested. During any 12 month period, an investor can invest up to:

  1. the greater of either $2,000 or 5% of the lesser of the investor’s annual income or net worth IF the investor’s annual income or net worth is less than $100,000; or
  1. up to 10% of the investor’s annual income or net worth, whichever is less, but not to exceed $100,000, IF both the investor’s annual income and net worth is each more than $100,000

There are some important caveats when looking at these limitations, and investors should familiarize themselves with these limitations through their own research or discussion with their advisors. First, net worth can NOT include the positive value of an investor’s personal residence. An investor can, however, include the income or net worth of an investor’s spouse even if the income or net worth is not jointly owned. Second, if the investor consolidates his or her spouse’s income or net worth to satisfy the above criteria, the investment amount limitations are still determined based on the individual investor’s income or net worth.

Investors need to be careful. Crowdfunded securities are not like public company stock. There are limits on reselling crowdfunded securities. An investor may not sell these securities for one year after purchase except to the original issuer, to an accredited investor, as part of a registered public offering, to a family member or trust created for the benefit of a family member, or in connection with the death or divorce of the purchaser. Each of these classes of persons have specific definitions under the securities laws. Although Regulation Crowdfunding doesn’t state this, transfers of the crowdfunded securities after the one year holding period can’t be done unless the transfer complies with applicable federal and state securities laws. Because of this, crowdfunding securities will be extremely illiquid. Investors will have to be prepared to hold the stock indefinitely, or at least until the issuer goes public or is sold to another company in exchange for cash or publicly tradeable securities.

Crowdfunding provides opportunities for both issuers and investors. Investors needs to carefully evaluate the risk of investing in the issuer, and need to be prepared to hold their investment for a long period of time, or lose it altogether.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

Crowdfunding – Is this the deal for you?

By: Robert Hawn

If you are an emerging growth high technology start-up , or a closely-held small business, you’ve heard of crowdfunding. Crowdfunding is commonly used to describe an approach to fund raising over the internet, often characterized by small investment amounts by large numbers of people. Recently, the Securities and Exchange Commission enacted its Regulation Crowdfunding. You can find all 685 pages of the release discussing the Regulation, and the Regulation itself, at https://www.sec.gov/rules/final/2015/33-9974.pdf . In this blog, we’ll focus on the requirements concerning issuers.

Under the Regulation, an issuer can raise a maximum of $1,000,000 through crowdfunding in any 12-month period from any person. The offering can’t be conducted by your company directly, however. Instead, it has to be conducted through a broker-dealer or online portal registered with the SEC and a member of the Financial Industry Authority, or FINRA, or other national securities association registered with the SEC. To see if a broker-dealer is properly registered with FINRA, check http://brokercheck.finra.org/ , and to check if a portal is properly registered with FINRA, check http://www.finra.org/about/funding-portals-we-regulate .

There are some eligibility requirements that can disqualify an issuer. These include, among others, companies that don’t have a specific business plan (or whose plan is to engage in a merger or acquisition with an unidentified company), issuers that violate so called “bad boy” rules, and companies that have failed to satisfy annual reporting required by Regulation Crowdfunding.

One major requirement facing issuers under the Regulation is the need to prepare a disclosure statement. Although not as extensive as the type of statement required for an SEC registered offering, the requirements are significant. Items that must be disclosed pertain to the offering itself as well as the issuer. Offering related items include, among other things, the desired amount of the offering, the deadline for reaching it, whether investments over the desired offering amount will be accepted, the price of the securities, how the proceeds will be used, and material risks associated with the investment. Issuer related items include, among other things, a description of the business and its financial condition, information about 20% owners, members of the Board of Directors of the issuer, and officers, information concerning transactions between the issuer and related parties, and a description of the issuer’s ownership and capital structure.

The disclosure statement must also include financial statements prepared in accordance with generally accepted accounting principles as applied in the US. The financials must cover the shorter of the immediately preceding two fiscal years or the period since inception. The review the financials have to undergo depends on the amount of the offering:

  • If the current offering plus previous offerings under the Regulation are $100,000 or less, the financials must be certified by the principal executive officer and accompanied by certain information from the issuer’s tax returns (but need not include the tax returns themselves.
  • If the current offering, plus previous offerings under the Regulation, are more than $100,000 but less than $500,000, the financials must be reviewed by a CPA.
  • If the current offering, plus previous offerings under the Regulation, are over $500,000, the financials must be audited. If, however, the issuer has not previously sold securities in reliance under the Regulation, the financials must be reviewed by a CPA.

Keep in mind that there are no exceptions to these requirements, even for very early stage companies. So, if your company has just been formed, and you want to raise over $500,000, you’ll need to provide audited financials.

The amount the issuer can sell to an individual investor is limited. My next blog will discuss the specific investor limitations.

Advertising the offering is, not surprisingly, very limited. An issuer can publish a notice advertising the offering terms similar to “tombstone” ads. The notice must include the address of the funding portal or broker-dealer who is assisting with the offering.

In addition to the initial disclosure documentation, an issuer must file annual reports with the SEC and provide them to investors. The annual reports must contain much of the same information required under the initial disclosure document. Once the issuer becomes a reporting company under the Exchange Act, there is no further need to provide the annual reports required by the Regulation. The rules under which a crowdfunding issuer becomes subject to the reporting obligations under the Exchange Act have been relaxed if the issuer is current on its annual reporting obligations, uses a registered transfer agent, and has less than $25 million in total assets.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

Creatively Covering Customers Catastrophes: The Exciting World of IP Infringement Indemnification

By: Robert Hawn

As a business attorney in Silicon Valley practicing in our firm’s office in San Jose, I spend a lot of time creating license agreements for our licensor clients. In creating and negotiating licenses, a number of risks need to be allocated. One of the most important of these goes by the fancy name of intellectual property infringement indemnification.

So, what is intellectual property infringement indemnification? In plain English, this means if you license something you don’t own, then you have to cover your licensee against a claim from the real owner. But, wait, you say: “I created this stuff on my own. What’s the problem?”

Remember, a license is nothing more than a licensee giving you money in exchange for you giving it the right to use your intellectual property. The rub here is that we are dealing with intellectual property. Unlike tangible property, such as a house, where you can run a title report and see who owns it, the ability to see if there are others that have superior rights to intellectual property can be difficult. Patent searches, for example, can be expensive and time consuming, and they don’t uncover patents in process that have yet to be published. Copyright, which is one of the key protective schemes for software, is rarely registered. Trade secrets are, by their very nature, secret.

Because of this uncertainty, or risk, a licensee will look at you and say “What happens if you don’t own this stuff?” Because you want the deal, you’ll say, “I’ll cover you if someone says ‘my stuff is their stuff’”. At this point, your attorney is saying “Are you crazy? If you get hit with an infringement suit, the costs alone in fighting it will kill your company!” So, why do you ignore your attorney’s advice? Because few if any licensees will buy your stuff if you don’t cover them against this risk. In other words, if you don’t provide this protection, you won’t have a company left to kill.

Now, there are some exceptions to offering intellectual property infringement in licensing deals. Often, in “direct consumer” licensing, particularly with downloads where few if any customers actually read the license to which they are agreeing, a licensor will not only leave out infringement protection, a licensor will affirmatively disclaim it, often in all capital letters. In other situations, a licensor may have sufficient market power to refuse to offer this protection. In others, the use of certain types of technology are understood to be a shared risk.

So what’s a young start-up, or even a sophisticated multi-national company, to do? First, you can close your eyes and jump, and this seems to be the most common choice. It is also one of the worst. Second, you can employ lots of high priced attorneys and other advisors to conduct searches and reviews of current technology to determine if what you are doing will infringe on anybody else’s technology. The problem with this approach, putting aside the expense, is that this type of broad approach is best suited to patented technology, and still can’t account for technology that is not yet publicly disclosed, e.g., in an unpublished patent application or if the owner has maintained it as a trade secret. Third, you can take a look at your technology, and the technology of your competitors or active trolls, and ask yourself what is the key item that would lead your competitor to sue you. You can then perform an analysis, using your developers and attorneys, to determine the risk you face in covering your customers against lawsuits. Although this method has many of the disadvantages of the second method discussed above, it is more directed and based on a practical assessment of where your exposure may exist.

As you might guess, provisions dealing with coverage against infringement risk tend to be highly complex and heavily negotiated. In upcoming blogs, we’ll explain some of these moving parts and how you, as a businessperson, can work through them.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.