By Julie Garcia
Indemnification is generally a subject that is important, yet easily overlooked during business transaction negotiations. Although the scope and purpose of the indemnification can take on many different appearances, the underlying theme always remains the same, who will be held liable in the event that a problem arises. Once the parameters of the indemnification are established between the parties, there are a number of logistical details that should be considered which may prove to be important in the event indemnification is sought at a future time by one of the parties. Companies that own or license intellectual property generally focus on the scope of the indemnification, which may include infringement and ownership issues. The process by which one party may assert a right for indemnification and the process by which any defense will be conducted should be carefully considered by the parties and incorporated into the agreement between the parties.
The scope of an indemnification provision is important and should be carefully drafted in order to prevent possible confusion in the future. The party agreeing to provide the indemnification should consider the ramifications of the indemnification to be provided and craft the provision in a manner that focuses on the issues as they relate to the relationship between the parties. Generally, the party receiving indemnification will want to obtain indemnification against suits brought by third parties alleging infringement of the intellectual property. The indemnifying party has generally conducted significant due diligence during the research and development process and is generally comfortable providing infringement indemnification, subject of course to specific parameters and limitations. Unless a territorial limitation is established, indemnification may be required for any alleged infringement, including under the laws of a foreign jurisdiction. If the company has filed for patent or trademark protection in a foreign jurisdiction, the company has likely reviewed and researched the existing intellectual property in that country to determine if the possibility of infringement on a third party’s rights exists. When entering into an indemnification provision, the owner of the intellectual property will generally want to limit the indemnification to the territory covered by the agreement, or at least to the territories in which the company has researched the existing technology.
A further limitation that is generally placed on the indemnification is a cap on the amount of the indemnification provided by the indemnifying party. Generally, the indemnifying party will limit their liability under the indemnification provision to the amount paid by the other party to the indemnifying party under the terms of the agreement in question. Depending on the type of agreement in which the indemnification is provided, the total amount may be specified up front or may be subject to continual change if periodic payments are due under the agreement in which case, the cap will be defined as all payments received by the indemnifying party as of a specified point in time.
Another area in which the scope of indemnification is important relates to the ownership of the intellectual property. If the indemnifying party agrees to indemnify the other party for any actions relating to the ownership of the intellectual property, the indemnifying party should take adequate steps to protect the ownership of the intellectual property and properly document all required transfers and assignments of intellectual property created on behalf of the company prior to entering into an agreement which will require indemnification for ownership issues.
Although the scope of the indemnification is generally of primary importance when drafting an indemnification provision, the mechanics in which indemnification is requested and the manner in which the defense is conducted may affect the amount of money spent by the indemnifying party and the control maintained by the indemnifying party during the process. Generally, the indemnifying party maintains control of the defense; however, the indemnifying party may allow the indemnified party to participate at its own expense as an observer only and not as a decision maker. The indemnified party will generally have a vested interest in the outcome of the action, however, if the indemnifying party agrees to pay for separate counsel and allows the indemnified party to participate in the defense in a decision making capacity the indemnifying party’s costs and expenses may be substantially higher than if the indemnifying party maintained control of the action and required the indemnified party to pay for its own counsel.
In some cases, if the party seeking indemnification does not provide notice to the indemnifying party within a specified period of time, the indemnifying party’s obligation under the agreement may be terminated for that particular action and the party seeking indemnity will be required to defend the action on its own. In other situations, the agreement may provide for a specified notice period, however, if the party seeking indemnification fails to provide notice within the specified period of time, the indemnifying party may still be required to provide the indemnification, however, the party seeking indemnification may be required to pay for some portion of the defense due to such party’s failure to act within the specified period of time. The party’s will generally come to an agreement as to the manner in which the actions will be handled and specify the procedure in the agreement in an attempt to prevent ambiguity about the obligations of each party in the event an indemnification obligation arises under the agreement.
Negotiating a business transaction requires attention to numerous details, some of which may seem boring and trivial to the negotiators, but which may have a significant impact in the future. Indemnification provisions are generally not viewed as the exciting and interesting part of an agreement, however, the economic impact of an indemnification provision may have a significant effect on one of the parties at a much later date and should be carefully considered and drafted during the negotiation process.