How to Improve Your Company’s Form Software License Agreement - Part 3: Indemnification
***This article is one part of a ten-part article published by Koley Jessen to help software licensors improve their form software license agreements. Please contact Koley Jessen’s Commercial and Technology Contracts Practice Group for further assistance.
A form software license agreement should:
limit the licensor’s indemnification obligations to third-party claims that allege the software infringes third-party intellectual property rights;
contain certain exceptions to the licensor’s indemnification obligations;
set forth certain indemnification procedural requirements; and
contain language that states the customer’s remedies set forth in the indemnification section are the customer’s sole and exclusive remedies for third-party infringement claims.
Indemnification is one of the most challenging concepts to understand in software license agreements for business teams and young attorneys alike. An indemnification obligation can be a very expensive obligation as well, if triggered. As a result, the indemnification provision is probably the most negotiated provision in software license agreements.
“Indemnification” typically refers to a set of related obligations that are triggered when one party is sued by a third party that is not a party to the software license agreement. It is important to remember that indemnification, if properly worded, does not relate to claims or lawsuits between the licensor and customer, but rather the obligations that “kick in” when the licensor or customer is sued by another party.
“Market” terms dictate that licensors should include an indemnification obligation in their form software license agreement that says the licensor will defend (i.e. pay lawyers to defend) any lawsuit against the customer initiated by a third party to the extent the lawsuit alleges that the licensor’s software infringes the third party’s intellectual property rights. In addition, the indemnification obligation will say that the licensor is responsible for the financial fallout from such lawsuit. Although licensors are expected to provide such indemnification protection to the customer, there are numerous provisions that the licensor should include to narrow the scope of its indemnification obligations.
First, a form software license agreement should not include any licensor indemnities except for the third-party intellectual property infringement indemnity. Indemnification of claims arising from licensor’s breach of the software license agreement and violation of law should not be included in a form software license agreement because many customers will not require such indemnification.
As alluded to above, the provision should clearly only apply to third-party lawsuits (not lawsuits filed by the customer) and to damages “finally awarded by a court.” This language puts clear parameters around the costs, expenses, and damages the licensor will need to pay. The licensor could potentially be liable for a much broader set of costs, expenses, and damages if the indemnification is worded more broadly.
It is also critical to have a set of exceptions that says the licensor is not obligated to defend and indemnify the customer from a lawsuit if the lawsuit arises from certain occurrences that are not within the licensor’s control. Typical exceptions are: (1) customer’s breach of the software license agreement or use of the software other than as intended under the agreement, (2) modification of the software by any party other than the licensor, (3) software that is developed in compliance with specifications provided by the customer, and (4) combination of the software with other software and technology not provided by the licensor.
The software license agreement should also include provisions addressing the indemnification procedure. Common issues to address are: (1) required notice by customer to licensor, (2) licensor’s sole control of the defense of the indemnified claim, and (3) required assistance to be provided by customer to help licensor defend the indemnified claim. A form software license agreement should expressly state that the licensor is excused from its indemnification obligations if the customer’s failure to timely notify the licensor of the claim or the customer’s failure to reasonably cooperate with the licensor in defense of the claim materially prejudices the licensor’s ability to defend the indemnified claim.
The licensor should also address what happens to the software license agreement if the customer is sued by a third-party alleging that the software infringes such third party’s intellectual property rights. The licensor will not want to continue to be obligated to provide software that is infringing (and possibly continue to incur more damages), so it should reserve the right to procure a license for the infringing software, modify the software so that it is no longer infringing, or terminate the software license agreement and refund only those pre-paid amounts for the remaining portion of the term. The licensor should include “sole and exclusive remedy” language with these express remedies that says all of the remedies set forth in the indemnification section (defend, indemnification, and the repair, replace, or refund remedies) are the licensor’s sole and exclusive liability, and the customer’s sole remedy, for any third-party infringement claim. The rationale is that the licensor should not expect to get sued by the customer directly for additional damages if the licensor defended the third-party claim, paid the resulting damages, and undertook the additional repair, replace, or refund remedies.
Finally, the licensor may include a provision that says its indemnification obligations are subject to the limitation of liability provisions, which means that the licensor would only be “on the hook” up to a certain amount for all of its indemnification obligations described above. Although some licensors do include this position in their form software license agreement, most customers will expect the licensor’s indemnification obligations for third-party intellectual property infringement claims to be uncapped (subject to unlimited liability). Most licensors accept this position because, in practice, licensors want to be in control of defending a lawsuit in which a third-party claims the licensor’s software infringes intellectual property rights of a third party.