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Redline indemnification agreement

when i am negotiating a contract it's quite often that the indemnification clause doesn't even even seem to be read so i get very few red lines back on it but my view as a former litigator who actually tried a couple of indemnification cases to judgement these are actually really super important clauses welcome to the contract teardown show from law insider where legal experts tear down contracts from some of the most well-known companies and high-profile executives around the world in this episode eric dratel general counsel at bruce defy tears down microsoft's online subscription agreement he gets into the indemnification clause and the other sections that might undermine it we talk about using clear language making sure you don't get tied up in long-winded litigation and staying afloat when i p is at stake this is a great breakdown of one of the most potentially contentious sections of an agreement so let's tear it down hey everybody welcome to the contract tear down show i'm mike whalen hanging out with smart friends like this guy eric dratel eric how are you today mike i'm doing very well thank you and you uh it's still 20 20. so what the freak uh today guys we are going to share a document with you and tear it down it is this one it is the microsoft online subscription agreement and specifically we're going to go down to the indemnification clauses which are found in a section called defense of claims so eric here's what i want you to do to start us off tell me why this section matters when are we going to see it why should lawyers care so you'll see an indemnification clause almost every contract and i think lawyers tend to insert them just as a pro forma matter without oftentimes understanding what it is they're asking for or why they're even asking for it and when i am negotiating a contract it's quite often that the indemnification clause doesn't even even seem to be red so i get very few red lines back on it but my view as a former litigator who actually tried a couple of indemnification cases to judgment these are actually really super important clauses both from the sellers or licensors perspective and the buyers the licensees perspective you see the clause that we're going to talk about today is in the microsoft agreement which is a tech license agreement so we'll talk about a lot of things that are applicable to tech license contracts agreements uh but all of them are really equally applicable to a construction contract a service contract all all the same principles really apply well we'll start we're going to go through the different language but we're going to start with just the title of this document i found this document for a legal document surprisingly easy to read the fact that they called this a defense of claims so if you guys are looking at the document it's down in five defensive claims versus using the language that's common does that strike you it just strike struck me as interesting it does strike me as interesting because a number of companies have endeavored to make contract language simpler and by making it simpler you have less of an opportunity to argue about whether there's an ambiguity in a contract so for example microsoft refers to themselves as we they refer to the licensee as you and it's that kind of easy familiarity i think makes this a very easily readable contract it's also a fairly short contract relatively speaking i looked at others in preparing for our show today and there were some that were you know 20 plus pages long and didn't fundamentally say anything more than what microsoft says yeah so this one's about 10 pages and we're going to start with that defensive claims it is still a legal document so we can still parse the language uh under a it says defense it says we uh being microsoft will defend you being the licensee against any claims made by an unaffiliated third party that a product infringes that third party's patent copyright or trademark or makes unlawful use of its trade secret we like this we don't like this what do you think uh i like this actually very much although we we can we can talk about parts the aspects of it so first of all why is microsoft offering this and when you look at this what microsoft really wants to do is defend the paternity of its ip so if a third party makes an ip infringement claim the licensee has absolutely no incentive to to defend that right and what microsoft is really the one with the incentive to defend and you'll see sprinkled throughout this is language very similar to that which shows the intent of microsoft to defend the paternity of the ip so that's pretty important now microsoft says we will defend and in depends on the state you're in if you say that i will indemnify you some states indemnification automatically includes defense other states defense is a completely different obligation so what microsoft is saying here essentially is they will defend but they're also going to say they're saying they'll indemnify as well later using different words but meaning the same thing so that's pretty important that microsoft will defend now an important point here to note again depending on the state law that governs excuse me the indemnifying party microsoft in this instance can either defend as the claim is brought or wait until the resolution of the claim to defend right and so if you're a small licensee microsoft's got all the power you don't um what you especially if you don't have the financial resources what you want is the defense to be with when the costs are incurred for defense so you'll oftentimes see language saying we will defend you for these various claims as incurred i would say half the indemnification clauses i look at have that language or don't again in some states oddly you can have indemnification between the contracting parties for claims one brings against the other and that's never made any sense to me uh i think it's more appropriate that the indemnification be for third-party claims and the fact that what microsoft is doing here is qualifying that as saying unaffiliated third parties is important saying that you a subsidiary of yours or a sub licensee of yours perhaps can't bring a claim but a third party who asserts ownership of the iep rights could bring that claim so that's that's that's important language and then what microsoft says is that we'll we'll indemnify and defend you uh for any claims that that patent rights are infringed now i've been practicing law for i won't say how long has been a long time and when i first started practicing law we were always told 100 of the time never indemnify for patent infringement and that's because in the u.s at the time the law was the first to invent this the patent went to the first to invent as opposed to the first to file which is like the rest of the world however u.s patent laws changed over the last few years and now u.s is also a first to file jurisdiction as opposed to a first-time jurisdiction so if it was a first to invent jurisdiction somebody could sit on their patent rights not do anything see microsoft's come up with something and file meanwhile microsoft would have indemnified uh for that claim that they could have done a patent search and found a clean patent and just kind of blindly stumbled into an indemnification claim but now as i said the last 20 years or so it's pretty common for the the licensure to indemnify for patent infringement and again it goes back to protecting the paternity of the iep yeah it sounds like they're using pretty modern language to talk about you know this is a pretty updated contract it doesn't sound very copy pasty they do go over some licensee obligations right after that but let's jump down to the limitations because i think it puts the constraints on this thing you know they say our obligations in 5a will not apply to a claim reward based on any customer solution customer data non-microsoft products uh or your combination of the product with or damages based upon the value of customer data or non-microsoft so if you're blending uh three your use of microsoft trademark without our consent and then uh also your redistribution it talks a bit about free products so they put a lot of constraints on this thing are these is this the right way to format this to you yeah this is this is actually pretty standard uh if you make modifications to a microsoft product microsoft is actually saying that the their indemnification won't apply to the extent that the claim is based on the modifications so if you've modified something and the modification causes the claim then you don't get indemnification for that right and the same thing with what's referred to in two as use in combination if if a microsoft product standing alone doesn't indemn rather doesn't infringe and your product standing alone doesn't infringe but the two together infringe then to the extent that combination caused the claim then microsoft is saying we're not indemnifying you for that it those are really corner cases you you typically don't see that very often that something like that actually happens in the real world but nonetheless it's pretty good draftsmanship to have the language in there like that yeah i like jumping down to remedies and see some of these qualifications they put on uh what they'll do for you uh it says that if you get this claim under 5a uh that make it so you can't use the product we microsoft will seek to obtain the right for you to keep using it or modify or replace it with an equivalent if it's not commercially reasonable we might just terminate the rights to use the product and then return any advance fees that sounds like a pretty nice remedy to have in there so that's that's an interesting one that's one if if the indemnification clause is ever negotiated that's where i see actually a fair amount of negotiation this committee is referred to as repair replace refund remedy so i'll either uh fix it so you can continue to use it i'll pay the third party a license fee so you can continue to use it that's the repair i'll replace it i'll swap out something that is non-infringing with uh with something that uh i'm sorry swap out the infringing product for a non-infringing product or if all else fails if if it's not commercially reasonable to do otherwise then i'll just i'll just refund your money that's where a lot of people have an issue on that refund piece the repair place is not objectionable it's the refund piece that that creates some problem so i'm relying on the microsoft product microsoft simply wants to choose to exit that product and refund my money that's oftentimes a pretty hollow remedy but because of the way patent claims in particular ip infringement claims tend to go they go on forever and it's very common when an infringement claim is fraud uh it it can take months for even the the accused party in this case microsoft to even determine whether there's some valid infringement or not so you probably as the licensee have a lot of notice as to whether there's uh indemnification or not or whether you're going to get a refund or not and we're so often times what i'll see is some i think it's somewhat uninformed licensees will say that within 30 days you have to make the remedy available which is absurd because again it's going to take a year to 18 months for microsoft to do all the things it would do to determine whether there's an infringement or not so 30 days is way too short period of time and then the refund piece is also potentially challenging and it sounds you know as you mentioned the length of time that it takes to sort these things out if you look in d under obligations you know they point out that you got to give the other side so console control over the defense and the settlement and then you got to help uh in defending the claim and then it it talks about the party providing the protection will reimburse the other party for out-of-pocket expenses and pay the amount of the the final judgment or settlement you know you made the point this could take years that's right that's right one of the indemnification cases i litigated um i believe went about five years from the time of the claim until we finally got to court so that's not that's not uncommon to happen so would you shift these obligations to to for some kind of interim support while that's happening um well as long as they're not yanking the product out from under no i think that this is perfectly appropriate uh and what i'm looking for as a licensee what microsoft is offering i think is both commercially reasonable and something that actually works for both of us quite well so it's not something i i would typically want to negotiate um and then as you you've already referred to the obligations indeed the uh what the obligation to tender the defense that's pretty pretty standard um it says you have to notify the other promptly of a claim again the law in some states is that and you oftentimes see in an indemnification clause the obligation to within 10 days 15 days 30 days tendered the defense of the claim and uh and you'll also see language that says and if you don't tender the defense within the time provided then our obligation uh is is waived first of all um that i've never seen anybody's obligation ever get away because again as the license or you want to defend the paternity of your ip therefore if you're it if it's on the 16th day and you said you had attended the defense in 15 days you're not going to say okay i'm not liable any longer so that's that doesn't make any sense and then again in some states failure to timely tender the defense only reduces the amount of the indemnification by the extent to which the indemnifying party is prejudiced by the late tendering of the defense so let's play the scenario out if i'm like if you're the licensed sword i'm the licensee and i get a claim and i spend a year defending that claim and make some careless admissions and things like that that make it harder for you to defend the claim then the chances are that whatever damages i'm entitled to whatever indemnification i'm entitled to would be reduced by the amount that for example i made missions that that caused the the damages to go up so it's to the extent that you were prejudiced by my untimely tendering of the defense of the claim is what you will usually provide you with some sort of ad microsoft interestingly doesn't use that language here they just say you have to promptly tender the defense so i think that that's quite common giving the sole control again is very often the case one thing you will see from time to time is the indemnified party will have a right to appoint council of its own as co-counsel or to to oversea or whatever but at my expense the indemnified party's expense and uh and we have no right to make admissions or do anything it's just really to to monitor the status of the case you see that every so often especially in high stakes indemnification claims but i don't i don't think that's it's it's the language here again is quite common uh and then one thing that's in here that i really like from a licensee's perspective is reimburse the licensee for out-of-pocket reasonable out-of-pocket expenses oftentimes the agreement is silent on that or i've seen some in fact it looked at one even recently which says that the uh indemnified party has to pay for its own costs of helping the endemic uh the indemnified party did i say that right yes the identifying party has to pay its own expenses of cooperating with the indemnified party so this is pretty good this is pretty up front and says that we will pay you and and uh and it's all the right language now remember earlier i mentioned in that first paragraph in in 5a talked about the cost of defense so here's now where they say in d2 uh where they will pay the amount of any any judgment so that's that's the indemnification piece again they've never used the word indemnify here but it's it's it's very clear from that language that they are not just defending but they're also identified well i want to talk about the relationship of a couple of other sections with the indemnification piece and the first is the limitation this is down in six um and it talks about the aggregate uh liability of each party for all claims under this agreement it's limited to direct damages to the amount paid under this agreement for the online service during the 12 months before the cause of action provided that in no event the aggregate liability for any online service exceed the amount paid for that online service during the subscription than it talks about for free products that's capped at 5 000. how i mean this that seems like a low number relative to what this claim could become it's it certainly would be uh but for an exception they've created so the language here is again fairly common that that there's a limitation of liability 12 months fees is a very standard uh amount that you kept liability at that they're even throwing in five thousand dollars for free product is relatively speaking generous five thousand doesn't sound like much but when it's free standing up for the product is is still pretty good um but what they do is they say that the limitations of liability do not apply to claims under uh parties obligations under section five the defense of claims or indemnification clause this is this is really well written uh this is saying that so the cap on liability does not apply the exclusion of damages doesn't apply to indemnification claims so whatever the costs of defense are whatever the damages are that are owed microsoft's saying despite the limitation of liability we're paying that now this is one that i do see also negotiated fairly often and sometimes it's because of really terrible drafting so sometimes you'll see in an exception to limitations provision something along the lines of except for breaches of confidentiality or indemnification right now so a breach of an indemnification clause so if if somebody is really parsing the contract and you get a judge who or jury that's reading just the literal words of the contract the only time the exclusion would apply in that case is if there was a breach of the indemnification clause that's not what you're looking for the exclusion for what you're looking for the exclusion for is the obligations under the indemnification clause so what microsoft has done here is exactly what i would be looking for saying not requiring breach first but just saying the parties obligations under section five give an exception and and then the the damages are potentially uncapped what what i s this is also often negotiated uh because i do see from time to time in not typically in uh in ip infringement indemnifications but indemnification for other types of things where somebody will want to put up a cap so as an example there are a lot of contracts today that involve the the processing of data for a third party you and i enter into a contract you give me your customers data to to process if i have a data breach what's my obligation to indemnify you in that instance it's a very common clause you see in a lot of contracts these days and so if there were a data breach and i'm processing your your data the liability could be in the tens of millions of dollars for a very low value contract so as the as the processing party as the party who ultimately would bear that potentially that liability i would want typically want to see the identification capped at some multiple perhaps of the the fees paid so it might be five times or ten times fees paid but the indemnification exclusion here in the microsoft agreement as it applies to uh the the the ip license is is perfectly appropriate and one that would i in my view passed about objection well before we talk you know sort of the general principle from this in closing i want to give you a chance to talk about the relationship between this section and the warranty section which is back and forth we won't read it but but give me your thoughts on the you know the fact that we've got both indemnification and warranties does that tell you anything yeah so microsoft again has done a good job here um what a lot of drafters do and i think it's somewhat sloppy is they both want a warranty of non-infringement and an indemnification and in my view um you you really should be entitled to one remedy not two so this is this is oftentimes coming from the licensee the licensee says i want you to warrant non-infringement and i also want the uh an indemnity for non-infringement so it gives potentially two different claims the warranty claim would be capped by the limitation of liability whereas the indemnification would not and as the licensor i want it clear where the licensee's remedy lies because under the warranty clause if the licensee is going to make a warranty claim there's no obligation to tender the defense and all the things that as the license store protect the license or it enables the license order to guard the paternity of the ip whereas under the identification clause all of that is there so as the license soar i will say to the customer you pick one remedy you get one not both and i try to steer them to the indemnification because it's not capped by the limitation of liability i would say in most cases not all but most the when the licensee understands that they're getting a better remedy under the indemnification clause they really don't need that that warranty of non-infringement it's it's something that's been in lots of clauses for years and years and nobody pays any attention to it and i think it's actually worthwhile paying attention to so uh i i i would exclude it uh and go under the indemnification plus exclusively so in terms of drafting and wrapping up is what's the principle here is there something that we can draw from this do you like this document overall i do i do like this document overall i think from a licensed source perspective it's a very good document from a licensee's perspective it's it's likewise a very good document as i said earlier i think that one thing from a licensee's perspective that could really improve this is the obligation to defend uh as costs are incurred not let microsoft wait till the end but in reality it's not something it's not a hill i would die on right because i think that microsoft would without a doubt want to defend immediately from from the the moment a claim is brought i think one other piece of language that could possibly improve this and i hadn't mentioned this earlier but uh there's no real definition of a claim except it's a claim brought by unaffiliated third party sometimes um i as the indemnitor i will want not just indemnification for actual claim that is brought but also for a threatened claim so i've seen this actually in the past where i've gotten a a cease and desist or some other communication from somebody who claims to be the owner of the iep they don't file a lawsuit they just have sent me a threatening letter and we have that question okay is this subject to indemnification or not is should i tender the defense of this or not or do i wait till i'm sued so i think just for clarity sake what notice requirements do i have right we're supposed to timely notify them is that when the letter happens exactly yeah so in the couple of times this has happened to me where i've gotten the demand letter or something from the party claiming ownership or some right to the ip i've just tended the defense and nobody's ever argued saying but you tendered it too soon so i think that that that could clean up the language a little bit so i think overall it's microsoft did a nice job here it's it's a well-written contract and something that uh honestly um you i think most people most business people could understand without having to engage the legal department to have to parse what does this mean right so that's that's always a good thing well i can guarantee you we have a special kind of nerd who's watching this show right now if those people want to hang out with you and just talk indemnification all day eric what's the best way to reach out to you so you can uh reach me by email uh i general counsel of rustify uh you can reach me at e dratel that's e d r d-r-a-t-t-e-l-l at roostify r-o-o-s-t-i-f-y dot com and i'd be happy to exchange information touch bases with people this i can nerd out about this all day long we're a special crowd uh and if you are the special kind of nerd who wants to learn more about this stuff please go over to lawinsider.com resources we'll have the information with this contract and some links for you as well as getting in touch with eric and if you want to be a contributor on the contract tear down show just email us just go to community law insider dot com we'll connect with you thanks you guys for watching thank you eric for hanging out we'll see you guys next time [Music]