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Professional services vendors that develop custom software or technology to the specifications of their customers often face demands to indemnify and defend their customers from infringement claims of any and all intellectual property rights. “If I’m sued because of your deliverable,” the argument goes, “then you should step up and take responsibility for your failure to respect third party IP rights.”
This stance, though common, fails to appreciate the unique danger posed by “strict liability” IP rights for such vendors, in which liability for infringement attaches regardless of whether the accused infringer knew of the existence of the protected subject matter, and regardless of any intention or knowledge. Utility patents, design patents, trademarks, trade dress, and, in the EU, design registrations, represent strict liability IP rights.
On the other hand, copyrights, EU design rights, and trade secrets, where copying or misappropriation is an integral element of proof of infringement, are for this reason not strict liability IP rights. Buyers of custom deliverables are justified in holding their vendors to account if they failed to exhibit the necessary professionalism to prevent copyright infringement or trade secret theft. Plagiarists and thieves should have no place in product development.
Strict liability IP rights are quite different. Studies have demonstrated that it’s impossible to write software that doesn’t infringe a utility patent somewhere in the world. Design patents (which can apply to user interfaces) are particularly hazardous: they are granted automatically without review, and in the US, require disgorgement of all profits attributable to an infringing product or component.
Demanding that custom-development service vendors indemnify for strict liability rights infringements is problematic. The customer typically controls the specification, and the work is often iterative, driven by customer feedback that takes no account of potential infringements. Generally, there’s no time or budget, during the crunch of the project, for strict liability IPR clearance searches or freedom-to-operate opinions. The customer says, “please add this, and do it this way,” and the vendor complies, without asking questions about patents or trademarks. Such searches are not within the vendors’ core competency in any case.
In the custom development context, knowledge qualifiers connected to a non-infringement warranty, or a shared liability allocation, might be more appropriate with respect to strict liability IP rights. Strategies for drafting and negotiating relevant work product in this regard can be found here at Redline.
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The intended audience for this post is licensed and practicing lawyers, not laypersons seeking legal advice for their situation. If you are not a lawyer, hire one before using or relying on any information contained here. This post is: (1) informational only and not intended as advertising or as solicitation for legal services, (2) not intended to render legal advice to you, and (3) not a substitute for obtaining legal advice from a qualified attorney to assess your exact situation. The information here is subject to change and may not be applicable or correct in your jurisdiction. The views and opinions expressed here are Sean’s alone and do not necessarily represent the positions of Sean’s present or former employers, law firms, or clients.
Professor Tanya J. Monestier, in a thought-provoking piece entitled, Damages for Breach of a Forum Selection Clause, 59 Am. Bus. J. (forthcoming 2021), available here, quite ably goes through the incentives for those inclined to breach mandatory forum selection clauses, and how little some courts do to redress the harm caused by such breach:
Why would a party sue in (ostensible) contravention of a forum selection clause? It stands to reason that most parties sue in a non-chosen forum for strategic reasons. For instance, a party may perceive that a non-chosen forum provides it with a leg up in litigation—perhaps because it offers better law, a better jury pool, better judges, and so on. …
In a related vein, a party may also violate a forum selection clause to protract litigation, to cause the other party to expend resources, and to secure a favorable legal or settlement result. Here, the goal is not so much actually litigating in the alternate forum, but instead placing strategic obstacles in the way of one’s opponent right from the beginning. The non-breaching party may decide that the light is simply not worth the candle and proceed in the non-designated forum.
Why do some courts refuse to award damages for breach of such clauses?
First, some courts reason that by enforcing a forum selection clause through a dismissal or transfer, an innocent party has been made whole, thereby precluding a suit for damages. These courts usually refer to the forum selection clause being ‘specifically performed’ and that an order for specific performance is incongruent with an order for damages. For instance, in Hydrogen Master Rights, Ltd. v. Weston, the court noted that it was not aware of any case ‘where plaintiffs were allowed to recoup damages in addition to their remedy of specific performance.’
Second, some courts rest their analysis entirely on the American Rule. For instance, in Alexsam, Inc. v. Mastercard International Inc., the court refused to award attorneys’ fees, reasoning that ‘Plaintiff’s demand for damages comprising attorneys’ fees it sustained in [enforcing the forum selection clause] is an impermissible attempt to circumvent the American Rule.’ Similarly, in Steel City Landscape, Inc. v. SMS Assist, LLC, the court noted that even though the plaintiff pled and arguably proved damages in the form of attorneys’ fees, the plaintiff would not be able to recover them because Illinois follows the American Rule whereby each side must pay its own attorneys’ fees.
In any case, losses incurred in enforcing mandatory forum selection clauses can be significant:
Regardless of the reason for suing in contravention of the clause, the net effect on the non-violating party is the same: they must spend time and money convincing a court to give effect to the forum selection clause. This will usually require a party to go to the non-designated forum and seek to have that court enforce the clause. This process may take months—or even years—depending on the complexity of the case, scheduling considerations, delays, and the like.
The monetary losses incurred in enforcing a forum selection clause tend to be significant. …. For instance, in Allendale Mutual Insurance Co. v. Excess Insurance Co., the plaintiff incurred $234,633.99 in litigation expenses associated with enforcing a forum selection clause.
As Prof. Monestier points out, agreeing to a forum selection clause is an agreement not to sue in other forums. “If damages are not awarded for breaching a forum selection clause—for specifically doing what one promised not to do—the promise is an illusory one that can be breached with no legal consequences.”
In a query entitled, There should be consequences for breach of a mandatory forum selection clause, the lawyers of Redline exchange clauses and debate strategies for overcoming specific performance and American Rule obstacles.
The intended audience for this post is licensed and practicing lawyers, not laypersons seeking legal advice for their situation. If you are not a lawyer, hire one before using or relying on any information contained here. This post is: (1) informational only and not intended as advertising or as solicitation for legal services, (2) not intended to render legal advice to you, and (3) not a substitute for obtaining legal advice from a qualified attorney to assess your exact situation. The information here is subject to change and may not be applicable or correct in your jurisdiction.
Consider the following scenario. Your startup client, a developer of a popular app recommendation engine, is running low on cash, and further investment is not in the cards. The shareholders decide it’s time to sell.
Excitement ensues as a massive personal technology lifestyle company takes an interest. After completion of due diligence, however, enthusiasm wanes. Soon the discussion focuses on a potential “acqui-hire,” meaning, a purchase of the company, not to exploit the company’s technology or market share, but simply to hire away the top engineering talent—with a commensurately lower valuation.
Too low for the shareholders, in fact, so negotiations end.
The story doesn’t, however. BigCo turns around and hires away the startup’s top engineering and marketing talent. The startup is now dead in the water and of no interest to any other potential suitors.
These are essentially the facts in Hooked Media Group v. Apple (Cal. Ct. App. 2020). Hooked Media Group sued Apple (BigCo) for interference with contract and prospective economic advantage, misappropriation of trade secrets, and aiding and abetting breach of fiduciary duty, among other claims.
The claims went nowhere at either the lower court or on appeal—despite evidence demonstrating that the hired-away engineers developed a recommendations system substantially similar to Hooked’s version, down to the source code. The staff were expressly hired to build what Apple refused to buy from Hooked, but the courts held that mere possession of a trade secret is insufficient to impose liability unless acquisition of that secret was somehow wrongful.
Ultimately, the absence of an enforceable anti-poaching clause in a due diligence NDA or term sheet proved fatal. Such clauses can be tricky, however, due to recent developments casting doubt on the enforceability of employee non-solicit clauses. But proceeding without them in M&A discussions invites disaster for small private companies relying on a handful of talented people to survive.
Join the discussion on Redline for strategies and clauses that mitigate this risk.
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The intended audience for this post is licensed and practicing lawyers, not laypersons seeking legal advice for their situation. If you are not a lawyer, hire one before using or relying on any information contained here. This post is: (1) informational only and not intended as advertising or as solicitation for legal services, (2) not intended to render legal advice to you, and (3) not a substitute for obtaining legal advice from a qualified attorney to assess your exact situation. The information here is subject to change and may not be applicable or correct in your jurisdiction.
Redline has emerged from beta and is now live, with private guilds, an enhanced member experience, and more. Watch the trailer Lawyers with Mojo or click here to learn more.