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When a licensee is paying top dollar to license first class software, can one assume that the software does not infringe upon the rights of others? If someone wants to shut down the licensee’s business because they claim that the software infringes upon their patent or copyright, should the licensor be forced to defend its product?

These are some of the issues raised in a recent case heard before the British Columbia Supreme Court (Coastal Contacts Inc. v. Elastic Path Software Inc., ((2013) BCSC 133). This judgment is likely to have a deep impact for licensors and licensees when the time comes to draft license agreements.

Coastal Contacts had licensed software for its e-commerce website. The licensing agreement contained a requirement that the licensor defend any claims made against Coastal based upon allegations that its software infringed any patent. The agreement also contained a clause requiring the parties to resolve disputes by way of arbitration.

Coastal was sued in the United States in respect of an alleged patent infringement related to the licensor’s software. Coastal initiated third party proceedings in British Columbia against the licensor after it refused to defend Coastal.

It is not surprising that the court held that the duties to defend and/or indemnify, as well as to arbitrate, which are usually set forth in a license agreement, must be clearly defined in order that the parties mutual obligations are well understood.

Therefore, license agreements must be carefully crafted to minimize chances of conflict. Among other things, the clause should clearly identify which intellectual property rights will be indemnified.  For example, it may be useful, for a licensor, to try and limit the intellectual property rights in question to United States and Canadian patents, trademarks and copyrights in existence at the date of delivery of the software.

Many sophisticated licensees are insisting on indemnification for all intellectual property rights worldwide.  While this may seem reasonable from a licensee’s point of view, nevertheless, this can be dangerous for a licensor.

In addition, it should be clearly stipulated when the licensor’s obligation to defend and/or indemnify comes into force.  It should be stipulated that the licensee is required to promptly advise licensor as soon as it becomes aware of a claim or potential claim in order for the licensor to begin to do its research immediately and to plan strategy.

The extent of the duty to defend and/or indemnify should be clearly stipulated.  Many licensees ask for complete indemnification with no limitation of damages.

In my view, a wise licensor limits its liability to the defense and/or settlement of any action/claim and only to the payment of any award by a court of final jurisdiction by the third party against the licensee.  The licensor should retain complete control of such defense and settlement at its discretion and not be responsible for any damages suffered by the licensee or expenses or legal fees.

The reason for this is readily apparent.  If the intellectual property of the licensor is attacked, it will in all likelihood extend to many or all of the licensee’s clients. In such case, it would be chaos if each client is entitled to have its lawyer involved in the defense or settlement of an action and for the licensor to have to pay costs and legal fees of all of these lawyers.

Furthermore, in the event of a final injunction being rendered against the use of the licensed software, the licensor should have the right, at its option, to either secure the right for the licensee to use the infringing software, to modify it so that it becomes non-infringing, as long as it maintains substantially the same functionality, or to terminate the license agreement.  In such latter case, it should be stipulated precisely as to what penalty will be granted to the licensee.

Frank M. Schlesinger is a partner at Spiegel Sohmer with extensive experience in the field of computer law, including software licensing, hardware, sales licensing and maintenance, intellectual property and trade-marks.