Indemnifying Software Development Projects

Our practice regularly handles both sides of software development transactions.  The developer on one side and the customer on the other.  We frequently encounter inexperienced attorneys demanding that the software developer indemnify the customer for use of the software.  For example, in the event that the software was found to infringe upon a patent, the software developer would "indemnity, hold harmless and defend the customer."

A developer would not assume such broad and unlimited liability unless:

1. The developer had complete control over the deployment of the application;

2. The developer had the authority to shut down execution of the application in the event a claim was made, thereby mitigating any future damages attributed under the provision;

3. The developer had a substantial ongoing royalty stream to pay for the indemnification overhead; and

4. The project was worth at least $250,000 amortized over 24 months.

Even with these circumstances, a developer would need an opt-out clause in the event: (1) the allegedly infringing product could not be modified to avoid infringement and (2) a license could not be secured to continue to use the product. Typically, the developer would be able to walk away from infringement liability by paying out either the last 6-12 months of licensing payments, or a pro-rata share of the one-time development costs on a 5 year product lifespan. For example, if a project had an upfront fee of $500,000 and the product was deemed infringing after Year 1 (and no way to circumvent or license), then the developer would return $400,000. If the infringement was found in Year 4, then a refund of $100,000 would be given. The window would close at Year 5 (end of the product lifespan). Some larger companies (Fortune 500) we work with insist on a 7-year lifespan.

Absurd Results

In most cases, indemnifying a custom software project  by the developer would lead to absurd and unconscionable results. The developer would effectively be an unpaid IP insurer of the customer’s business activities. If a claim is made, the customer could continue to rack up liability that the developer would have to pay. Furthermore, the customer could deploy the solution in a manner or in combination with other technology that would cause an originally non-infringing solution to become infringing. Again, the developer would have no means to limit its liability.

How to Advise the Customer Demanding Indemnity

1. You are producing software in accordance with the customer’s specifications;

2. You will have no control over how they deploy it, market it, or use it with other technologies;

3. You cannot provide development services at the price quoted and then also retain IP counsel to clear the technology for non-infringement;

4. At the costs quoted you cannot allocate capital to an infringement defense fund to adequately cover a potential infringement;

5. The customer is in a better position to mitigate damages, defend allegations and potentially license the IP asserted against it.

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