Chris Sloan’s Blog

China Law Blog had a good post the other day on China OEM agreements, including some interesting points on using Chinese as the official language and governing law/venue.

China Law Blog nicely summarized the crucial imporantance of a strong contract when dealing with China here. A few takeaways:

1. Chinese companies are not that different from U.S. companies in how they view contracts in many respects. For example, a strapped Chinese company might pay its Chinese vendors before its U.S. vendors, not because of culture, but because the Chinese ones can cause trouble more quickly. Same is true in the U.S.

2. If you don’t have a good contract, you’re dead if you end up in a dispute.

3. You are usually better off with a Chinese language contract that allows for litigation in China.

In yesterday’s post, I talked about why, if you are the customer, a knowledge qualifier in an intellectual property representation/warranty is inappropriate. Today, I’ll tell you what you should REALLY care about, and why the knowledge qualifier may not be that big of a deal.

What you should really care about is having an unqualified, uncapped indemnification obligation covering third party IP infringement claims involving the software or services that the vendor is providing (including embedded third party software, but that is a topic for another day).

What’s the difference between an IP rep/warranty and an IP indemnity? The remedy. If there is a third party IP claim, and the vendor defends and indemnifies the customer, then the vendor has satisfied its obligation to the customer. If there is also an IP infringement rep/warranty, then, regardless of whether the vendor defends the claim, the customer also has a claim that the vendor breached the agreement.

So, if you are the customer, your top priority is the unqualified, uncapped indemnity. The IP rep/warranty is also nice to have, but in most cases, it’s of secondary importance.

I review a lot of IT agreements (as well as traditional IP license agreements). I’m constantly surprised at the creative ways that IT vendors try to shift risks inappropriately to their customers; I call these “weasel” provisions. One of the standard ones involves the relatively common intellectual property non-infringement representation.

Often, the vendor agreement includes language like this (taken from an actual agreement that I reviewed recently):

4.4 “Vendor warrants that to its knowledge, the Licensed Software does not infringe or violate the patent, trademark, copyright, trade secret or any other intellectual property right of any entity not a party to this Agreement.”

When I review one of these for a client, I always strike the knowledge qualifier. Sometimes I get the following argument (quoting the vendor from the contract I quoted above):

We will not be able to remove “to its knowledge” in paragraph 4.4. We only know, and can warranty, what we know today.

At first blush that sounds like a convincing argument, but it completely misses the crux of the problem. Knowledge qualifiers are risk-shifting provisions. By adding the knowledge qualifier, the vendor is shifting the risk to the customer that the vendor’s software unknowlingly infringes someone’s intellectual property. Of course, it’s true (at least with respect to patent infringement) that the vendor may not know that it is infringing, but neither does the customer, and the vendor is in a much better position to control the risk. Put another way, the risk of the unknown must be borne by one party or the other; in this case, the vendor should bear it, and the knowledge qualifier should come out.

You can analogize this to buying a car. If your car’s warranty were limited to “reasonable efforts”, and you took it in for a warranty repair and the dealer said “We tried but we couldn’t fix it. Tough luck,” you’d be pretty upset, right? The knowledge qualifier described above is really the same issue.

In part 2 tomorrow, I will explain why this may not matter very much, if you have a strong indemnification provision.