Coastal Contacts Inc. v. Elastic Path Software Inc. 2013 BCSC 133
An interesting recent decision from the BC Supreme Court highlights some of the importance of a patent indemnification clause in licensing agreements.
The respondent is a software provider, Elastic Path Software Inc, who had licensed their online retail software to the appellant, Coastal Contacts Inc. As part of the software license, Elastic provided Coastal with a patent indemnification clause. That is to say, Elastic agreed that “Elastic Path shall defend or settle any claim made or any suit or proceeding brought against Licensee [Coastal] insofar as such claim, suit or proceeding is based on an allegation that any of the software supplied to Licensee pursuant to this Agreement infringes (directly or indirectly) any patent [...]”
The purpose of patent indemnification clauses such as this one in a software context is to protect software users from potential liability for patent infringement claims. Patent infringement is a strict liability tort, meaning whether or not you know you are infringing, or had any intention to infringe, is irrelevant to whether you can be found liable for infringement. (Knowingly infringing may result in higher damages though). As a software user is unlikely to know whether or not the software they are using is infringing another party’s patents it is generally advisable to obtain an indemnification from the provider.
In this case the user (Coastal) was eventually sued for patent infringement in the East District of Texas, alongside several other companies, for allegedly infringing patents covering aspects of online purchases.
While the license agreement required Coastal to provide notice to Elastic of any infringement claim (in order for Elastic to evaluate and prepare a defence to the claims) Coastal did not, and instead retained counsel and settled the action for 200k dollars.
Coastal sought compensation from Elastic for the settlement amount and legal fees they had incurred, and Elastic refused. Coastal then sought a Court order requiring Elastic to indemnify them for their litigation costs. Elastic responded by forcing the matter into arbitration, which was the required mechanism to resolve disputes regarding the indemnification clause under the license agreement.
Elastic was successful in the arbitration on two grounds. On the first ground the arbitrator found that Elastic’s software would not have infringed the patents and consequently there was no duty to indemnify. The second ground was that Coastal was no longer entitled to the indemnification due to breaching the agreement, by failing to provide notice and by attempting to litigate rather than arbitrate the dispute over indemnification. The arbitrator also awarded Elastic costs against Coastal for the arbitration.
Coastal sought leave to appeal the arbitrator’s decision to the BC Supreme Court. The Court held that the arbitrator was focused on the wrong question in considering whether the patent was actually infringed or not, rather the issue was whether the claim was against the software provided by Elastic. As the claim did allege that the software was part of the infringing activity the indemnification clause required Elastic to defend the claim, no matter how weak the case against the software might have been. The Court also held that the two breaches of the agreement by Coastal were not sufficient to negate Coastal’s right to indemnification, primarily as the breached had occurred after the lawsuit was launched (and thus should not affect whether Elastic had a duty to defend the suit or not), and there was no evidence that the breaches harmed Elastic in any significant manner.
As a consequence, the Court reversed the cost award of the arbitrator, and required Elastic to indemnify Coastal for their litigation costs in the US patent claim and the settlement costs.
Another interesting aspect of this case is the light it sheds on the harsh economics of patent litigation. Coastal settled the patent suit for 200k dollars. While this is not the spot to delve into the merits of the claim, it is interesting that this significant amount was paid on the claim. Note that the arbitrator found that “There is no question that there cannot be “direct infringement” of any of the claims of the Hill patents by use of the Elastic Path Software.” And that “… on a balance of probabilities and based on the evidence that was before me, I find that the Elastic Path Software was likely not impugned by the Hill patent action.” Nonetheless when reviewing the reasonableness of the settlement amount the Court held that the 200k dollar settlement was reasonable (and as such payable by Elastic). This was on several grounds, namely that Coastal acted on advise of legal counsel in entering the settlement agreement, that they were advised that costs to defend the Patent claim could escalate into the millions of dollars, that Coastal was at risk of suffering judgment after trial, that 200k was the smallest amount any of the defendants to the patent lawsuit settled for. As well, had Coastal proceeded with the trial and won, they still would likely be unable to recover there legal costs (and as such would be out more than 200k dollars even after a ‘victory’). This is a key difference between the US and Canadian legal systems, as Canada offers the successful party partial recovery of there legal costs.