Avoiding contractual pitfalls and 'gotchas'

by McAfee & Taft
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You’re likely to see the same clauses repeated in most patent, trade secret and software license contracts. As a result, these agreements have a similar structure and feel, which can lead one to assume that a clause in a new contract contains exactly the same language found in the previous contract. However, that assumption could easily result in the loss of important rights.

For example, take the following clause of a joint development agreement:

Each Party may, at its own expense, file a patent application in any country for any Developments that it solely owns. The parties acknowledge and agree that the disclosure of a Party’s Confidential Information in the patent application of the other Party may be necessary for, inter alia, enablement, best mode and written description requirements, and the filing party agrees to minimize such disclosure and provide the other party at least thirty (30) days advance written notice with the description of what is to be disclosed to enable the other Party to seek patent protection for the subject matter to be disclosed.

Initially appearing to conventionally outline a party’s right to file patent applications on technology owned by that party, the clause has an easily overlooked “gotcha.” If you look carefully at the highlighted portion, you’ll see that the party filing the patent application has the right to include the other party’s confidential information in a patent application. This means that the party owning the confidential Information, i.e. trade secrets, cannot block the filing of the patent application. The 30-day period for filing a patent on the trade secret is a poor trade-off. Patent protection may not be available for the trade secret, or the resulting patent may have significantly less value than the trade secret. Clearly, the last sentence of the clause should be deleted.

Common trouble spots

A few other trouble spots in software licenses are the grant clause, the software backup clause, the limitation of liability, and the indemnification clause.

Grant clauses should be reviewed to ensure that the license granted includes future versions of the software received by any means from the licensor. If the future versions or updates are not covered by the grant, the indemnity clause may not apply to the future versions.

Sometimes, the software backup clause limits the number of backups to a single copy. Depending on the software and the system where it is installed, backups may occur daily or weekly resulting in multiple breaches of the backup clause. Such breaches could lead to termination of the license.

The limitation of liability might appear to be standard boilerplate in many software licenses. However, it can be written so broadly as to limit the liability for IP infringement. As a result, the licensee could be responsible for patent or copyright infringement damages not covered by the Indemnification clause.

Indemnity clauses can be easily overlooked as standard boilerplate. Typically, a licensor will agree to indemnify a licensee for infringement or other damages resulting from the use of the licensed technology. However, indemnity sections frequently include exception clauses that may act as loopholes allowing the licensor to escape their obligations, like this one:

The indemnification obligation does not extend to any claim of infringement resulting from any modification of the licensed technology by Licensee.

Sounds reasonable, but what if the licensee modified the technology per instructions from the licensor? The language should be amended to exclude modifications made at the direction of the licensor from the exception.

Bankruptcy or default clauses may also contain hidden language. For the most part, these clauses appear to be almost identical from one agreement to another. However, recently some bankruptcy and default clauses have been modified to contain language that results in the immediate transfer of the ownership of licensed intellectual property from a licensor to a licensee in the event of a default.

Finally, even if you drafted the initial document, do not assume that the marked-up version you received from the other party identifies all changes in the document. Especially in a contentious negotiation, it might be wise to create your own marked-up drafts for review.

Even sophisticated companies can produce marvels that defy comprehension or interpretation, like this one from a Fortune 100 company:

Each Party may undertake not to file, without the prior written consent of the other Party, any patent application which includes Confidential Information of the other Party developed solely for the Purpose of this Agreement and not being the other Party’s Background IP.

The bottom line

To avoid gotchas in contracts, scrutinize every clause (even the familiar ones), order the contract logically, and always use the same word to identify the same element.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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