Should an IP Indemnity Be Premised on Actual Infringement?

IP warranty & indemnity clauses are legal tools often used by buyers to manage and distribute supply chain risks, in particular IP litigation and associated financial hazards in connection with the seller’s products once linked to the supply chain.  Per our observation, these clauses are treated in Taiwan’s courts in a buyer-friendly manner, especially when the two parties are both business entities.

A question often raised during the buyer-seller negotiation on indemnity clause is whether the seller’s indemnity obligation should be premised on “actual infringement” of the products the seller supplies, or an “asserted infringement” is good enough to trigger the buyer’s indemnity claim. In most cases where this question is spotted, the parties either solve it with a clearer contract language or end up without a deal. As such, this question is not often tried at the court. Still, an exception comes up recently: a three-judge panel of the IP Court rendered a second-instance decision in April 2020 on this issue with a holding in favor of the buyer. Unity Opto Technology, Ltd. v. TongFang Semiconductor (HK) Co., Ltd., 108 Min Zhuan Shang 30, Taiwan’s IP Court (April 2020).

According to the IP Court decision, the indemnity letter in dispute, drafted by the plaintiff itself in English language and signed by the defendant straight away without any revisions, contains the following warranty and indemnity clauses from which the dispute arose:

[Paragraph One] We [TongFang the defendant, a member of the Tsinghua Tongfang Group] warrant that all Chip products manufactured and/or sold to Unity [Unity Opto the plaintiff, a Taiwanese company] do not infringe or misappropriate any Intellectual Property Rights, including without limitation, patent, copyright, trade secret, industrial design, know-how, trademark of any third parties in design, construction, manufacture or use of the Products.
[Paragraph Two] We will defend, indemnify and hold harmless Unity … from and against any asserted claims, suits, injunctions, demands, actions, expenses, losses or damages (including, without limitation, shipping costs, repackaging fees, recalls, handling fees, losses of product distribution, custom tariff, tax, fines, field return expenses and/or attorney fees) arising from or related to we do not comply [sic] with the warranty and representation hereinabove in any manner .

In spring 2015, TongFang’s chips employed in Unity Opto’s LED products sold to the US were accused of infringing on four patents in an ITC Section 337 investigation proceeding and a corresponding lawsuit both filed by Cree Inc the patentee. According to the IP Court’s findings, Unity Opto notified TongFang of these US proceedings in August 2015, requesting TongFang to sign a joint defense agreement yet TongFang “refused to sign the same and failed to perform the obligations stipulated under the indemnity letter or provide any defense assistance.” When Unity Opto settled with Cree Inc in late 2016, it had incurred more than US$ 1 million of attorney’s fees and expert witness’ fees. As TongFang refused to pay the same, Unity Opto filed this reported litigation in Taiwan, possibly owing to a jurisdiction clause in the indemnity letter or a supply agreement that confers jurisdiction on Taiwanese courts.

TongFang contended that the Paragraph Two indemnity clause did not apply unless and until the Paragraph One warranty obligation was actually breached in the first place, i.e. the products that TongFang supplied were proved to be actually infringing.  As the US proceedings were settled and Unity Opto denied infringement in every proceedings including the IP Court lawsuit, TongFang argued that it never breached the Paragraph One warranty to trigger the Paragraph Two indemnity claim.

However, this somewhat textualistic interpretation of the indemnity clause was not accepted by the IP Court panel.  Unity Opto was awarded the full amount of the attorney’s fees and expert witness’ fees it claimed.  The judges’ main rationales are as follows:

Due to the costly attorney’s fees and compensatory damages usually incurred in an IP infringement lawsuit, it is common in commercial practice for a purchaser to demand an IP indemnity letter from a vendor….  Owing to the complexity of technological and legal issues involved in an IP lawsuit, it usually takes the tribunal considerable length of time in completing the discovery and trial proceedings before being able to render a final decision [on whether an infringement actually occurred].  However, the legal actions a third party claimant may launch against the supplied products commence at the moment when he asserts the products infringe on his IP rights, and therefore may include, for example, sending a demand letter to a manufacturer or distributor for recalling or ceasing to sell these products, filing a preliminary injunction motion, and filing a lawsuit, etc.  Each of these actions brings forth immediate impact on the business activities and legal status of the accused infringer, hence the necessity for him to adopt the necessary measures to respond or defend. 
If the defendant’s assertion were to be approved, it would have become unreasonable/unnecessary for it to undertake an obligation with such a wide scope to encompass all these pre-lawsuit or pre-final decision matters including “asserted claims, suits, injunctions, demands, actions,” not to mention the obligations to defend the plaintiff and hold it harmless….  The defendant’s assertion is therefore inconsistent with the entirety of the textual meaning expressed in the indemnity letter it signed.
As testified by the witness [being the plaintiff’s in-house counsel], … the defendant did not express any dissenting opinions before readily signing the indemnity letter, and we do not find … any apparent disparity of market powers between the two parties.… Further, given the defendant’s better knowledge about the technologies used in the products they supplied, it is reasonably necessary for it to be subject to an obligation of providing the plaintiff with relevant technical materials and assist the plaintiff to defend [against a third party claimant’s actions].  As such, the defendant’s assertion … is obviously in contravention with the object the plaintiff intended to achieve when demanding an IP indemnity letter from the defendant.
Moreover, if the defendant’s assertion were to be followed, … it would lead to a huge risk on the purchaser’s side, as the purchaser would thus be caught up in defending the vendor’s products at its own costs and these costs would not be recoverable from the vendor even when a favorable judgment is obtained.  Is it not the case that the defendant’s theory if adopted would eventually lead to the result that a purchaser could henceforth choose not to answer an IP infringement lawsuit at all but rather claim against its vendor whatever damages the court awards [the third party claimant] in a default judgment?  Such result is obviously unfair. 

As the above paragraphs show, deft use of teleological analysis and reductio ad absurdum as contract interpretation tools is not uncommon in IP Court’s decisions, particularly when the dispute before the court is novel and the legal text from which the dispute arises does not provide unambiguous interpretation.  Whether TongFang has appealed the decision to the Supreme Court is yet unknown, yet any development of this case is definitely worth continued attention from the IP community.