Today, virtually any contract, including a business process outsourcing contract, for the delivery of goods, services or licensed rights in applied technology contains an indemnification clause concerning possible infringement of third-party intellectual property rights.  In the initial draft of the agreement, the typical clause provides for unlimited indemnification for patents, copyrights, trademarks and trade secrets.  Increasingly, the suitability and evidentiary issues in such clauses are getting careful scrutiny.  A recent U.S. federal judicial decision revoked a twenty-year old common law precedent relating to the measures that must normally be taken in order to eliminate certain special statutory damages and liability for attorneys’ fees.

Ordinary Infringement of a Patent.

Patent holders face a challenge in protecting their rights.  The U.S. patent law ordinarily imposes actual damages for patent infringement.

Patent holders must think twice about suing for infringement.   The stakes are high.

• Legal Fees.
  Ordinarily, the patent holder has no right to recover its attorneys’ fees.  The patent holder will have a significant amount at stake in order to justify paying the huge expense of attorney’s fees for complex litigation.
• Invalidation of Patent.
  Invariably, the patent holder’s infringement lawsuit will invite a counterclaim for invalidation of the patent.  As a result, the infringement litigation could risk termination of all license royalties from parties other than the alleged infringer.

Willful Infringement of a Patent.

The patent holder’s risk of an invalidation can be reduced if it raises the stakes in the litigation.   It can do so by alleging that the infringement was “willful.”  This puts into motion a threat that the alleged infringer will be liable for punitive damages.

Consequences of Willful Infringement.
If the infringement can be shown to have been “willful,” then the court may award attorney’s fees and triple the compensatory damages.  35 U.S.C. § 284 (“the court may increase the damages up to three times the amount found or assessed”);  35 U.S.C. § 285 (“the court in exceptional cases may award reasonable attorney fees to the prevailing party”).

The Definition of “Willful” Patent Infringement.
In determining whether a patent infringement was “willful,” the court must balance the totality of the circumstances.   Many circumstances may be taken into consideration.  See compilation in Rolls-Royce Ltd. v. GTE Valeron Corp, 800 F.2d 1101, 1110 (Fed. Cir. 1986) and Read Corp. v. Portec, Inc., 970 F.. 2d 816, 826-27 (Fed. Cir. 1992).   “Willfulness” is not an absolute, based on “all or nothing,” but is a matter of degree.  Knorr-Bremse Systeme fuer Nutzfahrzeuge GmBH v. Dana Corporation, __ F.3 __, NYLJ (Sept. 24, 2004), p. 21, cols. 1-4, p. 22, cols. 1-2 (2nd Cir. 2004) Judge Newman.

The Service Provider’s Defensive Strategy: Get an Attorney’s Opinion.
Under a 1983 decision by the U.S. Court of Appeals for the Federal Circuit, judicial precedent required that, as a precaution, the potential infringer of a patent should obtain a review by a patent lawyer of the patents at issue.  Underwater Devices, Inc. v. Morrison-Knudsen Co., 717 F.2d 1380 (Fed. Cir. 1983).  In the context of a flagrant disregard for the patent owner’s demand for payment of a royalty for infringing presumptively valid patents, that court ruled that “where, as here, a potential infringer has actual notice of another’s patent rights, he has an affirmative duty to exercise due care to determine whether or not he is infringing,” including “the duty to seek and obtain competent legal advice from counsel before the initiation of any possible infringing activity.  Id. at 1389-90.

The “duty” or “best practice” of getting a legal opinion is not specified in the patent statute.  Instead, the defensive strategy was raised to the level of a common-law duty by interpretation of the patent statute.  Courts applied the common law rule as a matter of evidentiary procedure. This applied specifically to cases where a patent holder had warned the potential infringer and asked that the infringement cease.

Change in Common Law.
This “legal opinion” requirement was applicable as judicial precedent from 1983 to 2000.  In September 2004, the same court, in the Knorr-Bremse decision, overruled this precedent because the evidentiary principle promoting caution violates an even more fundamental principle, the attorney-client privilege.  The court ruled that, while the issue is not one of legal privilege, it is the related issue “whether there is a legal duty upon a potential infringer to consult with counsel, such that failure to do so will provide an inference or evidentiary presumption that such opinion would have been negative” and would have concluded the potential infringer had no right to use the patented process.

Having framed the issues, the Knorr-Bremse court decided that, as a matter of public policy, it is so important to continue the general principle that courts should decline to impose, as a procedural rule of evidence, any “adverse inference” on invocation of the attorney-client privilege.   Expanding this principle to the treble-damage and attorney’s fee provisions of the patent law, the court concluded that no such adverse inference may be drawn:

• when the potential infringer (such as an service provider in outsourcing) invokes attorney-client privilege, and/or attorney work-product privilege, or
• when the potential infringer fails to consult with counsel.

Impact on Outsourcing.

This decision eliminates a negative presumption against potential infringers of U.S. patents. Since the U.S. patent law permits registration of patents on business methods, this judicial decision will make it easier to defend, and harder to prosecute, business method patent infringements. The impact on the ordinary business process outsourcing should be small, but it will give some comfort to service providers. When notified of an alleged infringement, consultation with an attorney will still be highly advisable, but no adverse presumption will apply if no consultation occurs.