Series on ALI Software Contract Principles: Changes Default Rule from Implied Warranty to Implied Indemnification Against Infringement

As we posted yesterday, the American Law Institute has just approved its Principles of the Law of Software Contracts. As promised, we are launching today the first in a series of postings on the new Principles to educate our blog readers in the software industry on the practical implications of these Principles.

If you have ever taken part in a software contract negotiation, you know that much of that negotiation will focus on negotiating indemnification language. For those of you who may not be familiar with the concept of indemnification, this is when one party takes on the legal responsibilities and more importantly, the financial responsibilities, for a potential lawsuit and often for the legal defense of that lawsuit. In the case of a software contract, the indemnification at issue is typically the intellectual property infringement risk: generally, the risk that the developers of the software code may have incorporated infringing code into the software.

What is important about the ALI Software Contract Principles that involves indemnification? Well, the Principles now provide for an implied indemnification that can be disclaimed in a software contract. This is a change of approach from the approaches set forth in Article 2 of the Uniform Commercial Code (U.C.C.) and the Uniform Computer Information Transactions Act (UCITA), which provided for an implied warranty of noninfringement that can be disclaimed. For those of you who are not familiar with the UCC and UCITA, for your purposes, you need to understand that rather than reading an implied warranty of noninfringement into your contract that you can choose to adhere to or disclaim in a disclaimer of warranties, which was the previous "standard," the Principles now provide for an implied indemnification that you can either choose to adhere to or to disclaim in a disclaimer of indemnification.

In addition, the Principles also now provide certain remedies to a party in an infringement scenario, to the extent that those remedies are not excluded in the agreement.

What is the rationale for this change? The Principles explain as follows:

[The change] respects the customs that have developed in the industry. The hope is that by changing the applicable default rule from an implied warranty to the narrower obligation of implied indemnification, more vendors will be willing to offer a tailored indemnity rather than disclaiming liability altogether.

Interestingly enough, the Principles create a carve-out on this rule for parties who do not pay for the software, in a nod to the open source community. The Principles explain:

Open-source developers often are a large, diverse group and individual contributors may not have access to counsel to assist them in evaluating copyright claims and searching for patents, many of which may be invalid. An indemnification duty therefore may have a chilling effect on participation in open-source projects.

What should you take away from this posting? Well, if you are a company that offers software for sale, you may want to take another look at your form contracts and consider whether revisions should be made to the indemnification and remedies sections in response to the Principles. As we explained in yesterday's posting, while the Principles are not at this point law, they could become law and are likely to become authoritative to courts, so it could pay to give them some consideration in advance of a contract dispute.

Related Postings:
American Law Institute Approves Principles of the Law of Software Contracts