Intellectual property rights (IPR) are of utmost importance in today’s capital markets. They not only provide protection for innovations that have been developed, but now offer revenue-generating opportunities for proactive companies looking to license or sell their products in new markets.
Unfortunately, there is an aspect of intellectual property rights that is often overlooked. This is the impact on a company’s supply chain. Specifically, what happens if a third party hits you with a claim for technology infringement found on a component supplied by a vendor? Or what happens if a supplier closes its business or decides to exit a line of business that manufactures a key part for its product? Will your business be paralyzed by someone else’s decision?
Let’s examine how to mitigate the risks associated with those scenarios so that you can keep selling your products.
Build to spec vs. Build to print
First, some definitions that you should already know, but are worth updating. “Build to spec” is when a company literally instructs a supplier to build something of a certain size and with specific operating parameters. The degree to which the component is specified may vary, but ultimately the supplier is free to use its own design experience and manufacturing knowledge to produce the parts to be supplied. The benefit is that the supplier retains responsibility for the design and quality of the part, which can reduce your overhead as you do not need to maintain in-house expertise in a subject area that is not a core competence for your company. . . The definite drawback is that the vendor owns the intellectual property rights to that party, which can be a key component of your product. More on the impact of this later.
“Build to print” is when a company not only specifies the functional requirements of the part, but produces assembly drawings, work instructions, and describes specific manufacturing practices that will be used in the production of the parts. This method requires more work and development costs on the part of the company, but the advantage lies in maintaining control of intellectual property rights and having the ability to select any suitable supplier to produce the parts for you. This approach is more expensive as you are likely responsible for quality and design liability issues. However, if you have the expertise, it is always better from an intellectual property rights perspective to design “in-house”. This approach also facilitates the subsequent vertical integration of your business.
Authorization Search / Non-Violation Assessment
When introducing a new product, seeking patent authorization is an essential part of mitigating business risks. A clear path to non-infringement of existing patents and applications provides confidence to launch your new ideas.
While most companies work with their legal advisors to ensure that their own IP position is secured and they are free to operate, most neglect risk mitigation needs within their supplier base.
All companies must work with their suppliers to ensure that there is a clear path to non-infringement. Otherwise, the company may be subject to a direct or contributory violation claim as a result of a problem with a component supplied by the supplier.
These claims can damage the brand and reputation of the company and could even cause monetary damages to the third party, even if the infringement was on the part of the supplier.
There is a way to mitigate this risk, but there is more than simply claiming compensation. Protocols such as the patent clearance search and non-infringement analysis by your vendors should be mandatory as part of the qualification process.
Beware of someone who tells you that they have investigated the intellectual property rights of others and that it “doesn’t matter” or “won’t be a problem” without enough supporting material.
Indemnification clauses in supply contracts
Beyond requiring a patent authorization search to be completed for parts supplied by the supplier, as the buyer / licensee, you should require explicit language in the supply agreements to cover compensation for third party infringement claims.
“The use of [product] for [the buyer/licensee] will not infringe or otherwise violate the industrial or intellectual property rights of any third party of which [the seller/licensor] has knowledge. If any third party affirms that [the buyer’s/licensee’s] practice of the Rights Licensed under [the Supply Agreement], either resulting from explicit knowledge [the buyer/licensee] had or should have had through reasonable due diligence, will constitute an infringement or misappropriation of the industrial or intellectual property rights of that party, [the seller/licensor] will defend, indemnify and maintain in accordance with this article [the buyer/licensee] harmless against each and every one of those claims. “
A request for the licensor to take out insurance with respect to this matter may also be included in the supply contract, depending on how much bargaining power the buyer retains. In addition, most supply agreements provide a user license to the purchaser, which is generally transferable to the end consumer for OEMs and system integrators. Therefore, your customers must rest assured that they will not be subject to a court order of “suspension of use” as a result of the purchase of your product.
However, this compensation requires the additional work of patent authorization. The language used above requires that you have explicit knowledge or should have known about third-party patents. At a minimum, the above language helps mitigate any claims of gross negligence, but if a patent clearance initiative is not carried out, your business may still be subject to damages for misconduct and damages. This misconduct would not be covered by compensation, so mitigating this risk requires appropriate steps in the supplier qualification process.
It should be the supplier’s responsibility to convince you that the product offered for sale does not infringe the intellectual property rights of a third party. Also, you may become aware of certain patents as a result of your own product authorization search or your gardening efforts. You should be sure to maintain a patent catalog or “watch list” that covers subcomponents obtained from vendors. This watch list should be communicated to the supplier during the qualification process to give them an opportunity to address these issues if they have not already done so.
When conducting the patent authorization search, the provider should have legal opinions from their attorney if necessary to demonstrate a non-infringement position or a reasonably comprehensive approach to invalidation. Like their own efforts, those opinions should address 1) literal infringement, 2) infringement through the doctrine of equivalents, 3) prosecution history and / or preclusion of record, 4) unfair conduct, and 5) means of invalidation ( if required).
Second source: another possible impediment to intellectual property rights
For manufacturers who have “made to spec” rather than “made to print” parts, another problem arises when it comes to second sourcing and replacement parts.
Imagine a scenario where one of your suppliers provides you with a key component of your product, but later discovers a quality issue that leads to a mass recall of that part. The financial and public relations cost of an extensive warranty claim can put them out of business, but it can also hurt your business if you sell numerous units of your own product and there is no way to repair / replace supplier-supplied parts.
If you have something built to specification, then you should have a clause in your supply agreements that refers to your ability to take the supplier’s drawings, manuals, and manufacturing knowledge to a second source in case they can’t or choose to do so. We will not provide you with a sufficient supply of parts for use or replacement in your product (s).
Also, the more you specify the parts to be supplied, the greater the control of the supply scenarios. If you have more than one supplier of a part and these parts are not “interchangeable” then you should ask yourself the risk exposure question in case one of those suppliers is unable or unwilling to supply you for any reason.
Taking precautions to protect your business when it comes to counterparty intellectual property rights isn’t just a good idea … it’s a must!
