Intellectual property rights (IPR) are of paramount 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 overlooked aspect of DPI. This is the impact on a company’s supply chain. Specifically, what happens if a third party hits you with an infringement claim for technology found in a component supplied by a vendor? Or what happens if a supplier goes out of business or decides to exit a line of business that makes a key part of their product? Will your business be affected by someone else’s decision?
Let’s take a look at how to mitigate the risks associated with those scenarios so you can keep selling your products.
Build to Spec vs. build to print
First, some definitions that you should already know, but are worth refreshing. “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 know-how to produce the parts it supplies to you. The benefit is that the supplier retains responsibility for the design and quality of the part, which can reduce your overhead as you are not required to maintain in-house expertise in a subject area that is not a core competency for your company. . . The ultimate drawback is that the vendor owns the intellectual property rights to that part, which may be a key component of their 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 mentions specific manufacturing practices that will be used in the production of the parts. This method requires more development work and cost on the company’s part, but the advantage lies in maintaining control of the intellectual property rights and having the ability to select any appropriate supplier to produce parts for you. This approach is more expensive since you are likely to be responsible for quality and design liability issues. However, if you have subject matter expertise, it is always better from an IPR perspective to design “in-house”. This approach also facilitates the subsequent vertical integration of your business.
Authorization Search / Non-Infringement Assessment
When introducing a new product, seeking patent clearance is an essential part of business risk mitigation. 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 counsel to ensure their own intellectual property position is secured and they are free to operate, most do not consider risk mitigation needs within their vendor 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 infringement claim as a result of a problem with a supplier-supplied component.
These claims can damage the company’s brand and reputation and could even result in monetary damages to third parties, even if the infringement was on the part of the provider.
There is a way to mitigate this risk, but there is more to it than just asking for compensation. Protocols such as patent clearance search and non-infringement screening by your vendors should be mandated as part of the qualification process.
Beware of someone telling you that they have researched the intellectual property rights of others and that it “doesn’t matter” or “won’t be a problem” without sufficient supporting material.
Indemnity Clauses in Supply Contracts
Beyond requiring a patent clearance search to be completed for supplier-supplied parts, as a purchaser/licensee, you should require explicit language in supply agreements to cover indemnification from third-party infringement claims.
“The use of [product] for [the buyer/licensee] will not infringe or violate in any other way the industrial or intellectual property rights of any third party of which [the seller/licensor] is aware If any third party claims that [the buyer’s/licensee’s] practice of Rights Licensed under [the Supply Agreement]either resulting from explicit knowledge [the buyer/licensee] had or should have had with reasonable due diligence, constitutes an infringement or misappropriation of the industrial or intellectual property rights of that party, [the seller/licensor] shall, in accordance with this article, defend, indemnify and retain [the buyer/licensee] harmless against any and all such claims”.
A request for the licensor to take out insurance in respect of this matter may also be inserted into 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 typically transferable to the end user for OEMs and system integrators. Therefore, your customers should rest assured that they will not be subject to a “suspension of use” court order as a result of purchasing your product.
However, this compensation requires the additional work of licensing the patent. 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 pursued, your company may still be subject to misconduct and damages. This misconduct would not be covered by compensation, so mitigating this risk requires appropriate steps in the vendor qualification process.
It should be the seller’s responsibility to convince you that the product they offer for sale does not infringe the intellectual property rights of a third party. Additionally, he may be made aware of certain patents as a result of his own product approval seeking or landscaping efforts. You should ensure that you maintain a catalog or “watch list” of patents that refer to sub-component elements that are sourced from vendors. This watch list should be communicated to the supplier during the qualification process to give them the opportunity to address these issues if they have not already done so.
When conducting the patent clearance search, the provider should have legal opinions from their attorney if necessary to demonstrate a position of non-infringement or a reasonably comprehensive approach to invalidation. Like your own efforts, those opinions must address 1) literal infringement, 2) infringement through the doctrine of equivalents, 3) prosecution history and/or file wrapper impediment, 4) conduct unfair and 5) the means for invalidation (if necessary).
Second source: another possible impediment of intellectual property rights
For manufacturers that have “built to spec” rather than “built to print” parts, another problem arises when it comes to second source and replacement parts.
Imagine a scenario where one of your suppliers provides you with a key component of your product, but then discovers a quality issue that leads to a mass recall of that part. The PR and financial cost of a lengthy warranty claim can put them out of business, but it can also hurt your business if you’ve sold numerous units of your own product and there’s no way to repair/replace supplier-supplied parts.
If you have something built to spec, then you should have a clause in your supply agreements that refers to your ability to take the supplier’s drawings, manuals, and manufacturing know-how to a second source in the event that they cannot or choose to do so. does 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 more control you have over supply scenarios. If you have more than one supplier of a part and these parts are not “interchangeable” then the question of risk exposure should be asked if one of those suppliers is unable or unwilling to supply you for whatever reason.
Taking precautions to protect your company when it comes to counterparty intellectual property rights isn’t just a good idea…it’s a must!