Don’t come to me, if the product I sell you infringes IP

Disclaimers can take many forms…

The title of this post is almost poetic.  Recently, IP Draughts was asked for advice on the sale of products by an overseas company to purchasers in the UK.  The products were to be sold to retail businesses, who would resell to consumers.

The question that was raised was whether the contract terms between the client and the retailer could include a provision by which the client excluded liability if the retailer were sued by a third party for IP infringement.

Any such provision would face some legal obstacles.

Section 12 of the (UK) Sale of Goods Act 1979 (SGA) implies into contracts for the sale of goods, in summary:

1. A condition that the seller has the right to sell the goods; and
2. A warranty that the buyer will enjoy “quiet possession” of the goods.

In Microbeads v Vinhurst Road Markings [1975] 1 All ER 529 (CA), Lord Denning MR discussed that either or both of the above implied terms could be breached if the buyer were sued for patent infringement by a third party.  In that case, on the facts, a breach of the first of these terms could not be established, but a breach of the quiet possession warranty was established.  The latter is an ongoing warranty that continues while the buyer remains in possession of the goods.

Lord Denning also discussed the earlier Court of Appeal case of Niblett v Confectioners Materials [1921] 3 KB 387 (CA), in which a similar point was discussed in relation to trade mark infringement.  In the latter case the products in question were tins of condensed milk marked with the name Nissly, to which Nestle (pronounced ness-lay) not surprisingly objected.

These are the only two cases of prominence that IP Draughts is aware of, in this field.  The SGA and its predecessors date back to the nineteenth century.  In 1975, in the Microbeads case, Lord Denning described the infringement issue in relation to section 12 as a “new and interesting point”.

If one accepts that the law is this area was settled by the Microbeads case, the next question is whether a seller can avoid liability for IP infringement by the buyer through the use of suitable contract terms.  Unfortunately for sellers, there is another legal obstacle.  Section 6(1)(a) of the Unfair Contract Terms Act 1977 (UCTA) states that liability for breach of section 12 of the SGA “cannot be excluded or restricted by reference to any contract term.”

So, the short answer seems to be that a seller is liable if the buyer is sued by a third party for IP infringement.  No doubt there are special cases where this might not be so.  For example, sections 12(3) and (5) of SGA limit the implied terms of title where “there appears from the contract or is to be inferred from its circumstances an intention that the seller should transfer only such title as he or a third person may have”.  And section 26 of UCTA disapplies certain of UCTA’s prohibitions in the case of “international supply contracts”.

Moreover, if the buyer provides a detailed design and specification for the product, and the seller simply follows the buyer’s instructions, common sense might suggest (although IP Draughts hasn’t yet worked out whether the law follows common sense on this point) that the buyer should not able to rely on section 12.  Or perhaps section 12(3) then applies.

Has any reader encountered this legal issue under English or other laws?  If so, what conclusions did you reach?

Clients who agree fancy deal terms: when should you pour cold water?

An easy way of ‘getting a rise’ out of IP Draughts (one of many) is to comment in his hearing that lawyers like to make things complicated.  No they don’t, he is likely to reply, in a style that has been compared to Hillary Rodham Clinton answering a Republican question at a Congressional enquiry.  It is clients who make things complicated, with their innovative deal structures.  If only they stuck to ‘plain vanilla’ deal terms, the contract drafting would be so much easier, and the bill so much smaller.

This thought crossed IP Draughts’ mind more than once in recent weeks.  The deal that prompted it related to an early-stage technology company that was ‘boot-strapping’ with a modest loan and the goodwill of some individuals who were not being paid for their services.

These individuals were to receive some ‘sweat equity’ as compensation for their past efforts, and some further shares that were to be linked to the future performance of the company.  The conventional way of structuring the latter would be to issue share options whose exercise is conditional upon future performance.  In the UK, share options typically have tax advantages for the individuals who receive them, compared with a simple issue of shares.

For reasons that are entirely understandable, the parties to this transaction did not agree on share options.  Instead, they agreed that the individuals would receive shares now, which would be returnable to the company if performance targets were not met.  This is known as a share ‘buy-back’ arrangement.  The company’s chairman, who negotiated the basic deal structure, had experience of such an arrangement in previous transactions.

Until fairly recently, it was very difficult for a UK company to buy-back its own shares.  While it is now easier to do so, company law has required the parties to go through additional corporate procedures before such an arrangement is valid.  The tax treatment of such an arrangement has its own complexities that need to be considered.  Moreover, as the individual owns the shares, additional steps need to be taken to ensure that the company can recover them in situations where they are forfeited.

As if this did not add enough complexity to the transaction, there was also complexity in the performance targets and the precise number of shares to be forfeited if they were not met.  While it was fairly simple to describe the arrangement in high-level terms, the detailed drafting took several hours to get right to our satisfaction.  When we showed the drafting to colleagues they scratched their heads until we explained the deal to them.  At that point they said they thought the drafting worked and was clear and accurate, which was reassuring.  But we were left wondering whether it was right for parties to enter into arrangements so complex that the drafting cannot be immediately understood by an experienced corporate lawyer.

Naturally, we pointed this concern out to our clients and suggested a more simple structure.  However, the negotiations were too far advanced to make changes.  The clients’ response, once they had reviewed the detailed wording, was that both parties were “very pleased” with the drafting and that they recognised that the deal terms were “logically complex”.

In the end the deal (which had other elements to it, not mentioned here) required us to prepare 29 separate documents for signature.  Once signature had taken place, the client thanked us for our efforts and suggested that the deal structure would be “an interesting exam question for company secretaries and corporate lawyers”.

IP Draughts agrees that there is an exam question (or several) in this deal.  The question could focus on how to structure and document the transaction.  But a more interesting question would be what the role of the lawyer should be when faced with such a deal structure.

How far should the lawyer interfere in a structure that apparently experienced and sophisticated parties have agreed?  Should he make clear his reservations and then get on with making it happen?  Or should he devote a considerable amount of time into trying to persuade the parties to think again and come up with a simpler structure?

What do you think, dear reader?