Editors Note: Caroline Horton Rockafellow is a member of the Research Triangle Park law firm of Daniels Daniels & Verdonik, P.A.Earlier this month, Microsoft Corporation created a buzz in the software industry when it announced that it would indemnify nearly all of its customers against intellectual property infringement claims resulting from use of Microsoft software products. Microsoft’s position is that this new indemnification provides a significant benefit to its customers since Microsoft is now one of only handful of software companies offering such a high level of protection its customers.

The need for this new indemnification, and the extent of additional protection provided to Microsoft’s customers, has become the subject of debate in the industry. What remains to be seen is the impact this announcement will have on Microsoft customers and the software industry as a whole.

Indemnification — What does it mean?

Because of its nature, software may be afforded several different forms of intellectual property protection, including patents, trade secrets and copyrights. In protecting the intellectual property rights in software, the owners of the software are given the option of pursuing infringement claims against the manufacturer of the infringing product or against any of the end-users. This means any end-user could unknowingly and unintentionally end up as a defendant in an infringement case as a result of using licensed software in accordance with the license terms.

Accordingly, it is not uncommon for a licensee to request that its licensor agree to “indemnify” the licensee in the event that a third party brings an infringement claim against the licensee. Indemnification is akin to an insurance policy; it shifts the risk of loss due to a claim of infringement from the person holding the policy (in this case the licensee) to the person agreeing to indemnify or absorb the risk (in this case Microsoft). Thus, if the indemnified party (the licensee) has any loss as a result of an infringement claim, then the indemnifying party (Microsoft) will reimburse the licensee for that loss–usually including all attorneys fees.

As a result of the potential risks and expense of indemnification, it is often a highly negotiated term in software licenses. Now Microsoft has decided that it will take on the risk associated with claims that may arise under its licenses.

Of course, this risk is limited. Microsoft disclaims liability for claims based on (i) use of its software after it has told licensees to discontinue its use; (ii) combination with non-Microsoft products; (iii) damages attributable to the value of a non-Microsoft product; (iv) distribution to third parties; (v) unauthorized trademark use; or (vi) trade secret claims, if the claim is based on misappropriation by the customer. It also does not cover embedded products such as Windows CE or Windows XP Embedded.

Why Now?

Microsoft already indemnifies its volume license customers, and last year it increased the indemnification by raising the monetary cap on the indemnification protection. Why does it now feel the necessity to extend this protection to virtually all of its customers, and why is it such big news?

Most observers would agree that the reason is two fold. First, in view of the rapidly changing litigation environment, this new indemnification may help to raise the comfort level of end-users concerned about infringement litigation. This increasing litigation concern is primarily driven by the lawsuits launched recently by The SCO Group (“SCO”) against users of Linux operating systems. Such suits allege that end-users of Linux are violating SCO copyrights by running Linux operating systems which SCO alleges contain SCO proprietary code. Unlike most intellectual property infringement suits, these suits were not aimed at the distributors of the code, but rather the end-users.

These suits are somewhat reminiscent to the suits over the last year or so brought by the Recording Industry Association of America (“RIAA”) against individuals charged with illegally sharing music. While the situation with the file-swappers is fundamentally different in that these persons were knowingly and intentionally infringing copyrights, the overall perception of the general public as a result of the RIAA and SCO lawsuits, is increased awareness of potential risks to end-users resulting from intellectual property infringement. This in turn results in an increased call for end-user protection from such claims.

So, one of the reasons behind the new Microsoft indemnification language is probably, and quite simply, market demand. What is interesting about this, however, is that the most likely targets of any end-user suit would be large entity customers. These entities were most likely already covered under Microsoft’s volume license agreements. Accordingly, while the language may give some comfort to concerned end-users, it is not clear that it actually provides any additional protection for end-users truly at risk and it appears to be more sizzle than steak.

The second impetus prompting Microsoft to act now is to provide a competitive edge. In recent years, manufacturers and distributors of the Linux operating system and related software have emerged as a serious source of competition for Microsoft’s products. Although Red Hat, HP, Novell, IBM and other Linux product distributors have not yet matched the market share held by Microsoft, Microsoft clearly recognizes the risk of significant additional competition. Although major Linux distributors all have some form of customer protection in place, whether through indemnification provisions or warranty protection, Microsoft argues that the protection offered by these entities is not as broad or as encompassing as the protection now being offered by Microsoft, and claims that at least some key customers have chosen Microsoft products over Linux because of the expanded indemnification. If Microsoft is sufficiently able to demonstrate its customers have increased protection that is actually a benefit to them and the same protection is not being provided by distributors of Linux products, Microsoft is likely to retain or secure users that might have otherwise left the Microsoft product line. The question remains whether that protection is truly an advantage over the protection offered by the Linux competitors, and if so, whether that protection will be viewed as critical protection for new customers.

Real impact?

Much remains to be seen as to the impact of this new Microsoft indemnification. At a minimum, the fact that it has been deemed by many to be a newsworthy event has provided useful free marketing for Microsoft. In the end, however, it is not clear if the indemnification will prove only to be either a creative marketing strategy with limited benefit, or whether it will become a major change that will impact the entire software licensing industry. If indemnification proves to be a customer requirement and plays into purchasing decisions, this decision by Microsoft, for whatever reason it was made, could create a new industry standard. If, instead, customers are more focused on security and warranties, this new indemnification may have limited benefit for Microsoft without any negative consequences for its competitors.

Daniels Daniels & Verdonik, P.A. has been serving the legal needs of entrepreneurial and high technology clients for more than 20 years. Caroline Horton Rockafellow is a licensed patent attorney who works primarily in the areas of technology deals and licensing. Questions or Comments can be sent to crockafellow@d2vlaw.com