Coastal Contacts Inc. v. Elastic Path Software Inc., 2013 BCSC 133
Overturned on Appeal [2013 BCCA 541]
Elastic Path and Coastal Contacts entered into a Software Licensing Agreement allowing Coastal to use Elastic Path’s software. The Agreement included a provision containing common indemnity language requiring that Elastic Path defend any patent infringement claims made against Coastal arising from the use of Elastic Path’s software. The Agreement also included a mandatory arbitration clause.
Coastal was sued in the US (“Hill action”) for patent infringement for using the software. Contrary to the Agreement, Coastal failed to promptly notify Elastic Path of the Hill action. Based on this failure, Elastic Path refused to defend Coastal. Subsequently, Coastal initiated third party proceedings against Elastic Path in the Hill action, in breach of the arbitration clause.
Coastal settled the Hill action and claimed indemnification from Elastic Path for costs of defending the action and the amount of the settlement payment. Elastic Path initiated arbitration proceedings under the Agreement seeking a declaration that it was not obliged to defend Coastal nor to indemnify it.
The Arbitrator rejected Coastal's claim for indemnity and relief from forfeiture and ordered it to pay Elastic Path’s costs. Coastal applied for leave to appeal the Arbitrator’s decision.
Leave to appeal is granted.
Upon appeal, Coastal is granted relief from forfeiture and is entitled to recovery of the monies expended to achieve a reasonable settlement of the Hill action, as well as its costs. Elastic Path is entitled to the arbitration award of costs incurred by it in defending the third-party proceeding.
Duty to Defend – the Correct Test
In granting leave to appeal, the Court held that the Arbitrator committed an error of law in engaging in an analysis of the merits of the Hill action and, in essence, conducting a summary trial on the issues raised in that action. The Court emphasized that the Arbitrator ought to have confined his conclusions to the question of whether there was a mere possibility that the Hill action impugned the software.
Duty to Defend – Extrinsic Evidence
The Court underlined the limitation that the Arbitrator was entitled to consider extrinsic evidence only to determine the substance and true nature of the allegations in order to appreciate the nature and scope of the Elastic Path’s duty to defend.
Relief from Forfeiture – Actual Prejudice
Late notice of the Hill action alone did not deprive Coastal of the right to claim relief. Absent actual prejudice to Elastic Path caused by delayed notice, relief from forfeiture could be granted.
Coastal did not tender any evidence during the arbitration to prove the absence of prejudice to Elastic Path by reason of its late notice. However, Elastic Path had denied liability on the basis that there was no obligation to defend and, in that circumstance, non-compliance with the notice requirement did not prejudice Elastic Path because it would not have provided a defence or indemnity. The Arbitrator wrongly denied Coastal relief in the face of Elastic Path’s denial of its obligation to defend the Hill action.
Relief from Forfeiture – Unclean Hands
The Arbitrator erred in denying Coastal relief from forfeiture due to its lack of clean hands. The issuance of the third-party notice occurred because Elastic Path had breached its obligations to defend Coastal. Furthermore, the failure to give prompt notice did not have a direct relationship with the third-party notice nor was it unconscionable to such a degree that would disentitle Coastal to relief from forfeiture.
Leave to Appeal
Coastal has met the requirements for leave to appeal the arbitration award in that the importance of the result of the arbitration justifies intervention by the Court. The amount at issue is significant, the parties have a continuing contractual relationship, and there is merit to this appeal. The issues are such that, if the appeal is allowed, the outcome may be different.
Commentary
Intellectual property indemnity clauses can be a major source of risk for parties seeking indemnity protection and parties undertaking indemnity obligations. IP damages and associated legal fees can be substantial, and effectively managing the allocation of indemnity risk is a key commercial consideration. This decision highlights the risks associated with indemnity provisions in technology and licensing agreements, particularly when there is exposure to a claim with a US-patent infringement and damages dimension. As well, the case reinforces the principle that indemnity obligations and rights can turn on contractual principles, the underlying intellectual property principles, and a sprinkling of equity principles as well. The decision highlights the importance for parties to fully understand and manage both the contractual and IP implications of indemnity clauses, whether to limit risk and exposure as an indemnifying party, or to manage risk as a party seeking the comfort and (enforceable) protection of an indemnity right. This case serves to remind parties that through careful upfront drafting and negotiating, they can actively manage IP indemnity-related risks in their commercial contract portfolio, both as granter and beneficiary of such clauses.