Liability management: Intellectual property rights-related recourse claims

This article reviews certain measures aimed at optimising the liability of consumer goods producers and supply chain actors in business-to-business transactions. Although the legislation that provoked these thoughts and interpretations is consumer-protection legislation, this review will not address business-to-consumer liability issues.

The relatively new Directive (EU) 219/771 of the European Parliament and of the Council of 20 May 2019 on certain aspects concerning contracts for the sale of goods (amending Regulation (EU) 2017/2394 and Directive 2009/22/EC, and repealing Directive 1999/44/EC ("SGD")), has shifted the spotlight onto the legal defects of goods and the legal consequences related to such defects. In contrast, the usual legislative approach until now was for consumer-protection legislation to cover mainly material defects, where legal defects had been left to the rules of the respective local general civil law.

Already in paragraph 35 of its preamble, the SGD states that "Conformity should cover material defects as well as legal defects." In addition, the EU legislator pays special attention to legal defects related to violation of intellectual property rights ("IPR"), by confirming in the same paragraph that "Restrictions resulting from a violation of third-party rights, in particular intellectual property rights, could prevent or limit the use of the goods in accordance with the contract." Moreover, the SGD provides for identical legal consequences for both material and legal defects, by stipulating that "Member States should ensure that in such cases the consumer is entitled to remedies for the lack of conformity as set out in this Directive, unless national law provides for the nullity of the contract or for its rescission in such cases."

Developing the above principles, as set out still in the preamble, Article 9 SGD entitled "Third-party rights" provides that "Where a restriction resulting from a violation of any right of a third party, in particular intellectual property rights, prevents or limits the use of the goods in accordance with Articles 6 and 7, Member States shall ensure that the consumer is entitled for the remedies for the lack of conformity provided for in Article 13, unless national law provides for nullity or rescission of the contract in such cases."     

Consider the following example: A consumer bought some goods from a seller, but already in the process of producing the goods third-party IPR were violated. The holder of the IPR legally enforced its rights and/or ensured their protection (by restrictive technical means). The IPR protective measures resulted in the prevention or limitation of the use of the goods by the consumer (for example, the functionality or compatibility of the goods have been negatively affected).

Risk of recourse (redress) claims

In this hypothesis, the SGD provides the consumer with the same remedies applicable for the cases where a material (technical/non-legal) defect occurred, namely bringing the goods into conformity (replacement or repair), price reduction or right to terminate the contract. Of course, the main liable party is the seller – the counterparty of the consumer in the business-to-consumer sell-purchase legal relationship. All the extrajudicial (reclamation) and judicial (claim) instruments would be directed by the consumer against the seller. The seller would need to bear the burden of its hard and generally unmanageable liability under the SGD (and under the respective local consumer protection legislation); liability for something for which the seller would usually not have any fault and, in most cases, no idea about the existence of the legal issue itself, i.e. a violation of third-party IPR resulting in limitation of the consumer's right to use the goods.

To ensure a balance of interests of the parties involved, the SGD provides the seller with the right to recourse (redress) against the person or persons liable in the transaction chain, i.e. mainly the producer and the wholesalers (Article 18 Right of redress). The particular categories of persons to play the defendant in case of such a recourse claim will be determined by the respective national law.

IPR clearance (pre and post production and distribution) is an integral part of each diligently managed production and commercial process. The problems appear either as a result of intentionally or unintentionally skipping the IPR clearance process, or because full and exhaustive IPR clearance (to give a 100 % guarantee) is not always possible, especially as regards copyrights. To be more precise, it could be possible, but only with an outlay of money and effort far exceeding any reasonable business and financial plans and resources. That is how producers and wholesalers could easily fall into the trap of bearing sometimes hundreds or thousands of recourse claims related to IPR infringement in the context of Articles 9 and 18 of the SGD.

Liability management – risk-mitigating measures

When addressing the general conditions on the discussed recourse claim, the SGD explicitly underlines the relevance of both the active and passive behaviour of the person or persons liable in the transaction chain. That is why it is strongly advisable that commercial players actively take all possible measures directed at mitigating the risks of third-party IPR violations and of bearing material negative legal consequences on their smooth commercial operations, stable asset status and reputation.

IPR clearance process

IPR clearance is the gold standard preceding a diligently managed and driven production and distribution process. It involves, among other things, identifying the relevant rights and respective holders, assessing the quality and stability of the rights, tracing the right-holding chain, outlining the types, volume, territorial and time parameters of the necessary rights to be acquired for the needs of the projected production and/or commercialisation process, identifying the legal instruments to best serve the proper  acquisition process, and acquiring all the necessary IPR.

Declarations

Since full and exhaustive IPR clearance is not always possible (especially regarding copyrights and other non-registered rights), it has become common practice for the IPR assignor to undersign a declaration (as a separate document or as part of the contents of the respective IPR transfer/licence agreement). Such a declaration would usually consist of declaratory confirmations on the fact that the declarer is the sole owner/holder of the respective rights and no third party holds and could enforce any rights over the respective object of the relevant rights. However, the legal value of such a declaration would be insignificant if not secured/covered by respective securities. Real securities (like pledges and mortgages) are not really feasible (though not impossible in the case of big establishing/financing deals). Contractual securities would be more often proposed and accepted by the parties either in the form of damages compensation or a liquidated damages compensation obligation. Of course, the effectiveness of such contractual instruments would depend on the applicable law and agreed jurisdiction (arbitration inclusive).

Liability limitation measures

Since the IPR clearance and the IPR declarations could not fully mitigate the risk of adverse developments, the next possible step would be to limit the respective contractual liability. When speaking about limiting contractual liability we should not forget that although there is (almost) no option for limiting the seller's liability (in business-to-consumer legal relations) towards the consumer, the options for limiting the producer's/wholesaler's liability (in business-to-business legal relations) towards the retailer, for example, are not so limited. Of course, such limitation would be subject to the relevant local laws, including the contractual liability limitation rules and the relevant competition rules.

Contractual liability insurance

Even if the above measures have been duly taken, there will still be the risk of liability remaining uncovered. The reasons could be both objective (deficiencies in the nature of the chosen measures) and subjective (omission of relevant facts and rights). Here insurance, in particular contractual liability insurance, steps in. It could be in the form of general contractual liability insurance or in the form of specialised IPR-related recourse claims (within the meaning of the SGD). The insurance companies may even structure and roll out special insurance products in that regard. Of course, when it comes to insurance, budget issues are always on the rise. However, the "volume" of the liability to be insured and the risks to be covered could be optimised with the help of the other measures already taken, i.e. IPR clearance, IPR declarations and the contractual liability limitation.

A holistic approach

A proper liability management process requires a holistic approach, one that takes into consideration the specific territorial, time, subjective, objective, legal, factual, dispute-resolution-related and enforcement-related parameters of the particular business intention, both in the short and long term. There is no doubt that structuring and applying such a liability management process would require a significant investment of time, effort and money. Not to mention that such management will be less effective if applied only at the start (prior to production, for example), without a healthy monitoring programme to be applied during the distribution process, especially taking into consideration the dynamic of the companies' IPR portfolios. However, the potential trigger of the IPR violation discussed above – a recourse (redress) claims chain reaction – could result in material negative legal consequences, not just for particular producers and distributors, but for whole sectors of the economy, by drastically exceeding the expenditures necessary for proper and timely management of the relevant liability when selecting and taking risk-mitigation measures.

author: Ventsislav Tomov