Trouble Indemnity

Earlier in this series, we discussed precautions that can and should be taken to avoid the pitfalls of online promotions (PROMO May and June). But suppose those safeguards fail, and disaster strikes? What’s a marketer’s liability?

In the absence of insurance, two possible entities bear the burden of an economic loss: the company suffering the loss or the company causing the loss. This is where the concept of indemnification plays an important role. “Indemnification” is a legal term that appears in the agreement between the marketing agency or sponsor and the digital promotions vendor. To “indemnify” is to shift, by contract, the responsibility for the payment of damages to someone else.

Let’s review a simple example to make the concept and the relationships clear:

Company A (the brand manufacturer) hires Company B (an agency) to market its new product. Company B retains Company C (a provider of online promotion design and implementation) to conduct a digital promotion introducing the product to the marketplace. As part of their contract, Company C agrees to indemnify Company B for harm resulting from Company C’s actions.

Company C’s hardware collapses during the promotion, leaving thousands of consumers angry and causing the FTC to investigate. Company A has incurred significant costs in appeasing its customers and responding to the FTC investigation, so it wants to collect these expenses from Company B. In turn, Company B seeks to collect from Company C, the digital promotions vendor who caused this mess.

Indemnification in this example means that Company C will have to cover the costs that Company B is forced to pay to Company A.

In this example, no insurance is necessary because Company C agreed to reimburse Company B for the damage Company C caused. But what happens if Company C lacks the financial resources to pay these costs? After all, the underlying reason for insurance is to manage the risks that could otherwise overwhelm a company, by shifting some of the liability to an insurance pool. There is no third-party insurer in this case, and Company B needs to treat the indemnification as a financial obligation owed to it by Company C.

Just like any other debt, Company B will seek payment from the digital promotions vendor with one important caveat: if Company C cannot extinguish the liability with a lump sum payment, then installments will be derived from Company C’s future revenue.

The future can be risky, and Company C’s bankruptcy or other similar business distress will make Company B the sole party responsible for the financial burden. Under these circumstances, the indemnification can be worth little, if anything. Therefore, it is important to identify and select a digital promotions vendor that is financially solvent and unencumbered by substantial debts. Ideally, the vendor has a diversified revenue stream from which to make future payments, on the theory that little or no revenue will be derived from digital promotions after the indemnifying incident tarnishes Company C’s reputation in the industry.

While we are on the topic of indemnification, let’s also discuss “infringement of intellectual property.” Intellectual property generally includes patents, trademarks/copyrights and trade secrets that are owned by someone else. Infringement of intellectual property is no trivial matter. Unless you have the right to use the work of a third-party intellectual party, you could incur potentially massive legal liability for infringement. The flurry of technology-related and promotions-related patents granted in the last decade is particularly worrisome, and it will be difficult to always ascertain whether a digital promotions vendor is either the exclusive owner of its intellectual property, or has obtained the necessary rights to use third-party intellectual property, or both. Therefore, the agreement between the marketing agency and digital promotions vendor should at the minimum contain representations that:

• The vendor has exclusive and unconditional rights to any intellectual property used in the digital promotion and has obtained the necessary licenses from third-parties for anything it does not own;
• The vendor will seek prior written approval from the direct marketing firm before incorporating or deploying any third-party intellectual property in the course of executing the promotion; and
• No portion of the promotion for which the vendor is responsible shall violate or infringe upon any patent, copyright, trademark, trade secret or other property right of a third party.

The next step is to ensure that the digital promotions vendor indemnifies the marketing agency for any harm that results from a violation of the above representations by the vendor.

Comprehensive indemnifications should complement any insurance planning and are not a substitute for industry-specific insurance coverage, but if insurance is unavailable or unaffordable, indemnifications become even more important. Digital promotions vendors that are financially sound with no litigation history are the safest bet. Take extra care to indemnify against intellectual property infringement issues.

Jed Weissbluth is with Ascent Marketing Partners. He can be reached at [email protected].