Microsoft Deepens Indemnity

In the wake of rising concerns within companies about intellectual-property lawsuits over software, Microsoft is considering ways to broaden the indemnification policy that provides legal protection to its customers.

The vendor already promises to shield business customers that sign its volume license agreements from patent-infringement or other claims that might be made against its products by outside parties. Now, amid growing questions from customers about their legal exposure, "we're revisiting ways to make our indemnification as compelling as possible," says David Kaefer, Microsoft's director of business development for IP and licensing.

It's unclear what Microsoft has in mind, but the possibilities include expanding its indemnification policy to cover all business customers and maybe consumers. Microsoft executives have been promoting the company's indemnification coverage as a reason to license Windows at a time when questions are being raised in the courtroom and elsewhere over the source-code lineage of the Linux operating system.

"We understand that being on the wrong end of a software-patent lawsuit could cost a customer millions of dollars and massively disrupt their business," CEO Steve Ballmer wrote in a letter distributed via E-mail last week to Microsoft customers and partners.

The potential legal ramifications for software customers were driven home earlier this year when SCO Group filed lawsuits against AutoZone Inc. and DaimlerChrysler AG, after months of warning hundreds of companies that the use of Linux infringed on its Unix intellectual-property holdings. (In a related action, SCO Group is locked in a $3 billion suit with IBM over the alleged misappropriation of SCO Group's trade secrets.) More recently, Java users worried that they might be susceptible when a software-patent lawsuit by Eastman Kodak Co. against Sun Microsystems swung in Kodak's favor. Sun agreed a few weeks ago to pay Kodak $92 million to settle the matter.In a September speech to the Massachusetts Software Council, Ballmer warned that commercial software companies need to be thinking about the same issues. "Let's say you know you want to build your business around Windows or Linux," Ballmer said. "You have to decide what intellectual-property risk you want to build, what additional cost you might be pushing to your customers that is unanticipated because nobody stands behind the stuff."

That last remark is somewhat of an overstatement. While it's true that some Linux distributors don't offer indemnification, others do, though their offers of legal protection vary. Just over a year ago, Hewlett-Packard began offering indemnification to customers that run Linux on HP computers, subject to certain limitations. And in January, Novell introduced an indemnification program to cover customers of its newly acquired SuSE Linux. The Open Source Development Lab, a consortium of open-source developers and commercial software companies, has created a defense fund to help defray potential legal expenses of Linux users. However, the fund can be applied only to cases associated with SCO Group's litigation, and source-code contributors aren't covered.

Microsoft strengthened its original indemnification, or "duty to defend," policy in April of last year. It expanded the policy's provisions to cover trade-secret and trademark claims and removed a monetary cap on damages. "They're saying, 'We accept full responsibility.' That's almost unheard of in the industry," says Yankee Group analyst Laura DiDio. In doing so, Microsoft is exploiting the fact that some Linux distributors have been unwilling to provide their customers with similar guarantees, she adds.

None of this is lost on business-technology decision makers. "I have a lot of conversations with my various software vendors to make sure we stay on the right side of the licensing questions," says Mike Green, CIO of United Pipe & Supply, which sells water-distribution equipment for irrigation and golf courses. One software vendor recently pitched a Linux-based product to United Pipe. Says Green, "I'm asking, 'What flavor of Linux?'"

Customer protection is just one aspect of a broadening intellectual-property strategy at Microsoft that's putting greater emphasis on patents and cross-licensing arrangements and less on its trade-secret approach of the past. Kaefer says there are five underpinnings to Microsoft's new model: using process controls to track the origins of software; securing intellectual-property rights through patents and other techniques; acquiring rights for third-party software used by Microsoft; licensing its software; and protecting customers via indemnification.

In the process, Microsoft is building up its own patent portfolio. Chairman Bill Gates estimated this summer that Microsoft would file 3,000 software patents in fiscal 2005, a 50% increase over this year. Kaefer refers to patents as the "currency of exchange" used by vendors to assemble the technologies they need to build products without reverse engineering another company's approach or other workarounds.Patents also yield clout. "The more patents you hold, the more likely you are to legitimately restrain others from entering your market. That's what patents do," says Brian Beatus, a partner with the law firm of Pillsbury Winthrop LLP and head of its Silicon Valley IP group. For this reason, Linux distributor Red Hat Inc. argues that software patents impede innovation. Red Hat has begun filing for patents, too, but only for what it describes as "defensive purposes."

In the past 12 months, Microsoft has reached cross-licensing deals with Cisco Systems, SAP, Siemens, and Sun, and it has existing agreements with Hewlett-Packard, IBM, Unisys, and Xerox. The goal is to strike more of these deals, in which Microsoft doles out its patents in order to gain access to those of other companies. "If you can put deals [like these] in place, you can solve 80% to 90% of the patent puzzle," Kaefer says.

Microsoft isn't immune to intellectual-property disputes. In early April, the company agreed to pay Sun $900 million to resolve patent issues and $350 million in royalties. A few days later, it disclosed plans to pay InterTrust Technologies Corp. $440 million for access to that company's patented digital-rights-management software.

And the U.S. Patent and Trademark Office is re-examining patents awarded to Microsoft for its File Allocation Table file system, an early version of which was developed by Gates in 1976. Microsoft plans to respond to the Patent Office inquiry within 60 days.

Going forward, Microsoft will seek more licensing agreements of the type revealed in early October with PalmOne Inc., which will use Microsoft's ActiveSync protocol for wireless E-mail synchronization between Palm OS-based smart phones and Microsoft's Exchange Server.Microsoft also continues to expand its 3-year-old Shared Source Initiative, through which it makes source code for Windows and other products available to customers, outside developers, and students, under Microsoft's terms and conditions. For instance, Microsoft recently opened the source code to its Office 2003 applications suite to government agencies that qualify for its government security program. More than a million people have participated in Microsoft's shared-source program.

Microsoft also is assessing how its technology gets absorbed into the evolving world of Web services. In the months ahead, Kaefer says, it plans to be more "prescriptive" about when its .Net Web services code is available for royalty-free use.