Austin Technology Law Blog : Texas Technology Lawyers & Attorneys for Copyright, Trademarks & Software Licensing in Houston, Dallas & Austin TX

Startup Week here at AustinTechLawBlog continues with part 4 of our 5 part series on common startup issues – Employment agreements. Every company that has employees will need to make sure they properly set out an agreement between the company and the employee. There are many different types of provisions that can play a major part in your employment agreement, but we’re only going to cover a few today that seem to cause quite a bit of confusion. Non-competes, non-solicitation, and confidentiality are three areas of employment contracts that most employers and employees need to pay close attention to.

Confidentiality

A confidentiality (aka, non-disclosure) provision in an employment contract should protect the company’s sensitive information from being revealed to a third party. Many reasons exist why a company would want to accomplish this goal of confidentiality. For instance, the enforceability of some intellectual property relies solely on the confidentiality of certain information. Trade secrets are almost completely reliant on a company’s non-disclosure protection. If a company does not take the appropriate actions in maintaining secrecy, they cannot rely on the protection afforded in Texas (based on common law). The depth of confidentiality in trade secrets is beyond the scope of this post, but this Citizen’s Media Law Project article, does a great job outlining the basics of trade secret law in Texas. Patents also rely heavily on non-disclosure to ensure their protection, and if not appropriately handled the invention can actually lose its patentability if an application is not filed after a year of certain disclosures.

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Unfortunately not all businesses work out and must come to an end, or there is some even that requires the business to terminate.  How this occurs and how the business owner should handle it depend on whether it is a partnership (including limited partnerships and LLCs) or whether it is a corporation.  On the other end of the spectrum, a business may become so successful that it is in a position to receive substantial financing (venture capital or private equity) or even outright acquisition.  This post will discuss some issues presented in each of these circumstances.

Partnerships and LLCs:  Withdrawal and Winding Up

Certain events can bring about the withdrawal from a partnership under the Texas Business Organization Code (TBOC).  The most common are voluntary withdrawal, expulsion, the partner dies or ceases to exist, the partner enters into bankruptcy.  The partner's withdrawal must abide by the operating agreement to avoid breach.  If the partnership will continue after withdrawal, the exiting partner has a right to have his interest redeemed for the fair value on the date of withdrawal plus interest.  The partnership and withdrawing partner must come to an agreement on the redemption price.  If no agreement can be reached within 120 days after written demand for redemption.  The partnership must pay the withdrawn partner within 30 days its estimate of the redemption price. 

One issue to be aware of is the withdrawing partner's ability to bind the partnership.  For one year after withdrawal, a partner can bind the partnership to any agreement that would have bound the partnership before withdrawal if there was apparent authority to enter into the agreement, and the third party did not have notice of the withdrawal and reasonably believed that withdrawn partner was still a partner.  Additionally, the withdrawn partner remains liable for any partnership obligations that were in existence before withdrawal. 

When the partnership decides or is forced to "wind up" its operations, certain requirements under the TBOC must be followed.  A solvent business that is dissolved with liquidated assets must pay cash first to creditors and then to the partners' capital accounts.  Where a partner pays more than his share of the debt, he is entitled to a contribution from the others for that amount.

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In this, the third installment of “Start Up Week”, we will discuss some aspects of the fundamental document governing the internal operation and rules of a limited liability company (“LLC”). This is referred to in various state statutes as a “Company Agreement” (Texas) or an “Operating Agreement”. Regardless of what you call it, it contains the rules to live by in a LLC. Because of the blurring of the lines between various kinds of legal entities in the past few decades, the Operating Agreement is similar in many ways to the by-laws of a corporation and the partnership agreements in general partnerships, limited partnerships and limited liability partnerships, but the discussion in this post relates only to Operating Agreements.
“Why do I need one?” you might ask. You might tell me that you went on the Secretary of State’s web site and for $300 and 15 minutes of your time, you formed your own LLC and have not done anything else, so what’s the big deal?
Technically, you don’t even need a written Operating Agreement. An Operating Agreement can be written or oral, although I’m sure you recognize the problem of proof if you try to rely on an oral Operating Agreement. Therefore, you should have a written Operating Agreement even if you are the only member (owner) of a LLC. The Texas statutes recognize and provide for that situation, even if you are essentially agreeing with yourself. One of the best reasons for forming a LLC is the limited liability feature of such an entity and availing yourself of such limited liability requires that you treat the LLC as an entity separate from yourself in regard to contracting, bank accounts, leases, etc. The failure to make such separation can be that a court (in a situation you don’t want to be in) might say that since you disregarded the separate nature of your LLC, the court will do the same and therefore, you don’t have the limited liability protection. The existence of a written Operating Agreement, while not dispositive of the issue in and of itself, is evidence of your recognition of the separate entity and aids in the defense of any attempt to “pierce the veil” of the LLC.
Even if you don’t have a written Operating Agreement, the state has provided one for you. For example, in Texas the statute says, “To the extent that the company agreement of a limited liability company does not otherwise provide, (these statutes) govern the internal affairs of the company.”
So, if the state is going to write one for you, why not do one that might better suit your needs?
While not exhaustive, the following is a discussion of issues that should be considered in your Operating Agreement. These should be carefully considered and discussed with an attorney and an accountant to determine if they actually achieve the goals that the members have for the LLC and their investment in it. Also, since we have treated the posts during this “Start Up Week” as alpha and omega and “Cradle to Grave”, you can consider the Operating Agreement as a giant pre-nuptial agreement relating to the very real relationship you will be entering into in a multi-member LLC. Therefore, you should provide for how you get into the relationship, how you act during the relationship and how you are going to end the relationship. Good advice in life, good advice in LLCs.
Issues:

1. What happens when you or another member want to sell your interests?

Interests in small LLCs tend to be closely held and not particularly marketable, so this tends to be self-limiting. However, absent some contractual restriction, LLC interests are freely assignable, and you don’t want to wake up one morning and find that you are in business with someone that you didn’t anticipate, so you should consider restricting the sale in some way. Some methods of doing this are: (i) right of first refusal in favor of the LLC and the other members on the same price and terms as offered by a third party; (ii) exercise of a “stare-down” agreement (also called “push-pull”) where a party desiring to sell names a price and the other member(s) can either purchase the interest at that price or sell their interest at that price but one or the other has to occur; and (iii) declaration of intent to sell where a party who desires to sell declares that intent and the terms upon which the party would sell (this is similar to the right of first refusal but there is not a ready buyer at the time).
Other situations that you would possibly want to consider are purchase of a member’s interest in the event of divorce, death, disability, bankruptcy, retirement, breach of the Operating Agreement or termination of employment for good cause. The situations in this paragraph would require the establishment of a value for the interest that can either be done in the Operating Agreement (generally forgotten and rarely updated) or by a method established in the Operating Agreement (e.g. third party appraisal).

2. How capital is to be contributed and gains and losses are to be allocated?

In the event that not every member contributes the same amount to the enterprise (e.g. some contribute money, some contribute intellectual property or labor, etc.) the dynamics and results of that non-symmetry needs to be considered. The maintenance of each member’s capital account and how that will be affected if different capital contributions are made but gains and losses are passed through in equal amounts should be discussed in depth with a financial adviser. Also, if future capital contributions are to be made, what happens if there is default? Is the defaulting party’s interest subject to being bought out at some pre-determined price or is the defaulting party’s interest terminated? Other consequences can be set out. One of the values of a LLC is its flexibility. As long as it is not illegal, you can agree to do it in an Operating Agreement.

3. What are other considerations?

Aside from how to capitalize and distribute gains and losses and how to manage a termination of the relationship, other issues to be considered are how to form and manage the enterprise, whether to have the LLC indemnify the members for certain actions and whether to distribute money to pay for tax liabilities in certain situations.

Obviously, any lawyer worth his salt can work one of these agreements into a multi-volume set. However, the time, effort, expense and thought put into this on the front end when people are much more agreeable can avert a number of issues down the road when they might not be so congenial.
Avoiding future problems, that’s a good thing.
 

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So now you've chosen your entity, it's been incorporated, you have startup capital and are up and running, you've spent thousands of dollars in creating a logo, branding, and marketing.  Things are going great, and then one day you are hit with a cease and desist letter stating that you are infringing on another company's trademark because the name you are using is confusingly similar to the other company's name.  Now you are not only in danger of being sued, but you've just wasted thousands of dollars and many months of hard work on a name and brand you can't even use.  This is just one illustration of how important it is to assess as early as possible the intellectual property (IP) landscape of your company.  Three questions every new business owner should ask: "What IP does my company have?", "How do I protect that IP?" "Am I in danger of infringing the IP rights of another?"  This post will give a summary of the main types of intellectual property, how to protect IP, and how to avoid infringement.  This is just a summary and is no means comprehensive.  Every new business owner should consult with an attorney about their IP issues.

The four main types of IP: 1)Trademarks 2)Copyrights 3) Patents and 4)Trade Secrets. 

TRADEMARK LAW

Trademarks allow a company to easily distinguish itself in the marketplace in the minds of consumers.  A well known trademark is often one of a company's biggest assets.  Trademark law gives a company the exclusive right to use a distinctive mark used to identify its goods or services.  It allows for a company to develop a brand in the marketplace without fear that another company will cause a "likelihood of confusion" by using a similar mark.  Trademarks do have "common law" protection under federal law and the law of most states; meaning that you do not have to register to have protection.  But registering your distinctive mark at the federal and state level provides a number of benefits.  Registering serves as constructive notice that your mark is in use, it makes it easier to prove your case in court, and it gives you protection in a far greater area.  Prior to registration, the mark should be followed by "TM" for trademarks and "SM" for service marks.

Not all names are available for trademark protection.  The mark must be sufficiently distinctive.  The level of distinctiveness depends on the context it is used.  Generic or common terms are not protectable if they are used in the area they describe.  For example, "Apple" is protectable when used with computers, but would not be protected if the company sold fruit.  Marks can't be overly descriptive either.  For example, "Eye-Care Center" would not be protectable for an optometrist's office.  Suggestive marks have a better chance of obtaining protection, but are not perfect because they could be seen as too generic/descriptive.  For example, "America Online" is suggestive of the services it provides.  The best choice for a protectable mark would be an arbitrary or fanciful term.  (Think "Yahoo!" and "Google")  It should be noted generic or descriptive marks can become protectable through their use. A mark can obtain "secondary meaning" through its extensive and continuous use in commerce to such an extent that it has achieved the required level of distinctiveness. 

Picking a distinctive mark is just half the battle.  You must also ensure that you are not using a mark that infringes another company's rights.  The basic test the courts use when determining if a mark is infringing is "likelihood of confusion" in the minds of consumers.  There are thirteen factors courts consider when determining likelihood of confusion.  (Known as the "DuPont Factors")  You should search extensively for similar marks on the USPTO website  and consult with an attorney before deciding on your mark.

COPYRIGHT LAW

Copyright law protects original works of authorship fixed in a tangible medium of expression.  Obviously, this includes many areas: literary works, musical works, dramatic works, photos, paintings, sculptures, architectural works to name a few.    Business that don't produce these types of works should still consider whether they have copyrightable material.  Marketing materials, training materials, or other works that the business creates during its operations could potentially be copyrightable.

Anytime a business contracts to create something new it should consider the copyright involved.  Just because someone creates something for a business doesn't necessarily mean the business own it.  This is a common issue in "works for hire" cases, and every company should address ownership of the copyright when contracting for works made for hire. 

Similar to trademarks, copyrights can be registered, but they do not have to be.  Copyright protection exists from the moment of creation.  But like trademarks, there are a number of benefits from registration.  It is much easier to prove infringement if the copyright is registered, there are substantial statutory damages as well attorney fees available to the registered copyright holder.  Copyrights are relatively easy to register compared to patents and trademarks, but registration can be deceptive in its simplicity.  Consulting with an attorney is recommended. 

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This is the first installment of Startup Week here at AustinTechnologyLawBlog.com. We’ve talked with some small companies here in Austin and there was a request to focus our attention on some of the legal issues facing a local start-up. So we were happy to oblige. 

This first blog post focuses on business entity selection and will try and give a quick summary of the more popular Texas entities and give some advantages and disadvantages of each. It is important to notice that this information is meant to be educational and informative for the public, anyone attempting to form a business entity should consult an accountant and an attorney before forming an entity. This does not constitute legal advice in anyway. Personal wealth, investments, future investors, as well as a number of other issues can significantly change the outcome of the entity selection.

Sole Proprietor

A sole proprietorship is one of the most common and simplest forms of a business entity. When an individual begins work without formal registration with the state the individual/company is seen as a sole proprietor. The default entity for an individual, a sole proprietorship is the easiest to form and least expensive business entity out there (grand total of $0, unless you operate under a name other than your own surname then you would need to reserve an assumed name). The money from the business flows directly to the owner, and the owner can distribute the money as he/she sees fit. However, with such freedom comes much responsibility. The biggest trade off here is likely that a sole proprietor must assume all liability of the company. If the company defaults on a contract, an employee wrecks a car, someone slips and falls, etc. and damages are due from the company, not only would the company assets be subject to the judgment, but so would the owner’s personal assets.

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After asking some of our clients and others in the Austin business community what issues they would like to see Austin Tech Law Blog cover, the most frequent response was startups and the legal issues they face.  Be careful what you wish for. 

This week, ATLB will be blogging a "Startup Week" where we'll cover issues from the inception (great movie!) of a company to dissolution, or more optimistically, acquisition/funding. 

• Monday:  Entities:  Which entity should you form under?  The pros and cons of each.
• Tuesday:  Intellectual Property:  If you have it, how do you protect it?
• Wednesday:  The Operating Agreement:  What issues should you consider when creating it?
• Thursday:  Employee Agreements:  Issues in employment agreements  including noncompetes, nonsolitication, and confidentiality agreements.  
• Friday:  Dissolution, Acquisition, or Final Funding:  What issues should you consider for each?

So check in each day as we discuss the various legal issues you should consider when forming and operating a startup.

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Recently, one of our clients received an email from Chinese domain registration company stating a

 foreign company was attempting to obtain their domain name. Our client, for purposes of privacy we’ll call them “CustomerName,” is a start-up in the process of obtaining a trademark of their company name. This email, although suspiciously spam-like, created some concern and

 confusion for CustomerName. Was this spam? What rights would they have if a foreign company was to use this domain name? What is my recourse?

First things first, it’s important to determine whether something like this is just a “Nigerian Prince” scam. A quick search turned up an article on the domain registration email our client received. The article, by Happy Living with Hosea, provides a great analysis of the drafting of the email. Hosea pointed out things a Chinese company would have likely done differently if this was a legitimate operation. First, it was evident something peculiar was up based on the grammar and punctuation of the email. I’ll be the first to admit I send out letters with grammatical and punctuation errors on a daily basis. However, this one bereel bad! So I feel “it is our duty to notice you” (a little example) of how this poor drafting is a good indicator of a scam. Additionally, had this been one carelessly drafted email that would be one thing, but after some research, it becomes clear this is not an isolated case (just read the comments to the Hosea article).

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We recently wrote about the recent Bilski holding, and how the narrow decision seemed to do little, except for increase the confusion about business method and software patents. The issue is understandably complicated (likely why the Supreme court punted this decision), and the holding is evidence of that. As I was reading Techdirt, I saw The IEEE recently released a press release that illustrated how confusing the recent decision actually was. The IEEE reported, "The U.S. Supreme Court ruled 5-4 Monday that a new method of doing business can be patented, and that the ability to patent software should not be limited." As Techdirt points out, this is not exactly the case. It was not a 5-4 decision, but a 9-0 with a split majority, and the holding did not succinctly state “that a new method of doing business can be patented.”

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In the highly anticipated decision, Bilski v. Kappos, the Supreme Court affirmed the rejection of a specific business method patent, but left the door wide open on the validity of thousands of similar patents.  In what has become typical for decisions under the Roberts Court, the majority opinion was narrowly defined.  The court ruled only on the specifics of the case while failing to provide much guidance for similar patents. 

Watching the case intently were both sides of the patent divide. Of course, large sectors of the economy depend on patent rights for growth and innovation, and many feel that more patent rights further innovation. However, there exists a large segment of the business community, including many in the tech industry, who were hoping the court would take this opportunity to put an end to controversial business method patents (and software patents) by applying the "machine or transformation" test adopted by the Federal Circuit.  The test requires any patent to either: 1) be tied to a particular machine devised to carry out a process in a non-conventional, non-trivial way, or 2) transform an article from one thing or state to another.  Abstract ideas like business methods would not satisfy the test. 

At issue in Bilski was a rejected business method patent for a system to hedge on energy prices using weather projections.  And while the court rejected this particular patent, it went out of its way to state that it was a narrowly defined decision, and the machine or transformation test is only "useful and important clue," but should not be the sole test.  Many justices on the court expressed doubt about the validity of business method patents, but a majority of them were not ready to categorically exclude them from patentability.  The result is that thousands of business method patents and software patents remain valid, but future litigation will be needed to determine which ones.  So the lesson as always: nobody really wins except the lawyers. 

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