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The Morton Memo - July 2009

Law Offices of Eric D. Morton provide quality and responsive legal services

Welcome to the second edition of the new digital Morton Memo. This time around, we’ll be discussing intellectual property protection and how to deal with business partnership issues that can create a sticky situation at times! It is our hope you will find these regularly scheduled newsletters to be of value in your business. Please let us hear about any legal questions you may have that are important to you by e-mailing us.

>> Protecting Your Intellectual Property

>> Avoiding Pitfalls in Business Partnerships

>> Entrepreneurs: Keep Quiet!

 

PROTECTING YOUR INTELLECTUAL PROPERTY

All businesses have intangible assets that need to be protected, particularly intellectual property assets. These would include trademarks, copyrights and trade secrets. Systematic protection is called an intellectual property portfolio.

An IP portfolio is a method of protecting the IP of a business by inventorying, cataloging and periodically reviewing the business' IP. The reason for doing this is to prevent the loss of IP through the lapse of registrations or licenses and to prevent the misuse of a company's IP assets.

As an example, federal trademark registrations lapse after 10 years. Furthermore, a new trademark registration has certain filing requirements six years after registration or the registration will be cancelled. Unless a company has a systematic method of reviewing its IP assets, it may let the registration lapse. I have seen this happen.

Other advantages of creating an IP portfolio is that it reminds business owners of what IP assets they have and gets them thinking about their use and what else needs to be protected.

The last and most important reason for creating an IP portfolio is that it increases the marketability and value of a business. A company that does not have registrations for its trademarks or does not protect its copyrights is almost unmarketable. A company that not only protects its IP assets but has a standard system for reviewing and protecting all of its IP is much more valuable and attractive.

Large corporations have in-house attorneys, or hire big law firms to manage their IP portfolios. Companies that own large amounts of copyright protected material, own many patents, or have multiple brands, may have several attorneys dedicated to managing their IP portfolios. Those companies are very serious about protecting their IP. The small- and medium-sized business owner should act the same way.

How do you create an IP portfolio?

  • Take an inventory. Review all of the intellectual property of the company, including its copyrighted materials, trade secrets, trademarks and licenses.
  • Take steps to ensure that the company's IP is protected. Often the inventory will reveal assets that a company wasn't aware of that needs protection. Register copyrights and trademarks and create non-disclosure agreements. Also educate employees on the use of trademarks, copyright-protected materials and trade secrets.
  • Create an easy to use and understandable series of files or notebooks that have summaries of the company's IP. For instance, a file regarding a trademark might have a copy of the registration and a page with the dates that the registration must be renewed, and what goods or services with which it can be used.
  • Do a periodic review. Assign someone the job of reviewing the portfolio. I recommend not less than every six months. In this way, nothing lapses.

As a part of that review, the business owner should also think about what other IP assets the company has that need to be protected. For instance, a company might start using a trademark for goods that were not listed in its original registration. A new registration should be filed to list those goods. A well-managed IP portfolio can be invaluable to a business, by increasing the value of a company and preventing the loss of important IP.

For a modest fee, I help small- and medium-sized business develop their own IP portfolios. We review a company's IP assets and help organize a portfolio that the business can manage. I then send periodic reminders to my clients for them to review their portfolios. In this way, these businesses can have the same level of professional IP management as large corporations, even if they don't have their own in-house legal departments.

Contact us for a free consultation

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AVOIDING PITFALLS IN BUSINESS PARTNERSHIPS

A common, and potentially destructive, problem for businesses occurs when a partner in a business quits or stops working in his business. This might happen for a variety of reasons. The owners of a business might find that they are not compatible as partners, or they might discover that one partner may contribute much more to their business than the other. Other common issues are financial disputes between partners, including the simple fact that sometimes a business can’t financially support all its owners.

You should realize that historically, most business partnerships ultimately fail. Recently, I have been dealing with breakups between business owners. How harmful that breakup becomes depends on the amount of business and legal planning the owners put into their partnership in the beginning.

When I speak of partners, I mean owners of a business in which more than one person owns the business. This could be a general partnership, corporation or a limited-liability company. With each entity, the problem is nearly the same, depending on the type of business.

Frequently, the split happens when the owners do not have any agreements to cover this contingency. Typically, when individuals go into business together, they can be rather starry-eyed. They do not think that anything will occur that will disturb their partnership or cause it to fail. So, they do not think of things such as partnership or shareholder agreements that will cover such contingencies.

What happens when a co-owner of a business partner leaves? If the business is a partnership, then the partnership dissolves. Then either partner may, at anytime, cause the partnership to be dissolved and the business broken up. The debts of the partnership are paid and the remaining assets are distributed to the partners. As you can imagine, this could be a real hardship for the partners who might want to carry on the business.

If the business entity is a corporation or a limited-liability company, the situation is in some ways worse. Without an agreement to the contrary, the business continues. The remaining owners might be operating the business, but they now do so for the benefit of the departed owner. Without a shareholders’ agreement, or the appropriate provisions in an operating agreement, the owners who are still working in the business cannot get rid of their departed owner.

For instance, suppose two individuals own a corporation. They own an equal amount of stock in the corporation. Their intentions are to work full-time in the corporation’s business. Subsequently, they have a falling out and one of them quits. Without the appropriate agreements in place, there is nothing the remaining owner/stockholder can do. If the remaining partner wants to continue the business, he or she will do so for the benefit of other stockholder. 50% of the profits of the corporation will go to the stockholder who is no longer working.

The remaining partner cannot dissolve the business since dissolution takes a vote of 51% of the stockholders. The remaining stockholder cannot pay disproportionate dividends to himself or herself, as that would violate corporate law. Likewise, the remaining stockholder cannot set up a competing business and shift the existing corporation’s business to it. In either of the two above cases, the exited stockholder could successfully sue the stockholder working the business for breach of fiduciary duty. The only thing that the remaining stockholder can do is go to court and file a lawsuit to have the corporation dissolved by the courts. This, in turn, is very expensive and destroys the business.

What is the solution? Partners, stockholders or members of a business must have the appropriate agreements in place to take care of the possibility that they might have a falling out.

In the above example of the two 50/50 owners, the two owners would write down their expectations—that they intended to work full-time in the business with a shareholders’ agreement (also know as a buy/sell agreement). The agreement would state that if a shareholder who is working for the corporation ceases doing so, then the remaining stockholder would have the right to buy out the departing stockholder. The corporation and the stockholders would also sign employment contracts that state what each stockholder will do as an employee of the corporation. If a stockholder fails to perform, starts slacking off at work, or quits, then a mechanism is in place to buy out the stock of that stockholder and continue with the business.

Similar agreements can be reached in limited-liability companies and general partnerships.

What this really takes is a dose of realism between business owners when they get into business with one another. There are three steps in this process:

  • Look at each other realistically. Before individuals go into business together, they must ask themselves, what is each person contributing to the business? What are the strengths and weaknesses of each person? Do those compliment the strengths and weaknesses of the other? Are their styles of doing business, personalities, and working habits compatible? In other words, can they really expect to be able to work together?
  • What are the owners expectations? Do they intend to work full-time? Do they expect to draw salaries and make a living from the business? What do they expect to do for the business and what do they expect the other owner to do? The owners need to get their desires out in the open and fully discuss them, and agree as to how they are going to run the business, what they will do, and their business goals.
  • Finally, if the prospective partners can work together and their expectations are aligned, they need to get it all in writing. In fact, they need to talk to a lawyer and have those agreements professionally drafted. I can say with all humility that every dollar that business owners spend on shareholders/partnership agreements and employment contracts between them is money well spent.

I have litigated and handled disputes between business owners after they they parted ways. Those disputes are expensive and painful. They are very difficult to resolve due to the legal limitation set by the law—and every one of them could have been avoided if the owners had followed the three steps listed above.

These steps are simply good business practices and will more likely make the partnership succeed. Unstated and failed expectations are the most common grounds for disputes. If partners realistically look at each other, communicate what they expect and commit those expectations to writing, then the chances of them being successful are increased.

Remember, most business partnerships fail. They can be very rewarding but they are difficult to make work. If the owners have the appropriate agreements in place, the breakup between owners might be awkward and stressful, but it will be short and will reach an inexpensive conclusion. And that is much preferable to the alternate. Please contact us for further information and request and free consultation.

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ENTREPRENEURS: KEEP QUIET!

tradesecretsI have advised and represented several entrepreneurs in my career. They tend to be open and extroverted individuals interested in the next big thing: a deal, an invention, or a business idea. They are wonderfully productive and driven persons. They also have some downsides to their personalities, such has a tendency to not document transactions, not finish the organization of their business entities, and, potentially the most disastrous, the tendency to tell the world everything that they are doing or going to do.

I have known several instances when an entrepreneur has told others of his next great idea – and had it stolen. I have seen domain names, trademarks, business methods, ideas for inventions and other ideas stolen because a trusting entrepreneur divulged all. Sometimes, incredible as it seems, business owners/entrepreneurs will openly and fully describe their new venture—in great detail—to their competitors at trade shows or industry events. And they are always shocked and angry when their ideas are stolen, and almost invariably nothing can be done about the theft.

How can you protect ideas?

  • Copyrights can protect the description of an idea, but not the idea itself;
  • Trademark law protects the logos and names of businesses but not how they do business;
  • Patents protect the manifestations of ideas to a certain extent. However, ideas themselves cannot be protected unless they are kept secret.

Trade secrets are defined as any information that derives economic value from not being generally known and is kept secret (if reasonable efforts are made to maintain their secrecy). Trade secrets can include:

  • Business plans and methods;
  • Formulas;
  • Financial information and forecasts;
  • Customer lists, and many other things.

The first rule to maintaining trade secrets is to keep them secret—in other words don’t talk about them. This may seem obvious, but it is not so obvious in real life. People like to talk about what they are excited about, and often they will discuss details with their friends, family and contemporaries in business. Be warned that doing so makes those ideas fair game to anyone who hears about them. And the person taking advantage of the idea may be someone who hears it second- or third-hand because often people talk about what other people talk about.

The trick is to recognize when an idea is worth protecting. To paraphrase the law, what the entrepreneur needs to ask him or herself, is whether this idea is something that is valuable if only I know it. And can others use the information to their advantage and my detriment if they find out about it? If the answer is yes, then one had better keep quiet about it.

The second rule for maintaining trade secrets is to protect them. Remember, the law says that something is a trade secret if it has two characteristics: it is valuable if it is not generally known, and steps have been taken to keep it secret.

In addition to keeping quiet about ideas and items that should be kept secret, the entrepreneur should take physical steps to keep certain things secret such as locking up prototypes, putting passwords on certain programs or data, etc. Large corporations spend enormous amounts of money, including sophisticated security measures to keep their secrets safeguarded. The entrepreneur and the small- and medium-sized business owner may not need to take such extreme measures, but should be mindful of what is important that should be locked up or secured.

However, eventually other people will need to know of the secret. Employees will have to be in the loop in order to know business methods and customer lists or formulas. Investors and partners will eventually need to have trade secrets disclosed to them prior to contributing to the business. Also vendors and consultants will have to be informed.

As other persons will eventually need to know of trade secrets, the way to maintain those trade secrets is through agreements with those persons to keep them secret. These agreements are commonly called non-disclosure agreements or NDAs for short.

I don’t like the term non-disclosure agreement since its muddles what the agreement does. An NDA is actually a two-part contract. First, the party who is to learn of the secret agrees that it is a secret. Second, that party agrees to keep that secret confidential and not use it to his or her advantage or tell anyone else.

The first part is important and often overlooked. If there is any confusion about what was supposed to be treated as a secret, the party who learns of the trade secret can claim that he or she didn’t know that it was actually a trade secret. Most NDAs are vague about what secrets are being revealed and are so densely worded that they are probably not enforceable.

A professionally drafted NDA can be invaluable when it clearly states what is to be revealed and that all parties agree that it is a secret. Such an NDA will leave not doubt about the subject of the agreement and the expectations of the parties. It can be the final barrier in the protection of an entrepreneur’s next great idea.

If you need further information about trade secrets and how to protect them, or if you need a well-drafted, clear and enforceable NDA, call or e-mail us.

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