Bsusiness Lawyers Toronto Barrie

How Startup Can Lose Intellectual Property

Startup the new company while working for the old

Starting a successful new company requires good ideas, intense commitment, and the willingness to take risk. Many entrepreneurs try to put off the risk-taking by staying in a salaried job for as long as possible. This approach can lead to a lawsuit – and even to the loss of intellectual property developed for the new company. While the law in Canada and the USA is clear that one can prepare to start a new business and can even prepare to compete while working for one employer, the law is equally clear that actually starting a new job or competing while employed is a breach of fiduciary duty. The employee has a duty of undivided loyalty to his or her employer.

What this means, in practical terms, is that an employee who is supposed to be developing software for a current employer should not be developing software for a new company, even at home and even after hours. Otherwise, the soon-to-be former employer may have a viable claim that it owns the software, particularly if the software relates in any way to work the employee was supposed to be doing while on salary or was created using property of the former employer. Even if that claim ultimately fails, time and money spent litigating the issue with the prior employer can quickly drain startup capital. Further, while working for one company, the employee should not be soliciting its employees or customers to move to a new company. The employee needs to quit first and, unless contractually prohibited from doing so, recruit later. The employee should not be soliciting new customers on behalf of the new company, either, since the claim could readily be made that by so doing, the employee was diverting a business opportunity that should have been shared with the employer. Finally, the employee should not permit work to get the new company up and running to interfere with his or her work for the employer. Doing so may lead to a claim that the employee must repay the salary received during the period of overlap.

Wait to search and register trademarks and domain names until launch of the company or product release

Many entrepreneurs conceive of clever, memorable trademarks and trade names they plan to use once their business gets started. These trademarks and trade names dominate their thinking, their presentations to investors and potential employees, and their graphics and product design. When they finally get around to conducting a trademark search, however, they may discover that someone else has already registered, or is using, the very trademark and/or trade name they had counted on for similar goods or services. While that earlier registration may be the result of misappropriation - the registrant learned the entrepreneur's intended trademark and pirated it for its own use - more often the problem is simply that someone else independently thought of, and protected, the same trademark or trade name first.

To prevent the attendant loss of momentum, the entrepreneur should conduct a trademark search as soon as he or she comes up with an appealing name. The greater the commitment to the trademark, the more comprehensive that search should be. An initial screening of registered trademarks may knock out some proposed marks early on or raise some red flags by showing that others have registered or claim rights in the same or a similar trademark as a word or a logo. This limited search cannot, however, clear a proposed trademark. In trademark law, one gains rights by using the trademark, whether or not one seeks a registration. Thus, someone else may have acquired rights in the proposed mark by using it without filing for a registration. A good example is one of the designs for the Coca Cola bottle, which was only registered as a trademark many years after it was first used.

If the entrepreneur starts using a mark someone else had been using, the “prior user” may be able to put a stop to the new use in the territories where the prior user had used it first. Such “common law” rights enabled the University of Nebraska to stall NBC's proposed national launch of its new stylized “N” logo several years ago. Exacting common law searches are necessary to detect such use of proposed marks in commerce by third parties. These searches check telephone directories, trade journals, domain name registrations, provincial filings, and other resources. How can the Company protect the trademark it selects? Obtaining a registration with the Canadian Intellectual Property Office (CIPO) can certainly help. Many entrepreneurs believe that they cannot register their own proposed trademark until they can prove that they are actually using it. Since 1989, however, the CIPO has allowed parties to “reserve” trademarks they hope to use shortly but are not yet using in commerce. By filing a “proposed use” trademark application, they can get the trademark approval process underway and, if successful, obtain a registration once they begin using the mark which will be effective as of the date of filing of propose use application. In most instances, an entrepreneur will want to consider this approach, since a registration can generally give the applicant nationwide rights against later, or “junior,” users of the trademark even if the applicant has not actually used the mark nationwide.

Ignore trademarks and concentrate solely on domain names

Many entrepreneurs seek domain name registration the moment they think of a name. If they succeed, they believe they have protected “their trademark” and that others will not be allowed to use similar marks, online or elsewhere. This belief confuses domain name rights with trademark rights. The two are related, but are not identical. Registering a domain name, such as “www.goodidea.com,” simply gives the registrant the right to use that precise name as an Internet address. Obtaining a domain name, however, does not even prevent others from registering similar domain names, such as “www.good-idea.com”. Nor does it stand as a certification that third parties are not already using the name. Apart from seeking some representations from the applicant, the domain name registrar does not make an independent determination of the applicant's right to use a particular name. This means that the party that registers a name as a domain name will not necessarily prevail in an infringement lawsuit if another party has used the name first. Many entrepreneurs are familiar with this principle in the context of cyber squatting, when pirates register domain names incorporating well-known trademarks intending to sell them back to the trademark owner. The pirate who first registers “www.cocacola. com” will not thereby gain rights superior to those enjoyed by the Coca Cola Company. But the distinction between domain name rights and trademark rights can also affect the innocent domain name owner who has simply never checked to see if others are using the same or similar name as a trademark.

Just assume that the company owns what it pays others to create

Once they are up and running, many startup companies understandably rely on consultants, part time employees, or “jacks-of-all-trades” who do everything from marketing to raising capital to writing software. Each of these approaches at the very least complicates the question of whether the company owns the intellectual property it has paid others to create. Contrary to popular belief, simply paying someone who winds up creating intellectual property does not make the work created a “work-for-hire” belonging to the company. Nor does the fact that an employee created intellectual property necessarily make that property an asset of the company if it was created outside the scope of the employee's duties or without using company property. Under many circumstances, failing to obtain properly worded written assignment or work-for-hire acknowledgments will leave the company with only non-exclusive rights in the intellectual property. The parties who created the property will also be able to exploit and license it – with no obligation to pay any proceeds to the company. Moreover, by the time the lack of assignment agreements becomes apparent, many of the contributors to the intellectual property may have scattered or be unavailable, making it difficult if not impossible to cure the problem.

A related mistake is failing to keep copies of intellectual property created for the company. If the company has overwritten the software it wishes to protect, for example, or has failed to keep clear records of how and when its invention was developed, it may not be able to seek a copyright registration or apply for a patent. Moreover, the intellectual property owner who claims that a third party has infringed an early version of its software but does not have a copy of that version to introduce into evidence may face dismissal of the case. Even well-established companies have suffered these consequences of sloppy early record keeping. The solution? Archive and retain in company files all material variations of the intellectual property created for the company. Careful record keeping will also make it easier to sell or license intellectual property later on.

To generate excitement, freely disclose the company's plans and intellectual property without a confidentiality agreement

Entrepreneurs typically need to present their ideas to many people before they can get up and running or take the business to the next level. Bankers, angels, venture capitalists, strategic alliance partners, and key customers, among others, may all need to investigate the entrepreneur's ideas before they can commit to back them. But the more people who learn the plan, the more people who can divert it to their own use. While under certain circumstances courts may be willing to impose a duty of confidentiality on potential investors and others with whom the entrepreneur has shared his or her ideas, counting on these “implied” protections is foolish. Before presenting confidential intellectual property or business plans, or even proposed trademarks, the entrepreneur should get a written commitment that the information will not be used or disclosed except for purposes the entrepreneur specifies, and that all documents, including notes, discussing the disclosures will be returned or destroyed once the specified use ends. (Filing a “proposed use” application should give further protection for the proposed trademark.)

Many entrepreneurs fear that insisting that potential financial partners enter into confidentiality agreements will scare them away. It is true that many venture capitalists are so inundated with business plans to which they give only cursory attention that as a matter of policy they will not assume duties of confidentiality with respect to initial submissions from those seeking investment capital. Once past the initial submission, however, some venture capitalists increasingly view a request for a confidentiality agreement as an indication that the entrepreneur is taking proper measures to protect his or her ideas and, by extension, the value of what the investors are being asked to invest in. Thus requesting a confidentiality agreement before revealing confidential details makes good business sense as well as legal sense. The party receiving the disclosure may want to negotiate some limitations on the duties of confidentiality. Many may well be appropriate, such as mechanisms for determining whether the receiving party has already seen or separately developed similar intellectual property, or acknowledgments that the party receiving the disclosures is making no advance commitment to finance the project. But while the entrepreneur may be willing to be flexible as to certain details, he or she must be adamant about limiting and protecting the disclosures he or she does make. This is not an area to compromise. Otherwise, someone else may turn those ideas into the next successful IPO.

The company needs to be just as careful to insist that its own employees, consultants, and suppliers keep company secrets under wraps. Some startup companies start out well, carefully developing assignment agreements, confidentiality procedures and policies, non-compete/non-solicitation agreements, and other safeguards. But as time goes on, they get sloppy. They stop legending documentation as confidential. They freely display their breakthroughs to suppliers and potential customers. They “assume” consultants have signed non-disclosure and assignment agreements and “imagine” employees have signed appropriate covenants. They “expect” departing employees to understand their continuing obligations, but stop conducting exit interviews to remind them. Then they are surprised when their expectations are dashed. Finally, take care not to post secrets on the company website. It is amazing how many startup companies post customer lists, employee rosters, joint venture plans and technical papers for all the world - including all the competition - to see. Establishing proper internal protective measures can help but only if the company follows them. Otherwise, their major function is to serve as powerful evidence that the company did not follow what it knew were reasonable measures to protect its own property. As one court has emphasized, “One who claims that he has a trade secret must exercise eternal vigilance.”

Assume the founders and other key employees will stay with the company forever

Many startup companies are started by a few friends who spend 120-hour weeks establishing the company, creating the intellectual property at its heart, and developing its customer base. When these efforts succeed, the company is often sold to third parties or taken public. What happens to the founders then? Often they stay on as key employees or full-time consultants. But frequently they leave to pursue new undertakings. The far-sighted company will consider entering early on into agreements that provide for a smooth transition, limit immediate head-to-head competition, and prohibit use of the company's intellectual property and use and disclosure of its trade secrets. Without such protections in place, a startup company will be far less attractive to investors, including the public. Few announcements scuttle a public offering so quickly as those reporting that the founders are starting a new company to market version 2.0 of the company's intellectual property.

Anticipating key departures is important even if a sale or IPO seems far away. Particularly in the early stages of a company, the loss of a single employee or key consultant to a competitor can endanger the company. Share option agreements may entice employees to stay, but what if they do decide to leave? The legal protections available to an employer depend on provincial law. The contractual safeguards that work for a British Columbia company, for example, may not be enforceable in Ontario. But companies need to work with counsel before departures to plan how to prevent the loss of a key contributor from transferring company secrets, technology, and business to a competitor.

Ignore invasions of company rights by third parties

The last thing a company in the process of establishing usually wants to do is become embroiled in a lawsuit. Thus, when startup companies detect evidence that others may be adopting similar trademarks or slogans or may be copying the technology, some founders simply shrug and say there is nothing they can afford to do about it. An almost equally common reaction is to threaten to sue the offender for punitive damages and injunctive relief – and then either fail to sue, or sue and devote far too much money and corporate time to the effort. Deciding what to do about an apparent infringement of the company's intellectual property rights is a delicate balancing exercise. Every infringement does not warrant a lawsuit. Generally speaking, the courts do not require an intellectual property owner to sue everyone who encroaches upon its rights. But if the owner of a trademark does not protest now when others use substantially similar trademarks to promote their similar products, it may have to justify its inaction later when it does sue someone else for using marks similar to those ignored in the past.

Even if the company is not prepared to file a lawsuit, it may still make sense to send cease and desist letters making clear that the company objects to the infringing activity. The company should also document internally the reasons it decides not to file suit in particular cases, such as the very limited geographic scope of the infringement, the limited overlap in products, etc. The reasoning that seems logical now may be forgotten, and difficult to explain, in the future. The company should maintain records of any agreed compromises, as well. Such records can be used in the future to explain how an infringement that does lead to a lawsuit differs from events in the past. Cease and desist letters should be carefully reviewed with counsel to prevent them from being used by the alleged infringer as the basis for starting a lawsuit in an unfriendly jurisdiction to declare the parties' rights.

One type of misappropriation the intellectual property owner will almost always want to challenge at the outset is use or disclosure of trade secrets. Unlike other forms of intellectual property a trade secret, once freely disclosed, is lost forever. Others who learn it without knowledge that it has been misappropriated will generally be free to use it without limitation. While the party disclosing it may well be liable for damages, that fact may be of little comfort, especially if that party has few assets. Thus, at a minimum, a cease and desist letter to the potential discloser and to those likely to receive the disclosure is almost always in order, although it must be carefully drafted and circulation properly controlled to prevent claims of libel. Injunctive relief to “keep the cat in the bag” may also be warranted.

 Ignore cease and desist letters from others

Finally, the entrepreneur needs to be careful not to infringe on the intellectual property rights of others. Following the tips outlined in this article should reduce the risk. Requiring employees and consultants to certify that they are not incorporating the property of others into work they create for the company and are not using the confidential information of others should also help. But if cease and desist letters come, the startup company, in particular, must pay attention. Some protest letters are clearly unwarranted or overreaching. Some are sent by third parties who can be easily shown to have inferior, or no, rights to the trademark or writings or technology. If so, say so in writing. Many intellectual property lawsuits are filed simply because an initial cease and desist letter was never answered. Ex parte injunctive relief orders are sometimes sought for the same reason. The plaintiff in such cases is forced to persuade the court that nothing short of a court order will make the accused infringer pay attention and explain the conduct at issue.

Sometimes a cease and desist letter does seem to have substantial merit. Better to try to address it informally than to bog down in litigation. In the case of a trademark dispute, perhaps a license can be worked out permitting use of the trademark in a specific geographic area or for particular types of wares or services. Or perhaps the trademark owner could assist the innocent infringer in developing a new trademark, or allow some time to phase in the new trademark. In the case of a copyright dispute, perhaps certain segments of the computer code could be rewritten in a new version. In the case of potential use or disclosure of a trade secret by a former employee, perhaps the employee could be assigned to new duties which would not put the information at risk. Not every dispute can be readily resolved, of course. But confronting the risks early on, rather than simply ignoring them, may help prevent a lawsuit or, at the least, a major damages award. By contrast, companies that have simply ignored others' successful claims to intellectual property may find themselves having to pay multimillion dollar damages awards, or even stop selling their products altogether. Intellectual property can be among a company's most valuable assets, but only if the company works hard to protect it, and to ensure that it does not belong to others.