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Startups Protection of Intellectual Property Through Employment Agreements

Startup Companies and Intellectual Property Protection

More than any other industry, technology startups rely on their intellectual property for success. Keeping their employees motivated and their ideas protected and away from competitors is key. In this context, agreements between startup and employee take on special significance. Startups can keep employees' created intellectual property protected and away from competitors by contracting with employees to maintain confidentiality and making non-compete arrangements for some period after termination of employment.

The New-Hire Agreement

A New-Hire Agreement performs a variety of functions. Overall, the agreement is primarily intended to prevent employees from misusing information obtained on the job. The agreement achieves these objectives by incorporating clauses intended to thwart the business plans of, or in competition with, the employer, including the following: (1) the agreement prohibits employees from competing with the startup for one (1) year after termination in most circumstances; (2) the agreement requires that employees maintain the confidentiality of the startup's proprietary information for an indefinite period of time; (3) the agreement requires employees to disclose all the intellectual property they develop to the startup and to assign certain of that intellectual property to the startup.

Issues Related to Enforceability of Employment Agreements

In general, to be binding, a contracting party must receive consideration in exchange for undertaking contractual commitments. In the case of a restrictive employment agreement, the consideration is often one of the following: (1) the initial employment of the contracting employee; (2) a post-hire bonus or shares option granted to the employee contemporaneously with the execution of the agreement; or (3) a severance arrangement that exceeds the compensation and benefits that would otherwise be required of the startup. Startups who simply introduce a restrictive employment agreement to existing employees without offering anything in exchange other than continuing employment do so at the risk of not being able to enforce the agreements for lack of consideration.

The “Reasonableness” Standard

In Canada, courts will scrutinize the terms of an employer-employee contract with reference to the facts and circumstances surrounding its signing. If consideration is wanting, if the employment agreement is determined to be a contract of adhesion (i.e., with great disparity in the negotiating position of the parties), or if the employment agreement is found to be against public policy, a restraint of trade, or otherwise illegal, then courts have consistently either refused to enforce the agreement, selectively enforced the agreement' s terms, or modified the agreement' s terms to comply with applicable standards and enforced the end result. Some startups overreach in drafting employment agreements, including restrictions on an employee' s ability to earn income in the employee's chosen field after termination of employment. Unless in the context of an acquisition or other corporate transaction that is negotiated between parties with relatively equal bargaining power and in which consideration is substantial enough to obviate the need of the obligor to earn income from regular employment, a noncompetition agreement must allow the former employee a reasonable opportunity to earn a living by use of his training and experience.

Protection of a startup's trade secrets is often a primary objective in having employees sign non-competition agreements. The principal means of proving loss from unauthorized disclosure of trade secrets, after all, is showing how such information hurt the competitive position of the former employer. However, a confidentiality agreement masquerading as a non-competition agreement will face enforceability challenges if either the ability of the former employee to earn a living is unreasonably compromised or if the trade secrets are so broadly defined “that virtually all of the information acquired during his employment would be included within its definition.” Nevertheless, having employees sign non-solicitation covenants can be useful in order to prevent former employees from raiding a startup's customers, especially when the trade secret status of the startup's customer list is in doubt.

Special Issues Related to Noncompetition Covenants

New-Hire Agreements often restrict employees from going to work for a list of competitors specified by the startup. The restriction may or may not have geographical limits and usually expires in a defined period of time after termination of employment. Geographic limits are usually appropriate and desirable even if the nature of a startup's business is global. The fast-changing pace of the technology industry means that the startup's competitors change with time. Yet, there are such a large number of companies competing in the technology industry and related fields, that to restrict the employee from working for “competitors” generally would be too vague or too broad, or both, rendering the covenant unenforceable. The solution is for the startup to maintain a list of the twenty companies in the best position to do the employer harm if given the job-acquired skills and knowledge of the employee.

Termination

In most instances, a covenant not to compete will be unenforceable in the event the employee was terminated without cause. Termination without cause is viewed as the startup's admission that it does not require the employee's job-acquired skills and knowledge (although it is also common that such terminations are used with respect to underperforming employees in an effort simply to limit the amount of post termination dispute or to avoid litigation). One way for startups to still achieve a degree of protection in such settings is to include a non-solicitation covenant separate and distinct from a non-competition covenant. It could be argued that the concept of noncompetition subsumes the behavior proscribed by a non-solicitation covenant. After all, a former employee who solicits employees and customers of his former employer is most likely seeking such employees and customers to engage in commerce from which the former employer would otherwise have benefited. If the former employee of a software firm were soliciting these persons for other purposes, such as class reunions or the network selling of nutritional supplements, the former employer would not have an actionable claim. However, if the noncompetition covenant fails, for whatever reason, to be enforceable, in the event of a termination without cause, or if there is provincial law that disfavors enforcement, then some of the same objectives can still be attained through a well-drafted non-solicitation covenant. The New-Hire Agreement typically prohibits the employee from disclosing the startup's confidential information to persons not authorized by the employer, at any time during or after employment.

Covenants Relating to Intellectual Property

Often the central concern of any technology startup is protecting its intellectual property. Therefore, an essential part of the New-Hire Agreement will be how it addresses this concern. At a minimum a New-Hire Agreement should have covenants (1) to inform the startup of the employee's inventions, discoveries, know-how or improvements, both during the term of employment and for one year thereafter; and (2) to assign to the startup ownership rights in those items of intellectual property that are of a legitimate business and legal interest to the startup. In the interest of reasonableness (and therefore enforceability), the scope of intellectual property that must be disclosed to the startup should decrease after the employment relationship terminates. During the term of employment the startup should assert a right to review any intellectual property created or invented by the employee. For one year after termination, the startup should still require the former employee to disclose intellectual property related to the startup's business activities or proprietary information or the employee's work assignments during the employment term. All intellectual property meeting these requirements for post-termination disclosure, whether created or invented before, during or within one year after the employment term, should be assigned by the employee to the startup.

Establishing At-Will Employment Relationship

It is important that the New-Hire Agreement not be deemed a part of an employment agreement guaranteeing a specific employment term, compensation or duties. It is also important that any subsequent employment agreement not be deemed to supersede the terms of the New-Hire Agreement. For these reasons, the New-Hire Agreement provides that the employment relationship between the new-hire and the startup is at will and that the terms of the agreement survive and amend any subsequent employment agreement unless such terms are canceled expressly and in writing.

Employment Agreement

An effective employee relationship for a startup usually begins with either a written Employment Agreement or a letter setting out the terms of the employment relationship. Employment agreements serve a variety of functions, including setting forth for the benefit of all parties the principal terms governing the employer-employee relationship. These agreements also provide a benchmark for ongoing conduct by all parties and an efficient mechanism for resolving disputes.

Termination With and Without Cause

An employee may be hired for a specified term or for an indefinite period of time. Under some agreements, at one or either party's option the employment term may be terminated before any expiration, though there may be economic or other consequences associated with such termination. The employee may demand that a minimum amount of severance compensation be specified in the agreement, if subject to early termination without cause. Regardless of whether such a right is expressly provided in the written agreement, the startup will have the right to terminate the employee's job for cause, since the cause will constitute a breach of the employee's agreement to perform in exchange for compensation, an essential element of the bargain for the startup. Nevertheless, to increase the level of certainty and confidence in the continuing employment relationship, the startup and the employee should both want to define, with as much specificity as possible, what acts or omissions constitute cause for early termination.

Scope of Other Business Activities

It is not uncommon for employees to be engaged in more than one business relationship. For middle and lower level employees, this may include home business or family business activities. For more senior executives, it may include service on boards of directors or on-going consultative relationships. Regardless of the specific circumstances involved, startup will want employees to agree to provide a full-time effort or at a minimum to define the level of dedication to the startup in reasonable and, where possible, objective detail. For example, in the case of a newly hired executive, it is not uncommon for the new startup to allow a defined period of time for the executive to transition former employee projects and other work. In agreeing to any less-than-full-time effort from the employee, the startup must be careful to consider the possibilities for conflicts of interest between the employee' s independent activities and the work to be performed for the company. If there is some doubt as to whether such conflicts may exist at some point, then the startup may want special disclosure from the employee concerning the nature of the independent activities, as well as periodic disclosure and certification of conflicts of interest, related transactions, or the absence thereof. The startup may also want the right to require the employee to terminate independent activities if it has reason to believe that conflicts of interest exist, or the right to terminate employment if the employee refuses to do so.

Compensation

In describing the employee's compensation, the nature and timing of fixed amounts should be specified with precision. Agreeing to salary increase, bonus formulae, and shares option grant and vesting for an employee that are not compatible with existing compensation and shares option plans generally applicable to executive management (assuming that the employee is an executive manager) could require special disclosure to shareholders.

Noncompetition, Confidentiality and Disclosure of Inventions

The same terms regarding noncompetition, confidentiality and disclosure of inventions apply to the Employment Agreement as do to the New-Hire Agreement.