HOVIBLOG has moved

Please go to Sean's blog at his new website.

Thanks.

Sean

Employment Agreement Drafting Lessons from the "Barbie versus Bratz" 9th Circuit Decision

On July 22, 2010, the Ninth Circuit Court of Appeals held that Mattel, Inc., maker of the Barbie line of dolls, should not have been granted intellectual property rights ownership over the Bratz line of dolls, estimated to be worth $1 billion. The originator of the Bratz concept, Carter Bryant, presented the ideas for Bratz to MGA Entertainment, Inc., Mattel's competitor, while Bryant was an employee of Mattel (although the work Bryant performed was done after hours and at Bryant's home).

The lower court had ruled, essentially as a matter of law, that an employment agreement between Mattel and Bryant applied to capture Bryant's ideas such that Mattel was automatically the sole and exclusive owner of those ideas and any related or derivative concepts. As such, the district court held, Bryant's actions of presenting those ideas to MGA constituted trade secrets misappropriation and copyright and trademark infringement.

In overruling the district court, the Ninth Circuit held that the employment agreement was ambiguous on whether the specific Bratz concept was subject to the agreement's provisions assigning ownership of inventions to Mattel. The appellate court determined that the jury should have been allowed to decide the issue, and remanded the case for a new trial.

The employment agreement stated, in pertinent part:

I agree to communicate to [Mattel] as promptly and fully as practicable all inventions (as defined below) conceived or reduced to practice by me (alone or jointly by others) at any time during my employment by the Company. I hereby assign to the Company . . . all my right, title and interest in such inventions, and all my right, title and interest in any patents, copyrights, patent applications or copyright applications based thereon.

The term "inventions" is defined to include all "discoveries, improvements, processes, developments, designs, know-how, data computer programs and formulae, whether patentable or unpatentable."

The court found two specific ambiguities: whether the mere "idea" of an urban, multi-ethnic and trendy line of dolls with exaggerated features is captured within the definition of "inventions", and whether the Bratz concept was developed by Bryant during the period and within the scope of Bryant's employment with Mattel.

With respect to the first ambiguity, the Ninth Circuit noted that in the definition of "inventions", ideas are "markedly different" from most of the listed examples, and that as a rule of contract construction, courts should avoid interpretations that would "make a particular item in a series ... markedly dissimilar to other items on the same list." Although the court readily admitted that the contract text supports an interpretation that would include ideas, the text does not compel that reading. As such the jury should be entitled to rule on that issue, that court stated.

The second ambiguity relates to the fact that Bryant created the Bratz concept on his own time, without use of Mattel resources, and outside the scope of his duties. At Mattel, Bryant was responsible for fashions and hair styles, and not new doll lines. The phrase, "at any time during my employment", could be interpreted to mean the entire calendar period Bryant worked at Mattel, or more narrowly, as capturing only those inventions created during work hours, the court held.

The Ninth Circuit's ruling carries important lessons for employers utilizing employment agreements to ensure ownership of employee-developed works and inventions. Primarily, employment agreements should be tailored to the type of business the employer operates. The definition of "inventions" for doll fashion designers should differ from that used for computer programmers, for example.

At a minimum, in all employment agreements, "ideas" should be covered in the definition of "inventions" subject to the company's exclusive ownership rights. In fact, a prudent definition would include "proposed trademarks" as well. Here is an example of a more robust "inventions" definition: "trade secrets, inventions, mask works, ideas, innovations, processes, proposals, formulas, source and object codes, data, programs, know-how, improvements, discoveries, developments, concepts, designs, techniques and proposed trademarks."

Further, the employment agreement should clarify the exact conditions under which inventions are to be assigned. A employer-preferred employment agreement would ensure that all such inventions are assigned, whether conceived or reduced to practice during or after work hours, so long as such inventions relate to the employer's business or anticipated research and development. Example:

You agree to assign to Company all Inventions, whether or not registrable under patent, copyright, trademark or similar statutes, made, developed, conceived, reduced to practice, or learned by you, either alone or jointly with others, which relate to the Company’s business, or actual or demonstrably anticipated research or development of the Company, or which result from any work performed by you for the Company, and (a) with the use or aid of Company resources, or (b) during the general period of time (whether during or outside Company business hours) of your employment with the Company; or (c) pursuant to or in furtherance of your employment with the Company.

(Section 2870 of the California Labor Code renders unenforceable any employment agreement that purports to require assignment of inventions to the employer for inventions developed on the employee's own time and without use of the employer's resources, except for those inventions that relate to the employer's business or anticipated R&D, or which result from work performed by the employee for the employer.)

Had provisions like those suggested above had been in place in the employment agreement between Mattel and Bryant, there's a strong possibility that the case would have been resolved more quickly via settlement or summary disposition. In any case, employers would be wise to consider the lessons this case provides and adjust their employment agreements accordingly -- with the help of licensed counsel, of course.

Enforceability of Vendor On-Line Terms After Written Contract Execution

National Auto Lenders, Inc. (NAL) purchases installment contracts from retail car dealers in Florida, thus enabling indirect consumer loan purchases for cars. NAL contracted with SysLOCATE to purchase over 2,000 GPS units to track vehicles covered by its loans on SysLOCATE's website SysLOCATE makes available to its customers. Unfortunately, many of these units turned out to be defective, thus frustrating NAL's ability to locate and repossess vehicles of owners in default. While the parties were trying to resolve their dispute, SysLOCATE changed the terms of its online click-accept access contract that would have effectively limited NAL's ability to recoup its losses, and that would require binding arbitration as a means of resolving disputes. NAL's executives, upon learning of these new on-line terms, instructed SysLOCATE that only certain named individuals have authority to bind NAL to the terms of any contract, including any online click-accept agreement.

Despite this, two NAL lower-level employees subsequently click-accepted the terms of SysLOCATE's online agreement. After NAL filed a lawsuit against the successor-in-interest to SysLOCATE, the latter predictably filed a motion to dismiss in favor of binding arbitration. NAL resisted such motion by arguing that these two lower-level employees lacked apparent authority to bind NAL to the new online terms containing the binding arbitration clause.

In National Auto Lenders, Inc. v. SysLOCATE, Inc. (S.D. Fla. Feb. 10, 2010), the district court agreed with NAL and denied the defendant's motion. The court ruled that the two lower-level individuals at NAL lacked apparent authority because NAL made clear that only certain executive level personnel have authority to bind the company to such terms. The court stated, "The reliance of a third party on the apparent authority of the principal's agent must be reasonable and rest in the actions of or appearances created by the principal ...." (citations omitted).

Vendors frequently deliver products, technologies or services online, even if the original contract between the vendor and the customer is a traditional written – and usually heavily negotiated – document. As a result of the SysLOCATE decision, vendors may soon start seeing language in these written agreements clarifying who within the customer's organization has authority to bind the customer to subsequent online terms, so as to avoid any possibility for the vendor to alter the terms of the written agreement via subsequent (and perhaps inadvertent) acceptance of vendor online terms. Unless the vendor implements a mechanism to ensure that only such authorized customer personnel assent to the online terms, the vendor may find itself unable to enforce such terms against the customer altogether.

Tech Startup Nightmare on My Street: How Lack of Written Documentation for Staff Developers Wreaks Havok

It's difficult to imagine a more frightening scenario for tech startup founders. Envision a small bootstrapped tech venture hiring a software engineer, with family connections and a proven track record of competence and trustworthiness, to perform coding work from his home in a remote out-of-state location. The engineer is paid solely in shares. He receives no benefits and no tax withholding occurs. No written agreement between the engineer and the company exists.

Now imagine that this engineer suddenly perceives inequitable behavior among the founders. Disputing the notion that he's an employee, this engineer claims for the first time, after nearly a year of development, copyright ownership over the source code he's written, and deletes every copy of the code from all company computers, including the laptop PCs of the co-founders. He alone holds the only copy of the company's heart, blood and soul. He refuses to release the code until his demands for more equity are met.

Imagine then that the founders bring a lawsuit against this engineer, asserting that the engineer is in fact an employee, that the company owns the code in question, and as such, the engineer by his actions committed misappropriation of the company's trade secrets. After an extensive factual and legal record is established, the court of appeals affirms judgment in favor of the company on the issue of copyright ownership of the code, but against the company on the trade secret misappropriation claim. Surprisingly, the developer faces no legal consequences for his ransoming of the company's valuable trade secrets.

The recent case of JustMed, Inc. v. Michael Byce, No. 07-35861 (9^th Cir. April 5, 2010), presents this exact factual and legal scenario, and recounts the story of two brothers-in-law embarking on a entrepreneurial adventure that takes an acrimonious and costly turn for the worse.

In the mid-1990s, Joel Just and Michael Byce co-developed a hands-free digital audio larynx to facilitate speech for those whose larynx had been surgically removed. Both have double-E degrees and are both tech company veterans. In 1998 they secured a patent to their invention.

Shortly after the patent issued, however, the company was hit with tragic news: the sudden and unexpected death of the wife of Byce and the sister of Just. No activity takes place again until 2003, when Joel and Ann Just form JustMed, Inc. in Beaverton, Oregon, to continue development of the product.

Joel Just offers and Byce accepts 130,000 founder shares in exchange for $25,000 cash, and Byce takes a position on the board. He begins work with another engineer in the company, Jerome Liebler, to create the hardware prototype and embedded software that runs it.

No one in the company was working for salary at this time. All were paid in shares. Cash to pay company expenses originated from angels in the form of family and friends, and from a loan from the Justs.

By the summer of 2004, the company finally had a product ready to market, "JusTalk". At this point, Byce took over complete development of the software from Liebler, who moved to Kentucky and assumed a less active role in the company. Byce's sole compensation at this time came in the form of 15,000 shares per month, valued at fifty cents a share. However, no written employment agreement or other writing documenting the relationship existed. The company issued no W-2s, paid no workers' compensation or unemployment insurance for Byce, and processed no tax, Social Security or Medicare withholding.

Byce worked from home, using his own computer, in Boise, Idaho. Byce set his own hours, often working late into the night. Communication with the rest of the company took place solely via emails and telephone calls. Byce would periodically send over new versions of the source code to Just in Beaverton. Just never made any modifications to the code, trusting Byce's skill over his own. Eventually Byce had nearly completely re-written Liebler's code.

Byce had a company business card and company title, and was listed as an employee in the company profile brochure. He attended conferences and conducted product demonstrations, and performed marketing duties in addition to his development responsibilities.

By May 2005, Byce, who had been living off credit, became concerned about his financial situation and requested that half his compensation be paid in cash. Just agreed, Byce signed a W-4, and the company issued three paychecks to Byce as salary for May, June and July of 2005 – checks that Byce never cashed.

The checks were not cashed because, by this time, Byce had convinced himself that he was not being treated fairly. Apparently realizing that if he started accepting cash salary, his status as an employee would be difficult if not impossible to contest, Byce refused the cash.

What followed next is best recounted by a direct quote from the Ninth Circuit's opinion:

At this point, Byce became concerned that Just did not view him as an equal in the corporation. In order to protect what he perceived as his intellectual property, Byce changed the copyright statement on the software, so that it now read “Copyright (c) Mike Byce 2005” instead of copyright JustMed.

Then, while Byce was working in the Oregon office two days before Just was scheduled to meet with a potential merger or buy-out partner, Byce deleted all copies of the source code from JustMed’s computers. Byce testified that he made the decision after seeing a spreadsheet showing a large disparity between the number of shares Byce owned and those shares that the Justs and Liebler owned. In its memorandum decision, the district court found that Byce deleted the code to gain leverage over Just in Byce’s efforts to acquire a greater share of the company. The next day, Byce raised with Just the disparity in ownership between Byce and the other primary shareholders. The two talked for several hours, but Just declined to give additional shares to Byce. During this conversation, Byce did not mention that he had deleted the source code from JustMed’s computers.

Just still had a recent version of the object code loaded on a JusTalk unit, but after flying to Chicago for his demonstration meeting, Just could not get the unit to work. Hoping this was a curable problem, Just tried to recompile the source code on his laptop and then load it onto the unit, only to discover that he no longer had a copy of the source code. Just called Byce about the missing code, but Byce claimed to have assumed “revision control,” meaning that he had removed the source code to insure that no one else would make changes to it.

Only upon returning to Oregon did Just realize that Byce had deleted the source code from all of JustMed’s computers. Just was able to recover some prior versions of the source code files, but not the most recent one. Byce later returned the latest version of the source code, with some of the programmer’s notes removed, but only after JustMed filed suit against Byce and the Idaho state court issued a temporary order. Because Just did not trust the code he received from Byce, JustMed has since worked from older versions of the code to develop the device.

_____________

The US Copyright Act's default rule of copyright ownership is that the creator or author owns the copyright to the work in question. One exception arises in the situation in which an employee creates works on behalf of and in the scope of employment for an employer. In this case, the employer is deemed to be the owner from the outset. If however the developer is not an employee but is instead classified as a contractor, the exception does not apply and ownership remains with the contractor.

The Ninth Circuit affirmed the district court's judgment that Byce was an employee, based on the following factors:

i) Byce was not hired for a specific term or with a defined end in mind. The parties envisioned an indefinite relationship.

ii) Byce performed other work for JustMed in addition to product development and programming, such as web site maintenance and marketing work, thus suggesting that the company could have assigned additional non-programming related tasks to Byce. And, the formal title that Byce gave himself ("Director of Engineering") was indicative of broad duties and permanence of position.

iii) The Ninth Circuit characterized the shares that Byce received as "salary", paid "in the same way as other JustMed employees".

iv) Byce's work was critical to the success of the product and to the company's future.

That Byce worked from home, set his own hours, and directed his own work, was not viewed as dispositive, but rather endemic to the type of work that Byce was doing in the environment that he was doing it in.

The strongest argument Byce marshaled in support of his claim that he was never an employee stemmed from the company's failure to pay benefits and complete the appropriate payroll forms, and the company's tax treatment of Byce. The Ninth Circuit dispensed with this argument by noting the unique characteristics of small technology startups:

JustMed’s treatment of Byce with regard to taxes, benefits, and employment forms is more likely attributable to the start-up nature of the business than to Byce’s alleged status as an independent contractor. The indications are that other employees, for example Liebler, were treated similarly. Insofar as JustMed did not comply with federal and state employment or tax laws, we do not excuse its actions, but in this context the remedy for these failings lies not with denying the firm its intellectual property but with enforcing the relevant laws.

As a small start-up company, JustMed conducted its business more informally than an established enterprise might. This fact can make it more difficult to decide whether a hired party is an employee or an independent contractor, but it should not make the company more susceptible to losing control over software integral to its product.

Having found that Byce was in fact an employee and therefore that the company is the rightful owner of the source code, the Ninth Circuit turned to resolution of JustMed's trade secret misappropriation claim. It was undisputed that the source code was JustMed's trade secret, and that Byce was under a duty, under the Idaho Trade Secrets Act, to maintain the code's secrecy and limit its use.

The Court of Appeals first noted that Byce's disclosure of limited parts of the code to the US Copyright Office, in an attempt to obtain copyright registration in his own name, "is not necessarily inconsistent with maintaining the secrecy and value of the trade secret". The Copyright Office policy is to deny direct public access to in-process files, and after registration issues, the Copyright Office releases reproductions of the work "under limited circumstances", the Court observed.

As this was the only form of disclosure that occurred, the Court next considered whether Byce had "used" the code in violation of his duty to protect the company's trade secrets. The term "use" as utilized in the Idaho Trade Secrets Act "generally contemplates some type of use that reduces the value of the trade secret to the trade secret owner," the Ninth Circuit noted. In this case, Byce filed for a copyright registration and threatened permanent loss of the code for the company, but this use, the Court of Appeals held, did not diminish the value of the code or its secrecy. As the code had been fully returned to JustMed, no harm or diminution in value occurred.

The district court had awarded JustMed damages of $41,250, to compensate for the salaries of Just and Liebler for the three months they spent in recreating the source code Byce had deleted. The Ninth Circuit overturned this award:

These damages, however, do not reflect damages from Byce’s use, as opposed to his mere possession, of the source code. Byce returned the source code to JustMed after the court ordered him to do so. His possession of the source code for some period of time did not result in a loss of secrecy or a loss in value, which is evident from the fact that the court did not award damages for lost value or unjust enrichment. Thus, not only are damages not appropriate under Idaho law, but neither is a finding that Byce misappropriated the source code.

____________

What could be a more common occurrence among tech startups in the Valley: an early employee of a tech startup, paid in shares, working from home, with no benefits, no tax withholding, and no written agreement between the staff member and the company.

Founders of most venture companies would not necessarily expect that such staff would be considered employees subject to tax withholding and employee protection regulations. Yet, at the same time they expect the company will own all intellectual property rights to the inventions and software such staff create.

The JustMed decision's value is the lesson it gives all tech startup founders: always require everyone who works for you, whether they are doing so for cash or stock, or as employees or contractors, to sign a Proprietary Information and Inventions Agreement (PIIA), which clarifies the company's sole ownership over the staff member's creations and mandates an irrevocable assignment of intellectual property rights for inventions and code. Had Byce signed such a document, Byce would never have been able to hold the JustMed code for ransom in the way that he did.

The other lesson to be learned here is that classification of staff members as employees or as contractors, particularly software engineers working from home in exchange for shares, is tricky business. Don't assume that such staff will be considered to have the status you intend. Make a determination, after consultation with your attorney, and comply with all necessary tax and reporting obligations associated with that determination, and thereafter act consistently with that decision.

The bitter irony for JustMed is that its apparent victory over Byce in its claim that Byce was at all times an employee, thus confirming JustMed's ownership of the source code, now means that Byce may have claims against the company resulting from the courts' post hoc determination of an employment relationship over a period of several years.

Japan Fair Trade Commission Accuses Qualcomm of Anticompetitive Practices

San Diego, USA-based Qualcomm is in the business of licensing patents its holds covering the CDMA wireless telephony standard. Such patents cover technologies related to CDMA integrated circuits and CDMA base stations. Qualcomm participates in various standards-setting organizations related to the CDMA standard in which Qualcomm promises to license its technically essential patents on fair, reasonable, and non-discriminatory terms. In reliance on such promises, the members of such standards-setting groups agree to approve and promote the CDMA-related standards in question. The Japanese government, specifically, the Japanese Ministry of Posts and Telecommunications (MPT), adopted such standards for exclusive use in Japan.

Qualcomm's patent licensing agreements with manufacturers of CDMA-based chips, base stations and other equipment mandate that such licensees agree never to assert patents such manufacturers may have that read on the same technologies that Qualcomm is licensing, on a royalty-free basis. Manufacturers who refuse to assent to this non-assertion covenant are denied access to the patent licenses from Qualcomm.

By order dated September 30, 2009, the Japan FTC has ordered Qualcomm to cease such licensing practices. The order itself can be found here. Qualcomm's press release regarding this order can be found here.

In its press release, Qualcomm justifies its practices by making the following assertions:

A) "None of our Japanese licensees were forced to enter into license agreements with us."

B) "The provisions at issue were subject to arms-length negotiations" and "are common in technology licensing agreements".

C) "These provisions promote 'patent peace' and reduce transaction costs and licensing fees."

With respect to the argument in (A) above, it's true that manufacturers are not obligated to license the patents from Qualcomm; but if they don't, they cannot manufacture telephony devices and equipment compliant with the telephony standards adopted by the Japanese government.

With respect to the assertion in (B), such provisions are not common, in my opinion. While it is not uncommon for a technology licensor to attempt to extract patent non-assertion covenants from its licensees, such clauses are rarely if ever agreed to unless the licensor has superior bargaining leverage over the licensee, or unless there's separate consideration flowing to the licensee in exchange for such non-assertion promises. Qualcomm knows that the licensees in Japan have little choice but to agree to Qualcomm's terms. As such, it's extermely doubtful that such provisions were truly the subject of "arms-length negotiations". Rather, they were, in all likelihood, presented to the Japanese manufacturers on a take-it-or-leave-it basis.

Finally, the argument in (C) that such clauses promote "patent peace" is true, but such peace accrues solely to the benefit of Qualcomm. The Japan FTC concluded that such clauses have the effect of frustrating legitimate research and development efforts of the Japanese manufacturers and thereby impede competition.

Qualcomm has sixty days to request an evidentiary hearing and Qualcomm has indicated that it intends to do so.

ALI's Principles: My Recommendation for Software Vendors

I'm recommending to all of my clients that they insert into their operative software license agreements the following or something close to it in the choice of law clause: "This Agreement and all related disputes shall be governed by the laws of _______, without regard to the United Nations Convention on Contracts for the International Sale of Goods or the American Law Institute's Principles of the Law of Software Contracts ("Principles"). The parties agree that (i) the Principles shall have no application whatsoever to the interpretation or enforcement of this Agreement, and (ii) neither party shall invoke the Principles in whole or in part in any judicial or arbitral proceeding relating to this Agreement."
But, aren't many of the rules stated in the Principles, especially the controversial ones like the implied warranty of no hidden material defects and the implied indemnification obligation, not excludable or disclaimable, or disclaimable only with specific prescribed language?
Well, that's what the Principles say. The Principles dictate, for example, that the newly-discovered warranty of no hidden defects cannot be excluded or disclaimed.
Here's the thing: the Prinicples have no force of law whatsoever. They have persuasive authority only. They are not the equivalent of a statute or judicial decision. If the parties agree in their contract that the Principles will have no effect, why would a court feel free to disregard that?
For example, if a famous law review article written by a highly regarded law professor advocated for a specific interpretation of common contract language, and this interpretation would benefit one side over the other, there's no reason why the parties could not simply agree that this professor's article will be disregarded in any legal proceeding.
The same should hold true for the Principles.

ALI's Proposed Principles of the Law of Software Contracts Approved for Final Release

In a previous blog posting, I discussed the new ALI Principles of the Law of Software Contracts. On May 19, 2009, the ALI membership, at its annual meeting, gave final approval to these principles. A number of provisions will prove controversial among software companies, particularly the new non-waivable implied warranty of no hidden material defects.

This implied warranty drew rebuke from a pair of unlikely allies: Microsoft and the Linux Foundation. In a joint May 14, 2009 letter to the academic representatives of the ALI responsible for the principles, Microsoft and the Linux Foundation requested that the ALI delay adoption of the principles pending further discussion and input from commercial software distributors and developers.

This [implied] warranty [of no hidden material defects] does not reflect existing commercial law: no similar warranty appears in the Uniform Commercial Code, and no explanation is given … for treating software contracts differently …. [T]he inability to disclaim the warranty does not reflect existing law or public policy: the UCC permits disclaimer of all implied warranties ….

Apparently the ALI stewards of the principles were unmoved by the entreaties of these two powerful representatives of both sides of the software industry spectrum.