satyaJuly 31, 2013

By Satya Narayan

The nondisclosure or confidentiality agreement, commonly referred to as the “NDA,” is typically used in discussions for evaluating the potential for a new business relationship and as such, at this preliminary stage, neither party to the NDA wants to make any warranties regarding their products, services, or their business relationship when no value has yet been exchanged between the parties.  From time to time, recipients of confidential information ask disclosers for a warranty regarding the accuracy of their confidential information, usually in one-way recipient favorable NDAs but also in some mutual NDAs.  While such a warranty at first glance may seem innocuous, it can expose the discloser to significant liability.

RAA Management LLC v. Savage Sports Holdings (C.A. No. 577, 2011 (Del. May 18, 2012)).   This case, decided by the Delaware Supreme Court in 2012, is informative on the potential liability that may arise from agreeing to accuracy warranties in NDAs.  RAA Management LLC (“RAA”) was a potential bidder for the purchase of Savage Sports Holdings (“Savage”).  After abandoning negotiations for the potential purchase, RAA sued Savage claiming $1.2 million in due diligence and negotiation costs, alleging that Savage had told RAA at the outset of their discussions that there were “no significant unrecorded liabilities or claims against Savage,” but then during RAA’s due diligence into Savage, Savage disclosed three such matters.  The Delaware Supreme Court rejected RAA’s claim enforcing an express disclaimer in the NDA executed by RAA and Savage that provided that Savage was not making any representation or warranty, whether express or implied, as to the accuracy of the information furnished by Savage to RAA.  Obviously, Savage’s liability would have been quite different (and potentially costing $1.2 million) if Savage had provided an accuracy warranty.

But we need to be able to rely on the information provided. This is the oft-repeated argument by recipients for insisting on an accuracy warranty in the NDA.  However, aside from the point that the preliminary nature of discussions may not justify granting an accuracy warranty, the NDA is not the appropriate vehicle to grant such a warranty.   The definitive agreement (or, if the opportunity is related to the supply or exchange of technology, an initial evaluation or trial agreement), aside from the NDA which should be separately executed, would be more appropriate.

Keep in mind that the main purpose of the NDA is to protect the discloser’s confidential information.   Since direct damages associated with a confidentiality breach are small and the consequential damages (for example, lost profits) to the discloser’s business from such a breach may be significant, NDAs are structured to imposed unlimited liability on the breaching party.  The reciprocal liability exposure for the discloser’s breach of its accuracy warranty may not, however, be justified.   When giving an accuracy warranty in a definitive agreement, limitations on the type of information subject to such warranty, limitations on the recipient’s scope of use, applicability of exclusions, applicability of materiality thresholds to determine whether there has been a breach of such warranty, and exclusive remedies (for example, correcting the information) and limitations on liability if and when a breach occurs, are heavily negotiated. The parties’ mutual promises in the definitive agreement, the value exchanged between the parties, and the warranty terms that are standard based on the industry in which the discloser operates, are some of the factors that are considered during such warranty negotiations.  An NDA should not specify such a warranty or any of these terms or limitations given its intended purpose.  Also an ancillary consideration is that in many cases, given the business need to move quickly to initiate discussions on new opportunities, NDAs are often executed without an opportunity for legal review and a thorough understanding of the substantial risk associated with being the discloser of confidential information.

Concluding Tips.  As a rule, therefore, if you are the discloser of confidential information, avoid providing an accuracy warranty (or, for that matter, any other warranty) in NDAs; there are more appropriate vehicles for such warranties that will come into play at a point in the transaction when value is exchanged between the parties justifying the risk undertaken by the disclosing party in providing such warranties.   Also provide adequate time for legal review of warranties to limit the impact to your business from a breach of those warranties.

September, 2012
By Satya Narayan

When was the last time you had legal counsel review the consulting or contractor agreement form you use to engage consultants? If it contains a “work made for hire” provision, as many consulting/ contractor agreements do, it may create an employer-employee relationship exposing your company to employer-related obligations and liabilities with respect to your consultants in California.

Most consulting/ contractor agreements will include a boilerplate provision that the work product created by the consultant for the company is protected as a “work made for hire” under the United States Copyright Act 1976, as amended (the “Copyright Act”). There are benefits of including such a provision from a copyright law-perspective, including treating the company as the “author” and, therefore, under the Copyright Act, the first owner of the work made for hire for certain categories of works. It is also included to potentially obtain a longer copyright protection term for the work (“works made for hire” are entitled to U.S. copyright protection for 120 years after creation or 95 years after publication, whichever expires first; while the standard U.S. copyright term is life of the author plus 70 years).

A “work made for hire” provision, however, has serious consequences for companies with respect to consultants in California. Under California Labor Code section 3351.5(c), a person who creates a work under a contract that expressly provides that the work shall be considered a work made for hire, is an employee and similarly, under California Unemployment Insurance Code section 686 and 621(d), a party commissioning a work under a contract that expressly provides that the work shall be considered a work made for hire, is an employer. As an employer, your company will be required to maintain workers compensation and unemployment insurance for California-based consultants performing work under a contract that states that the work is a “work made for hire.” Failure to obtain workers compensation insurance for such consultants may be a crime under California law, as it is with respect to employees. Payroll taxes may be applicable to such consultants. The company may also potentially find itself exposed to claims by such consultants for benefits offered by the company to its employees. Note, however, that work made for hire references in agreements with contractor companies or entities is not an issue as companies or entities are not considered “employees” under the said California statutes for the purposes of their “works made for hire.”

While copyright-related reasons for including a “work made for hire” provision in consulting/ contractor agreements are generally sound, with respect to your California consultants, given the exposure to employer-related obligations and liabilities under California law, all “work made for hire” references in the consulting/ contractor agreement should be removed. As to copyright issues that may result from removing the “work made for hire” provision, the most important issue relates to the transfer of copyright ownership to your company, which is easily addressed through an express present assignment clause.

For additional information on this topic, contact Satya Narayan.

July 24, 2012
By Satya Narayan

Customers sometimes ask vendors and service providers to accept or negotiate from the customer’s standard contract terms. But customer contracts are intentionally one-sided, containing terms that tend to overreach for the customer’s benefit while being unduly burdensome for you, the vendor. Here are five common overreaching or unduly burdensome clauses or issues for vendors in customer contracts:

1. Restrictions on Your Freedom to Operate. Restrictions on the freedom to operate can take many forms including: most favored customer clauses; non-compete clauses; clauses that prohibit assignment or transfer of the contract in the event of a sale or merger of your business; non-solicitation clauses that do not exclude general advertising or contact that is not initiated by the vendor; and clauses that restrict or require minimum notice periods for product or service related end-of-life events or changes in technology. These clauses require careful business and legal review and, if accepted, should be narrowly tailored to limit their impact on your business and exit strategy.

2. Unlimited Liability. Parties to a contract typically negotiate a limitation of liability clause that limits or caps their respective liability to a specified amount for most types of contract breaches. Obligations in a customer contract will predominantly lie on the vendor; as such, it is not in the customer’s interest to include a limitation of liability clause in its standard contract that is protective of the vendor. What this means is that if you breach the contract, the customer may claim from you direct and consequential damages, and where applicable, even punitive damages. These damages may well exceed the contract value unless you specify limits in the contract. Consult with counsel to negotiate liability limitations that are market in your industry or reasonable given the nature of your products and services.

3. Unmanageable Warranties. Review each representation and warranty that your customer asks you to make in the contract. Product and performance-related warranties that are not limited in time may lead to revenue recognition issues. Customer contracts will not excuse you from your warranty obligations for customer or third party-related negligence, modification, misuse of the products, virus or hacker attacks, or for issues arising from customer specified instructions; these are exclusions you will have to negotiate. You should also consult with counsel to draft clauses specifying exclusive remedies tailored to each warranty that may be breached so that the entire contract value is not at risk in the event of a warranty breach. Also, often overlooked, is the impact of warranties that are implied by law such as the warranty of fitness for a particular purpose; the customer will be entitled to these implied warranties unless you specifically and expressly exclude them in the customer contract.

4. Overbroad Indemnities. Customers overreach when they seek indemnification for all types of contract breaches by the vendor and particularly when no third party claim is involved. Consult with counsel to limit your indemnification obligation and negotiate exclusions for damages that arise from customer or third party-related negligence, modification, misuse of the products, virus or hacker attacks, or for issues arising from customer specified instructions. Where it makes sense, negotiate to control the defense of the third party-related action for which the customer may seek indemnification.

5. Intellectual Property Transfer. Customer contracts typically will provide that all work product developed by you or resulting from your services during the contract term will be exclusively owned by the customer and is assigned by you to the customer. If you are licensing proprietary software to the customer, such a clause should be struck. Unless the customer will pay non-recurring engineering fees for custom work and you will not use such work in your own products and services or for other customers, granting the customer a non-exclusive license to use the work for the relevant time period may be sufficient. Finally, if you are a service provider providing development/ consulting services and as such, regularly assign to the customer rights in the work product developed for that customer, you should include a clause (sometimes called a “residuals clause”) that permits your personnel to use the knowledge and experience gained from that customer engagement when providing similar services to other customers. While such a clause may initially raise eyebrows, tailoring it narrowly will give you the freedom to operate without compromising the customer’s legitimate concerns regarding its confidential and proprietary information.

Watch the Royse Law Firm website for an upcoming webinar series by Satya Narayan discussing in more detail the issues mentioned in this article.

For additional information on this topic contact Satya Narayan.

June 18, 2012
By Satya Narayan

Companies regularly consider whether to protect their latest invention or technology by obtaining a patent or using trade secret measures. Obtaining a U.S. patent gives the patent holder the right to exclude others from making, using, or selling the invention in the U.S. for a period of 20 years from the patent application filing date; however, this right is granted in exchange for full disclosure of the invention claimed so that others may make and use your invention at the end of such period. Alternatively, you may choose to protect your company’s invention or technology as a trade secret by taking reasonable measures to maintain its confidentiality. A trade secret can theoretically last forever as long as you maintain it as a trade secret; however, you will have no right of action against third parties who learn of the trade secret through lawful reverse engineering, independent development, or inadvertent disclosure. Ultimately, your choice of patent vs. trade secret protection for your invention should take into consideration the following factors: (1) whether your invention is patentable; (2) how easy or hard will it be for your competitors to reverse engineer or independently develop your invention; and (3) the cost implications of a patent or trade secret protection strategy.

Is your invention patentable?
Filing a patent application is no guarantee that a patent will be granted or that all of the inventions claimed in the patent application will be granted without modification. The U.S. Patent and Trademark Office examines patent applications and will review your invention for the following requirements: (a) whether the invention is patentable subject matter (that is, whether it falls within the permitted categories of patentable inventions under the U.S. Patent Act), (b) whether the invention is new (that is, it must not form part of the state of art anywhere in the world), (c) whether the invention is useful (that is, it must capable of use and provide some identifiable benefit), and (d) whether the invention is non-obvious (that is, it should not be obvious to a person skilled in the relevant art). The U.S. Patent Act also requires that your patent application be filed within 1 year of the first public disclosure or offer for sale of your invention. Keep in mind that discussing your invention with potential partners or friends without a confidentiality agreement may constitute “public disclosure” and start the 1 year filing clock.

How easy or hard will it be for your competitors to reverse engineer or independently develop your invention?
When evaluating your patent vs. trade secret strategy, a key consideration will be just how complex your invention is and whether the novel aspects of your invention are in a form that would make reverse engineering difficult. If your invention can be easily reverse engineered (e.g., mechanical inventions incorporated in consumer goods) or independently developed, seeking patent protection is a better strategy assuming the invention is patentable (see above). If it would be difficult to reverse engineer or independently develop, such as complex beverage formulations or internal manufacturing processes, trade secret protection may be a better choice as the protection can last for as long as you can keep the invention or technology a secret.

What are the cost implications of a patent or trade secret protection strategy?

After adding up lawyers’ fees, prior art search fees, and filing and processing fees, obtaining a U.S. patent can cost between $5,000 and $10,000, with patent prosecution costs for complex inventions costing even more. Patent maintenance charges and foreign patent costs are additional. None of the patent processing / maintenance charges applies to trade secrets. Common costs of a trade secret strategy involve costs associated with implementing reasonable security measures to protect the invention or technology as a trade secret, such as securing the company’s facilities and networks, training employees and subcontractors in confidentiality practices, and securing non-disclosure agreements from anyone who will have access to the company’s trade secrets. The incremental costs of a trade secret strategy may be lower to the extent such measures are implemented as part of your company’s best practices for operating its business.

For additional information on this topic contact Satya Narayan.