

Startup uses flawed contract with consultant, has to go to court to stay alive - dctoedt
http://www.ontechnologycontracts.com/2009/07/startup-company-uses-incomplete-software-development-contract-with-outside-consultant-ends-up-having-to-go-to-court-to-stay-alive/

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grellas
Founders often mistakenly assume that they will own the IP as long as they pay
a consulting company for its work. However, while payment is generally enough
to secure IP rights from employees, more is needed when dealing with
contractors.

When it comes to rights in copyrighted work product, a consultant will own the
IP unless a contract explicitly treats it as a work for hire or unless the
rights are expressly assigned by the contract.

As appears from this piece, these rules are so fundamental that even a startup
that pays a large amount of money can still be found not to own the IP
resulting from that development work. Even with the litigation, the only
relief obtained by the company was a right to modify the work _licensed_ to
it, not owned by it. A disastrous outcome by any measure.

For a general discussion and some illustrations of how these rules work, see
my write-up at <http://grellas.com/faq_business_startup_015a.html>.

~~~
hugothefrog
Do you know if this is the case in the United Kingtom?

Does anyone have any experience with this sort of thing in the UK?

~~~
grellas
Don't know, since I am not a UK lawyer - here is a comprehensive discussion of
work for hire that includes what appears to be an informed discussion of UK
law on this point: <http://bit.ly/ysePr> (pdf)(concluding that the UK law is
very similar to US with the except of certain categories of works). Hope this
helps.

------
jellicle
The key point of the story is not "company had bad contract". It's "company
stopped paying invoices for work that had been done, annoying its workers and
causing them to file a lawsuit".

If you want your product to go to market smoothly, pay the invoices of the
people who build it for you.

~~~
grellas
An unpaid developer normally cannot sue for copyright infringement, even when
the work has not been paid for (unless the contract explicitly states that the
IP rights transfer _only_ upon payment, which few contracts do).

The problem here is that the underlying contract was not done as a work for
hire. Because of this, _even if the contractor had been fully paid_ , all the
startup would have obtained as a result of the development effort would have
been a license to use the work product as contemplated by the contract. Such a
license would normally not have included a right to modify the work without
the permission of the copyright owner (i.e., the original contractor).

Thus, the startup put itself in a horrible legal bind, not from its failure to
pay as such (though this obviously inflamed the situation so as to bring on a
lawsuit), but from its failure to have a work-for-hire agreement in place when
it commissioned the work.

Even without an immediate lawsuit, the underlying problem would _not_ have
gone away. Imagine VCs doing their due diligence for a funding after this work
had been done and discovering that a major piece of the IP used in the
company's business had been done under a contract that did not give rights in
that IP to the company (this would be apparent to a trained lawyer simply from
examining the face of the contract). In such a case, unless the startup were
able to get a release from the contractor, the startup would still face the
threat of an infringement claim whenever it attempted to modify this code
without the original developer's consent. Thus, without a release from that
developer, funding would still have been impeded and likely blocked.

Even with the lawsuit as filed, it appears that the startup has obtained only
a temporary reprieve when the judge denied the application for the
_preliminary_ injunction. That denial is based on a judge's assessment of the
contractor's likelihood of success on the merits of his claims and on weighing
equities of what is fair to do pending a full trial on the merits. Thus, while
the company squeaked by this phase, a cloud still hangs over its future
depending on what eventually happens at the time this thing comes up for a
real trial. This cloud is a clear deterrent to investors putting money into
such a company.

In practical terms, this scenario is mutual self-destruct for the contractor
and for the startup unless they settle up, which means they likely will.

~~~
timwiseman
You have some well thought out reasoning, but I have to respectfully disagree
with a couple of points. (Obligatory IANAL.)

 _An unpaid developer normally cannot sue for copyright infringement, even
when the work has not been paid for_

Again, IANAL but I do not believe this is true. First, in America anyone can
sue for just about anything even if the basis is flimsy in the extreme. So the
developer could potentially sue no matter what the circumstances. Now, if he
was unpaid he can sue _with a real chance of winning_. Even if the contract
states that the IP belongs to the company, they break the contract by not
paying him in the time specified by the contract, and since they broke it he
can argue that it is invalid and that he therefore owns the product of his
work, even if they paid for most of it. It is similar to the fact that a
mortgage company can repossess even if you are down the last payment if you
fail to make that payment.

As to the VC and their due dilligence, you are completely correct, but there
is a caveat. Most developers (remember he has a reputation on the line as well
as stock or options in the company to think about) would be quite willing to
formally sign over the IP after the fact if they had been treated well. This
becomes doubly true if that developer talks to his attorney and is told that
the company probably has implied ownership (or at least full rights to modify)
under Numbers Licensing, LLC v. bVisual USA, Inc as is pointed out in the
original article.

And finally: _In practical terms, this scenario is mutual self-destruct for
the contractor and for the startup unless they settle up, which means they
likely will._

This is probably what he is looking for. I am guessing here, but he is
probably hoping for a combination of more equity and some secured bonds. The
first will give him a big (or bigger) payoff later if the company does well,
and the second will give him first (or at least very early if others also hold
secured bonds) shot at the scraps if the company folds.

~~~
grellas
I sympathize with the position of an unpaid developer and, if the case is
extreme enough, rescission laws do enable one to break such a contract. I
don't think this will normally help a developer who is denied the last payment
- in that case, fair or not, the law will normally limit the remedy to one of
suing for payment.

Of course, the problems can all be avoided if the terms of the contract
explicitly state that no IP rights will transfer unless payment has been made
in full. In that case, I would agree with your assessment 100% (I don't
disagree with your other points either - they are good clarifications).

~~~
timwiseman
Thank you for clarifying. That all makes a lot of sense.

------
edw519
I once went to a sales presentation by a lawyer selling his product, a CD full
of legal forms he had designed. Then entire presentation was just 4 stories,
people who should have, but didn't, use his forms. All 4 lost fortunes by
forgetting to include important clauses in the contracts.

This sounds like another "Don't let this happen to you" case study. $6 million
for dev, but they saved $2,500 on legal fees and almost lost their business.
Someone should be whipped.

------
lutorm
This exact question came up on a recent StackOverflow podcast.

