Beware of the “work for hire” language in CA independent contractor agreements

Problem: Best IP protection makes your outsourcer your employee

Naturally, when you pay somebody to create any IP for you (software code, articles), you then want to own that IP but without having your independent contractors magically reclassified as your “employees.” Designating outsourcer’s work product as “work for hire” (WFH) gives you the best IP protection but if you are in California or a similar jurisdiction, it automatically makes the outsourcer an “employee” for the purposes of unemployment insurance, workers' compensation and other tedious, potentially expensive consequences. This is so even if the agreement explicitly states they are independent contractors. See below: California Unemployment Insurance Code Sections 621(d) and 686; California Labor Code Section 3351.5(c).

Most of the independent contractor agreement templates out there contain a “work for hire” designation which basically means that your company automatically owns intellectual property rights to outsourcer’s work product. WFH clause gives the business the best IP protection because without the WFH designation the outsourcer may claim the copyright back after 35 years of assigning it even if the assignment agreement was for “permanent” copyright assignment. Most templates contain the WFH language because in the vast majority of states the WFH clause is not a problem but it is a problem in states like California because it transforms contractors into employees.

Special note re Elance: professional relationships on that site are governed, among other things, by the Elance Independent Contractor Services Agreement which states that the contractor’s work product is normally “work for hire” (Section 5 "Intellectual Property Rights"). The aforementioned Elance Agreement also states that it is governed by California law (Sec. 14), and the California law quoted above states that “work for hire” = “employee.”

Solutions

There are several options to get adequate IP protection without having outsourcers reclassified as employees.

Option #1. NOT a Work for Hire – 35 years of copyright protection. The easiest option is not to designate the assigned work product as WFH, to cut all "work for hire" language out of the independent contractor agreement. This way the hiring party will have full copyright for at least 35 years, and chances are the software code will become obsolete in 35 years anyway.

Option #2. Work for Hire but Governing Law is NOT California – 95/120 years of copyright protection. What to do if the work product is not software but something that might still be valuable after 35 years (e.g. a book)? Designating it as WFH may lead to employer-employee classification if your business is in California or a similar jurisdiction. To avoid the “employee” classification, you can choose the contractor’s state or country as governing law but the drawback of that is that in case of any problems you will then have to litigate in that other state/country. Some foreign jurisdictions do not have strong IP protections and are biased towards the locals. For example, asking an Indian court to issue some IP injunctions against an Indian party sounds difficult.

Option #3. Incorporate. Have the freelancer contract in the name of their company. Companies cannot be “employees” like individuals can. If the deal is significant enough to worry about IP protections past 35 years, both parties will save more money in the long run than they will spend on forming a Delaware LLC, which will then act as a sort of insurance policy for both the outsourcer and the hiring party.

Relevant law:

CA UNEMPLOYMENT INSURANCE CODE

621.  "Employee" means all of the following:
...
(d) Any individual who is an employee pursuant to Section 601.5 or
686.

--------------------------------------------------------------------------

686.  "Employer" also means any person contracting for the creation
of a specially ordered or commissioned work of authorship when the
parties expressly agree in a written instrument signed by them that
the work shall be considered a work made for hire, as defined in
Section 101 of Title 17 of the United States Code, and the ordering
or commissioning party obtains ownership of all of the rights
comprised in the copyright in the work. The ordering or commissioning
party shall be the employer of the author of the work for the
purposes of this part.

--------------------------------------------------------------------------
CA LABOR CODE

3351.5.  "Employee" includes:
...
   (c) Any person while engaged by contract for the creation of a
specially ordered or commissioned work of authorship in which the
parties expressly agree in a written instrument signed by them that
the work shall be considered a work made for hire, as defined in
Section 101 of Title 17 of the United States Code, and the ordering
or commissioning party obtains ownership of all the rights comprised
in the copyright in the work.

--------------------------------------------------------------------------

Emphasis added

Read next:

- Drafting a Solid Web Design Contract
- Independent Contractor/Consultant Agreement Drafting Tips
- US companies and US bank accounts (for foreign and domestic clients)

SaaS Agreement Drafting Tips

1.            Don’t grant any "licenses," don't title it EULA. Avoid using the word “license” because it implies certain rights to your software, such as the right to copy it. However, if your software is in the cloud, you’re only giving users the right to subscribe to the service. So, don’t call your agreement EULA, a more appropriate title is SaaS Subscription Agreement. A good clause to include may go something like this:

Subscriber acknowledges that Company has no delivery obligation and will not ship copies of the Company software program to Subscriber as part of the services. Subscriber agrees that Subscriber does not acquire under the agreement any license to use the Company program in excess of the scope and/or duration of the services. Upon the end of this Agreement, Subscriber’s right to access or use the Company program and the services shall terminate.

2.            Consider keeping the Maintenance clause and the Service Level Agreement (SLA) simple. When you update the software on your system and fix the bugs, all users automatically benefit from it in a SaaS arrangement. So, it’s usually enough to have Maintenance encompass 99.(xxx)% uptime warranty, various performance standards, system administration, system management, and system monitoring. SLA would normally address different time frames for fixing problems.

3.            Intellectual Property. User keeps its own data, provider keeps IP ownership of the software. If any third party technology must be used with the SaaS provided, it’s a good idea to include a statement that usage of such third party technology  is governed by the terms of the third party technology license agreement and not under this SaaS Agreement.

4.            Confidentiality. You host and monitor users’ proprietary business information and other sensitive data. It’ll give them some peace of mind knowing that you’re bound by the confidentiality clause not to disclose or use that information. If you use subcontractors, the Confidentiality must state that you will bind those subs to at least the same level of confidentiality as the present SaaS Agreement.

5.            Warranty and Limitation of Liability. SaaS deal is a source of great potential liability since you’re undertaking to maintain large amounts of others’ important data. Therefore, consider including a disclaimer encouraging users to back up their data and to acknowledge that this SaaS is provided “as is” to be used at own risk with no warranty of any kind, no liability for lost profits or other special damages. It’s a fairly standard practice to disclaim all warranties due to the high potential liability involved in a SaaS deal.

6.            Subscriber Reference is a good clause to include:

Subscriber agrees that Company may identify Subscriber as a recipient of services and use Subscriber’s logo in sales presentations, marketing materials and press releases.

  

7.            Independent Contractor clause ensures that parties to the contract are not liable for each other’s mistakes (as they would be in a partnership or a joint venture deal).

8.            Audit clause gives you the right to inspect user’s business to ensure that your program is not used on unauthorized (unpaid) computers/locations. Even if you know you’ll never bother auditing any user, it’s still good to have an audit clause because its very presence in the SaaS contract will deter many users from trying to cheat you.

9.            Governing Law is an important clause to have, especially if you’re hosting data in a very remote jurisdiction and you don't want to have to go to court there. This clause ensures that all disputes are to be resolved in your home jurisdiction and not anywhere far away. Same goes for a Late Fee provision for overdue balances – even if you don’t bother enforcing it, people tend to pay faster knowing that some extra charges might be forthcoming.

10.          Arbitration clause ensures that, instead of going to expensive, confusing public court, your disputes will be resolved relatively inexpensively, confidentially close to you by a private arbitrator (or a panel) with a business background from a reputable arbitration organization, such as the American Arbitration Association (for US disputes). Arbiration is more informal, so you don't necessarily need a lawyer to represent you, although it's still a good idea to consult one.

Independent Contractor/Consultant Agreement Drafting Tips

When outsourcing work, it’s important that the worker is classified as an independent contractor and not an employee because the latter makes the employer liable for employee’s benefits, worker’s compensation insurance, taxes, vacation pay, etc. Generally, the more control the hiring party has over the worker, the higher likelihood such worker will be considered an employee. Read more on employee/contractor distinctions and tips on avoiding your contractors reclassified as employees here. A good independent contractor agreement should contain the following clauses.

Relationship of the Parties clause must clearly state that the worker is an independent contractor and not an employee, partner or agent. The contract must be titled Independent Contractor/Consultant Agreement to avoid confusion. Avoid using words like “partner,” “associate,” or “agent” because they imply joint liability where you will be liable for the other party’s mistake.

Assignment of intellectual property rights to the work product. Best IP protections for the hiring party contain "work for hire" designation but unfortunately in jurisdictions such as California this may reclassify an independent contractor as an employee. Read: Beware of the “work for hire” language in CA independent contractor agreements.

The more control you exercise over the method of work, the more directions you give, the higher the likelihood the contractor will be reclassified as an employee with all resulting penalties and financial burdens. Therefore, the Scope of Services clause should, if possible, be limited to desired results of work but the contractor shall be as free to achieve such results as reasonably practicable and not precluded from working for (competing) businesses. Providing tools, equipment and training weighs towards employee classification.

Contract Term – the shorter the better.

Confidentiality clause must be included if the contractor will have access to sensitive information, trade secrets, client lists, etc. Tips on drafting nondisclosure agreements and clauses here.

Payment by the hour/week suggests employer/employee relationship. Paying for results/milestones is indicative of independent contractor. Reimbursement of expenses may also suggest employment relationship; a better strategy would be to estimate expenses before signing the contract and include them in a lump sum fee paid to contractor for job completion.

Indemnification is a clause that ensures a party will be reimbursed for the other party’s wrongdoings, although the odds of enforcing this clause against a remote party (i.e. web developer in India) are very slim.

Statement of Work (“SoW”) is a short convenient attachment to Independent Contractor Agreement that describes each new task/project to be performed. SoW states that all general terms in the master Independent Contractor Agreement apply. Executing Statements of Work as part of an ongoing working relationship is easier than drafting a whole new contract for every new task the contractor has to perform. 

Elements of a Confidentiality/Non-Disclosure Agreement

Non-Disclosure Agreements are more or less the same but certain small elements make a big difference. Make sure everything you need is in place.

1. Unilateral or Mutual? Mutual NDA’s are common when both parties discuss potential joint business ventures.
2. Scope. Defines what information is deemed confidential and whether it should clearly be marked as such.
3. Permitted Use and Disclosure define what can the information be utilized for and who else may have access to it. NDA may contain a clause stating that the receiving party must give notice to the disclosing party prior to passing that information on to the third parties for permitted uses. Such third parties (e.g. subcontractors) must then agree to confidentiality obligations at least as protective of the confidential information as those in the original NDA.
4. Term of the Agreement and Duration of Obligation are not necessarily the same thing. It’s a good idea to state that the obligation of confidentiality survives the termination of the NDA for a period of X years after such termination.
5. Consequences of a Breach may be a combination or all of the following: a) fixed-sum amount per breach (“liquidated damages”), b) injunctive relief (court order), c) indemnification (the breaching party reimburses the innocent party for expenses of enforcement including attorney fees).
6. Jurisdiction and Choice of Law state where the confidentiality agreement will have to be enforced. This is particularly important if the negotiating parties are in different states or countries.

Legal Guide for Sweepstakes, Contests and Giveaways

1. Ensure your sweepstakes cannot be classified as an illegal lottery. A lottery has three elements: a) Prize; b) Consideration; c) Chance. Those elements are interpreted broadly: Consideration can be anything of value, such as liking your Facebook page, writing a comment on your blog, rating a product, subscribing to newsletter or Twitter feed. Chance element is present if winners are chosen predominantly by luck: for example Bingo is a game of chance while Solitaire is a game of skill, even though an element of luck is present in the latter. Using services like random.org or rafflecopter.com clearly establishes the Chance element present.

As you can see, many sweepstakes out there today do not strictly comply with all of these requirements. Violation of the provisions on operation of contests or sweepstakes is a misdemeanor in California (Bus. & Prof. Code §17534) and other states. While the prosecution for a small time website giveaway is not very likely, to ensure compliance, at least one of the three above elements must me missing. Entrants should not be required to do anything of value, or winners have to be chosen by showing some merit or skill such as winning a game or contest.

There are also state-specific rules. Foer example, in New York a sponsor must bond prizes valued above $5,000 or establish and maintain a special trust account with a balance sufficient to cover the total value of prizes offered.  Florida also requires a surety bond for any sweepstakes with a prize value of more than $5,000.

2 2. The following will help ensure compliance and prevent misunderstandings:

a.       Post sweepstakes official rules and link to them in announcements.

b.      Promotion Period – start and end date.

c.       “No purchase necessary.”

d.      “Odds of winning depend on number of entries.”

e.        “Entries that are not accompanied by orders are treated the same as entries that are accompanied by orders.”

f.       Eligibility for entry (“Open to legal US residents 18 years of age or older.”)

g.       How to enter and what is the maximum number of entries per person.

h.      Dollar value of the Prize.

i.        The maximum amount of money, including postage and handling fees, which a participant may be asked to pay to win each of the prizes offered.

j.        Avoid prizes involving  tobacco, alcohol, gasoline, insurance or financial services.

k.      How are ties and unclaimed prizes handled?

l.        Prize to any one person worth $600 or more requires you to file Form 1099 with the IRS.

Business Purchase Agreement Checklist

Basic clauses in LLC, corporation, partnership or sole proprietorship purchase and sale agreements are:

I. Purchasing Assets or Stock? Buyers would normally to just assets only because purchasing stock means the buyer will assume liabilities incurred before the sale.

II. Payment Structure. Subject to financing? Promissory note? What happens in case of default? Down payment? Escrow? Closing date.

III. Seller’s Warranties. At the very least, these should include warranties of:
a. Title (to ensure seller has the right to sell the business)
b. No material omissions
c. Authority to sign the agreement
d. Accuracy of financial statements
e. No new debt pending closing
f. No tax liabilities
g. No existing/pending litigation
h. No conflict with existing leases/contracts. Assignment clauses must be checked in leases and other contracts to ensure they will not become void after the sale of business.

Indemnification clause acts as parties’ “insurance” against the other party’s breach of representations and warranties. Indemnification means the breaching party will have reimburse the innocent party for damages incurred due to the breach.

IV. Non-Compete, Non-Solicitation and Non-circumvention clauses ensure that the seller will not just open another shop across the street and lure ex-employees over. Even jurisdiction like California that do not normally allow non-compete clauses, have exceptions for the sale of business.

V. Offset clause allows buyer to reduce the purchase price or the promissory note by deducting certain amounts such as undisclosed taxes, other debts or failing equipment.

VI. Appendices:
a. Schedule of inventory
b. Schedule of all indebtedness and liabilities
c. Business sale price payment schedule

Key provisions in Supply Agreements

1.  Minimum Quantities. Liquidated Damages. Does the Buyer have an obligation to buy any quantities? If so, what is the fee for failing to do so?  Such a fee is called “liquidated damages.” Courts are sometimes reluctant to enforce liquidated damages unless the clause contains the language stating that the liquidated damages fee is not meant as a penalty but is a good-faith attempt to estimate actual damages since such actual damages would be impractical or impossible to ascertain.

2. IP, Confidentiality, Non-Circumvention, Non-Competition. Supplier will learn about the Buyer’s product, market, transactions, business partners. Buyer will want to make sure to retain all intellectual property rights in the product and to prevent Supplier from going over Buyer’s head to compete while using Buyer’s contacts and other information learned. This is a good place to include a Liquidated Damages clause (see above).

3.  Prevailing Language clause ensures that, if your contract is written in more than one language, your language will control in case of discrepancies and ambiguities in translation. This is especially important in countries with legal systems different from that of the US, and a lot of the American legal concepts don't translate well or simply don’t exist. For example, injunctive relief, intellectual property rights are often quite literally foreign concepts in countries like Russia, China and India.

4.  Term and Termination. Can both or either of the parties terminate the agreement early for any reason or no reason at all? Early termination fee? It’s usually better to include a fixed price in short-term agreements but give Supplier some flexibility with price if it’s a long-term contract (e.g. Supplier must give ___% discount off of its normal wholesale list prices, beat competitors’ prices, etc.).

5.  Acceptance. Outline the procedure for the Buyer to reject defective products upon inspection. Supplier must replace defective products or give refund.

6.  Warranties. Suppliers will want to disclaim as many warranties as legally possible, while Buyers will want to include such warranties into the supply contract.

7. Remedies Cumulative or Exclusive? Can a party seek all possible remedies listed in the agreement or does the suffering party have to pick one remedy?

8.  Shipping risk allocation (what if products are damaged, lost, stolen, delayed in the mail?).

9. Who pays taxes, fees, import clearance?

11. Indemnification. A party must be reimbursed for damages resulting from the other party’s negligence.

12. Governing Law, Jurisdiction and Dispute Resolution. This is particularly important if your supplier is in a country like China but you don’t want to end up having to go there to sue them in Chinese if anything goes wrong. One alternative would be to include an arbitration clause, so the disputes are resolved quickly, inexpensively and confidentially in your hometown or close by. Some countries restrict the use of arbitration clauses.

14.  Severability/Survival Clause ensures that even if some clause(s) of the agreement are held invalid by a competent authority, the rest of the agreement still remains in force. So, even if the arbitration clause or liquidated damages are not allowed or disfavored in that jurisdiction, you still have an otherwise valid contract.

 13. Entire Agreement. This is to prevent a party from introducing evidence contrary to what the contract says (i.e. “oh, it’s not in the contract but they did promise to do this, that and the other”).