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Statistics show that despite or perhaps because of the recent economic downturn, new businesses are continuing to launch. As new ventures have gained traction in the marketplace, new franchises have continued to launch as well. In the United States alone, more than 300,000 franchised small businesses employ eight million people, earning an estimated $1 trillion of income each year.

While franchises are commonly associated with food mega-chains such as Burger King or McDonalds, many small businesses, from coffeehouses to beauty parlors to web design shops, have also turned to franchising as a means of expanding a successful venture. Likewise, an ever-increasing number of small companies are finding ways to use their corporate trademarks and brand assets to build market visibility. As franchising and licensing opportunities continue to grow, it is important for businesses to distinguish between them and find ways to grow without losing control of the business.

What Is A Franchise?

Simply put, franchising is a way for a company (the franchisor) to give an independent third party (the franchisee) the right to operate an extension of the franchisor’s business in specified territories under the franchisor’s logo and trademarks. It is a way for businesses to expand while retaining control of operations, in return for royalties or sales profits. A typical franchise agreement may address the following points:

• Trade names and marks to be used by the franchisee
• Equipment or supplies to be purchased by the franchisee
• Initial consideration (value) to be paid by franchisee
• Profit the franchisee will earn or is likely to earn
• Permissible franchise locations
• Methods of operation
• Territorial exclusions or carve-outs
• Marketing, sales or training programs to be provided by the franchisor
• Buyback of products, supplies or equipment by the franchisor

Franchises are regulated by both federal and state law. The Federal Trade Commission outlines regulations for franchising ventures in the Franchise Rule, which prohibits franchisors and franchise brokers from engaging in unfair or deceptive acts or practices. Under the Franchise Rule, a person seeking to launch a franchise must make certain disclosures of information prior to meeting with a potential franchisee. Required disclosures include trademarks, company history and the related business experience of each director and executive officer over the past five years.

Individual states vary as to how they regulate the creation and operation of franchises. Some state have franchise investment laws that require pre-sale disclosures similar to the federal Franchise Rule, while other states like California and New York treat the sale of a franchise like the sale of a security. In these states, it is necessary for a franchisor to file and register a public disclosure document with the Secretary of State. These state laws give franchisees the right to bring private lawsuits against the franchisor.

What Is A License?

Unlike franchising, which is based on securities law, licensing is a contractual arrangement between two parties for the right to use property in exchange for a fee or other consideration. Licenses may be used to grant usage of a variety of intellectual property rights, including copyrights, patents, and image/likeness rights, but in the context of brands, licenses most often deal with trademark, trade name or trade dress rights.

A trademark or trade name, according to the United States Patent and Trademark Office, is “a word, phrase, symbol or design, or a combination of words, phrases, symbols or designs, that identifies and distinguishes the source of the goods of one party from those of others.” Trade dress is the visual appearance of a product or its packaging that identifies the source of the product to consumers, such as the festive, bright-colored Tex-Mex restaurant décor held by the Supreme Court to be protected in the 1992 trade dress case Two Pesos v. Taco Cabana.

A company that holds the rights to a trademark, trade name, or trade dress (property) may capitalize on these rights by licensing them to others who find value in the brand’s cache. In the context of corporate trademarks, licensing is a way to bring a brand to a broader market without undertaking the groundwork of launching a full franchise. A brand licensing agreement may address the following points:

• Right to use the property exclusively or nonexclusively
• Product category
• Duration: period of time over which licensee may use the property
• Geographic territory where the products or services may be distributed
• Co-op dollars (cooperative dollars): money supplied by licensors to spend on promotion and advertising as licensees deem appropriate
• Financial terms: royalty rate, minimum royalty guarantee (money at the end of the term), royalty advance (money upfront), markup prices and audits

The Fine Line Between Franchising and Licensing

Small businesses are frequently drawn to licensing over franchising because of the lower barriers of entry associated with licensing. However, while a well-executed licensing strategy can be a source of revenue and marketing vehicle, a company can easily run afoul of state franchising or business opportunity laws with the intention of merely licensing its brand. This makes it particularly important for growing companies planning to expand to pay close attention to the definition of a franchise under relevant state law.

A licensing arrangement that qualifies as a franchise under federal law or under the maze of state franchise laws must comply with all relevant disclosure laws and regulations. Thus, for example, a coffeehouse may in fact be operating a franchise when it licenses for its name and logos, as well as the distinctive red-and-green art-deco theme that distinguishes the store, to a coffee stand operator who brews the same specialty coffee under the terms of the agreement.

If the coffeehouse operates in California, the California Corporations Code states that a franchise is formed when the franchisor (1) grants the right to engage in sale or distribution according to a specified marketing plan or system, (2) allows the franchisee to operate a business under the franchisor’s trademarks or trade names and (3) receives a franchise fee. Potentially, the coffeehouse could be liable under California franchise laws for failure to make required disclosures and filings, even if the agreement with the coffee stand operate states explicitly that it is merely a license.

Losing Control, Facing Liability

Trademark licensing arrangements cross over into the realm of franchising when a licensor receives compensation and continues to exert control over the licensee’s day-to-day business. Yet many businesses wish to retain control over the way that licensees use their properties, since the impact of a third-party’s rogue use of a mark could have lasting repercussions on the brand, as well as potential legal ramifications. What begins as a simple deal exposes the company to liability.

For example, in December 2008, the Walt Disney Company faced a highly-publicized products liability lawsuit brought by the family of a child who died as the result of a Winnie the Pooh bassinet with a flawed design. Six month-old Kennedy Brotherton Jones was strangled in the bassinett when she slid through a gap in the crib. Though Disney merely licensed the Winnie the Pooh character to Simplicity, the company that manufactured the cribs, the plaintiff brought suit against Disney for failing to control and ensure the safety of the licensed product.

The Disney suit, which is still pending, highlights the paradox sometimes faced by companies that wish to license their brands. As licensors, they can exert only limited control over the licensee’s day-to-day business operations, and yet in some cases may face liability or a tarnished brand as the consequence of not exerting sufficient control. It is advisable for companies, especially small companies, to consult an attorney when deciding whether to open a franchise, franchise a business or license a brand. These relationships which begin as complex agreements can ultimately lead to partnerships that are profitable for all parties involved.

- By Dava Casoni, Annie Lin

In 2007, a Georgia woman sued Donald Trump and NBC Universal for operating an illegal lottery in violation of state racketeering statutes. Similar class action lawsuits have also been filed against popular shows such as America’s Got Talent, Deal or No Deal and 1 vs. 100. The class action suits have called into question whether these SMS promotions constitute gambling, even though viewers were provided with a method of entering the contest for free online. Participants paid only the opportunity to participate, rather than anything of economic value.

Free Giveaways, Many Rules

With the advent of email blasts, web promotions and real-time Twitter giveaways, companies can now instantaneously engage large audiences with the promise of something for nothing. Mail order sweepstakes and promotions have traditionally been used to build brand awareness and win customer goodwill, most notably national sweepstakes like Publisher’s Clearing House and Reader’s Digest. Such marketing vehicles have become more accessible in recent years since even small companies can set up and administer large-scale promotions online with relative ease.

However, as the producers of Donald Trump reality show discovered, promotions and sweepstakes can pose complex legal issues because of the uneven landscape of state law. Federal agencies have some authority to regulate certain aspects of prize promotions under federal law, but at the state level, a raft of varied local laws may apply. Despite the fact that it was most likely vetted by in-house counsel, the Donald Trump sweepstakes still resulted in litigation because it ran afoul of a Georgia anti-racketeering law that prohibits “illegal gambling contract.”

Games of Skill vs. Games of Chance

Marketing promotions generally fall into one of several categories. The law applicable to a particular promotion or sweepstakes will depend on the rules of the game and how the game is structured.

• Sweepstakes. A sweepstakes is a random drawing governed by official rules. The success of a participant in a sweepstakes depends on chance, rather than skill. If a sweepstakes requires entrants to give up something of value to participate, it will most likely be considered a lottery and subject to state anti-lottery statutes, such as the Georgia statute that provided the basis for The Apprentice show lawsuit. These state statutes are discussed at greater length below.
• Contests. In contrast, a contest is a promotion where the result depends on the individual participant’s unique skills, rather than pure chance. In most but not all states, contests are not subject to anti-lottery statutes and pay to play may be acceptable. For example, the increasingly popular marketing trend of user-generated content promotions could fall into this category.
• Raffles. A raffle is a contest of chance where entrants who give up something of value for the opportunity to win a prize. The prize doesn’t necessarily have to be cash, and entrants don’t necessarily have to pay cash to participate. For example, several jurisdictions have held that the purchase of a product satisfies the requirement. Raffles are the equivalent of lotteries and are subject to state anti-lottery laws.

Federal Regulations: The Deceptive Mail Prevention and Enforcement Act

When launching a promotion, especially an online promotion, it is worth considering whether participants may hail from the United States or from abroad. A promotion or sweepstakes that launches internationally may also need to comply with foreign law. In the United States, agencies at the federal level can regulate how and when certain promotional games and contests are operated. Such agencies include the Federal Trade Commission (FTC), U.S. Postal Service, Federal Communications Commission, and the Bureau of Alcohol, Tobacco and Firearms.

One key federal statute in this area is the Deceptive Mail Prevention and Enforcement Act (DMPE), which is enforced by the FTC. Enacted in 1999, the law regulates some aspects of sweepstakes and creates strong consumer protections to prevent deceptive mailings. Under the law, the sponsor of a promotion must clearly and conspicuously disclose the terms and conditions of sweepstakes, as well as language stating that no purchase is necessary to enter. If the promotion is a contest, the sponsor must also disclose terms and conditions, as well as the cost of participation and the standards by which the contest will be judged. Sponsors must provide consumers with a method of opting out from notifications of future promotions and maintain an opt-out list.

In 2007, the FTC brought an action against direct-to-consumer adjustable bed marketer Craftmatic under the DMPE. The company operated a sweepstakes that gave consumers who filled out a form that chance to win a Craftmatic bed. The form did not inform consumers that they would be targeted with sales calls. However, the company nevertheless allegedly called numerous consumers who entered the sweepstakes, even when consumers requested to be placed on a do-not-call list. The company was subject to a $4.4 million civil penalty.

An Uneven Landscape: State Laws and Regulations

The real challenge for marketers is ensuring that promotions and sweepstakes comply with the state law regulations. The DMPE does not preempt state laws, so if a promotion is open to participants in all states, it will be necessary to ensure that the promotion does not violate the relevant laws of any of the 50 states. A state like Nevada will have different public policy goals from a state like Nebraska, so a promotion that is legitimate under the laws of one state may be illegal under the laws of another.

Given stringent anti-lottery regulations in certain states, it is not unusual for sponsors to exclude a promotion from certain states. The following are some examples of promotions and sweepstakes rules that apply in some states.

• Anti-Lottery Statutes. The difference between lotteries, sweepstakes and contests is important because it determines whether state anti-lottery rules apply. If the promotion is based on chance and entrants are required to give up something of value – even “a rose, a hawk, or a peppercorn,” as noted by the court in the Lucky Calendar case – the promotion may be an illegal lottery. Currently, states with anti-lottery statutes include California, Connecticut, Georgia, Maryland, Massachusetts and Michigan.
• Bonding and Registration Rules. Some states require sponsors to notify state agencies of their promotions and to register with state agencies if the total retail value of the prize exceeds $5000. These rules usually require sponsors to clearly disclose the rules of the promotion to the agency and to the public, and sometimes also require sponsors to post a bond. States with bonding and registration requirements include Florida, New York and Rhode Island.
• Alcohol Sponsors. Some states including California, Tennessee and Utah have particular rules restricting or barring alcohol companies from sponsoring promotions and sweepstakes. For example, the Tennessee Alcoholic Beverage Commission would prohibit a state resident from entering an online sweepstakes sponsored by an alcohol brand.

Vetting The Campaign

The degree of work involved in giving away something for nothing often surprises companies seeking to build goodwill through promotions. The Internet has reduced the barriers to entry for brand marketers, but it is important to ensure that sweepstakes drawings, interactive media contests, user-generated content competitions, rewards programs, and mobile marketing programs do not run afoul of the relevant state, federal and where applicable, international rules. Given the complexity of regulation in this area, it is advisable to have an attorney vet a campaign in advance of launch.

- By Dava Casoni, Annie Lin

On Call, But Unpaid

Like many companies, T-Mobile USA Inc. required its employees to log hours through a computer-based timekeeping system, but did not track or compensate time employees spent responding to emails and text-messages on smart devices. The mobile phone company, which provides services to approximately 33 million wireless subscribers and over 800 wireless stores nationwide, is now facing a class action lawsuit under the federal Fair Labor Standards Act, as well as wage and labor claims under California and New York law.

Interestingly, several other lawsuits this year have drawn attention to the issue of what constitutes work in the era of instantaneous communication. Like T-Mobile, commercial real-estate company CB Richard Ellis Group Inc. is facing an employment lawsuit filed by former maintenance worker John Rulli, who seeks compensation for time spent receiving and responding to messages on his phone after hours. In Jose Gomez v. Lincare, Inc., medical equipment provider Lincare Inc. was sued for requiring its service representatives to spend evenings and weekends on call. The plaintiff employees in the Lincare case sought back pay for not only the time spent resolving consumer questions by phone, but also for the time spent on call and at overtime rates. In April 2009, the California state courts reinstated the suit in favor of the employees on appeal.

Old Law, New Rules

The Fair Labor Standards Act (FLSA) was enacted in 1938 and governs minimum wage, overtime pay, recordkeeping, and child labor regulations for full-time and part-time workers in the private sector, as well as in the government sector. Under the FLSA, employers must compensate qualified workers for time spent working during the week. In addition, for every hour worked over 40 in a work week, employees covered by the Act must receive time and a half overtime pay.

Not all workers qualify for FLSA protections; the statute specifies in detail employers who are exempt, such as certain companies with an annual gross business volume of less than $500,000. However, employers not covered by the FLSA may still be required to comply with the FLSA if their employees are engaged in interstate commerce or the production of goods for interstate commerce, such as employees who work in communication or transportation. The Department of Employment offers a web tool (http://www.dol.gov/elaws/esa/flsa/scope/screen9.asp) to help businesses ascertain whether FLSA provisions apply.

The broad definition of employment under section 3(g) the FLSA – “to suffer or permit to work” – covers work performed automatically by an employee who is aware of the obligation to perform the work. On-call time may overlap with on-the-clock time when the employee is bound to work obligations and is not free to use the time for his own purposes. As applied to mobile devices, these regulations may be construed to require compensation if the employee is called frequently, required to respond promptly or tethered geographically as a result of being on call. Thus, the recent cases filed against T-Mobile, CB Richard Ellis Group and Lincare may reframe the definition of work in the age of rapid-fire technology and hold broad implications for employers.

Even if an employee volunteers to be reachable in order to gain access to a company-subsidized smart device, the company may be obligated under the FLSA to provide compensation for on-call hours. Under Department of Labor regulations, an employer in some cases may not be required to provide compensation for work if the employee offers services freely and without pressure or coercion to a public agency for civic, charitable or humanitarian reasons. However, the Department of Labor issued a clarification of its policies in 2005, stating volunteers must be compensated for any time spent performing work that is similar to their normal duties, even if those activities occur during non-working hours.

Setting Boundaries To Mitigate The Risk of Liability

Employee wages, salaries, commissions and other related payments are the single largest expense for the plurality of small employers, according to a recent report from the National Federation of Independent Business. Payroll not only represents a significant cost for small businesses, but also poses an administrative burden that is complicated by the numerous state and federal regulations governing when and how an employee may be paid. Moreover, the intimate environment of a small business makes it easy to overlook the boundaries between on-the-clock and off-the-clock time.

These recent cases underscore the need for employers to enact clear policies defining exactly what it means for employees to be “on call”, even if employees express willingness to be reached via cell phone, text message or email. The Wage and Hour Division (Wage-Hour) of the Department of Employment administers and enforces the FLSA in government employment, as well as private employment. For up to two years after a violation of the FLSA (or three years in the cases of willful violation), Wage-Hour has the authority to bring action against an employer for the payment of back wages.

Likewise, employees like the retail associates in the T-Mobile case may directly file litigation to collect back pay, attorney’s fees and court costs. Once an employee has filed an action under the FLSA, the company is put on notice and must avoid taking actions against the employee that could be construed as retaliatory termination. Department of Employment regulations state that it is “violation to fire or discriminate against an employee for filing a complaint or for participating in a legal proceeding under FLSA.”

Corporate Blackberry and iPhone use can be a mixed blessing for both the employer and employee, even when the employee is at first eager to embrace the prospect of constant connectivity. Given the risks of costly litigation, it is important for a company to consider working with an employment law practitioner to draft clear employment policies regarding on-call time.

- By Dava Casoni, Annie Lin

In 2005, a bookkeeper at the Washington construction firm Colonial Development, LLC expressed relief to the firm’s insurers over having dissolved the business prior to being sued. However, the bookkeeper’s assessment of her firm’s liability turned out to be premature, since Washington law preserves claims against an LLC up to three years after a company dissolves. Moreover, two years later the court ruled that the owners of the firm could be held personally liable because they in fact had failed to properly wind up the company’s affairs.

The decision to quit a venture is never an easy one for an entrepreneur. When the decision is driven by financial reasons, as is often the case in a troubled economy, it can be tempting to simply walk away under the rationale that no new business means the business is dead. The excitement of new projects or the appeal of a fresh start under a new name can overshadow the headaches associated with a failing business. But as cases like Emily Lane Homeowners Association v. Colonial Development, LLC show, maintaining the shell of a company is an all-too-convenient move that leaves owners vulnerable to lawsuits and liability. The failure to properly wind up affairs may lead to a variety of repercussions:

Leaving the Door Open to Liability

A majority vote of the owners recorded either in meeting minutes or via written consent form may be required to dissolve a company. The specific procedure for dissolution will vary according to whether or how a business has been incorporated, but regardless of the procedure, proper termination is a key step in avoiding future liabilities. After a company formally files for termination, creditors and other parties with known claims have a limited window of opportunity to pursue action against the corporation as an entity. This gives business owners the opportunity to resolve outstanding debts or issues, such as money owed to a bank, suppliers, landlord or service provider.

A business that has been officially dissolved can no longer incur business debts. Business owners who passively allow their corporations to lapse are not afforded this finality of resolution, and may be forced to defend suits filed against a corporation that no longer exists. The owners of the defendant construction company in Emily Lane Homeowners Association v. Colonial Development, LLC faced this scenario when they failed to properly dissolve their business and were ultimately held liable as individuals for the corporation’s liabilities. Likewise, in the 2008 case of Matter of Beverwyck Abstract, LLC, a New York appellate court found that the members of an LLC who started a competing venture prior to formal dissolution of the LLC owed the excluded members pre-dissolution profits. The court noted that an informal agreement to no longer work together was insufficient to dissolve the company, since the operating agreement specified that a vote or written agreement would be required.

Tax Consequences

Informally dissolving a business can lead to a variety of tax consequences, both obvious and less obvious. A state franchise tax board can prosecute a business owner for the failure to pay any taxes prior to the date of formal dissolution. Taxes are due unless the company has filed to dissolve, even if the company no longer has any employees or transacts any business. Moreover, if a business owner fails to make final payroll tax deposits, the IRS can hold the business owner personally liable and satisfy the debt from assets such as personal bank accounts or a retirement account. Filing for bankruptcy offers limited protection in this area; the best plan is to avoid tax liability in the first place.

Licenses, Permits & Fictitious Name Registrations

It is important to terminate any licenses, permits or fictitious name permits with the county or state. Failure to do so leaves open the possibility of tax penalties, trade name confusion or liability resulting from fraudulent third-party use.

Avoiding the Pitfalls

It is possible to walk away from an unsuccessful venture without looking back. Taking steps to properly wind down a business enables a business owner to move on without liability or with minimal liabilities.

1. Follow the procedures outlined in the articles of incorporation to dissolve the company, which may include obtaining written agreement from all co-owners.
2. Contact the regional tax board to obtain a certificate of dissolution and file a final tax return with the IRS and state tax agency, as well as all relevant final payroll tax deposits, employment-related paperwork and wages.
3. Contact the state or local government to cancel any licenses, permits or fictitious name permits associated with the business. Close all relevant service accounts in the business name.
4. Inform creditors, customers and employees of the dissolution.Additional measures may also be necessary, depending on how the business has been structured. It may be advisable to consult a legal professional who can tailor a dissolution plan to the needs of the company.

-By Dava Casoni, Annie Lin

The problems began in 2006 when web designer Terry Wilson launched a small business to market her custom-made laptop cases. Because the cases were designed to protect a laptop, like a pod protects a seed, and because she perceived “pod” to be an appealing buzz word, Wilson dubbed her product the TightPod, registered a trademark and began making sales at the domain of the same name. To her surprise, she received a letter from Apple, the company first to file for the trademark “pod”, requesting that she cease using the TightPod name and undertake the costly procedure of rebranding her product.

Intimidation Factor

Cease and desist letters can unexpectedly wreak havoc on a new venture when the subject of the letter is innovation, branding or a product that is central to the business plan. Usually sent by an attorney, a cease and desist letter is a document informing the recipient of someone’s legal rights against the recipient, commonly in the areas of libel, slander, copyright infringement, trademark infringement and patent infringement. The letter may take the form of a generic template or may be drafted to include points of law and specific facts to support a case for liability, much like legal memoranda filed with a court.

For a business owner, the first response to a cease and desist may be panic over the threat of legal action. But despite the intimidation factor, a cease and desist letter is simply a letter giving notice of an issue that needs to be addressed. Further legal action may follow if the recipient fails to comply, but doesn’t have to be evitable. By evaluating the facts, acknowledging the letter and formulating an appropriate response, a business owner can proactively address the problem identified in the letter and shape a savvy response strategy, which may even involve a resolution for all parties on mutual terms.

Assessing The Risk

It is important to realistically assess the risk of legal action, based not only on copyright, patent or trademark law, but also on straightforward business considerations. As a practical matter, an individual who sends a cease and desist letter might lack the resources to pursue action, whereas a major corporation like Apple can rely on both in-house and external counsel to rigorously defend its trademarks and other intellectual property. Likewise, an individual who sends a cease and desist letter might be more likely to pursue action against a solvent company that can afford to pay out damages.

A trademark owner may have a compelling incentive to defend a mark at the risk of otherwise losing trademark protection, whereas a copyright owner may not have the same incentive, since copyrights do not expire as a result of infringing uses. A writer may feel sufficiently motivated to send a cease and desist letter but lack the initiative to aggressively pursue the matter to the same extent as a company that has invested heavily in development of a patent. In the case of the trade name “pod”, Apple had filed for protection of its mark in several countries and planned to also register the mark in the United States at the time that it challenged Terry Wilson’s use of the TightPod name. Defending the brand was necessary step in strengthening Apple’s claim for trademark protection in the United States.

Performing Due Diligence

Another point to consider is whether the use does in fact infringe on someone else’s intellectual property. In the case of trademark or copyright law, it is important to assess the extent of liability and whether the use may fall into one of the protected categories of intellectual property, such has fair use. When liability is debatable, a copyright holder might be more amenable to negotiation.

In the case of patent infringement, a company actually has a legal duty of due care to investigate the allegedly infringing activity once the company has received actual notice of another’s patent rights. The cease and desist letter does not necessarily require the company to cease the activity or use, but it does trigger an obligation to investigate before proceeding. If proper due diligence measures are taken, the objecting party will have difficulty establishing willful infringement and will be much less likely to obtain penalties such as treble damages and attorneys fees. Courts have held that such due diligence measures usually involve receiving the go-ahead from a competent patent attorney.

As a general precautionary measure, it may be worth ceasing use of the brand name, product, technology or content until the issue has been resolved, whether by negotiating a deal or determining that the use is in fact not infringing. Intellectual property laws tend to yield harsher results for an infringing company when the company had knowledge of the infringement. By ignoring a cease and desist letter for patent, trademark or copyright infringement, a company may bolster the case for willful infringement and be subject to statutory penalties such as treble (triple) damages or reimbursement of attorney’s fees and costs.

Evaluating The Options

If complying with the cease and desist letter will cause significant losses for the business, it is advisable to consult with an attorney to determine the strength of the rights holder’s claims and the possibility of raising defenses or a counter-argument. If the cost of acquiescing is too high, it may be possible to negotiate in good faith with the rights holder and reach an agreement, such as a content licensing deal or language on a website to distinguish one trade name from the other. Rather than risk the unfavorable press, Apple ultimately offered to pay Terry Wilson an undisclosed sum to re-brand her product so that it would not include the word “pod.” The end result was the removal of the word “pod” from Wilson’s website and the emergence of a new product name: TightJacket.

-By Dava Casoni, Annie Lin

Even though an NDA had been signed, an appeals court in December 2008 dismissed Fada International’s claim and held that Cheung did not steal the information. According to the ruling, trade secret protection did not apply since the customers were “readily ascertainable outside the employer’s business as prospective users … of the employee’s services or products.” Moreover, the court refused to interpret the NDA in a way that would keep Cheung from competing against her former employer. The court noted that Cheung had signed a confidentiality agreement, rather than a non-compete agreement that could her conduct on behalf of a new employer or in a new venture. The story of Rowena Cheung’s departure is a familiar one to business owners, who contend with the perils of sharing confidential information whenever they hire an employee or work with an independent consultant or external business. It is common for employees to break away and join the ranks of another venture in the same industry or even found a new competing venture. Most business owners are aware of the hazards and protect sensitive internal information by having employees, consultants, third-party business sign confidentiality agreements.

The NDA or confidentiality agreement is a set of promises that facilitates the disclosure of trade secrets. Typically, the NDA binds one or both parties to treat specific information as confidential. The NDA can take a variety of forms, including a separately executed agreement or a clause in another agreement, such as an employment contract. What an NDA typically protects is information of a secret, private or confidential nature that pertains to the company’s financial state, business dealings or technology. The document may either limit disclosure of the information to certain third parties on a need-to-know basis only (e.g., executives, attorneys, employees), or prohibit disclosure entirely. At the bare minimum, an NDA will usually cover the term of confidentiality, the manner in which the information must be held confidential, and the definition of what information will and will not be held secret. Sometimes companies that lack in-house counsel opt, in the rush to move transactions forward, for boilerplate language taken from other deals or from the Internet. This approach may jeopardize the protection of intellectual property, a costly stake for businesses that invest heavily in research and development.

The non-disclosure of confidential information, whether through NDA or other measures, is critical to the protection of proprietary information under United States trade secret law. The Uniform Trade Secrets Act (UTSA), which has been adopted by 42 of the states, defines a trade secret as “information, including a formula, pattern, compilation, program device, method, technique, or process, that: (i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.” Information classified as a trade secret is not only protected by state statute, but also by federal trade secret provisions under 18 U.S.C. 1832, which provides criminal penalties for the theft of certain secrets involving federal employees or federal liabilities. However, protection of trade secrets under state and federal laws evaporates when the information is disclosed to third parties and no longer considered “secret”, regardless of how the information was disclosed. Thus, the consequence of a poorly-drafted NDA may be the permanent loss of trade secret protection.

Despite the importance of the NDA in maintaining trade secret protection, confidential information may still be vulnerable to disclosure in a variety of ways. The dismissal of Fada International’s case against its former employee-turned-competitor demonstrates that certain categories of information fall outside the protection of an NDA. Moreover, the case illustrates the risks of litigating trade secrets in open court, where disclosure is a necessity and enforcement can be uncertain. An NDA may not help or may even hinder trade secret protection in the following areas:

• Common industry knowledge. Trade secret law is intended to protect information that derives economic value from not being generally known. Information that is common knowledge, either to the public at large or to individuals working in a particular sector, will not be protected as a trade secret. As the court in Fada International Corp. v. Rowena Cheung affirmed, client lists will not be considered confidential information in a competitive industry where the clients are commonly known entities within the industry.
• Ideas and general concepts. These fall under the umbrella of copyright and patent law protection, not trademark law. For example, the idea of creating a device that could play MP3 files was never a trade secret. The technologies behind the idea were, however, eventually protected under several different patents.
• Residual clauses. Some confidentiality agreements include residual clauses that exclude from the NDA any information that is retained in employees’ memories, such as general skills and knowledge. Residual clauses can render an NDA ineffectual by severely limiting the scope of confidential information covered by the agreement.
• Court discovery. If the NDA becomes relevant to litigation, a court-approved subpoena would supersede the confidentiality agreement and could require the disclosure of the information. It would then be necessary to obtain a protective order from the court to preserve secrecy.
• Parties in quiet breach. There is a consensus among legal practitioners that the enforcement of confidentiality agreements is often impractical. It is difficult to ascertain whether a consultant or former employee has disclosed the information after having left the company.
• Parties in open breach. Moreover, even when it is possible to prove that there has been a disclosure, litigation is costly and often ineffective when the defendant is judgment-proof and the secret has been exposed to the public. For example, in 2008 case Master Mech. Corp. v Macaluso, a New York heating, ventilation and air-conditioning firm sued an employee who had been hired to bring in new business, but then left the company to start his own business. The employee had been bound by agreement not to disclose confidential trade secrets and not to do business with the company’s customers for two years after termination. However, by the time the appellate court issued a ruling on the preliminary injunction against the employee, the two year term was over. In spite of the NDA and non-compete clause, the employee was ultimately free to engage in business with the firm’s clients.

In light of cases like Fada International Corp. v. Rowena Cheung, it is important to note that no NDA is bulletproof and that there are gray areas that fall outside of the protection of trade secret law. It may be helpful to consult with an intellectual property attorney to develop a strategy for optimizing the protection of confidential information.

- By Dava Casoni, Annie Lin

In the digital age, many business owners have adopted the Internet as a relatively inexpensive, high-return marketing tool. Online advertising is a way to reach potential clients and customers in a seemingly limitless variety of ways. For little or no expense, companies can now target large groups of people and connect with diverse audiences via blogs, message forums, Twitter, social networks like Facebook, and a variety of other new media platforms. The freedom of web communication has fostered a free-for-all online marketplace where businesses aggressively deploy creative new advertising strategies to turn casual browsers into paying customers. But in the process of spreading the word online, businesses often overlook the fact that Internet advertising, like any other form of advertising, is subject to regulation. New policies in this developing area of regulation, such as the FTC’s May 2009 guidelines for word-of-mouth product endorsements online, have created confusion and concern in the blogosphere.

The Federal Trade Commission Act (Act) established the FTC in 1914 for the purpose of preventing unfair methods of competition and unfair or deceptive acts or practices in or affecting commerce. This independent federal agency continues to carry out its purposes today and has the authority to define unfair or deceptive practices, as well as investigate the business, practices and management of entities engaged in commerce. If the FTC finds that a business has violated statutes under Federal Trade Commission Act, it has the authority to levy fines and seek other relief. The FTC, which may target a single company or an entire industry, aggressively investigates and takes action against fraud and false advertising. Unlike civil litigation where a plaintiff brings a claim against a defendant, FTC actions originate in the administrative courts with the agency’s attorneys acting as prosecutors. If a company seeks to appeal the administrative judge’s decision, the decision can be appealed through a lengthy process starting with FTC review, then review by the U.S. Court of Appeals or the Supreme Court, if the court chooses to hear the case.

In recent years, the FTC has made an effort to update guidelines so that they reflect new changes in technology. The FTC has also taken an aggressive stance against Internet companies that have violated federal laws. Because of this trend, it is advisable for business owners to be aware of the regulations in this space and to make expectations clear to business partners and contractors, such as hired bloggers, email marketing firms or social media experts. It may also be advisable to vet online advertising strategies with a legal professional before sinking funds into a marketing campaign that could lead to liability.

• Testimonials. The FTC regulates testimonials in advertising, which includes personal experiences from consumers and quotes from a third-party (such as excerpts from a film review embedded in a movie poster). According to May 2009 regulations issued by the FTC, the rule now also applies to statements made by bloggers, Twitterers and other word-of-mouth marketers who might make statements about a product or brand online. A company may, for example, be liable if it posts a single positive phrase from an overwhelmingly negative blog review of a product because it mischaracterizes the testimonial.
• Endorsements. Additionally, the FTC regulates the use of endorsements in advertising. Under FTC rules, paid endorsements need to “reflect the honest opinions, findings, beliefs, or experience of the endorser” and “may not contain not contain any representations which would be deceptive, or could not be substantiated if made directly by the advertiser.” Likewise, under new regulations, new media marketers and advertising affiliates are obligated to disclose their interests when making endorsements after receiving money, free product giveaways or other forms of compensation. Liability may extend not only to the individual who made the false or misleading statement, but also to the company advertising the product. For example, a blogger who is paid to include a link to a nutrition bar brand under a list of “Fit Foods I Love To Eat” should disclose the sponsorship. Failure to do so puts both the blogger and the company selling the nutrition bars at risk for liability.
• Advertisements. The Federal Trade Commission Act also provides that (1) advertising must be truthful and non-deceptive, (2) advertisers must have evidence to back up their claims; and (3) advertisements cannot be unfair. According to FTC’s policy on deceptive statements, an ad is deceptive if it includes or omits information that is likely to mislead consumers acting reasonably under the circumstances. The statement or omission must also be important to a consumer’s decision to buy or use the product. These rules now apply not only to more traditional forms of media, such as radio and broadcast advertising, but also to ads posted online. The FTC cited and fined Member Source Media for the banners it used to attract consumers, with headlines such as “Congratulations. You’ve won an iPod Video Player”, “Here are 2 free iPod Nanos for You: confirm now” and “Confirmation required for your $500 Visa Gift Card.” Beyond FTC regulation, states may also have laws regulating advertising.
• Emails. The FTC is also authorized to take measures against companies that violate the federal laws governing the usage of email as an advertising tool. Under the CAN-SPAM Act, a “commercial electronic mail message” is “any electronic mail message the primary purpose of which is the commercial advertisement or promotion of a commercial product or service (including content on an Internet website operated for a commercial purpose).” Under the CAN-SPAM Act, companies may be liable for sending emails with false or misleading header information or deceptive subject lines. Companies can also be liable under the Act for failure to provide a legitimate opt-out link, failure to include a valid physical postal address or failure to properly mark the message as an advertisement. Again, although individual recipients of emails cannot pursue claims against a company, the FTC can levy hefty penalties of up to $11,000 per violation, as well as criminal penalties under certain circumstances.

- By Dava Casoni, Annie Lin

The decision to hire an independent contractor has always been attractive to small business owners seeking to rein in overhead costs. According to the Census Bureau, the number of self-employed individuals rose from 15.4 million in 1997 to 20.8 million in 2006. In the wake of the recent economic downturn, the number continues to grow as companies of all sizes scrutinize their operating expenses and question the cost of human capital. Hiring an independent contractor is an appealing option because it allows a business owner to avoid the paying for the raft of expenses associated with hiring salaried workers, including taxes, worker’s compensation payments, Social Security, Medicare, unemployment payments and health insurance costs. Since the per-worker cost of hiring an independent contractor is relatively low, companies that employ independent contractors can increase productivity by hiring more workers.

Companies are also inclined to hire independent contractors because of the notion that they operate as free agents who carry out business without incurring risk on behalf of the company. Under the legal principle of respondeat superior, an employer may be held vicariously liable for the negligent acts or omissions of an employee even if the employer is not directly responsible for the injury. If the act or omission is committed in the course of employment, an employer can be held liable for the employee’s negligence since the employer is deemed to be in control of the employee. On the other hand, a company contracts with an independent to have work performed on behalf of the company, but lacks control of the contractor as well as the ability to supervise the contractor’s methods of performing the work. The doctrine of respondeat superior does not apply to independent contractors, as the hiring company is not deemed to be in control of the contractor.

However, it is a misconception that the principle of vicarious liability never applies to independent contractors. The reality is hiring an independent contractor is not a risk-free proposition. An independent contractor may incur liability on behalf of the hiring company in several ways.

• Risky business. A company that employs an independent contractor to perform abnormally dangerous work, such as road blasting, can be sued for a contractor’s negligent acts or omissions. When hazardous work is carried out by independent contractors, companies may be held liable not only for the failure to take special precautions, but also for the contractor’s failure to exercise reasonable care. Courts determine whether work is hazardous by asking whether the work is inherently risky and whether a reasonable person would recognize a need for safety measures.
• Outsourcing risk. A company that hires an independent contractor remains responsible for maintaining a safe workplace and providing warnings about hazardous conditions. If the company knows or should know about a dangerous condition, like a malfunctioning elevator, the company will be liable for injuries caused by the condition. This legal principle, the non-delegable duty doctrine, is intended to prevent companies from outsourcing dangerous tasks in order to sidestep liability. Likewise, a company may be liable to the public for injuries that result from the failure to take appropriate security measures.
• Blind hiring. A company can be liable for the failure to properly screen employees and independent contractors. A company owes a duty of reasonable care to the public in hiring employees and independent contractors. If a person is injured by an independent contractor, the hiring company may be liable for failing to anticipate and prevent injury by conducting screening procedures such as background checks. For example, the Houston woman who was threatened and nearly abducted by a cab driver was able to win a negligent hiring claim against the hiring company, even though the cab driver was an independent contractor.
• Independent contractor as agent. A company may also be held liable for the actions of an independent contractor if the contractor is considered an agent of the company. Under the rules of agency law, an agency relationship may be formed if the company’s actions or words give the contractor or a third-party reason to believe that the contractor is an agent of the company. A contractor has not been paid or agrees to work without compensation for a particular project can still be deemed an agent. If an agency relationship exists or if a third-party believes that the contractor is an agent of the company, then the company will be liable for injuries caused by the contractor in the course of carrying out its work.
• Misclassifying a contractor. Many companies incur tax liability for back taxes, interest and penalties by misclassifying employees as independent contractors. There is a common misconception that a worker who signs an independent contractor agreement is indeed a contractor. However, independent contractor status actually depends on the extent of control that the company exercises over how the work is performed or the means of performing the work. The misclassification of a contractor not only has tax consequences, but also potential ramifications on a company’s liability since a company may be vicariously liable for injuries caused by an employee in the course of work.

Hiring an independent contractor can be a cost-effective alternative to hiring an employee, but it is important for companies to recognize the risks associated with contract work. It may be advisable to have a legal professional draft the contractor agreement and outline the measures that can be taken to minimize the liabilities.

- By Dava Casoni, Annie Lin

An arbitration panel subsequently issued a decision in favor of Traditional Medicinals, citing WorldWide Media’s lack of actual business activity and its practice of registering and reselling other trademarked domain names. But when the arbitration panel gave WorldWide Media 10 days to initiate a transfer of the domain name, WorldWide Media opted to challenge the finding by filing a lawsuit in federal court. Today the lawsuit is still pending, and the disputed domain remains parked with a single-page website showing linked ads.

A Crowded Digital Marketplace

Domain disputes have become common in the increasingly crowded digital marketplace. Companies launching new brands or businesses often discover, in the course of trademark due diligence, that a first choice domain name has already been claimed by a competing venture or parked by an unknown entity. Likewise, established brands end up on the offensive, dedicating significant financial and legal resources to stamp out domain registrations that infringe on trademark rights. Microsoft Corporation, for example, has filed suits against several different companies in 2009 alone for domain name registrations that are identical or confusingly similar to Microsoft’s trademarks and service marks.

Some companies like Traditional Medicinals have the resources and financial incentives to fight for a preferred name, but others relegate themselves to second choice domain names that have not already been claimed. Domain name registration is a seemingly murky area of law governed by global intellectual property treaties, out-of-court arbitration procedures and trademark law. Even when a trademarked domain name has been registered by an entity, smaller businesses often abandon the possibility of reclaiming the name space because do not know how to enforce their rights.

ICANN and The Internet

A domain name is a series of letters and or numbers assigned to a particular Internet Protocol (IP) address, the series of numbers identifying the devices participating in a computer network. It is a comprehensible way to call up the information hosted on these devices which, when linked together and made accessible to the public, make up the Internet. Domain registrars such as GoDaddy, Register and 1&1 are companies authorized to handle domain name registrations by the Internet Corporation for Assigned Names and Numbers (ICANN), the organization with the authority to handle resolution of all domain name ownership issues for generic top-level domains (i.e., those ending in .com, .net, .org and .info).

Under ICANN rules, which were drafted with the support of the World Intellectual Property Organization, anyone registering a domain name must agree to be bound by policies outlined in the Uniform Dispute Resolution Policy (UDRP). This means that anyone who registers a top-level domain agrees to submit to arbitration, a form of out-of-court dispute resolution where a third party evaluates the facts in light of relevant law and imposes a legally binding decision. According to WIPO, ICANN’s arbitration policies were originally instituted to provide a means of resolving domain disputes that would be less expensive and faster than litigation. After an ICANN arbitration proceeding, the parties are still free to challenge the arbitrator’s decision. Nevertheless for all top-level domain name disputes, arbitration through an approved domain name dispute resolution service provider is a required first step.

Making The Case For Cybersquatting

According to the UDRP, anyone who registers or renews a top-level domain name must “represent and warrant” that the statements made in the registration agreement are complete and accurate, that the domain registration will not infringe on any third-party rights, that the purpose of the registration is not unlawful, and that the domain name will not be used in violation of any applicable laws or regulations. The UDRP explicitly puts the burden of determining “whether [the] domain name registration infringes or violates someone else’s rights” on the registrant. If a registrant fails to comply with UDRP regulations, ICANN has the authority to cancel, transfer or change the domain name registration.
In order to challenge the registration of a domain name, a company must first file an administration proceeding with ICANN. The filing must establish all the following: (1) the domain name is “identical or confusingly similar to a trademark or service mark” in which the company has rights, (2) the registrant has “no rights or legitimate interests” in the domain name and (3) the domain name has been registered and is being used in “bad faith.” Bad faith is a determination made by the arbitrator on the basis of several factors, which may include circumstances showing the domain was registered for the primary purpose of transferring it to another party for profit. Proof of bad faith may also include facts indicating the domain was registered to prevent the trademark owner from registering or registered in order to disrupt the business of a competitor. The arbitrator may also find bad faith where the domain was intentionally registered to attract users by creating a likelihood of confusion with an existing trademark.

To defend against a domain name challenge, the entity that registered the domain may respond by demonstrating rights to or legitimate interests in the domain name. The registrant can establish this by providing evidence of use or preparations to use the name in connection with a good faith offering of goods or services. Timing is critical here: the proof of use or preparation to use must precede notice of the domain dispute. Likewise, the registrant can establish that its company, entity or product is commonly recognized by the domain name or that it is making a legitimate non-commercial or fair use of the domain name. In order to establish non-commercial or fair use, the registrant must show that there was no intent to misleadingly divert customers or tarnish the trademark or service mark at issue for commercial gain. For example, the anonymous creator of a website criticizing Powermark Homes recently defended itself successfully against a challenge, even though the domain name contained the name of the Ohio-based homebuilder.

Post-Arbitration Remedies

An arbitrator’s decision is binding unless either one of the parties decides to litigate the matter in court. If the party challenges the arbitrator’s decision on the basis of trademark or copyright, the case may be brought in federal court. It may also be possible to bring a challenge under the federal Anticybersquatting Consumer Protection Act (ACPA), which provides remedies against a defendant who has “bad faith intent to profit from a mark” and “registers, traffics in, or uses a domain name that” is at the time of registration identical or similar to another trademark. A plaintiff may solidify the case for bad faith intent to profit by showing that the registrant offered to transfer or the domain consideration, or by intentionally providing misleading contact information to the domain name registrar.

Litigation is costly in comparison with arbitration, but can yield remedies in addition to domain name cancellation, such as statutory damages up to $100,000 and attorneys fees. WorldWide Media, for example, is not only seeking declaratory relief to establish that SmoothMove.com does not infringe Traditional Medicinals’ trademark rights, but also payment of legal fees associated with the case. It is worth noting that in the United States, trademark protection disappears if the owner of a mark fails to adequately protect it against infringement. Since the onus of defending a trademark falls on the mark’s owner, a company may have incentives beyond branding and marketing to pursue a domain name of choice.

-By Dava Casoni, Annie Lin