Startup uses flawed contract with consultant, has to go to court to stay alive
ontechnologycontracts.com
ontechnologycontracts.com
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.
Does anyone have any experience with this sort of thing in the UK?
If you want your product to go to market smoothly, pay the invoices of the people who build it for you.
[EDIT: Keep in mind that the developer quit; the startup had to hire someone else to take over in order to get its product launched. What was the company supposed to do, fold its tent because one unpaid consultant -- who had also been given company stock, BTW -- decided to throw his legal weight around? I doubt many founders would agree.]
I sympathize with the developer, but in this case he shot himself in the foot just as surely as the company did.
Since he sued them for copyright infringement, that means they used code they hadn't paid for. If they'd realized they couldn't pay, told him as much and deleted any code developed during the unpaid time span, he might still have tried to sue for damages based on breach of contract, but not copyright infringement.
The developer could have just sued for the money owed him, without adding the incendiary copyright-infringement charge.
This was an example of a circular firing squad (well, to the extent you can have a circle with two people). It looks to me as though all hands played it badly.
The use of copyright-infringement forces the company to meet their ethical and legal responsibilities immediately, before proceeding with leveraging his work. It's not the contractor's responsibility to provide the corporation a bridge loan.
Whether work is "Work For Hire" or not should be in any contract with someone creating code or designs. I personally wouldn't hire someone without stipulating that all code and or designs (this comes up with getting source PSDs a lot) is WFH.
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.
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.
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).
There is case law to the contrary. See, e.g., Yojna, Inc., v. American Medical Data Systems, Inc., 667 F. Supp. 446 (E.D. Mich. 1987): An outside software contractor, at the request of a hospital corporation and its subsidiary, developed a computer program for hospital information management. The court held that the outside contractor was the owner of the software, but the subsidiary had a perpetual, royalty-free license to use and sublicense the program, including the right to unrestricted access to source code for purposes of developing new versions and enhancements. The court also held that the license was an exclusive license within the health-care industry. See id. at 446. [Copied from something I wrote a long time ago.]
I find that surprising -- all my contracts explicitly state that the transfer of copyright for a defined work unit occurs after payment in full. Our lawyer simply included it as a standard clause. From both the contractor and client perspective, I have no qualms with such a clause -- it simply means that if I want to use your work, I have to pay you what I agreed.
The problem here is that the underlying contract was not done as a work for hire.
The legal problem was that the underlying contract did not provide for copyright ownership. The ethical and human problem was that the company's management did not keep their word and pay for the work provided, and thus greatly reduced the likelihood of an amicable resolution to the legal problem of copyright ownership.
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.