Category: Contracts

Unclaimed Property in M&A Transactions: The Potential for an Unwelcome Surprise

GT Law

As the economy continues to recover, an increase in M&A activity is expected. A target company’s historical compliance with unclaimed property laws is an important, but often overlooked, area for due diligence in M&A transactions. A target company’s failure to comply with unclaimed property laws can potentially create multi-million dollar exposure for the buyer. The transaction itself may have the effect of drawing the attention of state unclaimed property regulators and third party contingency fee auditors. There are various ways, as discussed below, for the buyer to control or limit its potential exposure.

A Brief Introduction to Unclaimed Property

While the exact parameters of what constitutes “unclaimed property” vary from state to state, unclaimed property generally consists of a wide range of both tangible and intangible property held by a business. Once the business has held the property for a statutorily mandated holding period without communication with the owner, it becomes unclaimed property subject to escheat. Some examples of unclaimed property include: un-cashed rebate checks and other customer credits; unused gift certificates and gift cards; un-cashed vendor checks; un-cashed dividend checks; insurance proceeds; and the underlying stock or other evidence of an ownership interest in a business.

Businesses are responsible for reporting unclaimed property to the states on an annual basis in accordance with priority rules established by the U.S. Supreme Court. The first-priority rule is that unclaimed property escheats to the state of the apparent owner’s last known address, as shown on the company’s books and records. The second-priority rule provides that the unclaimed property escheats to the state of the company’s incorporation if: (1) the apparent owner’s address is unknown, (2) the last known address is in a foreign country, or (3) the last known address is in a state that does not provide for escheat of the property in question. As the unclaimed property laws vary from state to state, the outcome of this jurisdictional priority analysis can have a meaningful impact on the property required to be escheated. Some states even require negative reports to be filed, stating that no unclaimed property is due and owing to the state.

The Importance of the Transaction’s Structure

A transaction’s structure can significantly impact the unclaimed property exposure that a buyer may inherit from the target. In an asset purchase, the buyer acquires only those liabilities specifically identified in the purchase document. While it is still possible for the buyer to acquire certain unclaimed property liabilities in an asset purchase (such as those associated with bank accounts, accounts receivable, or gift cards), the buyer’s potential exposure for the target’s failure to comply with unclaimed property laws will typically be less than in a stock purchase where the buyer generally acquires all of the target’s disclosed and undisclosed liabilities, including its unclaimed property liabilities.

In addition, unclaimed property can arise in the context of a merger involving a share exchange, where the former stockholders (who now cannot be located) fail to receive the shares issuable to them in the merger. At least one SEC reporting company recently entered into a settlement with the State of Delaware as a result of more than four million shares which were reserved for issuance in the merger, but which were not claimed by former stockholders. The settlement resulted in the SEC reporting company making a $20,000,000 cash payment to the State of Delaware.

The Impact of a Target’s Failure to Comply with Unclaimed Property Laws

There are a number of factors that can make a target’s failure to comply with the unclaimed property laws very costly for a buyer. In many states, there is no statute of limitations on unclaimed property. As a result, even voluntary compliance arrangements with the states can result in a look-back period of five to ten years or even longer. Audit look-back periods can be significantly longer. Oftentimes, the buyer will not have complete records from the target. In such situations, state regulators in a post acquisition audit have been known to use various formula to estimate the liability. The target may have made acquisitions itself prior to being acquired, further compounding the potential for non-compliance. Once interest (and potentially even penalties) is added to the equation, a potential multi-million dollar exposure can be created — definitely an unwelcome surprise for the buyer.

Methods for Avoiding an Unwelcome Surprise

Prospective buyers can take proactive steps to manage and minimize potential exposure. Below are a few such steps:

Structure of Transaction. If possible, buyers should consider structuring a transaction as an asset purchase to minimize the unclaimed property liabilities inherited from the target. The purchase document should be carefully drafted and negotiated to leave any unclaimed property liabilities out of those liabilities acquired by the buyer.

Due Diligence. Oftentimes, unclaimed property compliance is overlooked in the due diligence process. As a starting point, buyers should request copies of the target’s unclaimed property policies and procedures, a description of the target’s unclaimed property due diligence process, copies of historical unclaimed property reports filed by the target, correspondence with state unclaimed property regulators, and any unclaimed property audit notifications. Given the current interest, especially in Delaware, in equity property (e.g., stock, dividends, etc.), buyers should make sure the target’s response includes materials that permit the buyer to determine the target’s compliance for this property type, especially because this information may be in possession of the target’s transfer agent or other third party. Depending on the materials provided, additional due diligence may be warranted.

Representations and Warranties. Unclaimed property is not a tax and thus is typically not covered by the tax representations and warranties. The purchase document should include specific representations and warranties of the target, backed by an indemnity and an escrow if possible, regarding the target’s historical unclaimed property compliance. The target’s indemnity obligations should be excluded from any basket and cap exceptions applicable to indemnities. Most representations and warranties only survive for a specified period following the closing of the transaction. However, as discussed above, oftentimes there is no statute of limitations with respect to unclaimed property compliance. If possible, the target’s representations and warranties regarding unclaimed property compliance should survive closing indefinitely. Additionally, even if the target is current in its compliance, provision should be made for property still in its dormancy period, i.e., property that may be abandoned but not yet subject to escheat.

Voluntary Compliance Initiatives. If it is determined that the target is not in compliance with the unclaimed property laws, the buyer should consider whether voluntary compliance is a viable option. Many states offer voluntary compliance programs with limited look-back periods.

©2012 Greenberg Traurig, LLP

Transformation. Repositioning. Adjustment.

The National Law Review recently published an article by Lisa L. Mueller of Michael Best & Friedrich LLP regarding the 2012 China (Suzhou) Service Outsourcing Innovation Development and Investment Promotion Summit:

Transformation. Repositioning. Adjustment. Service + Innovation = Jobs. These were the keys from today’s 2012 China (Suzhou) Service Outsourcing Innovation Development and Investment Promotion Summit in Suzhou, China.

The summit was attended by the Delegation, a number of local government officials, business leaders from Suzhou and other business leaders from around the world. The stage used for the formal presentations contained a large multimedia screen and was surrounded with red flowers, and the podium top had a dozen red roses on it. I was told by an attendee that decorating the stage with flowers is very common in China. Also, the introduction of each speaker was very unique. When introduced and while approaching the podium, a “theme” song was played, the morning session featured the “Star Wars” theme song. Although most of the speakers presented in Chinese, simultaneous translation into English was provided.

As emphasized several times by the various speakers during today’s presentations, service outsourcing has contributed greatly to China’s economic growth. As part of China’s 12th Five Year Plan, and in view of the recent global economic downturn, it is a top priority of the Chinese government to restructure and transform China’s economy. The fundamental purpose of this restructuring and transformation is to ensure the quality of economic growth and enhance the overall competitive strength of China. Therefore, the recurring theme throughout the day was the refocusing of China’s service industry from manufacturing outsourcing, considered to be low-end or low-tech outsourcing, to high-end/high-tech service and international service outsourcing. Innovation is considered to be the key in making the change away from low-end industrial and increasing the overall competitiveness of China’s service outsourcing enterprises. Clearly, China wants to be the worldwide leader in service outsourcing enterprises and is willing to invest the time and resources to achieve this goal.

In 2009, China’s state council approved setting up 21 cities as models of service outsourcing. These cities receive preferential treatment in terms of tax benefits and receipt of certain subsidies. The selected cities themselves have invested heavily in public infrastructure, industrial parks and education and training. One such selected city is Suzhou, the location of today’s summit.

Service outsourcing originated in Suzhou in the 1990′s and has developed rapidly. As of 2011, Suzhou had more than 1,600 service outsourcing enterprises employing approximately 160,000 people. In fact, in 2011, 488 new service outsourcing enterprises were established in Suzhou. Additionally, the signed contract value of Suzhou’s offshore outsourcing services in 2011 was 3.57 billion US dollars, an increase of 57.4% over 2010 with an executed contract value of 2.01 billion US dollars, an increase of 58.6%.

Suzhou hopes to lead the way in the transformation from low-end services to high-end service outsourcing and it appears to be well positioned to do so. Specifically, the city is the source of a lot of talent: (1) it’s home to 20 colleges and universities; (2) it has over 30 Chinese-foreign cooperatively run institutions; and (3) it has a variety of projects with universities such as University of Liverpool, National University of Singapore and the University of Dayton. In addition, Suzhou established the first service outsourcing institute having a capacity to train over 20,000 professionals per year.

Today, government officials described in detail Suzhou’s aggressive economic plan to create a unique service outsourcing industry in the following ten areas:

  1. Software development outsourcing – focus will be on software development in the areas of user operations, production, supply chain, customer relations, human resources and financial control, computer aided design, embedded software, system software, and software testing.
  2. Research and development design outsourcing – focus will be on providing design services in the automotive, electronic products, chip design, and other industries.
  3. Biomedicine research and development outsourcing – focus will be on the development of medical test technology services, animal experiment services, medical non-clinical research and evaluation services, biotechnology services, clinical trials for new pharmaceuticals, preclinical services, drug safety and evaluation, and medical apparatus design, research and development.
  4. Financial background service outsourcing – focus will be on the development of financial outsourcing businesses, including data mining and analysis, financial payment services, credit analysis and rating, insurance services, and financial consulting services.
  5. Animation and creativity outsourcing – focus will be on the development of international animation processing, original animation development, comic digitized applications, and special effects production.
  6. Logistics and supply chain management outsourcing – focus will be on the development of total logistics and supply chain management services in the areas of e-communication, chemicals and pharmaceuticals.
  7. Testing and inspection outsourcing – focus will be to establish “world-renowned” testing and inspection outsourcing enterprises and to actively develop professional analysis and testing services, including software evaluation services, quality inspection and testing services, and consulting services.
  8. Outsourcing in the field of cloud computing – focus will be on the development of software operation services including on-line software delivery services, on-line system maintenance services, IT infrastructure management, data centers, trust and call centers.
  9. Outsourcing in the field of Internet of Things – focus will be on the construction of a smart city and expansion in the business fields including the Internet of Things, development of information processing platforms, development of intelligent building equipment, sensor networks, small grids, and intelligent equipment.
  10. Shared service centers for transnational companies – focus will be on those transnational companies that have settled in Suzhou and encouraging them to establish shared service centers by separating their service businesses.

The government officials of Suzhou are very proud of all that they have achieved with respect to their service outsourcing enterprises and are confident that they can achieve a service outsourcing industry in the above areas. Time will tell.

© MICHAEL BEST & FRIEDRICH LLP

13th Great-Idea China Sourcing & New Industrial Delegation to China – Day 2

Recently an article by Lisa L. Mueller of Michael Best & Friedrich LLP regarding the 13th Great-Idea China Delegation appeared in The National Law Review:

We woke up to a bright, beautiful and warm morning in Shanghai. The nice weather was greatly appreciated as the Delegation was up and out early, traveling to the Shanghai Pudong Software Park (Park). The Park is only 12 years old and is currently home to 1,086 companies. Two of these companies are in Forbes’ Top 20. Additionally, companies such as Citi, Texas Instruments, Olympus, Sony, Kyocera, Tell Labs and Qualcomm, each have offices within the Park.

During our visit we were taken to the first location and given a short presentation describing the size of the Park, the various campuses that comprise the Park and the development cost of each campus. After the presentation, we traveled to a second location which was quite stunning, as it contained a central lake surrounded by several buildings and beautiful landscaping. The lake contained docks that were staffed with paddle and small motor boats. Interestingly, the campus was very quiet; there was very little activity, at least on the outside, and strangely, we saw very few people during our visit.

After completing our visit to the Park, the Delegation traveled to a restaurant in downtown Shanghai specializing in Peking duck. The duck arrived after course number two, each course being anywhere from 2-3 different dishes, and was followed thereafter, by four additional courses. Favorites among the Delegation included the duck skin and meat, which were presented on separate plates, deep-fried fish in red sauce, and wheat rolls stuffed with duck. I particularly enjoyed the spicy jellyfish, which was a new experience for me.

After lunch, we boarded a bus to travel to the town of Suzhou. Suzhou was founded in 514 B.C. and its history dates back more than 2,500 years. Suzhou is frequently referred to as the “Venice of the East” or the “Venice of China” for its beautiful canals and stone bridges. Suzhou also has a number of magnificent gardens. In fact, several of Suzhou’s classical gardens were named UNESCO World Heritage Sites in 1997 and 2000.

Upon our arrival in Suzhou we were taken to Dushu Lake Hotel. The hotel blends traditional Suzhou architecture with cutting-edge contemporary design. There is a beautiful story the locals tell regarding Dushu Lake:

“Ancient stores tell the tale
of a small branch that fell
from the moon into the lake
and grew into a large single-branch there.

Locals believe that those who live
around the lake will be
Blessed with happiness.”

The hotel is located in the Suzhou Industrial Park (SIP). The SIP is the largest cooperative project between the Chinese and Singapore governments. SIP covers an area of 288 square kilometers, of which, the China-Singapore cooperation area covers 80 square kilometers.

After a wonderful buffet dinner, the Delegation was treated to a nighttime cruise on Jinji Lake.

Tomorrow the Delegation will participate in the 2012 China Service Outsourcing Innovation Development and Investment Promotion Summit and China-Europe CIO Summit.

In addition to reporting on the day’s activities, I thought it might be interesting to profile some of the people comprising the Delegation. Therefore, I will try in each blog to introduce you to one or two people in the Delegation.

Delegate Spotlight: Thomas Gephart from Irvine, California, US.

Tom is the founder and managing partner of “Ventana,” which is Spanish for “window”. Ventana was founded in 1974 and is a leading multi-stage equity firm. Specifically, Ventana invests in the best of breed innovative companies with technology products and services that meet the challenging global demands of commercial industrial, technological, federal, and international customers. Most impressively, Ventana has provided more than 30 years of syndicated financing for 100 plus portfolio companies totaling 3.2 billion US dollars from Southern California to Latin America, and Europe to Asia.

Tom has an engineering degree and worked for several years for Hughes Aircraft and then TRW, Inc.  After TRW, Tom was hired to find and develop new products for AMP, Inc. After AMP, Tom started his own electronic components business that ultimately had two divisions. Three years after Tom started his business he sold it and founded Ventana.

Tom is currently working on forming a China-US strategic alliance and innovation region cross-border fund and hopes to launch the fund later this year. In working on forming this fund, Tom has observed that the Chinese government seems particularly interested in moving technology to China, and once here has no problem paying for its commercial development. Specifically, in Tom’s opinion, the Chinese government is interested in things that are “explosive” and beneficial to Chinese society and is willing to pay for them. Once this China-US fund has been completed, Tom hopes to form a similar fund between India and the US.

Delegate Spotlight: Martin Venzky-Stalling from Hamburg, Germany.

Martin works as a senior advisor for the Technology Development Center for Industry (TDCI) at Chiang Mai University in Chiang Mai, Northern Thailand. Martin’s role with TDCI is to assist with the development of a Science and Software Park and creating links between government, universities and private sectors. In addition to the Science and Software Park project, Martin also supports the local government with a creative economy initiative called, “Chiang Mai Creative City.” This initiative aims to establish Chiang Mai as the international center for creative industries, including software, crafts, and graphic design.

Prior to moving to Chiang Mai, Martin was Senior Vice President for International Operations at PCCW (Hong Kong Telecoms), Director of Consulting at Ovum in London and Associate Director with the Global IT, Communications, and Entertainment (ICE) Strategy Group of PricewaterhouseCoopers. Martin specializes in strategy development, market entry, technology enabled business transformation, and launching new entities.

© MICHAEL BEST & FRIEDRICH LLP

Opening of the 13th Great-Idea China Sourcing & New Industrial Delegation to China

The National Law Review recently published an article by Lisa L. Mueller of Michael Best & Friedrich LLP regarding The New Industrial Delegation to China:

Today was the first day of the 13th Great-Idea China Sourcing & New Industrial Delegation (Delegation). The first stop: Shanghai.

Because this was my first time to China, I really did not know what to expect when my plane landed in Shanghai. All I really knew about China before leaving home is that from a geographical standpoint, it is an extremely large-sized country with an equally large population, and that many of the products that I rely on day in and day out in my life (my running shoes, many of my clothes, etc.) are made in China. Well, I was certainly not prepared for what I found when my plane landed in Shanghai. What struck me immediately was that Shanghai is absolutely enormous in a multitude of different ways. First, the sheer number of people who live and work in Shanghai is colossal. Since my arrival, I have heard that the number of residents in Shanghai to be anywhere from 20 to 23 million. Regardless of the actual number, I can tell you that there are simply people everywhere and they seem to be going in every direction. In fact, there are so many people in Shanghai that there is not enough room for people to walk on the sidewalks, so they frequently travel in the streets along with the buses, cars, mopeds, motorcycles and bicycles that make up traffic.

Second, the sheer number and size of free-standing skyscrapers in Shanghai is astonishing. Some of the more prominent skyscrapers include the Jin Mao Tower, the Shanghai World Financial Center, which is the tallest skyscraper in mainland China at the moment, the Oriental Pearl Tower and the Development Tower.

Third, the amount of new skyscrapers that are under construction is tremendous. There seems to be skyscrapers under construction no matter which direction you look in Shanghai. Based on the work done thus far, it appears that many of these skyscrapers are going to be just astronomical in size.

Fourth, the traffic in Shanghai is monstrous. Growing up on Long Island, NY, I thought I was used to the immense day-to-day traffic that has long been a staple in the New York Metropolitan area. NOTHING could prepare me for the mammoth traffic in Shanghai. Getting around by car, cab or bus is absolutely painful during what most people would consider “reasonable” waking hours during the day. I took a bike tour on Saturday and I can personally attest that this traffic makes biking a challenge when you have to traverse cars, buses, cabs, mopeds, motorcycles, bicycles and people crossing the streets. In fact, at times, the weaving in and out was better than any amusement park ride I’ve been on in years (and far less expensive).

Fifth, not surprisingly given the number of cars, buses and motorcycles that comprise the traffic in Shanghai, the pollution is gargantuan. It has taken my eyes and lungs a bit of time to adjust to the increased levels of pollution.

In addition to the enormity of China, I was also not prepared for what I have found in terms of the people of China. For the most part, the Chinese people are very friendly and warm. I have found them to be very hard-working and capitalistic. Unfortunately, given the large number people in China, there are far more people than jobs. In view of this, as part of China’s 12th Five-Year Plan for National Economic and Social Development, the Chinese government is trying to spread the benefits of economic growth to a higher number of Chinese citizens. The plan’s key themes involve rebalancing the economy, ameliorating social inequality and protecting the environment. Part of this plan involves changing the export-oriented economy of China from low-end manufacturing outsourcing to advanced manufacturing outsourcing and international service outsourcing. The three main sectors to be targeted by this plan are healthcare, energy and technology.

The Delegation is part of an international summit and forum that has come to China to learn more about the plan, to meet with local business leaders and politicians who will be instrumental in implementation and to foster cooperation and investment opportunities between China and other nations based on the plan of the International delegates. Some are venture capitalists or other types of investors, some are lawyers and others are technology specialists.

This evening, the delegation visited Hand Enterprise Solutions Company (Hand) for a presentation by Mr. Dean Chen, President. Hand was established in Shanghai in 2002 and was one of the first local enterprise resource planning (ERP) consulting firms in China. They currently have over 700 employees and an average growth rate of 30% in recent years. In 2002, IDC named Hand one of the “Top Consulting Companies” in the China IT Industry. Hand currently provides a variety of IT services ranging from traditional IT strategic consulting, business process optimization, ERP implementation service, as well as, mobile solutions and business intelligence. They have provided consulting services in a variety of industries such as machinery, electronics, automotive, pharmaceutical, chemicals, food and beverage, financial services, telecommunications and the Chinese aviation industry. Hand has about 400 customers in China, Japan, Europe and the US and has offices in Beijing and Guangzhou in China and in Tokyo, Japan.

Tomorrow morning the Delegation will tour the Zhangjiang Science and Technology Park in Shanghai before heading to Suzhou.

© MICHAEL BEST & FRIEDRICH LLP

ICC Conference Cross-Border Sales – April 19, 2012

The National Law Review is pleased to bring you information about the upcoming ICC Conference Cross-Border Sales in London April 19, 2012:

 

 

What is the Best Legal Framework for Business-to-Business Contracts?

Thursday, 19 April 2012
London, United Kingdom

Objective

The contract of sale is certainly the most commonly used agreement in international commerce. When drafting a sales contract or general conditions of sale (or purchase) to be used in cross border trade, it is essential to choose the legal framework (applicable law) within which the agreement is to be placed.

Choosing one solution instead of another may have very important effects on the rights and obligations of the parties. Parties therefore need to have the information which is necessary in order to make the best possible choice between the various alternatives.

The speakers will examine and discuss on one side the project of a Common European Sales Law, which has been recently proposed by the European Commission, and on the other side the CISG (Vienna Sales Convention), which is the law applicable to cross-border sales in most countries of the world.

Members of the ICC task force that has been revising the ICC Model International Sales Contract will also take the opportunityto discuss their approach and present issues that have been the subject of relevant discussion.

Who should attend?

Legal directors and corporate counsel from companies involved in international trade, practising lawyers, legal practitioners advising international trading companies, business people involved in international trade and dispute resolution

ICC Conference Cross-Border Sales – April 19, 2012

The National Law Review is pleased to bring you information about the upcoming ICC Conference Cross-Border Sales in London April 19, 2012:

What is the Best Legal Framework for Business-to-Business Contracts?

Thursday, 19 April 2012
London, United Kingdom

Objective

The contract of sale is certainly the most commonly used agreement in international commerce. When drafting a sales contract or general conditions of sale (or purchase) to be used in cross border trade, it is essential to choose the legal framework (applicable law) within which the agreement is to be placed.

Choosing one solution instead of another may have very important effects on the rights and obligations of the parties. Parties therefore need to have the information which is necessary in order to make the best possible choice between the various alternatives.

The speakers will examine and discuss on one side the project of a Common European Sales Law, which has been recently proposed by the European Commission, and on the other side the CISG (Vienna Sales Convention), which is the law applicable to cross-border sales in most countries of the world.

Members of the ICC task force that has been revising the ICC Model International Sales Contract will also take the opportunityto discuss their approach and present issues that have been the subject of relevant discussion.

Who should attend?

Legal directors and corporate counsel from companies involved in international trade, practising lawyers, legal practitioners advising international trading companies, business people involved in international trade and dispute resolution

Will Auditors Influence How Executives Are Paid?

Recently The National Law Review published an article by Andrew C. Liazos of McDermott Will & Emery regarding Executive Pay:

PCAOB proposals would have auditors reading the employment and compensation contracts of corporate leaders and, possibly, forcing changes to comp programs due to unacceptable risks of material restatement.

Unfortunately, the PCAOB is suggesting that auditors also evaluate whether the design of an executive-compensation program could itself lead to excessive risk taking. Here’s what one of the board members, Steven Harris, had to say about this matter:

“Equity-based compensation arrangements may also provide strong incentives for excessive risk-taking by executives. Studies have shown that these arrangements can position executive officers to benefit from the upside of high-risk investments, while largely insulating them from the downside risks. In addition, excessive risk taking generally is viewed as one of the contributing factors to the recent financial crisis. For example, ‘The Financial Crisis Inquiry Report’ concluded that ‘Executive and employee compensation systems at these institutions disproportionately rewarded short-term risk taking.’ The Board’s proposals would require auditors to focus on the potential opportunities and motivations for executive officers to exaggerate gains, or minimize losses, and to consider any effect compensation incentives might have on the reliability of the financial statements.” (Emphasis added)

That type of statement raises the possibility that an auditor might view the structure of an executive-compensation program to be so problematic that, when coupled with other factors, the auditor may be unable to issue an unqualified opinion. This risk (i.e., not receiving an unqualified opinion on financial statements) could give the auditor significant influence over executive-compensation decisions.

What’s particularly interesting about the timing of the PCAOB release is that its focus on executive compensation is happening when shareholders now have a “say on pay” under Dodd-Frank and there is an increasing focus on “pay for performance.” As discussed in my January column, ISS, the leading shareholder advisory service, recently revamped its guidelines for making recommendations on executive compensation by focusing on total shareholder return (TSR) as compared with peer companies, and it’s reasonable to expect that issuers will start to use TSR performance goals. One can only imagine the reaction of compensation committees if their decisions to restructure executive pay in response to shareholders were to be second-guessed by auditors, particularly in light of the current lawsuits regarding failed say-on-pay votes.

The PCAOB is moving quickly on this change. While the proposed amendments require SEC approval, the PCAOB anticipates that these changes would be effective for audits of financial statements for companies with fiscal years beginning on or after December 15, 2012.

© 2012 McDermott Will & Emery

Custom Software and Technology Development. Do You Actually Own the Deliverable(s)?

The National Law Review recently published an article by Ivan T. Kirchev and Derek C. Stettner of Michael Best & Friedrich LLP regarding Custom Software Ownership:

I.  Introduction

When a business “hires” a vendor and pays for the development of custom code or another deliverable, a common belief is that the business or customer “owns” the deliverable provided by the vendor. After all, if a business pays for office equipment, furniture, an automobile and a myriad of other items, a transfer of ownership is part of the transaction. However, every-day experience is not an appropriate guide when dealing with intangible property. This article provides an overview of the ownership rights of customers that purchase information technology development services.

II.  Default Ownership Rules

Intangible property (such as patents or copyrights) is not transferred merely because possession of an item changes hands. Software and other deliverables are protectable under intellectual property laws and these laws govern the ownership and right to use such items. While other laws can be important, copyright law is the focus of this discussion.

As a general rule, ownership of a copyright initially vests in the “author” of a work. Copyrightable works include works of art, novels, screen plays, music, marketing materials, technical drawings, specifications and software code. Copyright exists as soon as an author reduces the work to a tangible form (such as creating a file with source code). In other words, when a work is written down or otherwise set in tangible form, the copyright immediately becomes the property of the author of the work. Only the author or those deriving rights from the author can rightfully claim copyright. To transfer ownership, the author must sign a written agreement that expressly transfers or assigns his or her rights to another person or entity.

 III.  Works Made For Hire

There is an important exception to the general ownership principles discussed above. Certain works are classified as works “made for hire.” Works made for hire are defined by federal law in the Copyright Act. If a work is properly classified as a work made for hire, then ownership does NOT vest with the author. Depending on the circumstances, the author’s employer or the entity that has contracted with the author, owns the copyright in the work. The statutory definition of the term “work for hire” does not cover “hand shake” or other informal transactions where a vendor is paid money to create a work.

The statutory definition of a “work for hire” is as follows:

  1. a work prepared by an employee within the scope of his or her employment; or
  2. a work specially ordered or commissioned that falls into one of nine classes: (1) a contribution to a collective work, (2) a part of a motion picture or other audiovisual work, (3) a translation, (4) a supplementary work, (5) a compilation, (6) an instructional text, (7) a test, (8) answer material for a test, or (9) an atlas, provided the parties expressly agree in a written agreement that the work will be considered a work made for hire.

In cases where a business hires a vendor to create a deliverable, the vendor is an independent contractor and not an employee. As a consequence, the deliverables of the vendor will not qualify as a work prepared by an employee. In such circumstances, statutory work for hire rule applies only if the work falls into one of the nine classes and the parties enter into a written contract. While “software” is not explicitly listed in the statute, certain software might be classified as audiovisual works. However, other software may not qualify for any of the statutory classes. So, reliance on the work for hire exception is unwise.

IV.  Suggestions

Because default ownership rules favor authors (not buyers) and work for hire exceptions to ownership may not apply when purchasing technology services, it is critical that buyers enter into a written contract with their vendors. The contract must include a specific provision that addresses ownership of any deliverables that the buyer expects to own. The contract should also include license provisions that specify the rights of the buyer to use any deliverables that are provided by the vendor. In the absence of such an agreement, the buyer will most likely end up with no ownership rights and only an implied license of uncertain scope to use the deliverables. Since the ownership and license provisions can be complex, consulting an experienced lawyer can help ensure that a buyer receives appropriate rights in exchange for the remuneration paid to the vendor.

© MICHAEL BEST & FRIEDRICH LLP

ICC Conference Cross-Border Sales – April 19, 2012

The National Law Review is pleased to bring you information about the upcoming ICC Conference Cross-Border Sales in London April 19, 2012:

What is the Best Legal Framework for Business-to-Business Contracts?

Thursday, 19 April 2012
London, United Kingdom

Objective

The contract of sale is certainly the most commonly used agreement in international commerce. When drafting a sales contract or general conditions of sale (or purchase) to be used in cross border trade, it is essential to choose the legal framework (applicable law) within which the agreement is to be placed.

Choosing one solution instead of another may have very important effects on the rights and obligations of the parties. Parties therefore need to have the information which is necessary in order to make the best possible choice between the various alternatives.

The speakers will examine and discuss on one side the project of a Common European Sales Law, which has been recently proposed by the European Commission, and on the other side the CISG (Vienna Sales Convention), which is the law applicable to cross-border sales in most countries of the world.

Members of the ICC task force that has been revising the ICC Model International Sales Contract will also take the opportunityto discuss their approach and present issues that have been the subject of relevant discussion.

Who should attend?

Legal directors and corporate counsel from companies involved in international trade, practising lawyers, legal practitioners advising international trading companies, business people involved in international trade and dispute resolution

ICC Conference Cross-Border Sales – April 19, 2012

The National Law Review is pleased to bring you information about the upcoming ICC Conference Cross-Border Sales in London April 19, 2012:

What is the Best Legal Framework for Business-to-Business Contracts?

Thursday, 19 April 2012
London, United Kingdom

Objective

The contract of sale is certainly the most commonly used agreement in international commerce. When drafting a sales contract or general conditions of sale (or purchase) to be used in cross border trade, it is essential to choose the legal framework (applicable law) within which the agreement is to be placed.

Choosing one solution instead of another may have very important effects on the rights and obligations of the parties. Parties therefore need to have the information which is necessary in order to make the best possible choice between the various alternatives.

The speakers will examine and discuss on one side the project of a Common European Sales Law, which has been recently proposed by the European Commission, and on the other side the CISG (Vienna Sales Convention), which is the law applicable to cross-border sales in most countries of the world.

Members of the ICC task force that has been revising the ICC Model International Sales Contract will also take the opportunityto discuss their approach and present issues that have been the subject of relevant discussion.

Who should attend?

Legal directors and corporate counsel from companies involved in international trade, practising lawyers, legal practitioners advising international trading companies, business people involved in international trade and dispute resolution