March 30, 2016
For whatever reason, we’ve witnessed an increasing tendency for people to abandon the daily employment grind and chase the dream of self-employment with their own startup. While this can of course lead to a fulfilling and happy life, it’s more often much easier said than done, as an employer can be left with a substantial claim against an employee if loose ends are not tied up properly. For example, in one case of ours, while the ex-employee was seriously successful in her startup, generating almost $1 million in gross profit (i.e. not just revenue) in the first six months, the ex-employer caught on and claimed the entirety of the revenue and the right to shut down the startup permanently. While we managed to successfully defend the claim, it could have been much worse for our client under different circumstances, given that the claim was at least arguable.
In situations like this, there will be a wide range of legal issues that must be considered. One example is the law on restraints of trade, and how that applies to someone approaching (or even just accepting an innocent invitation to do business with) their former employer’s clients or customers. We have written about this previously. The focus of this article is intellectual property rights, and specifically how an idea, invention or other business asset of value may be at risk after the employment relationship ends.
The starting point is that, according to common law, an employer is taken to own any valuable property created by employees in the course of their employment. In the context of a new startup business, such as an “app”, the term “valuable property” extends to intellectual property. This includes copyright (generally the exclusive right to publish, reproduce, adapt or otherwise commercially exploit a piece of work, idea etc), trade marks (whether registered or not), designs and patentable inventions. As such intellectual property is often the major underpinning of the startup – i.e. the idea or invention is the entire basis of the business – for it to be found to actually belong to an old employer could mean the obliteration of the startup and the dream itself.
Specifically, an ex-employer who is found to own the intellectual property rights of a former employee will be entitled to approach the Court for a temporary or (in some cases) permanent injunction restraining the use of the intellectual property. What this means is that the startup loses the right to use it at all for a defined or indefinite period. The ex-employer, on the other hand, would be free to use it as they please. If the startup had already started operating, the new owner could usually quite easily figure out their business model fairly quickly, particularly if the startup had already engaged in any public marketing activities. In effect then, if not careful, the ex-employee / new startup can end up handing the old employer a successful startup on a silver platter, and in the process losing all of the effort, time and money they sacrificed, possibly in addition to their future employment prospects if the matter goes public. In addition, in some cases, an ex-employer can recover equitable damages or an account of profits, which generally means the ex-employee or startup has to turn over all profit (or revenue) generated to the ex-employer also. Apart from being an obvious massive blow, such an order has the potential to create major tax problems on top of the initial loss, and put the solvency of the ex-employee or startup in serious jeopardy.
So, how do you get around this? The starting point is the contract of employment, for two reasons. The first is that employees and employers are free to agree on virtually whatever terms they wish in this context. Therefore, if you are a high-level employee with decent bargaining power, you could possibly insist on express acknowledgment in your contract that any such intellectual property will remain yours. However, this will not help most, as even if anyone has that level of bargaining power, naturally most people go into employment at a time when they have no startup or commercial idea, which only comes to them later. The other aspect of the employment contract will then be more relevant. Luckily, the Courts are increasingly taking a more modern approach to cases such as this, and looking at expressly defined roles in employment contracts in favour of employees to exclude intellectual property created outside the scope of those roles (i.e. holding that they were therefore not created ‘in the course of their employment). To illustrate, a university academic was allowed to keep his patented invention because his employment contract had no valid express provision requiring him to produce inventions, and a sales manager for a private company was allowed to keep his patented technology because he had not been paid to invent. Again, there is the option of excluding any express obligation to invent, create and so forth, if applicable and realistic. If not, or in any event, it may be worthwhile to insist on specific definitions of the employment role not only before signing the initial agreement, but at regular intervals during the course of employment, such as before accepting a promotion or a pay rise, or at a review point. Employers can be open to this, as it can also make an employee more accountable and render it easier to track performance.
If the contract is not a workable solution, caution will need to be exercised. Generally speaking, the following are things to avoid:
a. Working on your startup idea or business at the employer’s premises;
b. Using any of the employer’ resources or equipment in any way;
c. Devoting any work time towards your project;
d. “Killing two birds with one stone”, i.e. undertaking similar activities for your business as those for your employment duties; and
e. Generally pursuing an idea that is similar or connected to not only your employer’s business, but your duties as an employee.
Other factors that have helped people in the past include making the project known to the employer early on so that the employer was “on notice”, and offering to pursue the idea through work or otherwise with the employer for more money or under some additional form of commercial arrangement. In the former case, the employer’s failure to insist on and actually pursue any rights they claim immediately will work against them, and in the latter, the Courts will be more likely to find that a new and separate agreement was offered and rejected by the employer, and hence the project fell outside the scope of employment duties. In both cases, obviously, the bullet points above still apply.
It is important to note that the above is not an exhaustive summary of universal application – each case will turn on its own facts and circumstances, and there may be multiple other employment law issues and other legal issues to tackle in dealing with any particular claim.
As always, feel free to contact us about this or related issues at any time.