Dissension Follows When Business Owners Don’t Put Their IP House in Order
July 23, 2018
When you think about protecting a business firm’s intellectual property (IP), usually you think about protecting it from infringement by external actors.
But there also are internal threats — even mortal ones — to the business when the owners don’t take adequate steps to allocate and memorialize ownership rights in the business-related IP as between the company and those responsible for its creation.
Two recent cases illustrate the point.
What’s In a Name?
The first, from New York, involves a popular Manhattan restaurant serving Southern cuisine, called Root & Bone, operated by the eponymously named Root & Bone LLC. The company was formed in October 2013 by its three members, the plaintiff Freedman and defendants McInnis and Booth, each holding a one-third membership interest.
Five months before the LLC’s formation, McInnis, who had experience operating successful restaurants throughout the country, filed a registration request for the “Root & Bone” service mark with the U.S. Patent and Trademark Office (PTO) in the name of his separate company, Chef Jeff McInnis LLC. McInnis did not disclose the registration request to Freedman. The Root & Bone LLC operating agreement was silent about the ownership of the restaurant’s name.
In June 2014, the restaurant opened for business to overnight success. The restaurant’s opening was the first use in commerce of the “Root & Bone” name.
Almost a year later, by which time McInnis and Booth relocated to Florida, the PTO registered the “Root & Bone” service mark to Chef Jeff McInnis LLC. A couple of months later, McInnis executed both on behalf of Root & Bone LLC and Chef Jeff McInnis LLC a “Restaurant Management and Licensing Agreement” that granted the latter the right to license the name Root & Bone to third parties along with food and drink menus, operational manuals, and other intellectual property. The Licensing Agreement gave McInnis a 6% management fee and also provided for monthly “Target Distribution Amounts” for Freedman.
Freedman subsequently filed suit against McInnis and Booth, alleging that they unlawfully converted the Root & Bone name in breach of the operating agreement and fiduciary duty. Freedman alleged that, while he had discussed the Licensing Agreement with McInnis, he never approved it as required under the operating agreement. He also alleged that McInnis and Booth had opened restaurants with the Root & Bone name in other locations.
In December 2017, Freedman moved for a temporary restraining order and preliminary injunction to prevent McInnis and Booth from licensing the Root & Bone name, or working for any such licensee, and enjoining any such licensee from utilizing the Root & Bone name or other intellectual property.
Manhattan Commercial Division Justice Barry Ostrager denied Freedman’s request for a temporary restraining order and, after receiving defendants’ opposing papers, held an evidentiary hearing on the injunction application.
In his post-hearing decision in Freedman v McInnis, 2018 NY Slip Op 30210(U) [Sup Ct NY County Feb. 2, 2018], Justice Ostrager found that, while the Root & Bone LLC operating agreement was silent as to the name’s ownership, “it is implicit that absent evidence to the contrary, the entity that owns the restaurant called Root & Bone would own the name.” However, he added, at a full trial on the merits “defendants may be able to produce such evidence to the contrary” notwithstanding their inability at the injunction hearing to offer credible evidence that McInnis disclosed to Freedman his separate company’s request to the PTO to register the Root & Bone service mark.
Pointing in Freedman’s favor, Justice Ostrager also found that the Root & Bone LLC operating agreement “unquestionably” required Freedman’s consent to the Licensing Agreement and that by proceeding without it, McInnis also acted in apparent violation of section 411 of the New York LLC Law governing “interested manager” transactions.
What was the outcome? Justice Ostrager preliminarily enjoined McInnis and Booth from further licensing the Root & Bone name and intellectual property prospectively, finding that Freedman established a likelihood of success on the merits, irreparable harm, and that a balance of the equities tipped in Freedman’s favor.
The judge did not, however, enjoin them from working for the two Root & Bone restaurants they already had opened in Miami and Puerto Rico, and he did not enjoin those two restaurants from using the name or other intellectual property in recognition that Freedman “has benefitted from his association with the defendants who are largely responsible for creating the value associated with the Root & Bone name and intellectual property.”
Justice Ostrager conditioned the interim injunction on Freedman posting a $500,000 bond to secure the defendants from any damages suffered as a result of the injunction in the event they ultimately prevail at the trial on the merits. As of this writing over five months later, it does not appear Freedman filed a bond and the case has stalled pending the determination of Freedman’s subsequent motion to disqualify the defendants’ attorneys.
The choice of name for a new restaurant, or any start-up for that matter, is a critical branding decision with potentially great impact on the business’s goodwill value. Anyone investing in a new business needs to (a) perform a comprehensive trademark search for other possible users of the business’s proposed name, and (b) secure registration and ownership of the proposed mark in the new company’s name.
If, as in the Freedman case, one of the new business’s principals already has taken steps to register the mark personally, the co-owners must address upfront and memorialize some type of agreement, either to transfer the mark to the company or to license the mark on terms acceptable to all. Failing to take these steps is almost certain to generate dissension — or worse — down the road.
Speaking of Worse . . .
The second case, from Arkansas, presents an existential crisis for a successful business that developed and sells specialized software.
In Oliver v Johanson, 5:17-cv-05129 [U.S. Dist. Ct. W.D. Ark. June 29, 2018], the two defendant Johanson brothers operated a consulting firm that offered a methodology related to job valuation and employment compensation. In 2005, in need of a computer programmer to make the method commercially viable, they formed an Arkansas LLC named DB Squared with the plaintiff, Oliver, as equal one-third members.
By 2008, Oliver completed work on a program called JESAP for which he filed a registration application with the Copyright Office listing the program as a work made for hire and DB Squared as the author of the copyright. So far so good.
In later years, newer versions of the software were created and the program was ultimately renamed as DBCompensation as part of the company’s rebranding effort. The JESAP and DBCompensation software products, for which Oliver remained responsible, consistently displayed a message reading “© DB Squared, LLC.” Again, so far so good.
Then came 2016, when Oliver unilaterally announced his resignation from the company, but then offered to stay on temporarily to complete the rollout of the latest iteration of DBCompensation. In the following months, however, Oliver began to assert that he was the sole owner of DBCompensation, he had his lawyer send the company a cease-and-desist letter, and he threatened suit.
In early 2017, Oliver submitted a new copyright registration for the DBCompensation software identifying himself as the sole author. After the copyright application was approved, Oliver filed suit in federal court against DB Squared and the Johanson brothers, seeking a declaration that he is the true author and resulting owner of the DBCompensation copyright, damages for copyright infringement, and judicial dissolution of DB Squared. DB Squared countersued for a declaration that it is the rightful owner of the software and that Oliver’s subsequent registration of the DBCompensation copyright was procured by fraud.
Following discovery both sides moved for summary judgment on the issue of copyright ownership, but neither side prevailed. The court’s detailed opinion is well worth the read, so I’ll just share the highlights:
- The court rejected the company’s argument that it owns the copyright because Oliver agreed to contribute his original software development work in exchange for his membership interest. Under the Copyright Act, the court observed, authorship of a copyright belongs initially to the author unless it’s a work made for hire, and the alleged business relationship doesn’t alter the Act’s application. In addition, there was no written transfer from Oliver to DB Squared, as also required by the Act.
- The court also rejected the company’s reliance on the corporate opportunity doctrine which, the court opined, at least for summary judgment purposes may be pre-empted by the Copyright Act.
- The company’s contention that the DBCompensation software developed by Oliver was a work made for hire presented a more complex question also not resolvable on summary judgment. Under the Copyright Act, the court explained, if Oliver was an employee and prepared the work within the scope of his employment, DBCompensation was a work made for hire and therefore was owned by the company. If, on the other hand, Oliver was an independent contractor, the company failed to meet the Act’s requirement of a written agreement. The court listed a number of disputed factual contentions pointing in both directions that prevented the court from deciding the issue as a matter of law.
- The factors supporting Oliver’s status as an independent contractor included: (a) he was not a W-2 employee and received payment from DB Squared through his wholly-owned company; (b) the creation of the software required a high level of skill; and (c) Oliver worked partly from home and self-directed his software development work.
- The court also found disputed issues of fact, including those raised by the parties’ respective expert reports, concerning DB Squared’s ownership claim based on DBCompensation’s alleged status as a derivative work of the earlier JESAP program, the copyright to which indisputably was held by DB Squared.
The court’s opinion mentions the company’s operating agreement signed by the three members upon DB Squared’s formation but says little about it. One can readily assume that the operating agreement didn’t include a provision stipulating that any software developed for the company by any of the members would be treated as a work made for hire and that the company would hold all associated copyright and other intellectual property rights.
Alternatively, the Johanson brothers at the outset could have insisted that Oliver, as the developer of the software, enter into a separate, written employment agreement likewise designating his work product a work made for hire.
They are now paying a big price for these omissions, one that potentially could lead to the decimation of their business.