X

Thank you for sharing!

Your article was successfully shared with the contacts you provided.
The number of recent e-commerce-related transactions has resulted in the proliferation of new and novel agreements, structuring complex initiatives and services where no form agreements existed to draw upon. Now that the wave of dot-com euphoria has subsided to cautious optimism, e-commerce providers and their partners and licensees alike have increasingly been forced to re-evaluate and renegotiate many of their key e-commerce agreements, many of which were negotiated on “Internet time” with limited or no review by legal counsel. In the atmosphere of boundless optimism of the future and integrity of e-commerce ventures, key issues in such agreements may have been overlooked or intentionally left open by the parties. Whether based on actual or pending failure of a company’s dot-com partner or concerns of a company or its principal investors, counsel may be requested to “dust off” these agreements and evaluate the legal effects of a business partner’s actual or likely demise. The considerations to be observed while reviewing such agreements will largely depend on the type of business the parties are engaged in, the subject matter of the transaction, the underlying business relationship (i.e., whether vendor or customer), and the degree to which the subject matter of the agreement is critical to ongoing operations. Since the goods/services involved could include the provision of content, hosting of Web sites and applications, and application licensing and development, understanding the particular goods/services involved and the interrelationship of such goods/services with the client’s business model will be essential to any analysis of the situation. Customers of services retain as their primary concern the continuity of receiving services, and upon learning of the declining fortunes of their provider, may secure a substitute third-party provider and desire to terminate the agreement as soon as possible. Moreover, customers need to ensure that they have ownership or rights to use critical intellectual property developed or supplied by the dot-com business partner. However, a dot-com “provider” of services may only be experiencing a seasonal slowdown or a temporary liquidity crisis and therefore has an interest in vigorously retaining all of its business relationships in place in order to continue receiving revenues to support the business, and convince potential investors of the viability of its business. The ownership rights to any deliverables developed will be important to a dot-com vendor for use in future engagements for other clients, and as valuable assets of the company. This article will provide counsel with an overview of the material issues that should be reviewed in an existing e-commerce agreement with a dot-com business partner to help assess the risks associated with the dot-com company’s failure, with an explanation of the key provisions to investigate. A discussion is included regarding the terms which a party may seek to negotiate with a failing dot-com to mitigate the associated risks. Finally, a list of key issues is provided for consideration while drafting future e-commerce agreements. THE CONTRACT REVIEW The process of reviewing an e-commerce contract when the counterparty has failed or is likely to fail should be practical and based on the surviving party’s business needs and goals. While it is natural to want to review the provision in which the dot-com partner limits its liability that may not be the appropriate starting place, particularly since the dot-com may have little or no assets to collect against. Contracting parties in this situation want to know how they can continue business operations without their partner. This will entail understanding what goods and services are being provided by the vendor, and whether all of the “tools” (which could include a dot-com’s intellectual property) are available in order to ensure that operations will continue. WHO OWNS DELIVERABLES? If intellectual property is at issue in the agreement, such as software, data or content, an important determination will be which party owns the materials. Under U.S. copyright law, unless a work is determined to be a “work made for hire” as defined in 17 U.S.C. �101, a work is owned by the author. This analysis needs to be made not only for initial projects, but for other follow-on projects for which the parties may not have signed formal documents. Alternatively, the parties may have addressed the right to use deliverables through a licensing mechanism. Under a license, the bundle of copyright and other intellectual property rights are retained by a party as the owner, with certain rights “licensed” to the other party. Several key factors to review in a license are the particular materials licensed, the license duration, the “use” right granted and the limitations on the license. For example, the materials licensed may not address all of the deliverables, and the license may be for a fixed duration (e.g., two years) rather than perpetual. Additionally, the permitted uses under the license may be limited to the original plans of the parties (e.g., for display on the “xyz.com” Web site), when such site may no longer be the primary business focus. Moreover, the use rights granted need careful review to ensure anticipated uses of the materials are covered (e.g., the right to modify/update the materials in lieu of such services by the owner). It is also possible that both parties equally contributed to the development of a work, and that the resulting work may qualify as a “joint work” under the U.S. copyright law (17 U.S.C. �101). As joint owners of the work, each party has an independent right to use and license the material, subject to a right of accounting of royalties to the other party. This may pose a problem for a party concerned about further distribution of the work in the marketplace by the other party or a possible unknown transferee, particularly if the work provides a competitive advantage. REQUIRED TECHNOLOGY TOOLS Knowing what materials are necessary in order to continue to make use of particular deliverables is a key inquiry. For example, the source code (i.e., human readable version of computer code) is necessary to make changes to a software deliverable. While most vendors do not license their source code, a contract may include an escrow provision under which the vendor agrees to place the source code in safe keeping with a third-party escrow agent. The conditions upon which the escrow agent will release the source code (commonly referred to as “release conditions”) and the required release procedures will be essential in determining whether and how the source code can be obtained. Note that many “form” escrow agreements have stringent release conditions, requiring that the vendor actually be insolvent or file for bankruptcy protection for the vendor to release the source code, and may not address general service failures. Additionally, the escrow agreement may give the vendor an opportunity to contest the escrow release. There may be other tools required for continued use of a deliverable, which may include related software for maintaining the base software and vendor documentation explaining how the software was developed, as well as maintenance manuals. These materials are typically not included in the scope of the license granted, but may be vital to make any realistic use of the escrowed materials. CONFIDENTIAL INFORMATION There is no definitive standard for e-commerce agreements as to confidentiality obligations of the parties. While it may be a party’s expectation that its trade secrets will be kept confidential by its business partner, confidentiality obligations may be one-sided, mutual or non-existent. Additionally, the agreement should be reviewed to determine whether the confidentiality obligation survives termination of the agreement. Note that confidentiality provisions may require the receiving party to return all confidential information to the disclosing party upon a termination of the agreement, and may even require such return at any time upon request. The outcome of this inquiry may affect the party’s strategy for dealing with its business partner. THE RIGHT TO TERMINATE While not the best remedy available, the right to terminate the agreement can be a useful right and a powerful negotiating tool. Termination can be a useful remedy in circumstances such as service agreements in which the vendor fails to provide services as required by the agreement. If the contracting party does not require any assets of the other party to continue operations and has secured an alternate service provider, termination can be an effective means to avoid paying fees for flawed services. However, agreements may require a party’s failure to perform to be significant or “material” in order for a party to terminate the agreement for cause. While this standard is undefined in most agreements, it may be subject to interpretation particularly when the “materiality” of the failure is at issue. Whether a party is in material breach of the agreement will require careful review of the party’s obligations in the agreement, with special attention to provisions describing service levels or warranties of performance. Other events upon which a party may terminate an agreement typically address the financial failure of a party, which may include the other party becoming insolvent or becoming subject to a bankruptcy proceeding. Note that while many agreements include a bankruptcy filing as a termination event, such “ipso-facto” clauses are, subject to narrow exceptions, not unenforceable under U.S. bankruptcy law, particularly since the bankrupt entity may not be in breach and may still have the ability to fully perform its obligations during the pendency of the bankruptcy proceedings. Waiting for the supplier to either become insolvent or to materially breach its obligations is not particularly fruitful. If a supplier is failing but the actual termination events specified in the contract have not occurred, it may be possible to negotiate creative solutions, including terms upon which a customer will continue to use the vendor’s services in return for assurances that the vendor is still a viable supplier. Such novel solutions could include the parties agreeing upon certain financial conditions of the vendor that would trigger termination, such as failure by the vendor to obtain adequate additional funding or decrease in stockholders equity or a decrease in the ratio of cash flow to debt service. From the vendor’s perspective, such a clause is unusual, and will have to be carefully crafted to reduce the potential of further deteriorating the vendor’s financial condition, by including appropriate exclusions (e.g. temporary economic difficulties, seasonal slowdowns in its sales cycle). BANKRUPTCY OF LICENSOR Bankruptcy filings by failing dot-coms have become almost a daily phenomenon. As such, a contracting party may be concerned whether it will have the right to continue to use materials constituting intellectual property of its dot-com partner after that partner files for bankruptcy protection. Because a license to intellectual property in certain circumstances may be construed as an “executory contract,” it could be subject to the right of rejection by the trustee in bankruptcy under �365(a) of the Bankruptcy Code, even if such a rejection would adversely affect the licensee. Congress responded to the concerns generated by this section by passing the Intellectual Property Bankruptcy Act of 1988, and in particular �365(n). This section provides that: “[I]f a trustee rejects an executory contract under which the debtor is a licensor of a right to intellectual property, the licensee under such contract may elect � to retain its right � under the contract.” See 11 U.S.C. �365(n)(1)(B). The section was designed to provide a balance between the rights of the debtor licensor and the bankruptcy estate and the licensee’s right to continued use of the license. Note, however, that continued use of the license by the licensee requires ongoing royalty payments. As such, a key inquiry will be whether a party was granted a license prior to the bankruptcy filing, and whether the subject matter of the license constitutes “intellectual property” for purposes of bankruptcy laws. HIRING KEY EMPLOYEES The right to hire certain key employees of the vendor can prove to be an important asset for recipients of services, particularly in contracts relating to the provision of custom-developed deliverables that require the unique skills and qualifications possessed by the vendor’s employees. Contracts often have restrictions on the other party’s rights to solicit or hire a vendor’s employees. If a contract contains such a clause, the inquiry should include a determination as to what types of employees the clause covers (e.g., key employees or any employees) and the duration of the prohibition (e.g., during the term, survives after contract termination, for a fixed period of time after a particular employee has completed performance of services). It should also be determined whether the provision imposes non-solicitation and/or non-hire restrictions, as both of these types of restrictions are not always included. The contract could also permit the solicitation and hire of employees, but require the payment of a fee in the event such a right is exercised (e.g., 10 percent of the hired employee’s base salary). Since key employees are often a valuable asset of a failing dot-com, the dot-com company may be quite protective of them. As such, care should be taken in the interpretation of these provisions. If the contract contains a broad prohibition on the solicitation and hire of the vendor’s employees and the vendor is experiencing financial difficulties, the customer can attempt to exert its leverage over the vendor and carve out an exemption for certain key employees. The ability to hire such personnel in a timely manner is of great importance in such situations because many employees will leave for another, more secure company as conditions deteriorate. KEY FUTURE ISSUES While dot-com failures continue, e-commerce transactions are continuing to be completed for new and exciting products and services. While the foregoing discussion illustrates some of the key issues to review in existing agreements, the following summarizes some of the key issues that should be contemplated in new agreements with dot-com companies. � Ownership of Intellectual Property. If ownership is intended to be transferred, ensure that materials developed qualify as a “work made for hire” and include a full assignment of rights clause. � License Rights. Ensure that the license scope is complete, and covers anticipated future uses. Consider exclusivity, at least for a limited time frame. � Escrow Agreement. Provide conditions upon which source code and related tools are released, and procedures for release. � Confidentiality Provisions. Include appropriate confidentiality obligations with due consideration that disclosure may be required to allow an alternate service provider to continue support if the vendor fails. � Termination. Consider alternate termination provisions, including possible minimum financial thresholds that a partner must maintain if the financial status of a partner is of concern. � Right to Hire. Limit the applicability of this provision in terms of personnel covered and duration. Consider including exceptions for certain key employees in the event of termination by the customer or other events. � Bankruptcy. Explicitly state that the subject matter of the license is “intellectual property” as defined in �101(35A) of the Bankruptcy Code, and that the license agreement is governed by �365(n) in the event of bankruptcy of the licensor. While inclusion of such a language does not guaranty that the court will subsequently agree that the property qualifies as “intellectual property,” it does provide a starting point for such an inquiry. � Parent Guarantee. Consider obtaining a parent guarantee to protect against the financial failure of the contracting entity. CONCLUSION This discussion does not attempt to address the universe of possible dot-com failure scenarios. Rather, the facts and circumstances of each transaction will dictate which concepts will apply. An understanding of the subject matter and technical aspects of the contract and the business realities underlying the transaction are critical to formulating a strategy for addressing a dot-com partner failure. Kenneth A. Adler is a partner of Brown Raysman Millstein Felder & Steiner LLPin New York. David Crowell is an associate at the firm.

This content has been archived. It is available exclusively through our partner LexisNexis®.

To view this content, please continue to Lexis Advance®.

Not a Lexis Advance® Subscriber? Subscribe Now

Why am I seeing this?

LexisNexis® is now the exclusive third party online distributor of the broad collection of current and archived versions of ALM's legal news publications. LexisNexis® customers will be able to access and use ALM's content by subscribing to the LexisNexis® services via Lexis Advance®. This includes content from the National Law Journal®, The American Lawyer®, Law Technology News®, The New York Law Journal® and Corporate Counsel®, as well as ALM's other newspapers, directories, legal treatises, published and unpublished court opinions, and other sources of legal information.

ALM's content plays a significant role in your work and research, and now through this alliance LexisNexis® will bring you access to an even more comprehensive collection of legal content.

For questions call 1-877-256-2472 or contact us at [email protected]

 
 

ALM Legal Publication Newsletters

Sign Up Today and Never Miss Another Story.

As part of your digital membership, you can sign up for an unlimited number of a wide range of complimentary newsletters. Visit your My Account page to make your selections. Get the timely legal news and critical analysis you cannot afford to miss. Tailored just for you. In your inbox. Every day.

Copyright © 2020 ALM Media Properties, LLC. All Rights Reserved.