By Katya Fuchs, 3L, Gabriela Hernandez, 3L, and Giselle Sardinas, 3L —
Over the course of our time in the Startup Practicum this semester we met many startup founders and came to find that they often shared some of the same misconceptions about various legal issues. These are the ten most common.
- “I don’t need an Operating Agreement, I trust my friend/business partner.”
An operating agreement is a written agreement among the members who operate a business, typically those who operate a limited liability company (for partnerships it can be called a partnership agreement, and for corporations it is a combination of a shareholders agreement and bylaws). Operating Agreements can range from extremely simple to very complex, depending on the purpose of the business, the number of members forming the business, its capitalization structure, the management terms, and more.
An Operating Agreement spells out exactly how business decisions are to be made, anything from how the members will handle adding other members to the company, the protocol for selling the company, how to keep company records, and the protocol on how the company will dissolve, among others. This agreement gets down to the nuances of whether decisions will be made at a meeting, whether quorum is required, and how many votes must be cast to make key business decisions.
Trusting your friend or business partner is great, but inevitably there may come a time where there is a dispute or disagreement over one aspect of the business, and in such cases, having a well-drafted Operating Agreement that delineates how to handle such issues will ease the tension. In such cases, the Operating Agreement will become the focus of the disagreement, providing the answer on how to address or resolve the dispute, and if there is still some disagreement, the members can opt to call a meeting of the members to amend the Operating Agreement.
- “I don’t need a lawyer to draft a contract, I found a template online.”
Contracts should be drafted based on the unique facts that must be considered when drafting an agreement. Understanding the unique details of your contract helps protect you and your business from easily mitigated risks and liabilities. A good contract is drafted by an attorney in order to protect their client and protect against ambiguities. Traditionally, ambiguities are read in favor of the signing party and ignorance is not considered a valid defense.
For example, not including industry specific waivers against liability, will not afford you the protection that could have been easily avoided by speaking to a legal expert. As a business owner, especially a startup, it’s important to understand exactly what you’re obligatory yourself to. For example, not including an arbitration clause can lead to costly litigations. Similarly, not including an appropriate venue can subject your business to the personal jurisdiction of states that would favor the opposing party.
Additionally, although you may have found a perfect drafted agreement from 2012, that does not mean the agreement is still valid in 2019 because both the law and industry specific trends change over time. For example, if you are doing business online and gathering PII (“Personally Identifiable Information”) it’s important to understand and include legal provisions for both the GDPR and California Privacy Laws both which have changed since 2012. A template may be a good starting place to understand certain contractual provisions, but should always be reviewed by a legal professional in order to obtain maximum protection and understand the liabilities that you are subjecting yourself to.
- “I need my lawyer to sign an NDA.”
Not true. Whether you are a potential client, a current client, or a former client of an attorney, your confidential information is protected without the need to sign a non-disclosure agreement (“NDA”). Attorneys are bound by professional ethical rules that demand that they maintain their clients’ confidential information. Communications between you and your attorney are also protected by the attorney-client privilege and thus, attorneys can’t even be forced to disclose them by a court of law.
- “I’m a Sole Proprietor with liability insurance, I don’t need a formal business entity.”
Liability insurance is a great option for a small business owner, however, it should not be used as a substitute for a formal legal entity such as an LLC. One of the key considerations for an LLC versus a sole proprietorship is that the liability is LIMITED to the business and your personal assets are generally protected. Therefore, an owner is not personally liable for the debts incurred by the startup. A sole proprietor would be liable for the debts incurred by the business and thus would allow a creditor to go after a sole proprietor’s property including their home and other personal property.
Liability insurance alone is insufficient to provide protection against creditors. What if your policy doesn’t cover unexpected lawsuits? What if you forget to make a payment on time? What if you exceed the maximum coverage of your liability insurance? These are all important factors to consider when selecting a business structure. Although a sole proprietorship requires no corporate formalities, these corporate formalities separate the individual from the business. The act of setting up and maintaining an LLC can be achieved at a relatively low cost, but the cost is worthwhile when compared to the amount of money you may be liable for as a sole proprietor.
- “I don’t need to register my trademark to use it.”
Technically, this is true. In the United States you can establish trademark rights under common law. However, this alone will be insufficient to protect your brand. The problem with Common law trademark rights are that they are limited to the geographic area where the mark is used. Use is established by entering commerce. Thus, if a startup starts to go by the name “BRAND X” exclusively in Florida, the trademark right to that name exists only in Florida. If another startup begins to offer services under the name “BRAND X” in California, then there would be no trademark infringement. This can be especially detrimental to a startup that has hopes of national expansion. Additionally, if the California “BRAND X” registers their trademark on the federal registry they will have exclusive nationwide rights to the name in every state except Florida.
- “I have a non-profit business, therefore I don’t need to register my trademark.”
This is not true. Registering a trademark is not limited to for-profit companies. Non-profit organizations’ success is measured in part by their goodwill and reputation as charitable businesses. Thus, protection of a non-profit brand is imperative. In the absence of such protection, a competitor can use the non-profit brand to spin-off a similar, for-profit business by capitalizing off the brand your business has worked hard to establish. The risks are too great irrespective of whether profit is a motive for the business.
- “It is best to have a statement like: ‘By accessing or using the Services you agree to be bound by these Terms’ in my Terms of Service.”
A browsewrap clause and/or agreement usually consists of a small hyperlink at the bottom of a web page that redirects the user to the legal page. The Terms of Service (“TOS”) TOS state that by using or accessing the website, a user agrees to and is bound by the language within its TOS as presented. In contrast, a clickwrap agreement is defined by a checkbox that requires a user to check “I agree” in order to create an account, order a product, and/or continue towards a new section of the website. A clickwrap agreement also provides notice of its legal agreement (i.e. “By clicking the following button, you agree to…”)
When it comes to enforcing a browsewrap or a clickwrap agreement, there are no bright line rules. Instead, there are general principles of contracts as well as certain court cases that have provided factors to consider when determining the enforceability of an agreement. Specifically, the list can be boiled down to (1) whether the user was provided notice, (2) whether the user gave consent, (3) and whether enforcing the agreement is fair.
The consequences of using a browsewrap instead of a clickwrap agreement is that a court may find that your users never agreed to the browsewrap agreement and thus its terms that are very favorable to you, like the disclaimer of warranties, limitation of liability, etc, may be useless. It is recommended you use a clear clickwrap formation process, so your users cannot deny being aware of and agreeing to the terms of the agreement.
- “I am not a blog or social media platform, therefore I do not need to register a copyright agent with the DMCA.”
This is not necessarily true. The DMCA protects websites from liability for IP infringement by users of the website. The key here is that if your company runs a website, or facilitates running a website, where users are allowed to post any material of their choosing without the company’s approval, screening, or modification, the company should register a Designated Copyright Agent with the Copyright Office. The Designated Copyright Agent information should be available in the company’s Copyright Policy, posted on the company’s website.
But I am a retailer, and users who post on my site are typically only posting product reviews–should I still register? Yes! With regards to retailers, while the threat of copyright infringement appears less severe in these forms of user content, there still exist malicious users looking to sue companies for monetary gain on IP infringement claims. Not having a registered copyright agent can be potentially damaging if any product review includes infringing content for which liability will extend to the business because it was not protected under the DMCA’s safe harbor. Best Buy, Macys, Lululemon, Nike, Johnson & Johnson, among others, are examples of retailers registered with the DMCA Designated Agent Directory. Startup companies are more vulnerable to lawsuits than well-established business with cash flow and a legal team equipped to handle them, so it is highly recommended that these precautions are taken.
In closing, we really enjoy working with startups and helping them answer their legal questions. Misconceptions like those above may be common, but with the help of a good startup attorney founders can better understand the law and how to use it to help them and their startup thrive.