BUSINESS FORMATION & SALES BLOG

Federal antitrust laws seek to protect those entities that purchase goods directly from parties engaged in unlawful trade restraints, monopolies and other acts that violate antitrust laws. However, in a situation involving an antitrust violation, it is evident that certain other entities or individuals may also be indirectly injured as a result of these improper acts. For instance, take the situation where a manufacturer and its distributors agree that a certain product will only be sold at an inflated price. Suppliers who purchase products from those distributors must now pay excessive amounts for the product. The supplier will then sell the product at an inflated priced to its customers in order to recoup the inflated price charged by the distributor.

In such a situation, the supplier may have a claim pursuant to federal antitrust laws since it directly purchased products from an entity that may have engaged in unlawful restraints on trade. However, under federal law, the end users of the product would be precluded from bringing a claim, despite the fact that they may have been harmed by having to pay such high prices for the product. Could the end user circumvent the standing requirement of federal antitrust laws by bringing a claim under state law?

This question was recently examined in Stepan Co. v. Callahan Co., a decision issued by the District Court for the State of New Jersey. In that case, the Court determined that federal antitrust laws preempted a plaintiff customer’s state claim for unjust enrichment. There, the defendant supplier had received settlement proceeds in a separate action from a distributor who had charged inflated prices for a chemical product in violation of federal antitrust laws. The plaintiff had purchased the chemical product from the defendant supplier for an amount that was based on the distributor’s inflated price. Accordingly, it argued that by retaining the settlement proceeds, the defendant supplier had been unjustly enriched as it passed on the inflated price to the plaintiff customer.

Nonetheless, the Court dismissed the plaintiff’s state claim, finding that allowing such a claim would run afoul of the standing requirements imposed by federal antitrust laws. As mentioned above, only direct purchasers of a product (and not indirect end users) may pursue claims against sellers that engage in federal antitrust violations. The Stepan Co. Court reasoned that if it permitted the plaintiff customer to bring a claim under state law, it could open the door for a vast array of indirect purchasers to bring suits where a direct purchaser recovered monies in connection with an antitrust violation.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

A restrictive covenant is a provision of an employment contract that restricts the rights of the employee after he leaves a job. For example, a restrictive covenant might prevent a former employee from providing similar services to clients that he established a relationship with while he worked at his previous job. Such a restriction would typically limited to a fixed period, usually between six months and two years. It may also prevent the former employee from providing similar services within a certain number of miles from his former place of employment.

In general, New York courts will uphold restrictive covenants if they are not overly broad or unduly restrictive. However, where an employer sues its former employee for breach of such a covenant, the employee may be able to argue that he brought his own personal clients to the employer. Indeed, under New York law, even where the covenant is not on its face overly broad or unduly restrictive, it may still be unenforceable as to a former employee’s “personal clients.” In determining whether a particular client is considered a “personal client” for purposes of this defense, courts will generally look at whether the client was acquired prior to the hiring of the former employee and how much the former employer contributed to the acquisition of the client.

Notwithstanding that the personal client defense is well established under New York caselaw, an important exception exists where the covenant not to compete was signed during the sale of a business or a merger. In Weiser LLP v. Coopersmith, 2008 WL 2200233 (1st Dept. 2008), the New York Supreme Court Appellate Division, First Department held that where an agreement incorporating a restrictive covenant was signed by the parties in connection with a merger, the personal client defense was not available. In that case, the defendants had merged with the plaintiff to form a new firm and then left that firm to start their own practice. The Court held that the personal client defense could not succeed because the duty not to complete was ancillary to the merger agreement. As such, the Court found that the plaintiff had a right to enjoin the defendants from taking the assets and goodwill of their former company.

The Weiser opinion clearly suggests that a defendant will be very unlikely to prevail on a personal client defense where he signed a covenant not to compete in connection with the sale of a business. In light of this decision, New York courts are likely to find that personal clients that an individual brought into a firm are part of the assets and goodwill acquired by the company in the sale.

Accordingly, when a party seeks to merge or purchase a business, it is imperative that the terms of a restrictive covenant are clearly set forth in detail at the outset. To avoid any confusion, and possibly the preclusion of the personal client defense, the assets to which the restrictive covenant applies should be clearly defined. Otherwise, a party who brought client’s into the business may be left with little in the event that he wishes to strike out on his own.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Commercial Contracts: A fundamental principle of contract law is the public policy of freedom of contract: the idea that individuals should be permitted to bargain freely amongst themselves. Under this legal doctrine, courts will generally uphold the majority of contract provisions, including those which would limit or completely eliminate liability for one party. Such liability-limiting provisions are referred to as exculpatory clauses. In a recent decision, Wartsila NSD North America, Inc. v. Hill International, Inc., the United States Court of Appeals for the Third Circuit gave credence to these deep-rooted principles of contract law.

In Wartsila, the parties had entered into a written consulting agreement whereby the defendant would provide consulting services for the plaintiff in connection with the construction of a power plant. The agreement also contained an exculpatory clause (a clause that disclaims liability in advance), which stated that the defendant would not be liable to the plaintiff for any lost, delayed or diminished profits, revenues or opportunities or any other incidental, special, indirect or consequential damages resulting from the defendant’s performance or failure to perform the services under the agreement.

When the project was not completed on time and a senior consultant on the project was found to have overstated his credentials, the plaintiff sued defendant to recoup the losses it sustained as a result. However, the Court found the broad exculpatory clause to be valid and enforceable, reasoning that the public policy of freedom of contract would be best served by enforcing the terms of the parties’ agreement, including that clause.

In reaching its holding, the Court also noted that none of the defenses under which the exculpatory clause should be disregarded were applicable. Specifically, the Court found that (a) the defendant had not committed fraud; (b) there was no evidence of undue influence or unequal bargaining power; (c) the “public interest” exception did not apply; and (d) the clause did not deprive the plaintiff of the entire benefit of the contract. As none of these justifications would apply, the exculpatory clause was held to be valid and enforceable.

This case highlights the importance of careful review in drafting and executing agreements. Exculpatory clauses can be valuable tools for limiting one party’s liability, but they can also severely impair the other party’s ability to recoup its losses. This case also articulates potential arguments for overcoming the limits of an exculpatory clause. Therefore, even if a contract includes such a clause and a dispute arises, the underlying facts should be carefully examined before concluding that recovery may be foreclosed.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Business Law: It is an oft-asked question: I created a name for our business, isn’t that enough? Simply operating under a business name is generally not enough to protect the individual business owners’ rights, nor to comply with state laws regarding the operation of a business. Even if operating as a sole proprietorship (and not forming an entity with the state), a business still generally still needs to register the name of its business with the State. States generally require all businesses operating within them to register. Registration is essentially a way for the government to keep track of the different businesses and entities providing goods and services within the state and to ensure that taxes are paid.

Moreover, there are important benefits associated with operating a business through a corporate entity. One of the biggest reasons to form a company is to help protect the individual owner’s personal assets. A properly formed corporate entity is an independent, legal entity that is generally considered to be separate and distinct from its individual owners. If properly formed, and if the critical corporate formalities are adhered to, owners can take advantage of the corporate liability shield, often called a “corporate veil,” that generally shields the liabilities and debts of the company from becoming those of the shareholders. While there are exceptions to this protection, it is an important safety measure to seek when operating a business.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Non-Profits: The Sarbanes-Oxley Act is a United States law that was enacted on July 30, 2002 in response to several major, high-profile corporate accounting scandals, such as those involving Enron, WorldCom and Tyco International. Although most provisions of the Act apply only to publicly traded, for-profit corporations, there are a few provisions that also apply to non-profit organizations.

The first of these provisions provides protections for “whistle-blowers” (employees who report suspected illegal activity within the organization). The whistle-blower protections contained in Section 1107 of the Act impose criminal penalties for any actions taken in retaliation against those employees who risk their careers to report corporate wrongdoing. Violation of this provision could subject the violator to substantial fines or even imprisonment for up to 10 years. Clearly, the law wants to encourage employees to report wrongdoing.

In order to avoid violations of the whistle-blower provision, non-profit organizations should develop and adopt a formal procedure for dealing with complaints. These procedures should encourage individuals in the organization to come forward with a problem at an early stage so that it is more likely to be easily resolved. Protocols should also dictate an appropriate response and reporting by the person to whom the complaint is made.

Non-profit organizations should also establish and enforce strict policies to eliminate irresponsible accounting practices, unethical behavior and other misconduct by members of the organization. In addition, it is generally recommended that non-profit organizations conduct periodic internal audits by an independent party to identify any potential problem areas.

Two other provisions of Sarbanes-Oxley that are applicable to non-profit organizations address the intentional destruction of documents. Section 807 and Section 1102 of the Act make it a crime to alter, destroy, mutilate, conceal, cover up falsify or make a false entry in any document as an effort to impede an investigation or to prevent the production or use of that document in an official proceeding. In the modern business environment, if an official proceeding is commenced or threatened, the organization will generally be put into a “litigation hold,” during which the destruction of any document is strictly prohibited. If the organization purges any documents during this hold, it may be subject to criminal obstruction charges. Any party who violates the document destruction provisions is subject to substantial fines or imprisonment for up to 20 years.

Accordingly, non-profit organizations should generally have a written, mandatory document retention and periodic destruction policy in place. Such a policy should include specific, detailed guidelines for back-up procedures and archiving of documents, and should also address the procedure for handling and destroying electronic files and voicemail. It should be clearly explained to employees and the company should undertake efforts to be sure that the protocols are being complied with. In addition, the organization should conduct internal audits to ensure that its system is adequate and that its policy is being effectively enforced.

In light of the potentially significant criminal and financial consequences of non-compliance with the Sarbanes-Oxley Act, non-profit organizations should use careful consideration in structuring their whistle-blowing and document retention policies. The best practice is to consult legal counsel to ensure that all the necessary precautions are in place.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC

Intellectual Property: As a business owner prepares to sell its business, he seeks to highlight what the company has to offer a potential buyer. This may be the customer base, current accounts, inventory, equipment and other items. But, often what the buyer really wants is the intangible aspects of the business that have been built over the years. This is particularly evident in service-based businesses. Often times, the principal asset of such a business is its immense goodwill and name recognition. It is this, which the potential buyer often hopes to leverage off of in taking over the business.

This perspective highlights the importance of properly protecting and assessing the value of the intangible assets that one is transferring in the sale. If a business owner can present a solid book of intellectual property rights that are being transferred, and show that all have been properly protected and utilized, that increases the value of the intangible assets, and thus can help to increase the overall purchase price that may be asked.

To do this, it is important that a company properly identify and protect its intellectual property. Trademark protection is a huge aspect of this. Set forth below is a non-exclusive list of tips a business can undertake in order to protect its trademark rights. It is important to note that the following summarizes legal concepts that applied as of its posting in August of 2008; it does not account for future changes in the law.

Conduct an IP Audit. The first step to protecting intellectual property is to fully identify it. Though this discussion focuses on trademark rights, it is worth noting that many companies will also have an expansive combination of intellectual property including trademarks, copyrights, trade secret and perhaps patents. Prior to offering the company for sale, one should take a full evaluation of the value of its marketing materials, contracts and products. Underlying each of those will be critical intellectual property. For trademark purposes, the “easy” ones are the company’s name and logo. However, also potentially protected under trademark law are particular product names that the company has developed, unique service names and slogans. Further, the website, marketing materials, brochures and even price lists are ripe for copyright protection. In order to protect this intellectual property, one first needs to identify and treat it as such.

Use Your Mark. Trademark rights start from the use of the mark. That’s worth repeating: one gains rights from trademark law by using the mark. What does this mean? Its impact is two-fold. First, it means that use trumps registration. Accordingly, while registration is critical, if one register a mark that someone else used first, that other party has prior rights to it. Next, even if one has trademark registration for the mark, one must continue to utilize it in order to maintain those rights. If one fails to continuously utilize the mark, that could arguably be deemed an abandonment of the intellectual property rights to it. In order to argue that the company has rights to trademarks, it will need to be able to show that it actually used the mark. A mere idea for a mark that has not been used will arguably do little to add value as an intangible asset.

Evaluate the Mark. Because trademark rights lie in use of the mark, it is critical that prior to launch, one conducts an investigation to identify others’ use of that, or a similar, mark. A good starting point, of course, is checking the United States Patent and Trademark Office (USPTO)’s database, to see whether a similar mark has been registered. However, this is not enough. However, that database only demonstrates marks that are registered with the USPTO. It is not an exhaustive search, and it will not include an indication of parties that are using the mark but have not registered it. Again, because use trumps registration, it is critical to know more generally whether other parties are using the mark.

There are various resources available in order to conduct those searches, including utilizing private investigators to conduct them. For several reasons, it is critical to conduct such a search at the outset. First, it could save significant money. We generally recommend that our clients engage an investigator to conduct such a search prior to commencing a trademark registration. This enables the company to evaluate the likelihood of a successful registration.

For instance, if a search reveals that there are numerous other companies who have registered a similar mark in a similar industry, it is likely that the USPTO would identify those other marks as obstacles to registration, and could even deny registration on that basis. Identifying such obstacles at the outset can enable one to evaluate the risk and identify potential problems prior to incurring governmental filing fees and legal fees.

Moreover, if one identifies a potential conflict with others’ use of the mark one can address it before it becomes a problem. For instance, one may evaluate others’ usage of similar marks and determine that it would be best to simply redevelop the proposed mark. It is far better to do that at the outset, prior to incurring significant marketing money and building goodwill and branding associated with the mark, only to later abandon it. Last, but certainly not least, such an evaluation at the outset can help to avoid litigation. If a company proceeds to develop and use a mark without conducting such an evaluation, it may do so while completely unaware that the mark infringes upon another party’s use. Unfortunately, even innocent infringement could result in an infringement lawsuit and force one to cease use of the mark. Again, a proper evaluation in the beginning of the process can help to ward off such potential problems by allowing a company to evaluate the risks inherent in using a particular mark. Use of a trademark that arguably infringes on third party rights will certainly be less valuable as an asset to be sold. Moreover, such third party use may be discovered in a buyer’s due diligence and could in fact serve as a deterrent to the buyer.

Develop a Strong Mark. The selection of marks is critical to the ability to enforce rights to the mark. Trademark law has created a scale of marks, in which the strength of the mark is directly correlated to the creativity of the mark. For instance, the strongest marks are usually those that are made-up words (i.e., Kodak®) or are otherwise unrelated to the services or goods being provided under the mark. It is far more difficult to obtain trademark registration and protection to terms that are either generic or that merely describe goods and services. For instance, a name such as “Joe’s Landscaping” is arguably generic for a landscaping services company. Generic terms are not entitled to trademark protection at all. Moreover, if the company name is “Beautiful, Colorful Gardens,” that name arguably simply describes the services being provided. To obtain trademark protection in that situation, one would need to prove that the name has acquired what is termed as “secondary meaning.” This essentially means that consumers associate the mark “Beautiful, Colorful Gardens” with that particular company and understand and assume that that a particular entity is the source of the services being provided. In other words, they do not simply see it as a description for the goods and services that any landscaper might provide. Again, the more unique the name, and the greater “mental leap” that needs to be taken to connect your goods and services with the name, the stronger the mark.

Strength of the mark might be an issue when seeking registration: often times the USPTO’s examining attorneys will review this as a pre-condition to granting registration. However, it also will come into play in the event of litigation. For instance, if a business has operated for twenty years as “Beautiful, Colorful Gardens,” it might be upset if someone opened a business down the street and marketed their services as “Colorful, Beautiful Gardens.” The likely first step would be to try to force the latter party to cease utilizing the mark, and to try to recoup damages for their use of an arguably confusing mark (the same words simply re-arranged). However, at this point, that new company may be able to defend itself by arguing that the mark is merely descriptive and therefore not entitled to trademark protection. If they prevail on this argument and if one is unable to prove secondary meaning, one may be unable to stop their use, nor obtain damages.

Registration of the Mark. Once a business owner has made a final decision as to the mark, and has put it to use, the next step is to register it. Through the registration process, one submits the image of the mark to the USPTO, along with a description of the use and materials demonstrating that use. Notably, one can register variations of the mark. For instance, if the business is registering a company name, it may present that name in a stylized form, or in standard letters — both forms can be registered — although, they are considered to be two distinct marks, and thus, two separate applications. Next, one must indicate to the USPTO how the mark is being used. This involves developing various descriptions that depict the use of the mark. Importantly, a business’s use could be quite expansive, and it is important to register for all uses of the mark, not just the primary use. For example, the operation of an online business may touch on outside services, as well as services provided online, email services, and/or electronic forums, etc. Each of these should be reflected in the application.

Although we previously discussed the importance of use of the mark over registration, registration is nevertheless a critical aspect in protecting trademark rights. Having a registered trademark provides numerous benefits over rights as a mere common law trademark owner. For instance, once a mark has been registered, the owner is provided a legal presumption that he has valid ownership of the mark and an exclusive right to use it in connection with the registered goods and services. Further, once the mark has been registered for five or more years, the trademark owner is provided an additional legal presumption that your mark is valid — this presents various arguments and defenses that may be raised by a third party in the event of a dispute. For example, in the previous example relating to “Beautiful, Colorful Gardens,” had there been a federal registration for the mark for more than five years, “Colorful, Beautiful Gardens” would generally be prevented from arguing that the mark was invalid as a descriptive mark, thus eliminating that potential defense. As a registered trademark owner, one is also entitled to bring suit in Federal court, and thus have the ability to leverage US registration into registration and applications in other countries. Thus, having a mark that is properly registered arguably increases the value of the mark.

Maintaining Registration. Once one has registered a trademark, there are certain procedures with to which one must adhere in order to maintain it. First and foremost, as previously stated, the business must continue to use its mark. However, in addition, even once one has received the registration, there will be periodic filings that need to be made with the USPTO in order to continue the registration. For instance, after the fifth year of registration, the trademark owner must submit to the USPTO a declaration of continued use. Through this filing, it is essentially certifying to the government that it is continuing to utilize the mark per the registration, and must provide additional specimen to the USPTO proving that use. There are incremental filings that will also need to be submitted thereafter. If one fails to timely submit these post-registration reports, he may be deemed to have abandoned the registration, and can therefore lose the benefits of being a registered trademark holder.

Notice. The appropriate notice designation should also be used in conjunction with the mark. If the business has not yet registered the mark (this includes the time period in which one has submitted an application but registration is still pending), it can utilize the designation “TM” or “SM,” for trademarks and service marks, respectively, in order to notify the public of a potential claim to rights in that mark. Once the business has obtained trademark registration, the notice should be modified to use the ® symbol. Importantly, one can only utilize the registered symbol if he has a registered mark, and only in connection with those goods and services for which he is registered. However, this notice is critical, because failure to consistently use the registered notice in conjunction with the mark can prevent one from obtaining damages in the event that one sues a third party for infringing use. This can be a crippling penalty for neglecting a notice that is easy to utilize.

Enforcing the Mark. Once the business has registered and clearly established the trademark rights, they need to be enforced. Unfortunately, this area of the law can fall under the umbrella of “you snooze, you lose.” Essentially, if one fails to enforce rights he may be deemed to have waived them. Therefore, if a business knows that someone is infringing on its rights and fails to act to enforce the rights and prevent the infringing use, it may be deemed to have consented to that use. Accordingly, if the business changes its veiwpoint a year or two later, it may be too late. This is often referred to as the doctrine of “laches.” Moreover, if one does this too many times one could additionally be deemed to have waived all rights. For instance, suppose that a business learns that Company F is patently infringing its rights and is stealing a large number of customers and profits as a result of their use. When it sues Company F, the Court may look to the fact that the business has allowed Companies A, B, C and D to utilize the mark freely and without limitation.

Even worse, following our example, suppose that Company E is utilizing the mark in a confusing way and in addition is providing horrible service. As a result, in addition to lost profits from their infringement, the business reputation could also be damaged, thus arguably diminishing the value of the trademark. In such a situation, when one sues Company F, Company F could arguably say that due to Company E’s damaging (and unstopped) use, the damages are negligible. For all these reasons and more, it is critical that one carefully monitor the market to quickly identify and diffuse any wrongful use of your trademarks. Again, when assessing the value of intangible assets such as intellectual property, a potential buyer may look to see the strength of a mark and how well the seller has prevented others’ infringing use.

Contract for Trademark Protection. In order to best protect intellectual property rights, it is critical to specifically address them when entering into business transactions. For instance, if a business is granting a third party a right to utilize its company name or marks, it should make sure that the appurtenant rights and obligations are very clearly and specifically detailed. In such an event, and without limitation, the licensor should make it clear what if any, consideration is being provided in exchange (i.e., a royalty), and whether or not the license is exclusive or non-exclusive. If it is exclusive one should carefully define that exclusivity. Moreover, the trademark owner should ensure that certain protocols are in place to enable it to maintain quality control over the products or services being associated with the mark. If the trademark owner fails to maintain quality control over either the depiction or usage of the mark or over the goods and services that are associated with the mark, it may be hampered later on in trying to obtain damages for someone else’s damaging use.

Register with US Customs. As a registered trademark holder, one has the ability to file for registration with US Customs and Border Protection. This can allow a business to obtain a head start in preventing counterfeit goods from entering the country. Moreover, as a registered rights holder with US Customs, a business may even provide the agency with certain information or criteria relating to suspected infringers (e.g., the specific importer, manufacturer, country of origin, etc.). Once a business has a registered trademark, one can leverage that application into registration with US Customs by filling out an online application.

Again, each of these are critical for increasing the strength of a business’s trademark rights, and thus increasing the value of the intangible assets that may be sold in a corporate sale.

Comments/Questions: ljm@gdnlaw.com

© 2008 Nissenbaum Law Group, LLC