Intellectual property (IP), whether patents, copyrights, trademarks or trade secrets, is an important asset for almost every company, regardless of industry or market focus.
“Business owners should be careful not to fall prey to the misconception that if their business does not involve manufacturing, research and development, or high-tech innovation, there is no IP to protect,” says Alexis Dillett Isztwan, member at Semanoff Ormsby Greenberg & Torchia, LLC. “In fact, with reliance on the Internet for the delivery of goods and services, as well as marketing, strong brand recognition and the development of original creative works have become an important driver for generating revenue. It is not unusual today for a business to have only one category of assets — its intellectual property.”
Smart Business spoke with Isztwan about how you can know whether you really own the IP that you paid for.
How does ownership typically work when a contractor develops IP?
Often, owners assume if they paid a contractor to create something — a website design, an Internet platform or portal, a logo design, a software program — then the business owns all the rights. The reality, however, is quite the opposite. Under copyright law, the author — the graphic designer or the software programmer — owns the copyright, and under patent law, the inventor owns the rights. This is true regardless of whether, or how much, the company paid.
For copyrights, there is a narrow, often-misunderstood exception called the ‘work for hire’ doctrine. The work for hire exception covers only two categories: (1) employees who create works within the scope of their employment, and (2) nonemployees who create a work that falls within one of the specifically enumerated categories in the copyright law. The second category applies infrequently, covering only works such as contributions to a collective work, parts of a motion picture or other audiovisual work, translations, an instructional text, a test, answer material for a test, or an atlas. The first exception covers works prepared by an employee, not contractors.
Determining whether a person is an employee requires evaluating the level of control the employer has over the work as well as the creator and his or her conduct. Even if the creator is an employee, it calls into question when the work was created and whether the subject matter is related to the scope of employment.
What can business owners do to ensure they own what they pay for?
The best way to solidify IP ownership is with a written contract signed by both parties prior to any services being performed, whether by an employee or contractor. The contract should clearly grant ownership of all works and inventions and related IP rights to the business. Ownership should not be dependent on or timed with payments.
Even businesses that attempt to cover ownership in a written agreement sometimes limit effectiveness by stating that all work should be considered ‘works for hire.’ Since copyright law does not cover all IP rights, the contract language should contain an immediate, explicit and irrevocable assignment of all rights in the work created.
One pitfall is failing to recognize when the contract is necessary. Whenever a business hires an outside party to prepare a product or other deliverable, a written contract for those services should contain a favorable ownership statement.
Too often, the contractor convinces the owner a written agreement is unnecessary or that the contractor operates on a purchase-order basis only. This is a red flag, as trying to extract an ownership statement later will come with a price and often be refused.
Is this an area of growing concern?
To many business owners, it is counterintuitive that IP ownership generally resides in the author or inventor rather than the party paying for the work. As a result, a number of owners are unaware of the problem until it surfaces in another context, such as when trying to sell the company, looking for financing, or in a dispute with the contractor or employee who created the work.
The ownership issue is not industry specific, but startup companies are more vulnerable to missteps. Startups, often low on cash, frequently look to friends to work for them based on a handshake promise of future interest in the company. When the business starts growing, those ‘friends’ come looking for their equity, and if you did not obtain an assignment of rights, you have little leverage, particularly when the savvy friend holds the IP ownership hostage in exchange for a
percentage of the business.
During the due diligence of a sale or financing, buyers or potential investors look at whether the company owns all of the asset rights, either to determine the value or ensure security. Increasingly, those assets are entirely or largely IP related. An unclear ownership chain often devalues the business. For example, a business hires multiple programmers to develop software without agreements, and tying up ownership requires tracking down each programmer to obtain an assignment of rights. It may be impossible to find each programmer and, if you do, even harder to convince them to agree to an assignment.
If you don’t have an assignment, what can happen to your property?
If your company does not own the IP rights, not only is the business potentially vulnerable to infringement claims but the actual owner also has the right to license or sell the work to other parties, including competitors. Imagine having a new software platform developed by a contractor without an assignment, and then that contractor licenses or sells it to your competitor. You lose control over what was supposed to add value to your business, and you could have to focus time and resources on either defending an infringement claim or obtaining the rights from other parties, likely at a much higher cost than originally paid.
Alexis Dillett Isztwan is a member at Semanoff Ormsby Greenberg & Torchia, LLC. Reach her at (215) 887-0200 or email@example.com.
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There are several methods of design and construction that can be used on a project. Each determines who produces the designs, who performs the construction and who is liable in the event of litigation.
The type of project, whether public or private, its level of technical sophistication and the time frame in which it needs to be finished determine the preferred method.
Smart Business spoke with T.G. Davallou, partner and head of Alfa Tech’s San Francisco office, about the different methods, what they entail and which is better for a given situation.
What are the differences among the methods of design and construction?
Traditional design-bid-build features a consultant who will design the mechanical, electrical and plumbing (MEP) systems for the building, the construction of which is put out to bid. The contractor with the winning bid then performs the construction.
Design-build means the MEP consultant writes the performance specifications, which provide the design criteria for the project, then hires a design-build contractor who finishes the design based on the specifications and performs the construction.
Design-assist entails a MEP consultant who realizes the design and draws it up to 50 percent completion before bringing the contractor on board. The contractor becomes the owner of the documents and completes the designs. The MEP consultant in this arrangement remains the engineer of record.
Are each of these practical in different situations, or should one always be chosen over the other?
The most sophisticated or innovative projects are either full design-bid-build or design-assist through integrated project delivery. Even though design-build contractors are getting smarter and have greater resources than before, they can’t compete on the engineering side with traditional consulting. If you look at simple tenant improvements that don’t have any design elements, design-build makes sense. But if it’s an innovative design or a complex project, like one with renewable energy or façade natural ventilation, these resources need a true consultant and not just a contractor, so design-assist makes better sense.
Business owners are getting smarter and are looking at overall life cycle costs of buildings instead of just the initial costs of the building’s design. They consider initial construction, utility, maintenance and replacement costs over the life of the building, which means design-bid-build or design-assist is more appropriate.
The schedule also has a big impact. There’s no way traditional design-bid-build would do a proper job with no issues on a high-rise building that needs tenant improvements in two months. Design-build would be better in this case. Scheduling has a large impact on which method should be used.
Who should a company appoint to serve as a liaison between the contractor and itself to stay on top of the process?
Typically an owner will recruit a project manager or construction manager first if he or she is not sophisticated enough to oversee the project. That person is the conduit between the business owner, the architects/engineers and the contractors. The construction manager is a third party who manages the whole process for the owner and has input on who is hired, such as the architect and engineers. Scheduling and costs also come into their recommendations to the owner.
Which method is used more often today?
Design-bid-build was the traditional method from the 1970s until the mid-1980s. Contractors weren’t very sophisticated or knowledgeable enough to handle entire projects from designing the specifications to completing the construction, so they relied on architects and consultants for design and to be liable for any issues. Beginning in the mid-1980s, the method shifted because numerous legal claims came out against contractors constructing public properties, such as state/county hospitals, institutional facilities, educational facilities and libraries, after the projects ended.
The problem is that public jobs are awarded to low bidders, as state law dictates. This often resulted in changes to the design or materials used during construction so the contractor could keep the project on budget. The owner of the building didn’t want to spend money on litigation, which is why the design-build concept arose because it reduced or eliminated change orders. The contractor in this method is the owner, designer and builder so legal discrepancies are reduced because there are fewer change orders.
Design-build contractors, it was later discovered, were not really giving top quality because the interest from public entities is low initial costs, so contractors were cutting corners, which led to systems not performing as they should. Thus, design-build declined as the preferred method of construction.
Now ‘big campus’ designers have found other ways to get a better design. With so much interest in Leadership in Energy and Environmental Design, projects are getting more sophisticated, so property owners are looking at how to get the most efficient systems without claims or lawsuits against the contractor at the end. This led to the establishment of the design-assist method, where a consultant can introduce the most innovative design and then become a partner with the contractor. The consultant brings the design up to 50 percent, meaning all the design elements are there, and it’s just a matter of coordination to make sure ductwork fits, etc. The contractor can’t change the specifications by, say, undersizing the ductwork, because he’s the engineer of record and the designer stays involved though the project’s completion.
When does litigation become a greater concern?
During a construction project, all parties are legally liable. Litigation issues happen mostly with public contracts. For commercial jobs the construction manager has pre-qualified and negotiated with a selected contractor. However, with public projects, the low bidder gets the job, which usually results in a lot of change orders that can lead to litigation.
T.G. Davallou is partner and head of Alfa Tech’s San Francisco office. Reach him at (415) 403-3092 or firstname.lastname@example.org.
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When selecting a contractor for a job, it is important to choose the most fiscally responsible one for the construction project in order to mitigate and manage risk and ensure its timely completion.
Failing to do so puts your company at risk of economic devastation as you are gambling on a contractor or subcontractor whose level of commitment is uncertain or who could become bankrupt part way into the job. However, there is a solution to decrease your risk, says Jack Gaugler, vice president, surety bond specialist, at SeibertKeck Insurance Agency Inc. and the Jack Kohl Agency.
“Surety bonds offer an optimal solution. By providing financial security and construction assurance, they guarantee project owners that contractors are capable of performing the contract and paying specified subcontractors, laborers and material suppliers,” says Gaugler.
Smart Business spoke with Gaugler about how surety bonds can help protect you from a devastating loss.
What is a surety bond?
A surety bond is a three-party agreement in which a surety company assures the obligee (the owner) that the principal (the contractor) will complete a contract as promised.
There are three primary types of contract surety bonds: a bid bond, a performance bond and a payment bond.
A bid bond assures that a bid has been submitted in good faith, that the contractor intends to enter into the contract at the price bid and will provide the required performance and payment bond if awarded the contract. A performance bond protects a company from financial loss in the event that the contractor fails to perform in accordance with the terms and conditions of the contract. A payment bond assures that a contractor will provide certain workers, subcontractors and material suppliers and guarantees they will be paid for work performed under the contract.
Even if a contractor has been in business for 100 years and has a good reputation, past performance is no guarantee of future results. Risk lies in the uncontrollable, unpredictable and the unknown and it is never a good idea to gamble on something that could jeopardize your company’s future. The relationship that an owner has with a contractor is arm’s length, while the surety agent and bond company relationship is a day-to-day partner. A surety has a much greater insight as to contractor’s abilities to perform than an owner.
How is a contractor prequalified?
Surety companies back the performance bonds with their own assets, so they conduct a careful, rigorous prequalification review of the contractor. The goal for the contractor is to get a bond line set up. The bond underwriter’s analyses look at criteria including financial strength, annual and interim financial statements, investment strategies, cost control mechanisms, work in progress (both bonded and nonbonded), cash flow, net worth, working capital and bank and other credit relationships. The underwriter will also look at ability to perform, prior experience on similar projects, equipment and personnel — including strength of management and its structure, past and current workloads and a continuity plan. Finally, it will consider the contractor’s reputation with project owners, subcontractors, suppliers and lenders.
Weakness in any of these areas can cause a contractor to fail. Evaluating each of these areas allows the underwriter to become comfortable guaranteeing that a contractor will be able to complete the job as promised.
Who requires contract surety bonds?
Congress passed a law more than 100 years ago to protect taxpayers from contractor failure by guaranteeing payment from the primary contractor to subcontractors and suppliers. An update to this law, called the Miller Act of 1935, is the current federal law that mandates surety bonds on federal public work projects valued at $100,000 or more. The act removes the risk from the subcontractors involved in the project and places it on the surety company that issues the bond.
State and local governments also require these bonds on public construction projects and each state has its own ‘Little Miller Acts.’
Surety bonds for private projects, while not required by law, are highly recommended. Every major project that could potentially cripple an individual company or a financial institution should require a bid and performance bond for protection. The cost of the performance bond ranges from 0.5 percent to 3 percent of the total contract amount. There is no other risk transfer mechanism that guarantees a construction contract will be completed.
When compared with the cost of contractor failures, surety bonds are a low-cost investment, considering the protection that is provided by them. Thousands of contractors, whether they have been in business for two years or 100, whether they are large or small, fail each year, leaving behind unfinished construction projects with billions of dollars in losses to project owners.
What happens if a claim is made on a surety bond?
The surety company will first investigate the alleged contractor default by working with the principal to make a decision on whether it must perform under the terms of the bond.
Once it has determined default of a contractor under the performance bond, it could conduct a takeover in which it will hire a completion contractor. It could also perform a tender, where a new contractor will be provided to the obligee (owner).
Other options include retaining the original contractor and providing technical and/or financial assistance, or the surety could reimburse the owner by paying the penal sum of the bond.
Without the protection of a surety bond, none of these actions would be possible. To minimize your risk when dealing with contractors, seek the advice of an expert to help maximize your protection.
Jack Gaugler is vice president, surety bond specialist, at SeibertKeck Insurance Agency Inc. and the Jack Kohl Agency. Reach him at (330) 294-1352 or email@example.com.
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Failing to do so puts your company at risk of economic devastation as you are gambling on a contractor or subcontractor whose level of commitment is uncertain or who could become bankrupt part way into the job. However, there is a solution to decrease your risk, says Marc McTeague, president of Best Hoovler McTeague Insurance Services, a member of the SeibertKeck Group.
“Surety bonds offer an optimal solution. By providing financial security and construction assurance, they guarantee project owners that contractors are capable of performing the contract and paying specified subcontractors, laborers and material suppliers,” says McTeague.
Smart Business spoke with McTeague about how surety bonds can help protect you from a devastating loss.
What is a surety bond?
Even if a contractor has been in business for 100 years and has a good reputation, past performance is no guarantee of future results. Risk lies in the uncontrollable, unpredictable and the unknown and it is never a good idea to gamble on something that could jeopardize your company’s future. The relationship that an owner has with a contractor is arm’s length, while the surety agent and bond company relationship is a day-to-day partner. A surety has a much greater insight as to a contractor’s abilities to perform than an owner.
How is a contractor prequalified?
Surety companies back the performance bonds with their own assets, so they conduct a careful, rigorous prequalification review of the contractor. The goal for the contractor is to get a bond line set up. The bond underwriter’s analyses look at criteria including financial strength, annual and interim financial statements, investment strategies, cost control mechanisms, work in progress (both bonded and nonbonded), cash flow, net worth, working capital, and bank and other credit relationships. The underwriter will also look at ability to perform, prior experience on similar projects, equipment and personnel — including strength of management and its structure, past and current workloads and a continuity plan. Finally, it will consider the contractor’s reputation with project owners, subcontractors, suppliers and lenders.
Who requires contract surety bonds?
What happens if a claim is made on a surety bond?
Once it has determined default of a contractor under the performance bond, it could conduct a takeover in which it will hire a completion contractor. It could also perform a tender, where a new contractor will be provided to the obligee.
Marc McTeague is president of Best Hoovler McTeague Insurance Services, a member of the SeibertKeck Group. Reach him at (614) 246-RISK or firstname.lastname@example.org.
Insights Business Insurance is brought to you by SeibertKeck Insurance Agency
It can bring spouses together or it can rip them apart. It can be a labor of love or hard labor. It can be a fond memory or an experience to be forgotten. Smart Business spoke to Dennis B. Ellman, a partner at Greenberg Glusker Fields Claman & Machtinger LLP, about how, armed with a bit of knowledge, you can build a home that serves you and your family and have fun in the process.
Assemble the right team. Your financial success was likely achieved by hiring the best. The success of a construction project requires no less.
The Owner’s Representative (OR). Unlike a general contractor or design professional, an OR is a project manager who represents only your interests as the owner. Most are former architects or contractors, so their skill set is well suited to custom home development.
An OR’s responsibilities include negotiating contracts, preparing and tracking budgets, assisting in value engineering, attending weekly job meetings, reviewing invoices from the architect, contractor and consultants, confirming that all required lien waivers and releases have been submitted, reviewing, insurance for compliance with contract requirements, etc.
The Architect. Selecting an architect includes answering these questions: Do I want and can I afford a well-known architect? Does the architect design in the style that I prefer? Will the design meet my objectives or only serve the architect’s likes? What is the average cost per square foot of the homes designed by this architect? Is the architect someone I will enjoy working with?
Architects are typically compensated based upon a percentage of construction cost (between 10 percent and 20 percent), and are paid as their work progresses. This rate structure can lead to mistrust when the architect recommends a more expensive design or more costly materials. Consider suggesting a fixed fee based on the estimated cost or size of the home, which will be subject to adjustment only if significant changes are made.
Understand what the architect’s fee includes. Some include the cost of mechanical, electrical, plumbing and other engineers whose services are required for the preparation of the architect’s plans. Others do not include these consultants, in which case the owner must pay these in addition to the architect’s fee. Engineering fees can often total between 1 percent and 3 percent of construction cost. When comparing one architect’s fees against another, make certain you know what services are included.
The General Contractor (GC). Many custom homebuilders are excellent builders and people of integrity. Others are not. Owners should perform extensive due diligence before engaging a GC. Check personal references, visit homes that the GC has built, and ask your lawyer to investigate prior litigation to which the contractor has been a party.
The Attorney. Make certain the attorney you hire is not a generalist, but has extensive construction contract experience. Ask about projects in which the attorney has been involved. An experienced attorney may also be able to recommend potential ORs, architects and GCs.
Sign the right contract.
Negotiated vs. Bid Contract. There are two methods of engaging a GC. The first is to wait until plans and specifications have been completed and then send them to several GC’s requesting bids. This process should result in a truly competitive price for the construction of your home.
The second method, often referred to as a “negotiated contract,” is one in which the owner, with the assistance of the OR or architect, selects a specific GC and negotiates its fees (profit) and general conditions (project site and supervision costs) prior to plan completion. Once awarded the contract, the GC will be required to obtain a minimum number of bids from each subtrade. This enables the owner to hire a GC as the plans are being developed, leveraging their expertise for estimating costs and value engineering.
Contract Form. The most common construction contract forms are “cost plus” and “fixed price.” A cost plus contract pays the contractor the actual cost to build the home, plus a fee typically stated as a percentage of that cost. There is no cap or maximum price, although an estimated budget should be included. Require that all trades be bid to at least three potential subcontractors.
A fixed price contract sets forth a price for the completed house; it also includes cushion to protect the GC, which you will pay whether or not it is needed. Any changes during construction will likely increase the price.
A hybrid of these two contract forms is the “cost plus subject to a guaranteed maximum price” (or GMP) contract. As implied by its name, the owner pays the contractor’s actual cost of the work plus an agreed upon fee, not to exceed a maximum price. These contracts typically incentivize the contractor to complete construction for as little cost as possible by giving a percentage of “savings” (usually between 25 percent and 40 percent).
There are certain protections that should be included in all construction contracts. Since contractors are paid as the work progresses, the owner should be permitted to withhold a percentage of what would otherwise be due the contractor. This so-called “retainage,” which is typically 10 percent and paid upon job completion, is the owner’s insurance that, if the contractor fails to complete the work, funds will be available to pay any liens and the additional costs in securing a new GC.
A well-drafted construction contract should protect the owner from contractor claims for additional compensation. Representations should include confirmation that the GC has thoroughly investigated the project site, carefully reviewed the plans and found them to be complete and without inconsistencies, and that the contract price includes both work shown and work reasonably inferable from the plans.
Time to Complete. The contract should have a date for completion. The GC’s failure to complete by this date will give rise to damages. Contractors are typically entitled to extensions of time for causes beyond their control, such as inclement weather or labor strikes. Exceptions should be narrowly defined.
Know yourself and have fun
If you labor over the smallest of decisions and then second guess yourself, or if you approach every task as a work in progress changing course every step of the way, consider buying a completed home. Too many projects exceed their budget due to costly changes and owner-caused delays during construction. But, if you are reasonably decisive and secure, then consider a custom home. Remember, the process should be fun. No matter how wonderful the home you build, no one will be happy if it results in family strife.
Dennis B. Ellman advises and represents real estate developers, brokers, investors and affiliated construction and architecture professionals in financing and loan workouts, lease negotiations, construction contracts, project agreements, and all aspects of real property acquisitions and dispositions. He can be reached at DEllman@greenbergglusker.com or (310) 201-7417.