How to survive a software license compliance audit

Heather Barnes, intellectual property attorney, Brouse McDowell

Heather Barnes, intellectual property attorney, Brouse McDowell

You don’t have to be pirating software to get in trouble during a compliance audit.

“Where companies get ensnared is in the deployment phase. It’s not that they are trying to get away without paying, they get caught up in the terms of conditions found in the fine print of licensing agreements,” says Heather Barnes, an intellectual property attorney with Brouse McDowell.

Smart Business spoke with Barnes about what businesses can do to make the software audit process go smoothly.

What prompts an audit?

Software companies include the right to request audits as part of the terms and conditions of the software license agreement. The fine print contains the right for the software company to audit your computers and systems. Sometimes audits are performed because that organization received a tip from a discharged employee. There also are companies that conduct audits as a regular course of business, either itself or through a third party, such as The Software Alliance. Because of the economy, software revenues have decreased, so software owners are replacing lost revenue by ramping up enforcement with compliance audits.

Once you’re notified about an audit, what should you do?

If you are an organization with in-house counsel, contact them immediately. Smaller companies should retain outside counsel, because attorneys can make a big difference in the final outcome.

The first thing an attorney will do is assist with the parameters for the audit — how and when it will occur, as well as the scope. If there is a noncompliance issue, legal counsel can draft a settlement agreement; they may even negotiate the settlement to a more reasonable number. Even if there are no compliance issues, you still want a document drafted that acknowledges how the audit was conducted and what was found, as well as a release of any claims the software company could have brought.

What problems can occur if you proceed without legal counsel?

Much is dependent on the particular company, but the audited company wants to prevent the software owner from having free reign of its systems, and that is a role legal counsel can help control. For example, legal counsel can assist in defining the scope of the audit by determining which computers are included in the audit. Do you include every computer? Just computers in use? What about the computers that are older and sitting in a warehouse? A software company could attempt to include any computer you own, even those that are obsolete and unused.

Another potential issue is how the audit concludes. You might come to an agreement at the conclusion of the audit and think a settlement is in place. Without legal counsel involved, a company could find itself with no settlement agreement or other document detailing what occurred and the responsibilities of each side going forward.

What are typical noncompliance issues and how much do they cost to fix?

Terms and conditions of the software license agreement vary by company. Many companies allow you to use older versions of software when you obtain a license for their latest product, but some do not. However, many people think that it’s an industry standard that you can deploy older versions.

Another problem is maintenance of business records proving owned licenses for software. You need to have documentation and keep those records current and accessible. That can be complicated when the software was purchased from multiple third-party vendors and for software that is old. Companies should conduct internal audits to ensure they are in compliance with what their records reflect, which could help mitigate exposure when an audit occurs.

Normally, if you are out of compliance, you’ll be charged the licensing fee you should have paid. If it is $200, $300 or $500 per license, multiply that by the number of computers out of compliance and it can get expensive quickly.

Further, if you’re found to be noncompliant, develop internal procedures to ensure compliance in the future. If you are audited once and are found to have compliance issues, it is just a matter of time before the software owner is back to check again.

Heather Barnes is an intellectual property attorney at Brouse McDowell. Reach her at (330) 535-5711 or [email protected] Learn more about Heather Barnes.

Insights Legal Affairs is brought to you by Brouse McDowell

 

How borrowers can understand and limit legal risks for all loan types

Catherine A. Marriott, member, Semanoff Ormsby Greenberg & Torchia, LLC

Catherine A. Marriott, member, Semanoff Ormsby Greenberg & Torchia, LLC

Virtually every business and individual borrows money at some point. Although there are many different loan types available, some universal concerns apply to every loan. Borrowers need to understand these issues and know that they may be able to limit their risk through negotiating their loan documents.

“Borrowers don’t always fully appreciate the risks they are taking when borrowing,” says Catherine A. Marriott, a member at Semanoff Ormsby Greenberg & Torchia, LLC. “Often, a default which could have been avoided can result in acceleration of a loan, putting personal and business assets at risk.”

Smart Business spoke with Marriott about what provisions counsel should review, whether or not he or she participates in the negotiations.

What are issues borrowers should consider?

Often, borrowers extend lines of credit via a simple modification document, without reviewing the documents signed when the loan was first obtained. In doing so, they run the risk of violating representations and warranties that were true when the loan was first made, but are not necessarily true when the loan is modified. Further, borrowers may not be aware of operating and financial covenants that apply to their business, and often think that because they have not had any issues in the past, there is no need for concern now. While that may be true, reviewing the initial documents is critical in avoiding defaults going forward, as circumstances and goals may have changed.

For new and existing loans, borrowers must be sure that they understand:

  • All business terms, such as the monthly payment obligation, interest rate, amortization term, prepayment penalty, and operating and financial covenants.
  • What collateral is pledged for the loan, including security interests in equipment, inventory and accounts receivable, and, most importantly, personal guarantees.
  • The remedies that the lender has upon a default, including confession of judgment for money or possession of real property, and what effect enforcement of these remedies could have on business and personal assets.

What should be considered regarding personal guarantees?

Many borrowers form entities to keep business and personal assets and liabilities separate. Notwithstanding this goal, principals of small and midsize businesses are almost always required to personally guarantee business loans, resulting in risk to personal assets. Although these individuals are aware of their personal liability, the extent of their exposure may not truly be appreciated.

How does confession of judgment work to increase borrower risk?

Confession of judgment is a powerful remedy available to commercial lenders in Pennsylvania. It allows a lender to immediately obtain a judgment against a borrower or guarantor (or both) for money or possession of mortgaged property. The money judgment will include the accelerated amount of the balance of the loan, plus interest, late fees, attorney’s fees and costs of collection. A borrower or guarantor will have the opportunity to open the judgment only after it is entered, rather than defend the matter before it becomes a judgment. An attorney can advise of the risks and consequences of confession of judgment.

When should counsel be reviewing the loan documents?

Certain loan provisions are legal in nature, so borrowers should consult with an attorney to understand the legal risks. By doing so at the outset, counsel can advise not only on whether borrowers are receiving market terms, but also can assist with modifying or eliminating provisions that are negotiable. Counsel can make sure that borrowers understand their obligations, and that the loan terms adequately address the borrowers’ needs and business goals. The later counsel gets involved, the more difficult it becomes to improve the loan terms.

Even if a borrower has never had problems with its loans or lender, things can happen. Considering what is at stake, all borrowers should strive to minimize their risk. Spending a little time and money now to protect business and personal assets in the future is invaluable.

Catherine A. Marriott is a member at Semanoff Ormsby Greenberg & Torchia, LLC. Reach her at (215) 887-0200 or [email protected]

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

 

How to monitor the activities of business rivals through a competitive intelligence program

Matthew P. Dugan, partner, Fay Sharpe LLP

Matthew P. Dugan, partner, Fay Sharpe LLP

Competitive intelligence aims to provide as much insight as possible into the trends of an industry and into the strengths, weaknesses and current activities of direct competitors. Such programs can be as simple as monitoring the intellectual property (IP) filings within the U.S. of a single competitor, or as sophisticated as gathering and analyzing IP information for many competitors in different countries throughout the world. Either way, there is business value in establishing and maintaining a competitive intelligence program to understand how competitors are behaving through their IP habits.

Smart Business spoke with Matthew P. Dugan, a partner at Fay Sharpe LLP, about competitive intelligence programs.

What is competitive intelligence?

The term refers to a program to develop and maintain a body of data and information that can be organized and analyzed to provide a better understanding of one or more aspects of a company’s business environment. The analysis can provide a broad, high-level view of an industry by identifying trends in a particular area of technology. It also can give a focused view of the activities of a particular competitor or group of competitors. Often, the strategy includes both.

What types of information are included?

Information described in patents and published patent applications often form the backbone of the program. While records from the U.S. Patent and Trademark Office are easily accessible and can provide valuable data for a competitive intelligence program, in some cases other sources may provide access to information on a shorter time frame. For example, companies with foreign competitors should consider searching for patent applications in the competitor’s home country, since patent filings are often made and published there before a corresponding U.S. application is available for review.

Is just the technical information of the patent documents evaluated?

No. Often, useful information can be ascertained from what patents and patent applications a competitor decides not to aggressively pursue. So, once a potentially relevant patent application is identified, the application’s progress can be monitored to try to determine whether the competitor is moving away from that technology. With such an assessment, it can be helpful to ask:

  • Has the competitor continued to pursue its initial patent applications for a new concept? Or, did the initial applications go abandoned without further activity?
  • Did the competitor file just a single application for this new concept? Or, did it file a whole family of applications that cover a variety of aspects and variations of the concept?
  • Did the competitor pursue patent protection in a very limited number of countries? Or, did it go to the expense of filing the application all over the world?

What other information can be included in a competitive intelligence program?

News and announcements, regulatory filings and even domain name registrations can add to the overall effectiveness of a program.

Useful insight can be gained from the trademark and service mark applications filed by a competitor. They are normally available within days or weeks of being filed, so a company can be alerted to the possibility of activity by a competitor much earlier than by monitoring patents alone.

Also, in cases of new products and product lines, trademark applications are often filed in the U.S. based on an intention to use the trademark or service mark with a particular list of goods or services. Such information can be useful in determining that a competitor is working toward offering an updated product or expanded product line.

Why should a company undertake this?

Insight gathered through a competitive intelligence program can help business leaders make more informed decisions about a company’s strategic direction and where to focus marketing and product development resources. It can help identify trends in the evolution of existing technologies, which can impact existing product lines; find developing technologies near core businesses, which could lead to new products and business opportunities; and identify new or emerging players in the industry, which can help in preparing for new competitive threats and eliminate surprises.

Matthew P. Dugan is a partner at Fay Sharpe LLP. Reach him at (216) 363-9167 or [email protected]

Insights Legal Affairs is brought to you by Fay Sharpe LLP.

How to ensure your company complies with anti-corruption laws

Luis M. Alcalde, of counsel, Kegler, Brown, Hill & Ritter

Luis M. Alcalde, of counsel, Kegler, Brown, Hill & Ritter

It’s tempting to do whatever it takes to generate more business, but global companies are increasingly at risk of getting caught if an employee violates the Foreign Corrupt Practices Act (FCPA).

“There has been a tremendous increase in the amount of enforcement from the Department of Justice (DOJ) and the Securities and Exchange Commission (SEC) in the past five years,” says Luis M. Alcalde, of counsel at Kegler, Brown, Hill & Ritter. “In addition to that greater emphasis, the Sarbanes-Oxley Act of 2002 and whistleblower legislation expanded the ability to bring illegal activities within companies to the forefront.”

The FCPA, passed in 1977, was prompted by widespread bribery of foreign officials by U.S. companies and is intended to level the playing field and let market forces dictate business contracts, Alcalde says.

“It really addresses two pillars of our capitalist system — free markets and transparency. When companies win contracts through corruption, it’s a distortion of the marketplace. The best services and best prices should win the battle,” he says.

Smart Business spoke with Alcalde about anti-corruption laws, and what companies should do to comply with laws and avoid the significant financial sanctions and legal fees that could result from violations.

How do you know what is and isn’t acceptable?

Most people can agree it constitutes bribery when a company pays $20,000 to a government official to make sure that it gets a contract. Where it gets difficult is when dealing with a culture where personal relationships are important and everyone’s wining and dining public officials. The FCPA does not have a de minimus rule, so the central issue becomes the intent behind the gift or entertainment.

What steps should companies take to stay out of trouble with the FCPA?

The most important step is to instill a genuine belief system throughout the organization, starting at the top with the board of directors, to pursue business in an ethical manner. It’s not enough to simply have a code of ethics, all employees must understand and accept that in some cultures and situations being ethical might result in some loss of business.

Secondly, develop a process of internal controls and due diligence that covers how business will be conducted and how financials will be recorded. This includes everything from purchasing supplies, advertising expenses, to hiring consultants, etc. Have a protocol that lays out the criteria and documentation that is expected — information about the vendor’s financials, time in business and ownership, as well as getting prices and at least two or three bids. Be able to monitor these transactions and conduct audits.

Finally, you have to do something to punish the wrongdoer when a violation or risk is detected. If you find out a top salesperson was paying bribes to public officials, you have to take action against the wrongdoer and possibly disclose the wrongdoing or face worse anti-bribery sanctions if caught.

Can you provide examples of the costs of FCPA-related settlements?

Siemens was one of the more famous, it had an $800 million settlement in 2008. In 2011, Alcatel-Lucent settled for $137.4 million with the DOJ and SEC. Wal-Mart is involved in a bribery investigation in Mexico and is reported to be paying an average of $600,000 a day in legal fees to deal with the issue.

After the government imposes criminal penalties, companies could also face civil penalties. It looks great when a company shows a 12 percent increase in profits in China, but not if it turns out that was based on bribes to government officials. Those officials are going to jail and the contracts are voided. Then shareholders are angry that the company lied and shares lose value, so the company will face shareholder lawsuits.

Companies must ensure legal compliance even if it means a short-term loss of business. The price of getting caught is too high. Operating ethically is always the best long-term strategy. Walking away from a deal that compromises the company is the only smart business.

Luis M. Alcalde is of counsel at Kegler, Brown, Hill & Ritter. Reach him at (614) 462-5480 or [email protected]

Alcalde is a global business attorney and team leader for the Cuba, Latin America and Caribbean area at Kegler Brown.

 

Insights Legal Affairs is brought to you by Kegler, Brown, Hill & Ritter

How you might have to return a payment to a company that files for bankruptcy

Stephen C. Goldblum, member, Semanoff Ormsby Greenberg & Torchia, LLC

Stephen C. Goldblum, member, Semanoff Ormsby Greenberg & Torchia, LLC

A “preference action” is a lawsuit by or on behalf of a debtor seeking to recover certain payments made by the debtor prior to filing for bankruptcy. Preference actions are unfamiliar to many business owners and often seem illogical and unfair.

“Clients often receive a letter demanding the return of a payment that the debtor made to them before filing for bankruptcy. They call and say, ‘What does this mean? Do I have to return this money? We sold them products and they paid us, are they entitled to get their money back?’” says Stephen C. Goldblum, member at Semanoff Ormsby Greenberg & Torchia, LLC. “The answer is yes, you may have to return the money — unless the payment falls within one of the statutory defenses.”

Smart Business spoke with Goldblum about how preferences work.

What should you know about preferences?

Typically, a preference action is often preceded by a ‘demand letter’ from the debtor demanding the return of payments made in the 90 days prior to the debtor filing for bankruptcy. This seems patently unfair to the recipient of the payment. The business provided products or services and was paid for them, and it seems unjust to have to return the money, often many months after the payment was received. The policy behind the bankruptcy code, however, takes a broader view. The policy is to prevent debtors from treating creditors unequally and paying preferred creditors before filing bankruptcy, and to prevent aggressive collection activities that could actually force a debtor into bankruptcy. Such policies have been determined to be of greater importance than the rights of an individual creditor.

There are four elements needed to prove a preferential payment; if the payment was:

  • For an antecedent (previously incurred) debt.
  • Made while the debtor was insolvent.
  • Made to a non-insider creditor in the 90 days prior to the bankruptcy filing.
  • Allows the creditor to receive more than it would have if the payment had not been made and the claim paid through the bankruptcy proceeding.

Where do many businesses make mistakes regarding preferences?

A business’ biggest mistake is to ignore a demand letter received by or on behalf of a debtor. Often the debtor is willing to settle the preference claim for a significantly reduced amount before a lawsuit is filed. A business that ignores a demand letter or fails to timely retain counsel familiar with bankruptcy law often misses its best opportunity for a favorable resolution.

Do you receive the repayment back?

Usually not. The preferential payments recovered by the debtor are added to the bankruptcy estate. To the extent there are funds available, secured, priority and certain other creditors are paid first. To the extent there are funds remaining, they are distributed to the unsecured creditors, which often results in little or no payment.

What are the defenses when a payment is alleged to be preferential?

The three primary defenses to an alleged preferential payment are the following:

  • New value defense, which provides an offset against the preferential payment if the creditor subsequently gives new value to the debtor after the alleged preferential transfer.
  • Ordinary course of business defense, which protects transfers consistent with the debtor and creditor’s prior business history.
  • Contemporaneous exchange defense, which includes certain concurrent transactions such as a cash-on-delivery.

How are insider creditors treated differently?

With insiders — corporate officers or directors, relatives and related entities — a debtor may recover payments for up to 12 months prior to the bankruptcy.

How can you protect your company? 

It’s difficult for a company to pre-emptively protect itself from a payment later being deemed preferential. When you receive a letter demanding return of an alleged preferential payment, contact an attorney experienced with creditors’ rights. He or she will analyze the potential defenses and prepare a response to the letter. Often, a timely, well-reasoned response to a demand for the return of a preferential payment leads to a prompt and cost-effective resolution.

Stephen C. Goldblum is a member at Semanoff Ormsby Greenberg & Torchia, LLC. Reach him at (215) 887-5961 or [email protected]

 

Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC

How a trade secret can be better than a patent, and when it can’t

Daniel R. Ling, associate, Fay Sharpe LLP

Daniel R. Ling, associate, Fay Sharpe LLP

Companies have information that gives each of them a competitive advantage over competitors. Patenting this information is sometimes legally impossible or disadvantageous — patents expire, leaving vitally important information publically exposed.

Some companies choose to treat the information as a trade secret because such a designation can offer legal leverage in certain situations. And unlike a patent, a trade secret can last forever.

A patent expires 20 years from its effective date of filing, and that previously protected invention enters the public domain. With a patent, you’re disclosing how to make and practice an invention in exchange for 20 years of exclusive rights to do so,” says Daniel R. Ling, an associate with Fay Sharpe LLP.

He says many companies, especially smaller ones, don’t often consider the role of trade secrets, but in certain instances companies could be well served by recognizing and protecting such valuable information. But there’s one catch: “You have to take reasonable steps to maintain it as a secret.”

Smart Business spoke with Ling about identifying and protecting trade secrets.

What are some examples of information that could be a trade secret?

Customer and supplier lists, the arrangement of equipment in a factory and certain manufacturing processes are examples of valuable proprietary information that may not rise to the level of something that can be patented. Often, it comes down to that which makes your product better than that of your competitors but can’t be patented because it doesn’t meet the basic legal standards, which are that the invention is new, not obvious, useful and eligible to be patented.

How long does trade secret protection last?

Trade secrets last indefinitely, as long as the information is maintained confidential and the holder of the trade secret continues to take reasonable precautions against disclosure.

How are trade secrets best protected?

There are many methods of protecting sensitive information. If it’s a process that involves multiple steps, a company could isolate the responsibility for each of those steps across multiple locations so the entire process isn’t carried out in one place and a single person isn’t privy to the entire production.

It’s also fairly common to include confidentiality agreements and nondisclosure clauses in employment contracts for not only employees who might be aware of a trade secret in its entirety, but also for employees who may have only some knowledge of the process. Companies with such sensitive information should work with a business attorney to put together those agreements.

What can be done if a trade secret is leaked?

If the trade secret was misappropriated — obtained illegally or otherwise improperly disclosed — there are steps that can be taken to prosecute the perpetrator. The Uniform Trade Secrets Act, the general framework of which has been enacted by 46 U.S. states, offers remedies when a trade secret is acquired through improper means or through a breach of confidence. This can provide some relief to a trade secret holder in the form of injunctive relief (e.g., stopping the use of a misappropriated trade secret), monetary damages and/or attorney’s fees.

However, if the information is developed independently or introduced to the public lawfully, nothing can be done. Further, if the secret that was being held is a patentable idea, another company or individual could secure the rights to it and bar others from acting on it. That’s why it’s important to carefully consider what you hold as a trade secret; if it can be easily reverse engineered it’s not right for trade secret protection.

Regardless of whether the secret got out legally or illegally, once it’s widely disclosed the remedies under the law might not be sufficient to make a company whole again — once it’s out, it’s out. The trade secret holder ultimately has an obligation to take reasonable protective measures to guard its secrets.

Daniel R. Ling is an associate at Fay Sharpe LLP. Reach him at (216) 363-9000 or [email protected]

Insights Legal Affairs is brought to you by Fay Sharpe LLP.

Keeping your company’s secret information secret is a matter of increased focus on protecting company intellectual property

In the last three decades, international trade has increased by a factor of seven — but unfortunately, this advance has also ratcheted up the rate of trade secret theft, an impediment that costs corporations hundreds of billions of dollars a year.

That rate of growth has catapulted multinational commerce to such prominence that it now accounts for a third of all economic activity worldwide.

principal, Zavitsanos, Anaipakos, Alavi & Mensing

principal, Zavitsanos, Anaipakos, Alavi & Mensing

“The world is getting to be a smaller place at a remarkably fast pace,” says Joseph Ahmad, a principal in the Houston law firm Ahmad, Zavitsanos, Anaipakos, Alavi & Mensing. “When we were kids, there might have been a handful of companies that did a particular thing and probably most or all of those companies were in America.

“Nowadays, we’re seeing competition come from everywhere,” says Ahmad, who primarily represents business executives in trade secret cases and employment-related litigation. “The barriers to entry are rapidly declining, so now a lot of companies are facing competition from all over the world.”

Other factors driving the increased incidence of trade secret theft include large pockets of economic stagnation around the globe and the widespread conversion of analog business information to digital formats, which lends itself more readily to leaks and cyber attacks.

Pamela Passman, president and CEO, Center for Responsible Enterprise & Trade

Pamela Passman, president and CEO, Center for Responsible Enterprise & Trade

“In the last few years, there are a couple of key reasons why trade secret theft has grown,” says Pamela Passman, president and CEO of the Center for Responsible Enterprise & Trade, a nonprofit group whose mission is helping companies reduce counterfeiting, piracy and trade secret theft.

“One reason is the economic times we’re going through. People feel constrained, and they’re working under great financial pressure, so many people are cutting corners. Also, a great deal of companies’ information is becoming digitized and, therefore, more easily transferable.

“So instead of walking out of a place with stacks and stacks of papers, a person can walk out with a USB drive that has a huge amount of information on it.”

Increased cyber leaks and cyber attacks are also contributing to the problem, Passman says.

“There are some fairly aggressive third parties that have stepped up their activity in that area,” she says.

Ahmad agrees but points out that the lion’s share of trade secret misappropriation he encounters is a consequence of actions taken by a company’s employees or ex-employees.

“Of course, we do hear from time to time about individuals or organizations — especially overseas — who hack in to companies’ systems,” Ahmad says. “But, in my experience, that’s not a common occurrence. Most of the trade secret theft I see occurs via a current or former employee.”

That is why, Passman says, it’s essential to be straightforward with employees about your company’s policies regarding confidentiality, particularly as it pertains to trade secrets and other types of intellectual property.

“You have to be very clear with your own employees about your policies and about how serious you are about protecting your intellectual property,” Passman says. “Because that’s definitely where your greatest risk lies. And this is a critical issue both while those employees are at the company and after they leave the company.”

The labor market factor

Unemployment and sluggish job markets are also key factors contributing to the increased risk surrounding trade secret theft.

“Unfortunately, in this type of market, job seekers sometimes resort to extreme measures to gain the kind of edge they feel they need to get a job,” Ahmad says. “I’ve seen many new hires — whether consciously or subconsciously — come into a job with the belief that their value is increased if they can, as some of them would put it, ‘hit the ground running’ when they get on the job.

“In other words, they feel that with the help of their previous employer’s trade secret information, they can do a better job for their new employer. Sometimes this happens with the complicity of the new employer, but sometimes employees do it on their own, because they feel it makes them more marketable.”

What, then, are some practical strategies CEOs and their teams can employ to insulate their companies against the risk of having their trade secrets stolen? One of the important early steps executives can take is to enlist the help of a broad cross section of people in their organization to tackle the issue.

“First off, what I suggest is establishing a cross-group team of people to focus on protecting the company’s intellectual property,” Passman says. “This team should include somebody senior in the legal department, somebody senior in R&D, somebody from business development, somebody on the operations side, for example if they have a manufacturing division, and somebody responsible for procurement and the supply chain. It’s important to bring all these disciplines together and instruct them to establish some policies in this area, including trade secret policy.”

Another step that should be taken by companies that have significant intellectual property to protect is requiring employees to read and sign confidentiality agreements.

“The confidentiality agreement is first and foremost,” Ahmad says. “You have to make sure that every employee understands the significance of holding your company’s information confidential. All employees must be required to agree in writing they will do so.”

There are a number of items and types of information that companies can put into their employee confidentiality agreements to help protect their intellectual property.

One approach is to list or enumerate the company trade secrets and other types of information that are required to be held confidential. Another tactic is to include language stipulating that inventions and similar types of newly created information automatically become the confidential property of the employer.

“This helps the company in several ways,” Ahmad says. “First, you get to define what your trade secrets are and what information is expected to be held confidential and you get to formally notify the employee about it. This also enables you to make sure that whatever new intellectual property your employees develop will be the property of the company, and they will agree to hold that information confidential.”

Vetting third parties

Another area where companies seeking to protect their intellectual property need to be vigilant is conducting due diligence on third parties, such as suppliers and customers, as well as companies they may be seeking to acquire or merge with.

“For any key third parties that you’re going to be sharing your intellectual property with, it’s essential to conduct due diligence on them,” Passman says.

Due diligence encompasses activities such as research, interviews and online searches. A key part of the process is being alert to “red flags” — potential problem areas signaling that the third party may not be effective at helping co-protect the company’s sensitive information.

“Basically, you want to see if [the third party] has any red flags you need to be aware of,” Passman says. “For example, if they’ve been involved in different kinds of litigation, especially litigation involving intellectual property or trade secrets. And you’d want to explore and make sure you understand how they go about managing and protecting the intellectual property of the third parties that they in turn do business with as well.”

Regarding the employee confidentiality agreement, Ahmad says it’s unwise and potentially dangerous for a company to regard this process as a one-and-done deal. In other words, it’s insufficient to simply have employees read and sign the agreement and then file it away. Companies need to remind employees periodically about their confidentiality agreements and about the importance of keeping the company’s sensitive information private.

“Companies sometimes leave themselves vulnerable to trade secret theft loss if they approach these confidentiality agreements like a checklist,” Ahmad says. “By that I mean they can’t just have the employee read and sign the agreement, and then they knock it off their checklist and forget about it. The problem with doing this is you can be sure the employee will forget about it too.

“Many times, an employee will enter into a confidentiality agreement, and then they’ll work for the company for 10 or 20 years, and they’ll forget they even have the agreement. As a result, they don’t really respect the company’s trade secrets the way they should.”

Thus, it’s important to periodically remind employees about their confidentiality agreement — and even more important to underline that agreement’s significance when the person’s employment with the company ends.

“That’s probably the most critical aspect — how the matter is handled at the end of the employment relationship,” Ahmad says. “I’m often shocked at how many employees I see who have signed confidentiality agreements, and at the end of their employment, whether they resign or are terminated, they’re not even reminded that they have these agreements. Many of them don’t even know they have them.”

Business executives would be wise to take advantage of the employee exit interview because it represents their company’s last chance to underscore the imperative of keeping its trade secrets just that: secret.

“At the exit interview, employees must be required to sign and confirm that they understand their responsibilities in regard to keeping the company’s information confidential,” Ahmad says. “By doing that, you’re drilling in to the employee as they’re leaving the company — and presumably going to work for someone else, who just may be one of your competitors — that, ‘Hey, listen, this is serious. We take this matter very seriously.’”

How to reach: Ahmad, Zavitsanos, Anaipakos, Alavi & Mensing, www.azalaw.com; The Center for Responsible Enterprise & Trade, www.create.org

What to be aware of when agreeing to serve on a corporate board of directors

Tim Miller, Partner, Novack and Macey LLP

Business leaders are usually pleased if they are asked to serve on a business’s board of directors.

They should be. Being asked to serve on a board of directors is a recognition that a business leader has achieved success and that he or she has valuable insights into how a business can be profitable. Nonetheless, business leaders should recognize that serving on a corporation’s board carries with it very real responsibilities and risks, says Tim Miller,  a partner at Novack and Macey LLP.

“If a board member fails to take the responsibilities of board membership seriously, and instead treats board memberships as an ‘honor’ without responsibilities, or as a chance to periodically play a round of golf with colleagues, it can lead to serious repercussions,” says Miller.

Smart Business spoke with Miller about how to protect yourself should you agree to serve on a board.

What are some potential repercussions of failing to take seriously the responsibilities of being a board member?

A director could be sued for millions of dollars in damages. There are actions filed every day in this country in which stockholders allege that a director breached his or her duties and that this breach cost a company millions of dollars.

Ironically, such suits are filed even when a company is successful; sometimes these suits allege that the company should have been more successful. Even if such a case is meritless, it can cost a lot of time and money in attorneys’ fees to defeat it. In other cases, governmental entities can seek civil or criminal penalties against directors.

Don’t most corporations indemnify board members against losses from such suits?

Yes, most companies agree to indemnify board members against loss suffered by reason of serving as a board member. But if a board member is found to have not acted in good faith, he or she may lose the right to indemnification. And if a corporation becomes insolvent, its promise to indemnify its directors is not worth very much.

Even if a corporation is insolvent, doesn’t insurance protect board members?

Insurance may protect a corporate director. But insurance policies are usually written with exclusions that may leave a director uninsured against particular types of suits.

For example, many policies have an ‘insured v. insured’ exception.  If the stock of an insolvent corporation is sold, new management may decide to sue the directors who controlled the company when it became insolvent. In such a situation, the suit may not be insured. Moreover, penalties are usually not insured against.

All of this means that somebody who agrees to serve as a corporate director should try to do the job he or she has agreed to accept.

What duties does a board member have?

A director’s duties differ depending on the state where a business is incorporated, but usually directors are said to owe duties of care and loyalty.

What is the duty of care?

Just as it sounds, the duty of care requires directors to carefully act on behalf of the corporation. As the standard is usually formulated, the duty of care requires that the directors exercise the same degree of care that a prudent person would exercise in the management of his or her own business.

Among other things, this means that directors should attend board meetings, inform themselves of facts necessary to make decisions, exercise their judgment and make prudent decisions.

One of the more important aspects of the duty of care is that a director should make certain that he or she has adequate information to decide matters that come before the board. For example, if asked to approve of a corporation going into a new business, the director should make sure that he or she understands enough to make an informed decision about whether it is wise for the corporation to take such a significant step.

Frequently, rosy forecasts of future profits can distract from the need to be fully informed of risks before making a decision. A director may need to question management, test the assumptions underlying projections, consider what will happen if something goes wrong and ask how risks can be mitigated to make a reasoned decision.

In other words, a director should act as though the consequences of a decision is his or her responsibility — because it is.

What does the duty of loyalty involve?

The duty of loyalty requires that directors act in the best interests of the corporation — not their own best interests. Thus, for example, if a director learns of a business opportunity, he or she may need to refer it to the corporation and not exploit it for the director’s own benefit.

The duty of loyalty also means that, in situations in which matters are brought before the board and a director has a conflict of interest, he or she should recuse him or herself from the decision. For example, if the corporation is going to retain another business in which a director is interested, the director should disclose the conflict and should not vote on that matter. Indeed, the director should attempt to cause the minutes to reflect that he or she has not participated in a decision that could benefit him or her.

Does all of this mean that somebody should turn down a directorship if offered?

No. It means that those offered a directorship should think very carefully about what being a director means and should not accept the role unless they are willing to take it very seriously.

Tim Miller is a partner at Novack and Macey LLP. Reach him at (312) 419-6900 or [email protected]

Insights Legal Affairs is brought to you by Novack and Macey LLP

Establishing confidentiality protocol in an internal investigation

Andrea Gonzalez, Senior Manager, Cendrowski Corporate Advisors LLC

On July 30, 2012, the National Labor Relations Board (“NLRB”) reached a decision ruling that Banner Health Systems non-union employer’s system of advising its employees to refrain from discussing ongoing internal investigation matters with fellow co-workers violated Section (a)(1) of the National Labor Relations Act. Prior to the Banner Health System decision, businesses had a certain level of discretion in implementing confidentiality requests. However, the freedom to make such requests may no longer be exclusively in the hands of management and may even no longer be permitted without special justification. Companies should take notice.

Courts and administrative agencies are cracking down on blanket employer requests for silence without adequate justification during investigations and the NLRB confirmed this standard in Banner Health System d/b/a Banner Estrella Medical Center, 358 NLRB No. 93 (2012) (“Banner”). The Banner decision came after a technician working for a hospital voiced concern to the hospital’s human resources consultant about certain practices he did not feel comfortable following and believed could cause a patient to become sick. After complaining to human resources, he was instructed to not discuss the matter with any of his co-workers while the hospital conducted its investigation. The same human resources consultant would routinely make identical confidentiality requests to other employees who made complaints that were subject to an investigation.

Given the recent Banner decision, corporate response plans must be sensitive to the level of confidentiality involved in internal investigation matters and specify the proper protocol for disclosing information within an organization.

Smart Business spoke with Andrea Gonzalez, senior manager at Cendrowski Corporate Advisors LLC, about the Banner decision and the potential trickle-down effect it could have on business confidentiality processes during investigations.

What should an organization learn from this decision regarding confidentiality issues in internal investigation matters?

Companies will need to have established protocol ready in the event an internal investigation is launched and the protocol will need to address the issue of confidentiality. There may be a valid justification for confidentiality between co-workers in an internal investigation. However, in order to withstand a challenge, such as the one in Banner, companies will need to be able to readily articulate these justifications. Blanket requests are likely to fail, but well-planned and established processes will not only survive any challenges but continue to allow for effective internal investigations consistent with management’s plan. Each corporate response plan needs to take confidentiality issues into account, be planned in advance and be individualized to the present issues so that it is not found to be overly broad or too burdensome.

How can an organization justify a confidentiality request and likely succeed if challenged?

In Banner, the NLRB discussed the appropriate criteria for determining whether an organization has met the burden of justifying its approach. Despite the hospital’s argument that the confidentiality was necessary for protecting the investigation, the Court stated the hospital needed to show (1) it was necessary for the protection of the witnesses; (2) evidence could potentially be destroyed; (3) testimony could be fabricated; or (4) there was a need to prevent a cover-up. The hospital was unable to do so.

Management should keep these factors in mind during the planning phase of their response plans and protocol should reflect this idea. Retroactive planning after an internal investigation has been launched should also be avoided.

In the event of a challenge to the confidentiality request, what is the best course of action?

One of the most important aspects of combating a challenge to a confidentiality request is an organization’s effort to document its basis for each confidentiality request. An individual file should be maintained with detailed and updated information regarding the investigation. A company should also consider engaging counsel to maintain privilege and identify additional information needed to support or contradict its position. A company may never have perfect information, but a well-maintained file is instrumental in its analysis of a challenge and the manner in which it should proceed.

How can an organization ensure their plan for confidentiality requests is implemented properly?

An organization should monitor guidelines or protocols in place and ensure any blanket policies have been removed. From the moment an investigation begins, the organization should continue to revisit their confidentiality requests and evaluate the facts of the current investigation. A check list of all questions and open items should be kept and findings should be reviewed for accuracy and completeness. The communications protocol to personnel involved in the investigation should also be presented to all parties in a clear and concise manner.

How can an organization gain confidence in established confidentially request guidelines and policies?

Organizations can engage a third party to perform a detailed independent review of an ongoing investigation to evaluate whether the established policies and procedures are being adhered to by individuals conducting the investigation. The third party can also assess whether the confidentiality requests would withstand a challenge under Banner.

The feedback provided by the third party would enable the organization to adjust their guidelines and policies to help ensure future confidentiality requests succeed if challenged.

 

Andrea Gonzalez is a senior manager at Cendrowski Corporate Advisors LLC. Reach her at (866) 717-1607 or [email protected]

Insights Accounting is brought to you by Cendrowski Corporate Advisors LLC

How to cope with a partner or client who has problems with decision making

Suzanne Fanning, Attorney, Garan Lucow Miller PC

As the country’s population ages, a growing number of people will, unfortunately, suffer from diminished capacity, which can arise from conditions such as Alzheimer’s disease and dementia. “This is occurring more as businessmen and women work into their later years, and they become more susceptible to these conditions that affect their ability to make business decisions,” says Suzanne Fanning, an attorney with Garan Lucow Miller PC and co-chair of the Washtenaw County Bar Association Probate Section.

If someone with diminished capacity to make decisions enters into a transaction, that decision may be later subject to challenge in court.

“If it is established that the person did not have the requisite legal capacity to enter into the contract, the court may set the contract aside, to the detriment of the other party that entered into the contract,” she says.

Smart Business spoke with Fanning about how to take the legal precautions necessary to protect your business when concerns arise about another party’s possible diminished capacity.

What is diminished capacity, and who does it affect?

Diminished capacity is essentially an impairment of daily cognitive functioning, which can impact memory, reasoning, language and insights, all of which are skills critical to good business decision making. While the majority of businesspeople will not suffer from diminished capacity, as the population ages, there is a greater likelihood that it will become an issue.

Diminished capacity can also impact younger businesspeople who have been injured or who suffer from serious illness. This could be temporary, such as when medical treatments impair mental capacity, or permanent, such as when a person is in a serious accident.

What are the signs of diminished capacity?

There are no standard set of criteria, but there are red flags to consider if you are engaged in business transactions with someone who appears to have diminished capacity. These can include memory loss or forgetfulness, problems with the ability to communicate, loss of mental acuity, calculation problems, diminished comprehension, disorientation, inflexibility during negotiations, susceptibility to manipulation or even fraud by third parties.

Are there different standards of capacity for different business transactions?

Yes. Legal capacity has different legal definitions depending on the transaction and the applicable case law and statutes in the state in which you are operating. In Michigan, for example, the legal standard for the capacity to contract is whether the person in question possesses sufficient mental capacity to reasonably understand the nature and effect of the contract.

The more complicated the contract, the higher the level of understanding that is necessary to have the legal capacity to make that contract.  In a real estate transaction, such as signing a deed, the standard is whether a person has sufficient mental capacity to understand the business in which he or she is engaged, to know and understand the extent of the value of the property and how to dispose of it.

It is important that businesspeople be aware that a transaction can be set aside by a court if the other party is later found to have lacked the requisite legal capacity at the time the transaction was undertaken. Therefore, it is important to take appropriate steps to protect yourself and your business when concerns arise that the other party may lack the legal capacity to enter into a transaction.

How can you protect your business in the event that your business partner is showing signs of diminished capacity?

One way to address this concern is to create a durable power of attorney, in which you and your partner name each other as the agent to transact business in the event the other suffers from a diminished capacity. You can also name a trusted employee or adviser to this position.

Having a durable power of attorney will also prevent a spouse or family member of the incapacitated person from gaining the authority to transact business matters on that person’s behalf. This is especially important when those family members have little or no experience in business.

What can be done if a client or third party to a transaction appears to have diminished capacity?

One option is to ask for a capacity evaluation by a doctor to ensure that the person has the capacity to enter into that particular transaction. Of course, this topic must be approached with great care. Another option is to make the transaction contingent on a court guardianship or conservatorship in which the court will grant authority to a third party to act on the person’s behalf.

For example, while a person with diminished capacity might not be capable of signing a deed necessary to a business deal, his or her court-appointed guardian or conservator could be granted authority to sign the deed on behalf of that person and proceed with the transaction.

Clearly, such a scenario can be extremely difficult. It may be a client with whom you have worked over many years. It can be difficult to extricate yourself from the relationship, but it may be necessary to protect yourself legally because these transactions can be set aside. It may be a matter of approaching the client’s partner or spouse, explaining that you are having concerns and bringing in a third party to make sure the transaction is protected.

 

Suzanne Fanning is an attorney with Garan Lucow Miller PC and concentrates her practice in probate and trust litigation and planning.  She is co-chair of the Washtenaw County Bar Association Probate Section. Reach her at (734) 930-5600 or [email protected]

Insights Legal Affairs is brought to you by Garan Lucow Miller PC