ihwlaw

Law Blog – Business Law & Litigation

Monthly Archives: May 2015

Which gTLD .sucks — protecting your business brand

Since ICANN – the organization that allocates domain names — approved an initiative in 2011 to add thousands of new “generic” Top-Level Domains (gTLD), over 635 new gTLDs have been registered.  Many of these are creative efforts to expand topical diversity on the internet, but few have received as much notoriety as .sucks.

A gTLD is the portion of an internet address to the right of the dot, such as .com, .net or .org.  Under ICANN’s plan, third parties may register and administer new gTLD’s, such as .bank for banking, .law for the legal industry, and .golf for golfing, leaving it within the purview of the gTLD registrar to enable creation of domain names using the gTLD.  A partial list of some of the more recently approved gTLD’s can be found here.

The delegated registrar of .sucks, Momentus Inc., is charging $2,499 for pre-public registration of .sucks strings, which first requires a trademark to be registered with the Trademark Clearinghouse.  Beginning June 1, 2015, registrations of .sucks domain names are generally available to the public — at lower pricing — with an open registration process so that anyone can register a new .sucks domain without restriction.  (There are restrictions for registration of some gTLD’s but none for .sucks after May 31.) This enables trolls and trashers to gobble up .sucks strings bearing company names and brands alike.

The .sucks gTLD promises to ruffle the feathers of many a brand owner because trademark law, which protects the use of marks in domain names, may not apply to .sucks strings because one purpose of this gTLD is to enable public comment regarding brands.  Under existing law including the Lanham Act and its anti-cybersquatting provisions, courts have traditionally protected trademark owners from parties that register a domain utilizing a mark in a manner that is confusingly similar to, or dilutive of, the mark or which evinces a bad faith intent to profit from a mark the registrant does not own.  But registrants of .sucks URLs may be able to muster arguments that countervail these protections based on First Amendment law and the view that the .sucks string on its face is intended for brand criticism and thus ipso facto cannot cause confusion or be used in bad faith.  One need only consider the success of consumer darling Yelp in defending against manifold attacks on its platform to infer how .sucks registrants may be able to utilize the law in their favor to stop businesses from attacking web forums that are exclusively dedicated to trashing business brands.

Though many consider the purveying of .sucks domains to be little more than legalized extortion, businesses that value their names, brands and trademarks would do well to consider registering .sucks domains to prevent opportunists from trading-off valuable brand names to their detriment.  And some may even consider turning lemons into lemonade by using a .sucks domain to assist in their own customer relations program.

To learn more about the author of this article, visit www.ihwlaw.com.

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Selling stock for a promissory note may be unlawful

Did you know that selling stock in exchange for an unsecured promissory note may be unlawful, void or voidable?  In an area like Silicon Valley where stock may be worth a fortune from the second a company is born, companies might think to be creative in order to sell stock to a party that’s unable or unwilling to pay large sums for it immediately. One might think that a safe course is to sell the stock for a promissory note to pay for the stock later, such as when it’s worth more than the sum of the note.

However, a somewhat obscure law in California, which is echoed in other states, makes it unlawful for a corporation to sell or issue stock in exchange for a promissory note (a debt) that is not secured by property other than the stock itself.  Section 409 of the California Corporations Code makes it unlawful for a California corporation to sell or issue stock for a promissory note that is not “adequately secured by collateral other than the shares acquired.”  Thus, a company cannot sell or issue stock for a promissory note, even if the note is secured by the stock itself.  So what consideration in a sale of stock is valid?  The answer is money, services already rendered, valuable property received or a promissory note that is secured by property other than the stock itself.

Delaware corporations, which are not subject to this provision of California law, are nevertheless subject to a similar statute under Delaware law.  Section 152 of Delaware’s General Corporation Law provides that “[t]he board of directors [of a corporation] may authorize capital stock to be issued for consideration consisting of cash, any tangible or intangible property or any benefit to the corporation, or any combination thereof.”  While this statute is less clear on the issue than the California law, Delaware case law arguably supports a construction of the Delaware statute the same as the California law, and Section 152 itself implies the corporation must receive some actual benefit in exchange for the issuance of stock.  Interestingly enough, the Delaware Constitution (Article IX, Section 3) used to expressly prohibit the issuance of stock “except for money paid, labor done or personal property, or real estate or leases thereof actually acquired by such corporation.”  However, this provision was repealed in 2004, leaving the issue somewhat more ambiguous under current Delaware law.  One would have to check the legislative history to understand why that section was repealed, but in any case the statutory provision remains, along with at least one case which cites both as a basis to consider the stock sale invalid.  See Prizm Group, Inc. v. Anderson, 2010 Del. Ch. LEXIS 105, 2010 WL 1850792 (Del. Ch. May 10, 2010).

The legal implications of these statutes are potentially not good for anyone involved in the leveraged sale of stock – neither the company, its management nor the putative purchaser.  Taking the last case first, the sale to the buyer is likely void or voidable as against the buyer, which means the corporation may rescind (cancel) the sale of stock arguably at any time the issue is raised, at least until proper consideration is received by the corporation, such as all money due on the debt that is at issue.  (Note that the sale is probably not voidable by the buyer as against the corporation, and the note is almost certainly enforceable by the corporation against the debtor, the above notwithstanding.)  As respects the company, an invalid sale of stock might expose the company to liability from other shareholders who might argue that their equity in the corporation has been unfairly diluted by a sale of stock without real value received in return.  And officers or directors who approved the sale might also be exposed to action by the corporation and/or by other shareholders on a similar theory of liability, as might arise in the context of a shareholder derivative action (a lawsuit brought by one or more shareholders in the name of the corporation against officers and/or directors for mismanagement that harmed the corporation or its shareholders).

Turning to limited liability companies, it is much less clear and, at least for now, doubtful that the limitation on consideration for the sale of equity applies to LLC’s. The statutes cited do not apply to LLC’s – they are quite specific to corporations only. With that said, in principle, one could make the same policy argument in the context of LLC’s – that the sale of equity in exchange for an unsecured note does not provide actual value to the company and thus frustrates existing equity holders and creditors.  However, the statutory and case law for LLC’s on this is thus far non-existent based on research done to date, so currently there is no known legal basis to support this policy rationale as applied to LLC’s, or other types of business associations for that matter.

However, corporations, their managers and purchasers would be wise to heed the law in California, Delaware and other states that generally bar an unsecured debt obligation as consideration for the sale of stock.  Transactions violating these laws will be void or voidable, and the participants in such stock sales may be subjecting themselves to inadvisable risks and liabilities.  So, as the saying goes, buyer beware.

To learn more about the author of this article, visit www.ihwlaw.com.

Are you protecting your trade secrets?

When patent, copyright and trademark law is not available or not desired to protect your intellectual property and other business information, trade secret law may be all that remains between your valuable intangibles and those who would use them with impunity.  Most states, including California, have adopted the Uniform Trade Secrets Act which generally defines a trade secret to include any information that (1) derives independent economic value from not being generally known to the public and (2) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.  Most businesses know what information has independent economic value and is proprietary to their business, but some may not be undertaking adequate steps to maintain the secrecy of that information in order to preserve trade secret status.

Trade secrets come in many different forms, so no list will be exhaustive.  More common trade secrets may include a business’s confidential information, know-how, technology, software, hardware designs, schematics, formulae, algorithms, data, processes, methods, strategies, business plans, investment plans, business relationships, marketing plans, key contacts, financial and sales information, customer and supplier information, and related materials that have been developed and used in connection with a business.  Whether information has been the subject of reasonable efforts to maintain its secrecy is fact specific and thus depends to some extent on the nature of the business and trade secret at issue.  However, the extensive case law that has developed regarding trade secret definition and preservation reveals that the following types of protections will likely assist in preserving trade secret status:

  • Nondisclosure agreements with employees, contractors, vendors, and customers that restrict disclosure through the life of the trade secrets and which reasonably identify the types of information that are confidential without being over-inclusive to include information that can be found in the public domain
  • Restricted accessibility and disclosure of trade secrets on a need-to-know basis
  • Restrict physical access within a business premises and monitor entry and egress
  • Dynamic password protection for computers and computer networks
  • Implement role-based and rule-based access to areas where trade secrets reside
  • Utilize state of the art security software (e.g., firewalls, FTP’s, intrusion detection)
  • Marking materials as confidential in all formats including within code and designs
  • Notifying parties before meeting that confidential information will be presented
  • Training, instructions and regular reminders to all company personnel
  • Inventorying trade secrets and knowing how trade secrets conform to the law

Since the determination of whether protection is reasonable depends on the circumstances of each case, the nature and extent of protection required will depend on a variety of factors including the type and size of the business, the number of personnel and third parties involved, and the nature of the market and competition in which the business operates.  For example, larger businesses with many personnel and attrition in a competitive industry should be more vigorous about protection than smaller businesses with low turnover in a less competitive industry.  There is no bright line standard.  What is reasonable may also depend on the extent of a business’s resources.  The greater a business’s resources, the more it may be expected to expend to protect its trade secrets.  Finally, in determining which protections to implement, consider the importance of each trade secret, the relative risk of loss of each trade secret, and how each type of protection will help protect the trade secret.

Trade secrets are often the most valuable information that can be found in a business.  They can be so valuable that a business may elect not to seek registerable protection (e.g., patent or copyright) even where it may be available.  Given the importance of trade secrets to a business’s success, it is critical that every business know what its trade secrets are and institute proper measures to preserve and protect their value.

To learn more about the author of this article, visit www.ihwlaw.com.