Board of Directors May Mortgage or Sell All of the Corporation’s Assets

As you may know from one of my past blog posts, a corporation owns its own assets and the shareholders do not necessarily own those assets (they own shares in the corporation).

But what you may not know is that the corporation’s board of directors has broad powers to mortgage or sell the corporation’s assets.

The board doesn’t even need to get the shareholders to approve the mortgage or sale, under California law.

Let’s say that the corporation has a piece of real property that has equity and the corporation is in need of some money.  The board then seeks out a loan for the corporation that will be secured by the property

The lender agrees to loan the money to the corporation but requires that the real estate be put up as collateral with a mortgage on the property.

In other words, the lender wants security for the loan in the event there is a default.  If there is a default, the lender can foreclose on the property.

This means that the mortgage on the property puts the corporation’s property at risk.  Yet, the board of directors can authorize the mortgage even if such mortgage applies to all of the corporation’s property holdings.

Only if the corporation’s articles of incorporation require the shareholders’ approval would their approval be necessary.

Suppose, however, that instead of taking out a loan, the board decides to sell the corporation’s real property.

This situation is a little different from the loan-with-mortgage scenario.

Under California law, if the proposed sale is in the “usual and regular course” of the corporation’s business, the board alone can approve the sale.  Even if it is a sale of all of the corporation’s property or assets.

So if the sale of the corporation’s assets is part of the corporation’s regular business operations, the board does not need to get the shareholders to approve the transaction.

On the other hand, if the sale of assets is not in the “usual and regular course” of the corporation’s business, the shareholders must also approve the transaction.

If the shareholders approve the sale before or after the sale is consummated, that is fine. But it is better practice for all approvals, of the board and shareholders, to be obtained prior to offering for sale any of of the corporation’s assets outside the regular course of business.

In the event any sale transaction craters or otherwise becomes ill-advised, the board has the power to abandon the transaction without the shareholders’ approval.

The board can end the transaction even after the shareholders approved the sale.

If the board takes such action, the board must be careful to not cause a breach of contract with the buyer when terminating any sale.  The board’s right to abandon a sale transaction does not protect the corporation from liability owed to the buyer for breach of contract.

As you can see, the board of directors has broad powers regarding the disposition of the corporation’s assets.  For this reason, members of the board must be carefully selected.

Also, board members must be careful to not run afoul of their fiduciary duties owed to the corporation and shareholders.  Because even though board members are protected from liability if they exercise reasonable business judgment and discretion, they can be held liable if they acted in bad faith.

References: California Corporations Code sections 1000 and 1001.

This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction.

This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation.  If you need legal advice, consult a qualified attorney.

For more information please visit my website at www.palacioslawoffice.com.

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Selling a Stake in Your Business to Investors May Require a Securities Registration

A great way to raise money for your growing business is by selling a small interest to a family member or friend.

After all, they know you better than anyone and trust that you will give them a fair deal.

And even better, when you are the only owner of the business you don’t need to get the approval of any co-owners before selling an investment in your business.

Or maybe you and a coworker decide to make the break from your jobs to start a business together.  You form a corporation where it is just you and your co-founder as the only shareholders.

Can you just take the money from your friends or family?  Can you and your coworker invest freely in your new corporation?  It depends.

Your business is not (yet) Amazon or Berkshire Hathaway or any other kind of publicly traded company.

But under any of these circumstances you or your company may be caught selling “securities” that might need to be registered under federal law or qualified under California law.  Other states may also have their own requirements to satisfy before even offering for sale any securities.

This means that you may need to comply with federal or state securities laws even if it is just you and your work buddy starting a business together.

Or even if you are selling a small portion of your business to your wealthy aunt, you may still be subject to the securities laws.

More red tape on your way to starting or growing your business.

Fortunately, there is a way to cut through some of that red tape – legally.

California law requires that any “securities” offered or sold by the “issuer” must be “qualified.”

“Securities” basically means any investment resulting in an ownership interest by the buyer (e.g. stock).

The “issuer” is usually the company or corporation in which said ownership interest is granted.

“Qualified” is similar to registration of securities under federal law but is the term used  under California law.  Once qualified, you will have permission from the applicable regulatory agency to offer or sell the securities.

As you can see, you cannot even offer to sell securities without first qualifying the securities.

Qualifying (or registering) securities is very costly and time-consuming. You need to make extensive disclosures about finances and the risks involved with the investment.

The idea is to protect the average person from being defrauded by scam artists.

But if you know the persons who are investing in your business or your investors are savvy about finance and investment, shouldn’t there be a way to avoid the need to qualify the securities?

The red tape can be cut a couple of ways but only one way really matters to the situations we are looking at.

If the conditions are right, you can offer or sell an investment in your business to your wealthy aunt or start the corporation with your coworker.

The first condition is that the sale of the securities by the issuer (your corporation, for example) cannot involve more than 35 total buyers.

Also, the buyers must have a preexisting relationship with the corporation or its shareholders, officers, etc.

Alternatively, if there is no preexisting relationship, the buyers should have the ability to protect themselves in the transaction.  This really means that the buyers should be savvy in finance or have experience making similar investments.

Your buyers must also promise that they aren’t buying the investment to flip it (i.e. resell).  The buyers must truly be making an investment for the long-term.

And you can’t advertise the investment.  If you are selling to your family or friends this should not be a problem because you know these people and don’t need to publicize the offer or sale.

Some people, though, get overly optimistic and run advertisements or send out mailers to mailing lists.  Don’t do this unless you first consult a qualified attorney.  Advertising could eliminate the exemption protection altogether.

So if you are offering an investment in your business to people you know, family or friends, you should be basically fine making the offer and sale.

Make sure you are honest with your investors and don’t hold back any material information from them because the anti-fraud laws still apply.

And don’t forget to file the proper notice of exemption with the state regulatory agency.

References: California Corporations Code sections 25102(f) and 25110.

This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction.

This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation.  If you need legal advice, consult a qualified attorney.

For more information please visit my website at www.palacioslawoffice.com.

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A Corporation’s Directors Could be Liable for Monetary Damages

A corporation’s directors are essential to the operation of the corporation.

The corporation cannot do anything unless the directors take appropriate action.

Corporate law requires that a corporation have a board of directors.

So you are asked to become a corporate director or you are director of your own corporation. What could go wrong, right?

If the corporation ends up running out of money or racking up debt or starts failing to meet its legal or contractual obligations, guess who can be held responsible for all of that?

You, as the director, can be held legally responsible for money damages arising from the wrong actions of the corporation.

And if you are a shareholder and director this means that your actions as a director can end up making you personally liable for the corporation’s debts even if you are insulated from personal liability as a shareholder.

With such responsibility why would anyone want to be a director of a corporation?

To protect directors, and encourage people to take on such duties, the law offers some limits on the personal liability of a director for money damages.

But for a director to have the most protection under the law, the articles of incorporation in California must contain a simple clause.

The articles must state certain language (under California law) about limiting the directors’ liability “to the fullest extent permissible.”  If this clause is included, the fullest protection for directors is triggered.

Fullest protection is extensive so long as the alleged wrongdoing by the director is not intentional.

In other words, the fullest protection under law does not protect a director for certain bad actions.

For example, if the director acted with the intention to harm the corporation or knew his or her actions were against the law, the fullest protection does not apply and the director can still be held liable.

If the director acted without goof faith, or in a way that the director believed was not in the best interests of the corporation or its shareholders, the fullest protection also does not apply.

Or let’s say there was a corporate transaction approved by the director that gives that director an improper benefit, there would then be no protection for such director.

Suppose a director is aware of a risk of serious injury to the corporation or shareholders from the director’s actions but recklessly disregards the corporation or shareholders and takes such action anyway.

Here too the director’s actions are not protected by the fullest protections from liability.

Then there are some directors who are too busy to take care of their duties as directors.

Or they just don’t care about being an active director.

If such directors make it a habit to not participate as a director, and there is no excuse for such inattention, they have effectively abandoned their obligations.

Such directors will not be protected from personal liability if something bad happens to the corporation.

They won’t be protected even if the articles of incorporation contain the magic language giving directors the fullest protection.

So, if you are thinking about becoming a director, it is important to check the articles of incorporation to make sure they give you the fullest protection under law.

But even with the fullest protection you will still be personally liable if you don’t always act in good faith or don’t always discharge your duties to the corporation and its shareholders in their best interest and not your own.

References: California Corporations Code sections 204(a)(10) and 204.5.

This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction.

This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation.  If you need legal advice, consult a qualified attorney.

For more information please visit my website at www.palacioslawoffice.com.

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Shareholders Can’t Take Profit Distributions At Will

You are being judicious, prudent, and disciplined and are plowing your corporation’s earnings back into your corporation.

You are reinvesting in your business because that is how you grow your business.

But your business is doing well and you are in business to reap the benefits of your hard work and diligence.

As a shareholder, and more so as the controlling shareholder, you might believe you are entitled to take the occasional distribution of profits from the corporation.  Why would anyone care if you were to take a distribution to pay yourself?

You are generally correct that you, the shareholder, have a right to take a distribution of profits to pay yourself.  But like most legal rights, there are exceptions, conditions, and limits to be aware of.

For example, under California law a corporation cannot make any distributions to its shareholders without approval by the board of directors.

You might be the sole shareholder and lone member of the board so it may seem that there should be no question about approving a distribution.  It is true that you could readily approve a distribution by signing a unanimous written consent to that effect.

But there is a condition that must be first satisfied by the board of directors.  The board must determine in good faith one of two things.

Will the corporation have sufficient retained earnings before the distribution to the shareholder(s)?

Or, will the corporation’s assets be of a sufficient value after the planned distribution?

If the board determines that the corporation’s retained earnings will be equal to or greater than the amount of the distribution plus overdue dividends owed to preferred shareholders (if any), the distribution is allowed.

Or the board can determine that the corporation’s assets, after the distribution, will be equal to or greater than the corporation’s total liabilities plus the amount to pay preferential rights of shareholders (if any).

If either condition is satisfied in the board’s good faith discretion, the distribution of profits can be approved.

Preferential rights are rights that are paid to some shareholders before other shareholders who do not have such rights.  Not all corporations have these but if you have investors in your corporation, there may be some shareholders with these rights and they are paid first before the common shareholders or there must be enough value, earnings, etc. to be able to pay them.

The board of directors can rely on financial statements that are prepared using reasonable accounting principles in making its determination.

The board can also use a fair valuation or any other method that is reasonable.

Also, the articles, bylaws and any other agreements between the shareholders must be reviewed because those documents might contain additional limits or restrictions on distributions of profits to shareholders.

There is a further limit on distributions to note here.  If the corporation will not be able meet its liabilities that are not provided for, the distribution is not allowed.  In other words, your corporation must be able to continue to pay its bills after the distribution of profits.

Once the board has made these determinations, in good faith, distributions can generally be made to the shareholders.

References: California Corporations Code sections 500 and 501.

This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction.

This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation.  If you need legal advice, consult a qualified attorney.

For more information please visit my website at www.palacioslawoffice.com.

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Adding a Member, Shareholder or Partner to Your Business

A new member, shareholder or partner for your business might make sense. Maybe the new person adds great connections, special know-how, or deeper pockets to help capitalize the business for growth. But what exactly does it mean for you to add someone new to your business?

First, let us look at the differences between a member, shareholder and partner. These are the labels given to the owners of different types of businesses. A member is the owner of a limited liability company. A shareholder is the owner of a corporation. And a partner is the owner of a partnership. An owner of any of these types of entities is someone who owns an equity interest in the given entity. In other words, an owner, because he or she owns equity, shares in the profits and losses of the business. A member or shareholder each has the added benefit of personal insulation from the liabilities of the business. A partner may or may not be insulated personally from the liabilities of the business.

To add a new owner to your business is a major step. Once you do this, you are giving up some control over the business and you will share profits (and losses) with the new owner. The co-owner, especially if a minority interest owner, has certain protections and rights under corporate law because of the fiduciary duties between co-owners. Finally, a co-owner cannot be “fired” from the business even if the new owner commits egregious acts. In that event, such owner might only be excluded from management and control of the business but may still have an economic interest in the business.

The basic step to add a new owner is for the parties to agree on how the new owner will acquire his or her equity interest. The new owner can acquire a portion of the equity of the other owners. Or, the new owner can acquire a new equity interest issued by the LLC, corporation or partnership itself. This is where many business owners run into trouble. They add someone as a “partner” with such person being only a consultant (i.e. 1099 contractor) in the business owner’s mind. But the new “partner” might believe that he or she is an equity owner. For this reason, it is important for the business owner to only add new owners pursuant to a written agreement, such as an investment agreement or purchase and sale agreement, between the parties that sets forth all the terms and conditions of the transaction and intended relationship.

At the time the new owner acquires his or her equity interest it is highly advisable that the owners enter into certain additional agreements (e.g. buy/sell agreement) to regulate when, how and to whom any given owner’s interest can be transferred (or should be transferred). Finally, one must be aware that the mere offer or sale of an ownership interest in a business will trigger certain qualification, filing or reporting requirements under the securities laws of a given state and under federal law.

This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction. This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation. If you need legal advice, consult a qualified attorney. For more information please visit my website at http://www.palacioslawoffice.com.

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Restraints on Former Employees’ Competing Against Employer

An employer recruits and trains its employees at great expense and often gives those employees access to its best practices, technologies and customer list as part of their job duties.  It is always a concern for the employer when any employee jumps ship and goes to work for the competitor.  It is because of that concern that employers frequently add a noncompetition clause to their employment contracts, especially for key employees.

On the other hand, it is a matter of human dignity that employees should generally be at liberty to offer their know-how and abilities to any other employer so that such employees can grow their careers and income potential.  As the thinking goes, why should an employer be able to monopolize any given employee to the detriment of said employee?  And for that reason the various state legislatures and courts have long recognized the need to regulate the rights and obligations of employers and employees in regards the ability to compete.  In California, that regulation starts with California Business and Professions Code section 16600.  We will only discuss California law in this article and remind readers that other states’ laws can vary considerably in this field.

Section 16600 states plainly that, except for limited exceptions, “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”  The courts in California have long concluded that this means that any contract that purports to restrain an employee from competing is suspect and should be highly scrutinized.  The courts have recently gone further and held that even if the restraint in an employment contract is “reasonable” it can still be impermissible if the restraint does not fall under a recognized exception to section 16600.

The Business and Professions Code provides for certain exceptions where a noncompetition restraint is allowed.  Section 16601 states that in a sale of business transaction the seller of the business can be restrained from competing against the business sold under certain conditions.  Similarly, section 16602 allows a partnership agreement to restrain a dissociating partner from competing with the partnership so long as certain conditions are met.  Section 16602.5 mirrors 16602 in allowing members of limited liability companies to be restrained from competing with the limited liability company after leaving the company.

The courts in California, however, previously have determined that protecting the employer from having its other employees “raided” by a departing employee and protecting its trade secrets and other proprietary information can be in conflict with the right to compete embodied in section 16600.  For this reason many California employment contracts contain “non-solicitation of employee” restraints instead of (or in addition to) noncompetition restraints.   Such employment contracts frequently also contain a “non-solicitation of customers” restraint.

Because of a major California Supreme Court case in 2008, there is significant doubt about the enforceability of restraints on the solicitation of the employer’s other employees.  This is because such non-solicitation restraint can be viewed as an impermissible restraint on the other employees’ ability to find new employment if the departing employee is prevented from recruiting them.

On the other hand, the protection of trade secrets and proprietary information through a nondisclosure agreement is likely perfectly fine in an employment situation.  But employment contracts usually only insert a non-solicitation of customers provision into an employment agreement in an attempt to get around the prohibition on noncompetition restraints.  Because California courts are not clear on the enforceability of such restraints in employment contracts, such an approach is unwise.

If the restraint is simply included as part of an employment agreement and really only provides for non-solicitation of the employer’s customers, there is a high risk that it can be deemed an impermissible restraint on the employee’s right to compete.  If the restraint is instead a nondisclosure covenant that restrains the employee from using or disclosing the employer’s trade secrets, including customer list, then it becomes more likely to be enforceable.  The better approach, however, is to not include any such restraint in the employment agreement but have the employee enter into a separate, full nondisclosure or confidentiality agreement.

Thus, under current California law, it is better to not attempt to restrain an employee from competing in any way.  Instead, the employer’s focus should simply be on protecting the employer’s trade secrets through a proper nondisclosure agreement in addition to the employment agreement.

This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction.  This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation.  If you need legal advice, consult a qualified attorney.  For more information please visit my website at www.palacioslawoffice.com.

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Is it a Good Idea to Take Back a Note on Sale of Your Business?

When selling a business, a seller may decide to extend credit to the buyer by “taking back a note.”  Sometimes this is done in combination with bank financing, but not always.  In this discussion we will look at what taking back a note really means and what are the considerations in deciding to extend credit this way.

Taking back a note simply means that the seller accepts a promissory note from the buyer for all or some of the purchase price.  A seller may decide to take back a note so that he or she can receive periodic payments over time, to generate an income stream for example, and to earn interest on the principal amount loaned to the buyer.  Taking back a note may also expand the pool of buyers who can afford to buy the business.  Also, the seller may even choose to sell the note after he or she has accepted it from the buyer.

Once the seller has agreed to finance the buyer’s purchase, the loan structure should be very straightforward.  The buyer (the “maker” of the note) executes and delivers the note to the seller (the “holder” of the note) as a part of the purchase and sale transaction.  For this reason, the purchase and sale agreement must provide for the seller’s financing and there will likely be a need for other incidental documents (e.g. loan agreement, personal guaranty, security agreement).  As with any other promissory note, the holder of the note must keep the original note in a safe place because it is a negotiable instrument (like a check) and having the original note makes enforcement of the promise to pay exceedingly easier if necessary at a later time.

Having a promissory note from the buyer is nice and is evidence of the buyer’s promise to pay the seller the agreed amount of the purchase price.  But if the buyer fails to make payments as agreed, the seller may find that he or she will not have sufficient protection if the note was not secured by collateral and other means.  For this reason the seller will likely want to make sure that the note is secured by some form of collateral.  Such collateral can be property of the buyer (e.g. real property) or it can also be the assets of the business itself.  If the financing arrangements are done correctly (e.g. taking care to perfect a security interest by filing a UCC-1 financing statement), a seller may be able to regain the business or at least its major assets in the event the buyer defaults on the note.  Another way for the seller to protect him or herself is to get personal guaranties from individuals with greater financial strength who agree to become liable in the event the buyer defaults on the promissory note.

As can be seen, taking back a promissory note gives a seller a useful tool to use in selling a business.  However, the simplicity of taking back a note can hide the complications that can arise later if the financing is not properly structured.

This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction.  This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation.  If you need legal advice, consult a qualified attorney.  For more information please visit my website at http://www.palacioslawoffice.com.

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Consumer Medical Information Device Makers as Health Care Providers

If your company manufactures or otherwise distributes an app, software, hardware or other medical device that stores the user’s medical or health data, a recent change in California law is important to you. The California Confidentiality of Medical Information Act (CMIA), California Civil Code sections 56 et seq., provides in general that a provider of health care, a health plan, and other similar entities are prohibited from using anyone’s medical information for any purpose other than as expressly authorized by the individual or as otherwise required or authorized by law.

The California legislature passed Assembly Bill No. 658, which took effect as of January 2014.  The new law amends the CMIA to extend the definition of a “provider of health care” who is subject to the CMIA. Particularly, the legislature intended to extend the prohibitions of the CMIA to certain software or hardware providers, including mobile application providers. As amended, the CMIA defines a “provider of health care” as any business that enables a consumer to manage his or her medical information or that otherwise facilitates the diagnosis or treatment of such consumer. This extension of the definition of “provider of health care” is limited to the CMIA and does not make any business a health care provider for other purposes.

The CMIA now specifically provides that a business that offers software, hardware, or a mobile app, among other similar devices or services, are “providers of health care” so long as the devices or software are intended to maintain the individual user’s medical information for the individual’s own use or for the purpose of diagnosing, treating or managing the individual’s medical condition. As can be seen, this amendment can potentially reach many companies whose products gather medical information (e.g. heart rate) generated by the user. But under the CMIA “medical information” is defined generally as information that is “in possession of or derived from” a health care provider. It would appear that the focus of the amendment is not to cover companies whose devices merely record and store a user’s medical information but whose devices or services store and mange such information when such information comes from the user’s health care provider (i.e. physician) and is not just user generated. Under this amendment it does not matter whether or not the business of the device maker or provider of the software is mainly to manage and store medical information or whether or not such management and storage is an incident to another service. It now only matters that the software or device manages or stores “medical information” as defined by the CMIA.

This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction. This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation. If you need legal advice, consult a qualified attorney. For more information please visit my website at http://www.palacioslawoffice.com.

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New Rules on Withdrawing from a Limited Liability Company

California’s limited liability company (LLC) law was updated when the California Revised Uniform Limited Liability Company Act (RULLCA) went into effect on January 1, 2014.  The California RULLCA is found in California Corporations Code, sections 17701.01 et seq.  One of the many changes to LLC law made by the RULLCA deals with how an owner (member) of an LLC can withdraw (dissociate) from the LLC.

In general, a member can withdraw from an LLC at any time for any reason, whether the member is permitted to do so or not under his or her agreement with the LLC.  The withdrawing member need only give notice of his or her intent to withdraw.

A member can be deemed to have withdrawn wrongfully in two basic scenarios.  One is when the withdrawal is prohibited by an express provision in the LLC’s operating agreement.  The other scenario involves withdrawal prior to the termination of an LLC and the member either withdraws voluntarily, the member is expelled pursuant to judicial order, the member becomes a debtor in bankruptcy, or when the member (when an entity) is itself dissolved.  If the member’s wrongful withdrawal causes the LLC and the other members to incur damages, under the RULLCA the withdrawing member is liable for such damages in addition to any other liability that may be owed by such member to the LLC or other members.

There are other events under California’s RULLCA that could result in a given member being deemed dissociated from the LLC.  Such other events include any event that is set forth in the operating agreement as resulting in a member’s dissociation.  A member can also be expelled according to the terms of the operating agreement for expulsion of a member.  In the event of death or incapacity of an individual who is a member, such member is deemed dissociated upon death or incapacity.

The consequences of dissociation are as follows.  The dissociated member can no longer participate in the management and operation of the LLC.  When the LLC is managed by the members, the dissociated member’s fiduciary duty to the LLC and other members terminates upon dissociation.  But the dissociation does not relieve the dissociated member from any liabilities or other obligations that were incurred prior to dissociation.

This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction.  This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation.  If you need legal advice, consult a qualified attorney.  For more information please visit my website at http://www.palacioslawoffice.com.

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Should You License or Sell Rights in Intellectual Property

When a business or individual owns an intellectual property right (e.g. copyright, trademark, trade secret) the desire to monetize such rights arises.  This will require the intellectual property right owner to decide whether the rights should be sold or licensed.

A license is the transfer of less than all of the owner’s rights in the given property.  This means the owner retains some rights and the acquirer is given a “license” that allows for the limited use of the property rights so transferred.  A sale or, more technically, an “assignment” means that all of the owner’s rights are transferred to the acquiring party.  This means that the acquirer receives the absolute right to use the property transferred.

Many times when parties enter into a transfer of intellectual property rights, they may not define in their agreement the transfer by the proper technical term.  For example, the agreement may only say that a “transfer” is to be undertaken by the parties or that the owner is “granting” to the acquirer the given rights.  In these instances the intent of the parties would need to be considered to determine whether or not the parties intended for a license or assignment to occur.  Also, many types of intellectual property rights (e.g. copyright, trademark) require the transfer agreement to be in writing.  Consequently, great care should be given to the written agreement that gives effect to any transfer of intellectual property rights.

In general, licensing of intellectual property rights allows the owner to retain control over the distribution and use of such rights while earning a fee from the license.  This allows the owner to control who has access and use of the property right licensed.  The owner can better control the distribution and thereby retain control over the markets wherein the property can be sold.  Also, the owner retains control over future changes to the intellectual property and the development of derivative works.

A sale of intellectual property rights avoids problems that can occur with an ongoing relationship, such as a license.  A licensee-licensor relationship may entail support by the licensor and sharing of other, related technologies or proprietary information with the licensee.   In a sale transaction, the property transferred to the acquirer will be defined and limited to the subject of the sale transaction.  A license will require that the licensee report accurately sales of the licensed property and royalties payable to the licensor.  A sale will thus avoid the problem of the licensee failing to accurately report and pay royalties to the licensor.  Another problem that can arise occurs when the licensee underperforms as was expected when the license was entered into.  Depending on the terms of the license, the licensor may be forced to continue working with the underperforming licensee until the expiration or other termination of the license.   In a sale, there would be no concern about the licensee’s performance after the transfer.

This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction.  This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation.  If you need legal advice, consult a qualified attorney.  For more information please visit my website at http://www.palacioslawoffice.com.

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