Notes & Comment
Vol. 2010, No. 2
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Business Law
Case of the mythical "Small Technology Company": who owns the IP?
Agatha Christie never wrote the mysterious case Who Owns Intellectual Property Created While Working For A Poorly-Run Business? But if she had, the mystique of the "small technology company" might be her smoking gun. That's the outcome suggested by a recent decision of the U.S. Court of Appeals in San Francisco. JustMed, Inc. v. Byce, 2010 U.S. App. LEXIS 6976 (9th Cir. April 5, 2010).
The dispute in JustMed is familiar to the technology world: who owns IP developed while working for a company? In mature, well-run businesses, such cases are solved by the dog barking at night -- by a document trail which specifies who owns the developed IP. In young, under-managed companies, on the other hand, there might not be a barking dog at night -- no such document trail proving IP ownership. In those cases, JustMed asserts that the mystique of the "small technology company" helps to solve this riddle.
The Facts
Joel Just (Just) and Michael Byce (Byce) are former brothers-in-law (their wives were sisters). They developed the idea for a voice enhancement system for people who'd had their larynx removed, and they obtained a patent in 1998. Byce worked on the project from 1995-1999, when his wife unexpectedly died. For the next several years, the project stalled. Then, in 2003, Just and his wife formed JustMed, Inc. (JustMed) in Oregon to continue development of the patented device. Just hired Jerome Liebler (Liebler) as a full time employee, and Liebler wrote substantial software on behalf of the company (using JustMed's name in the copyright notice). Liebler and Just received no salary but were paid in JustMed stock. Byce, meanwhile, was offered founders shares in the company and a board seat but initially had no other role in the newly-formed JustMed.
By 2004, JustMed had developed a marketable product, but Liebler moved to Kentucky. Byce wanted to become more involved, and Liebler agreed to step aside as an employee and allowed Byce to assume his position and salary (which was paid in the form of JustMed stock). Just testified that Byce was hired as an employee of JustMed. Byce did not think he was an employee but was an independent contractor-software developer paid in company stock. There was no employment agreement between the company and Byce, and he didn't sign typical employment forms (I-9, W-4) nor receive W-2 wage statements. He received no benefits, employment taxes were not withheld and workers compensation insurance was not obtained. Just testified that he followed none of these employer formalities with respect to Byce because he thought Byce was a company executive, and JustMed's stock-only compensation structure was modeled on prior technology startups Just had worked for.
Byce substantially rewrote the source code that Liebler originally authored, and he did other tasks for the company too, such as website maintenance and representing the company at conferences and product demonstrations. Byce worked unsupervised from his home in Idaho. He submitted work product to Just in Oregon for evaluation when he'd finished it. In May 2005, Byce needed cash and the company agreed to pay him salary of half stock, half cash. He filled out a W-4 form, but never cashed the company's paychecks.
The relationship between Just and Byce soon broke down over equity ownership issues. Seeking leverage in negotiations with Just over more stock ownership, Byce then changed the copyright notice on the source code (in his name) and deleted all copies of the source code on JustMed's computers in Oregon, retaining a copy on his laptop at his Idaho home.
When Just discovered that the software was missing from company computers, JustMed filed a lawsuit in state court against Byce for misappropriation of trade secrets and breach of fiduciary duty, among other claims. Byce removed the case to Idaho federal court and requested a finding that he was sole author of the JustMed source code he'd almost completely rebuilt at his home in Idaho from Liebler's original source, and that he, not JustMed, owned the software's copyright. If Byce was deemed to be the owner of the software's copyright, JustMed's case against him would collapse and the company's ability to continue in business would be jeopardized.
Who Owns the Source Code?
The federal trial court kept the case (did not send it back down to state court) because it needed to figure out who owned the copyright to the source code which Byce had written on behalf of JustMed. This was a federal question. Under U.S. copyright law, works (including software) authored by an employee, or authored as a "work for hire" (unless otherwise provided in a contract) are deemed owned by the employer-company. This is the default rule. Works authored by a non-employee independent contractor, however, are typically owned by the independent contractor and not the company that hires the contractor, unless there's a written agreement between them that transfers ownership of the work from the contractor to the company.
The federal trial court held that Byce was an employee of JustMed, not an independent contractor, and that JustMed owned the copyright to the source code. This finding was upheld by a three judge panel of the U.S. Court of Appeals. JustMed, Inc. v. Byce, supra, 2010 U.S. App. LEXIS 6976.
JustMed ran itself quite informally and did not follow standard tax and employment law protocols. For example, the company did not obtain I-9 and W-4 forms from Byce, paid salaries in the form of stock, did not provide benefits, did not withhold or pay required employment taxes (until Byce received a cash salary), did not obtain required workers compensation insurance, and did not use employment agreements. Byce worked independently from his home in Idaho, far away from company offices in Oregon, and generally worked his own hours without supervision by Just or anyone at JustMed. These are typically incidents of independent contractor status, not employee status.
How did the court find that Byce was an employee of JustMed and not an independent contractor, and, therefore, that the software source code he wrote belonged not to him but to his employer? The Court largely focused on the way JustMed did business; it was substance over form. Though crediting Byce's arguments that he was an independent contractor and not an employee, JustMed's business practices seemed to carry the day for the Court:
"However, taking the various factors into account, we conclude that the district court did not err in finding that Byce was an employee. In particular, the contemplated duration of the relationship, the tasks Byce did for JustMed, the fact that Byce earned a salary from JustMed, and the nature of JustMed's business all support the finding that Byce was an employee. While no one factor is decisive, we draw some guidance in weighing the factors from JustMed's status as a technology start-up company. The evidence of the way JustMed operates gives support to the finding that Byce was an employee. Admittedly, some of the factors that Byce points to support his position, but mostly they are entitled to little weight when viewed in light of the way JustMed conducts its business." 2010 U.S. App. LEXIS 6976 at 18-19 (emphasis added).
Despite significant factual support under standard analysis that Byce was an independent contractor (and should own the copyright to the source code), the Court nonetheless found that JustMed, a typically small, informally-run, cash-poor technology start-up, shouldn't be punished because it didn't dot the traditional "eyes" and cross the customary "tees":
"As a small start-up company, JustMed conducted its business more informally than an established enterprise might. This fact can make it more difficult to decide whether a hired party is an employee or an independent contractor, but it should not make the company more susceptible to losing control over software integral to its product. Weighing the common law factors in light of the circumstances and JustMed's business, we conclude that the district court did not err in holding that Byce was an employee and that the source code was a work made for hire." 2010 U.S. App. LEXIS 6976 at 26 (emphasis added).
Summary and Conclusion
The dispute in JustMed, Inc. v. Byce would never have amounted to much if the company had used customary due diligence and properly documented its relationship with all personnel. Management was inexperienced, too casual, or pennywise but pound foolish, or all of the above. Yet, in romantic deference to the mystique of the small technology company, JustMed received a pass from the courts, thus salvaging its intellectual property rights in its mission-critical technology. JustMed dodged a bullet. It could easily have gone the other way.
Perhaps the lesson to similar small technology companies is properly document relationships with all personnel contributing valuable services related to the creation of vital intellectual property. Make sure they are clearly classified as employees and documented as such in accordance with tax and employment law precepts, or, if independent contractors are used, make certain proper written agreements are in place which specifically give the company clear ownership of all intellectual property created during the contractor relationship.
© Matthew Joseph 2010. Law Offices of Matthew Joseph, San Mateo, California, practices in the areas of intellectual property licensing, commercial real estate leasing, corporate formations and business transactions. No legal advice is intended by the information provided herein and recipients should independently consult counsel before taking any action related to this subject matter.