Fatal Legal Mistakes Business Owners Make: Failing to Protect Business IP
This is the fifth in a 10-part series exploring legal mistakes that can be fatal to a business (even a seemingly well-established one). The illustrations and guidance provided are designed to help you spot these mistakes early. Each of these mistakes is preventable with proper planning and preparation.
Last month, I discussed the dangers of failing to use a registered agent for your business. Texas law requires that every corporation or limited liability company identify a registered agent to receive certain legal notices, including certain legal notices in litigation and notices from the Texas Secretary of State. If a company fails to respond properly to a document served on its registered agent, it may be subject to devastating legal consequences. Unless you’re the person who always opens and reviews all mail and notices sent to your company, you should not serve as the registered agent for your business. Rather, identify a registered agent who is available to receive service of process and who knows what to do when it is served with legal notice.
So, you’ve taken the steps to properly incorporate, maintain, and segregate your business ventures and you’re using a registered agent. Congratulations! This article will discuss how to avoid the devastating consequences of failing to protect your business’s intellectual property.
Read on for an illustration of how easily mistakes can arise, how fatal they can be for even the most successful business, and how to avoid them entirely with dedicated planning.
Mistake 5: Failing to Protect Business IP
After suffering an accidental chemical burn while working as a commercial building cleaner, Margaret was intent on developing a safe, environmentally friendly (but highly effective) cleaning agent. For several years she spent all of her free time learning about cleaning agents and chemical interactions, preparing sample agents, and testing her formulas. After much trial and error, Margaret developed a formula that really worked. Though the product was made from commonly available and harmless chemicals, Margaret had discovered that if she heated the chemicals to a precise temperature and then cooled them rapidly, the chemicals combined in a way that was unknown to competitors in her industry. She quickly worked to incorporate “Cloud Nine Cleaning” as a new business and followed all the proper steps to set up her corporation. Using the CNC business name, Margaret began bottling and selling her “SafeAsClouds” cleaning agent to janitorial companies. Her existing connections in the industry helped her quickly become known.
Margaret’s formula was safer than anything on the market—so safe, in fact, that her sales reps would take a drink of the formula during their sales pitches to show how harmless it was. And CNC’s distinct cloud-shaped bottles became quickly recognizable. In contrast, all of CNC’s competitors recommended wearing gloves when using their cleaning agents and their bulky commercial bottles all looked identically boring.
Martin joined CNC as an entry-level associate but showed a great aptitude for the business. Margaret gave Martin positions requiring increasingly more responsibility until he eventually became the head of production. He seemed to enjoy his work so Margaret was surprised and a little disappointed when Martin left after eight years of service, but wished him well.
Just six months later, however, Margaret learned from one of her sales reps that Martin had formed a competing business that offered a product he claimed was “just as safe” as CNC’s SafeAsClouds product. He even drank some of the product in his sales meetings, just like CNC’s sales reps did. Martin’s cleaning agent “RightAsRain” sold for 20 percent less than Margaret sold hers. The RightAsRain bottle even had a distinct cloud shape to it that looked very similar to CNC’s bottles.
Soon, CNC’s customers were telling Margaret’s sales reps that while they liked Margaret’s product, Martin’s was just as safe and effective, but cost less.
Margaret’s investigation revealed that Martin’s formula was made at the precise temperatures and with the same cooling process that she used in her process. Martin had even somehow contracted with CNC’s same bottle manufacturer to make a slightly different, but very similar cloud-shaped bottle for his product.
To make matters worse, other competitors in the industry somehow learned how Martin made his formula, and three different companies began selling a product that was “just as safe” as Margaret’s SafeAsClouds cleaning product. Margaret’s sales plunged.
How to Avoid Mistake 5
Patents, trademarks, copyrights, and trade secrets are critical to the success of virtually every modern business. How you take care of those intangible assets will often determine whether your business succeeds.
A substantially high percent of the value of publicly traded companies comes from intangible assets – proprietary processes, inventions, good will, brand recognition, and the like. The same holds true for many small businesses, which often have few assets other than their intellectual property.
While people often think of patents as the most protective form of intellectual property for inventions, trade secrets are really the crown jewels of businesses. Patents require an inventor to share publicly their proprietary formula or process in exchange for a limited monopoly in the marketplace. Trade secrets, on the other hand, don’t require publication and can protect your proprietary processes indefinitely if properly maintained. If it is unknown to others in the industry, almost any type of information may meet the legal definition for a trade secret. Your trade secrets may be your company’s most important and valuable assets (think Coca-Cola’s proprietary recipe).
Trademarks (words or symbols that identify the source of goods) and trade dress (the visual characteristics and appearance of a product or packaging) are similarly valuable assets that can establish goodwill for your company and create brand recognition. Like trade secrets, if properly used and maintained, trademarks and trade dress can be used indefinitely. A business that properly maintains and protects its trademarks and trade dress can prevent competitors and other businesses from selling confusingly similar products.
Once a trade secret becomes publicly known, however, it is no longer a trade secret. And trademarks or trade dress that aren’t properly maintained or enforced against competitors can be lost or, worse, may be genericized and no longer point consumers to your products (think Kleenex, Jacuzzi, and Band-Aid).
If you want to protect your most valuable assets, you must act promptly at the start of your business’s product or service development. Establish a game plan to assess, inventory, and protect your trade secrets by using password protected files, keeping secret from the general public propriety processes and ideas, and ensuring employees are governed by properly drafted non-disclosure and confidentiality agreements. Regularly audit your practices and procedures to make sure that they adequately protect your trade secrets and talk with legal counsel about the pros and cons of filing for patents on specific inventions. Likewise, it is recommended that you seek legal advice on filing and maintaining trademark and trade dress protection for products and services to prevent competitors and unrelated businesses from causing consumer confusion by marketing similarly named or looking products. Protecting your hard-earned customer goodwill requires actively protecting your business’s intellectual property.
In the next article, I’ll address the fatal mistake of a business failing to implement restrictive covenants with employees and contractors.