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Updates to Michigan’s Legislative Battle to Permit Ride-sharing Statewide

The Michigan House of Representatives failed to pass on Wednesday HB 5951 which would have permitted ride-sharing companies like Uber and Lyft to operate in Michigan and preempted any more-restrictive local regulations.  The House may take up the bill again today.

The Michigan House of Representatives failed to pass on Wednesday HB 5951 which would have permitted ride-sharing companies like Uber and Lyft to operate in Michigan and preempted any more-restrictive local regulations. The House may take up the bill again today.

We recently overviewed Michigan’s proposed legislation, HB 5951 that would effectively allow ride-sharing services like Uber and Lyft to operate statewide by preempting local regulations. Here is a quick update to the status of this proposed legislation.

Michigan’s House of Representatives Fails to Pass HB 5951 on Wednesday

As reported by MLive, Michigan’s House of Representatives did not pass HB 5951 yesterday.  A House committee approved the bill last week and sent it to the House floor for a vote.  The bill would permit ride-sharing services to operate in Michigan provided they met certain requirements (outlined here) that are largely consistent with Uber’s current practices.

Yesterday, the House failed to pass the bill.  The bill is still alive, however.  Here is what happened, as outlined in the Journal of the House of Representatives for yesterday’s session.

  • The House made certain changes to the bill, including exempting from Michigan’s Freedom of Information Act any list of ride-sharing drivers provided to the state as required by the bill.
  • An amendment was proposed, but failed to pass, that would allow local municipalities to still pass their own ride-sharing regulations, even those more restrictive than state law.  This would effectively strip HB 5951 from having its primary impact (of having uniform state-wide requirements for ride-sharing services).  In particular, the amendment stated:

    Sec. 11. (1) This act does not prohibit a municipality or a group of municipalities that form an authority to regulate transportation network companies under the municipal partnership act, 2011 PA 258, MCL 124.111 to 124.123, or the public transportation authority act, 1986 PA 196, MCL 124.451 to 124.479, from adopting a rule, ordinance, or resolution that is more restrictive than this act.

  • When at least 50 representatives voted against the bill’s passage, the House passed on the agenda item.
  • The House will reconvene at 10am today, December 11, and may take up the bill again.  You can watch a live webcast of today’s House session here.

Opposition from Insurance Industry

Michigan's insurance industry continues to oppose HB 5951.

Michigan’s insurance industry continues to oppose HB 5951.

The insurance industry continues to vigorously oppose the bill in its current form, as laid out in its December 9 letter to the House.  One of their primary complaints is the gap in coverage for a ride-sharing driver who is on duty, but not currently carrying a passenger.

According to the executive director of the Insurance Institute of Michigan, HB 5951 leaves a gap in coverage that “may leave drivers and passengers of ride sharing companies at financial risk.”

In the meantime, all eyes will be on the House floor today to see if an agreement can be reached to allow HB 5951 to pass a House vote.

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Uber’s Regulatory Drama Continues: Portland Sues Uber

The City of Portland sued Uber on December 8 seeking to enjoin Uber from operating in the city limits.

The City of Portland sued Uber on December 8 seeking to enjoin Uber from operating in the city limits.

Yesterday’s post discussed Michigan’s proposed bill HB 5951 which would implement state regulations permitting ride-sharing services such as Uber and Lyft to operate in the state of Michigan provided they met certain regulations that are largely consistent with Uber’s existing practices.  That bill would preempt various city regulations (such as Ann Arbor’s), some of which conflicted with Uber and Lyft’s existing practices.  Just a few days after Michigan’s house committee approved HB 5951 and recommended the house pass the bill, a strikingly different approach has been taken in Portland, Oregon.

City of Portland v. Uber

On Monday, December 8, the City of Portland sued Uber seeking to enjoin Uber from operating in the city of Portland.  This lawsuit comes just days after Uber began operating in Portland on Friday, December 5.  The conflict involves Portland City Code Chapter 16.40, which requires as follows:

  • “for-hire transportation” drivers must obtain a “for-hire transportation” permit
  • for-hire vehicles must have certain decals and plates
  • taxicabs must adhere to certain fare and meter rates
  • taxicabs must adhere to certain regulations related to wheelchair accessibility
  • for-hire vehicles must maintain certain levels of insurance
  • taxicabs must maintain a dispatch system in operation 24 hours/day
  • taxicabs must service city-wide 24 hours/day, 7 days a week and accept any request received within the city
  • taxicab companies must have at least 15 cabs in their fleet and have at least 2/3 of their fleet in service at all times
  • for-hire vehicles must pass regular inspections
  • for-hire vehicles must be equipped with digital security cameras

According to the City of Portland’s complaint, which can be read here, Uber violates Portland City Code because it:

  • does not hold a valid company permit
  • all prospective Über customers must first download the Uber app and enter into an online agreement under terms dictated by Uber, including a waiver of any and all liability to Uber
  • the customer must provide credit card information to Uber, which is charged, rather than having drivers collect a fare from the customer
  • customers hail an Uber vehicle through the Uber app instead of a human dispatcher
  • the Uber app calculates fares based on time and distance rather than through a certified taxi meter
  • Uber’s drivers and vehicles are personally insured, and Uber does not require its drivers to purchase commercial at insurance
  • Uber does not require its drivers to be certified by the City of Portland
  • Uber’s drivers are not required to be dispatched to all ride requests in the city, but rather only to passengers who can pay via credit card and have access to the Uber app or website to request a vehicle

Portland’s Cease and Desist Letter to Uber

On December 8, the City of Portland sent a cease and desist letter to Uber demanding that Uber cease operations in the city limits.  The cease and desist letter is attached to the complaint as Exhibit A. While there have been varying reports of the city’s enforcement against individual Uber drivers, it does appear the

Support for Uber and Success in Other Markets

As of publication, close to 10,000 individuals have signed a petition to support Uber’s operations in Portland.   Uber remains wildly popular and it generally overcomes the legal obstacles it has faced in other markets.  As previously reported, Uber faced initial obstacles in Ann Arbor and Detroit.  While Ann Arbor sent Uber cease and desist letters, it generally did not crack down on Uber’s operations, and now a Michigan bill is likely to preempt any local regulations.  In Detroit, Uber worked with the city to enter into an operating agreement stipulating how the company could operate in Detroit.

Ride-sharing In and Around Portland

While regulatory issues are nothing new to Uber, the situation in Portland is slightly unique.  Uber is already operating in several cities in close proximity to Portland, for instance, Vancouver Washington.  Additionally, various tweets, such as the one below, were bring broadly disseminated citing the limited availability of traditional taxi services in and around Portland:


 Going Forward

Going forward, the legal questions related to whether Uber is complying with Portland’s City Code appear to be relatively clear:  Uber is not.  As in other cities, this is likely not a legal battle, but rather one of politics and policy.  If Portland desires to have Uber available in its city, it will ultimately amend its city code to provide for transportation network companies such as Uber, to obtain permits to operate in the city.  Alternatively, as happened in Michigan, the state of Oregon could pass statewide regulations that preempt the regulations of any particular municipality, thus permitting Uber to operate statewide as long as it abides by the state-level regulations.

So far, Uber’s tactics of commencing operations and then working out any regulatory hurdles have worked out with staggering success.  Indeed, Uber recently raised another $1.2B at an amazing $40B valuation.  So far, Uber has proven that massive customer acquisition can cure all evils – even legal and regulatory ones.

 

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Transportation Network Company Bill Supported by Uber Moves to House Vote in Michigan

The Michigan House of Representatives will vote on HB 5951 which would implement state regulations largely consistent with Uber and Lyft's existing practices.

The Michigan House of Representatives will vote on HB 5951 which would implement state regulations largely consistent with Uber and Lyft’s existing practices.

On December 4, Michigan’s House Energy and Technology Committee approved HB 5951.  The bill provides for state regulation of transportation network companies such as Lyft and Uber.  Uber supports the bill because it is consistent with its existing practices.  The bill would supersede any local regulations, such as the city regulations underlying Ann Arbor’s cease and desist letters to Uber and Lyft earlier this year.

Overview of HB 5951

HB 5951 directs the state to issue permits to any transportation network company that meets certain requirements, including:

  • the company carries insurance meeting certain minimum coverage thresholds;
  • drivers are at least 21 years old;
  • each driver maintains a Michigan chauffeur’s license;
  • the company performs background checks on and collects driver history reports from each drive;
  • that each driver vehicle undergoes a yearly safety inspection.

As reported here by Mlive, Michael White, manager of Uber’s Michigan operations, says Uber supports the bill and that Uber’s current practices are largely consistent with the bill’s requirements.

Existing Local Regulations

Currently, various municipalities provide their own regulations purported to cover ride-sharing services such as Uber or Lyft.  For example, as widely reported by outlets such as Business Week and MLive, on May 14 the city of Ann Arbor issued cease and desist letters to Uber and Lyft.  Other cities in Michigan, permitted Uber and Lyft to operate.  For example, Detroit entered into an operating agreement with these companies to permit their operation.  Section 11 of HB 5951 provides: “A local unit of government shall not enact or enforce an ordinance regulating a transportation network company.”  Accordingly, HB 5951 effectively trumps any local ordinances such as those of Ann Arbor seeking to restrict Lyft or Uber from operating.

Uber Urges Support for HB 5951

Beyond Michael White’s strong testimony in favor of HB 5951 at the committee level, today Uber also launched a marketing campaign urging its users to email their state representatives in support of HB 5951.  Michigan Uber users were emailed information about 5951, and a one-click mechanism for emailing the appropriate state representative.

On December 8th, Uber Michigan users received emails from Uber asking for their support of HB 5951.

On December 8th, Uber Michigan users received emails from Uber asking for their support of HB 5951.

HB 5951 Opposition
Not everyone supports HB 5951, however.  As noted here, the taxi industry and  Michigan Municipal league oppose the bill.  Objections include:
  • the bill does not require companies like Uber and Lyft to have large enough insurance policies;
  • the bill is unfair to taxi and limousine services that remain subject to harsher regulations; and
  • the bill may undo some beneficial regulations on limousine services (see the comments here).

In the end, Michigan’s legislature will have the final say.  The bill appears to have momentum and some have noted they expect it to become law before the end of the year.

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An EGG-cellent Example of How a Law Suit Can Backfire: Unilever v. Hampton Creek

Unilever, maker of Hellman's, sued Hampton Creek for false advertising and unfair competition over its egg-free "Just Mayo" product.

Unilever, maker of Hellman’s, sued Hampton Creek for false advertising and unfair competition over its egg-free “Just Mayo” product.

Hampton Creek, according to its website, is “a company dedicated to [helping everyone] eat delicious food that’s healthier, sustainable, and affordable.”  Earlier this year, Hampton Creek was featured on This Week in Startups where it demonstrated its “Just Mayo” product.

Just Mayo

Just Mayo is an egg-free dressing designed to replace traditional egg-based mayonnaise.  Indeed, one of the main points of Just Mayo, appears to be to avoid the use of eggs.  According to Hampton Creek CEO Joshua Tetrick, eggs are some of the most inefficient food products, requiring an energy to food ratio of 39:1.  Hampton Creek on the other hand achieves an energy to food ratio of 2:1.  According to Tetrick, Just Mayo resulted from two years of research and development by Hampton Creek.

The Lawsuit

Unilever sued Hampton Creek for false advertising and unfair competition.  See the Complaint.

On October 31, 2014, Conopco (a company that does business as Unilever), the maker of Hellman’s mayonnaise, sued Hampton Creek for false advertising and unfair competition under  the Lanham Act (federal law) and various state laws.  According to Unilever, the Food and Drug Administration regulations define “mayonnaise” as “the emulsified semi-solid food prepared from vegetable oil” and containing an “acidifying” ingredient of either (1) vinegar or (2) lemon or lime juice, and an “egg yolk-containing” ingredient.  Unilever also alleges that “mayo” is a commonly understood synonym for “mayonnaise.”  Therefore, according to Unilever, Hampton Creek is falsely advertising its product by calling it “mayo” when it does not include any “egg yolk-containing ingredient.”  See the Complaint here.

False Advertising Under the Lanham Act

False advertising plaintiff’s typically have to prove:

(1) the defendant made a false or misleading statement of fact in a commercial advertisement about a product;

(2) the statement either deceived or had the capacity to deceive a substantial segment of potential consumers;

(3) the deception is material, in that it is likely to influence the consumer’s purchasing decision;

(4) the product is in interstate commerce, and the plaintiff has been or is likely to be harmed by the statement.

Should the case progress, it will be interesting to see how a court addresses the second element above. Just Mayo is specifically and clearly marketed as being egg free.  Therefore, regardless of the FDA’s definition of “mayonnaise” it would seem hard to suggest that Hampton Creek’s “Just Mayo” brand could deceive or have the capacity to deceive a substantial segment of potential consumers looking for traditional egg-based mayonnaise.

The Backlash

Shortly after Unilever initiated its suit, it received significant public backlash.  Well known chef Andrew Zimmerman initiated a petition on Change.org asking Unilever to stop bullying Hampton Creek.  In the word of Zimmerman:

Unilever, a UK-based 60 billion dollar multinational corporation, filed a lawsuit confessing that Hampton Creek is taking away market share from a couple of its products: Hellmann’s and Best Foods. Thus, as Unilever admits, it’s attempting to rely on an archaic standard of identity regulation that was created before World War II to mandate that Hampton Creek removes its products from store shelves.

As of November 20, the petition had over 70,000 online signatures.

Additionally, as reported by One Green Planet, marketing experts have stated that Hampton Creek received over $3M of free product placement based advertising per day in the week following the lawsuit.  Accordingly Hampton Creek received over $21M of marketing benefits in just the first week following the lawsuit.

The Lesson

It will be interesting to see how far Unilever presses the lawsuit.  It is unlikely that they expected this degree of backlash and this outpouring of support for Hampton Creek.  Indeed, given the increasing awareness of the need for sustainable food sources, and allergy-friendly foods, the public opinion appears to be that Hampton Creek is on the right side of history.  Accordingly, filing a lawsuit against a competitor requires much deeper analysis than whether one is likely to prevail on its legal claim.  Here, even if Unilever ultimately prevails on its claims (which is not a certainty, as discussed above), it’s quite possible that Hampton Creek might end up the winner.

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The Risks of Corporate Incubators May Outweigh the Generous Rewards

Corporate incubators can nurture a small startup with big company resources.

Corporate incubators can nurture a small startup with big company resources.  Photo by Pete Prodoehl.

We have seen a recent wave of fortune 500 companies breaking into the entrepreneurship game by establishing their own corporate incubators – Nike, Google, Microsoft and Samsung just to name a few. This article provides an overview of considerations for whether your start-up should accept an offer to join a corporate incubator.

Overview of Corporate Incubators

Corporate incubators are industry specific accelerators that help start-ups and entrepreneurs build a successful company/product but only within the structure of a large corporation. As compared to the traditional accelerator (e.g. Techstars or Ycombinator) that invest money and resources in a broad array of startups which span many platforms, corporate incubators are designed to help the sponsor build a portfolio of long-term product options, develop offshoots to existing products and generate innovative ideas that can help the sponsor grow its profits.

Why Established Companies Seek to Incubate Startups

Corporate incubators and accelerators are a vital source for idea generation and growth. Particularly for markets that are constantly evolving, an in-house incubator can help large companies pivot and change directions or develop a new business quickly. Even for companies in mature industries where M&A is drying up quickly (i.e. manufacturing or many food & beverage sectors), incubators and accelerators have become a part of their corporate structure to derive new profits. Not only do corporate incubators provide valuable ideas but they can also provide a company with home grown talent if the company runs short on valuable human capital. Given the level of visibility and access corporate executives have to talented young entrepreneurs through the incubator, it is not uncommon for the sponsor to make employment offers from its toy chest full of start-ups.

Benefits to Joining a Corporate Incubator

While joining a corporate incubator may seem like “selling out,” the benefits of a corporate sponsor may be too much temptation for any starry-eyed entrepreneur to resist. Corporate incubators give a start-up access to the company’s vast array of resources such as R&D, legal services, mentorship and often stable financial assistance to help the start-up scale its business. Furthermore, as compared to your typical accelerator or incubator, corporate incubators are generally industry focused and can provide tailored mentorship and resources that even some of the top accelerators such as Ycombinator or Techstars may not have access to. Not only are the resources a substantial benefit but another advantage is that a corporate incubator can immediately place a start-up on the radar of a strategic acquirer. Getting support from a corporate sponsor can be a significant step in the right direction for a start-up and often signals that the entrepreneurs may be on to something big and therefore should think seriously about an offer to join a corporate incubator. Like most things in life, however, there is often no such thing as a free lunch and there some serious challenges that start-ups should be aware of before joining the corporate payroll.

Considerations to Joining a Corporate Incubator

(1)  Make sure you have clean title to your intellectual property

Joining a corporate incubator can be tricky when it comes to IP related issues especially when dealing with who owns any new IP that comes out of the incubation process. Before starting at a corporate incubator, make sure that all IP that has been created by any of the founders or employees has been documented and assigned to the business. While negotiating with a corporation is not easy and offers are often provided on a take-it-or-leave-it basis, try to work with legal counsel to ensure that any and all IP developed while in the incubator belongs to your start-up.

(2)  Corporate bureaucracy can crush a start-up’s flexibility

One of the best aspects of being a start-up is the ability to be nimble and make quick decisions when needed. Large corporations are often not afforded this benefit as their size and governance structure can slow decision-making. If the corporation running the incubator obtains certain veto or control rights in a startup, that startup may lose its ability to make quick decisions. Getting caught up in such corporate bureaucracy and indecision (or a slow and lengthy decision making process) can quickly destroy a budding company. A startup can protect against this risk by closely reviewing the deal documents and avoiding granting the company running the incubator control over important decisions that a startup needs to make quickly (i.e., hiring, product direction, market strategy, issuances of equity to new hires, etc.) If the company running the incubator insists on such control rights, a startup should get to know and staying aligned with the key corporate decision makers and stakeholders.

(3)  Corporate sponsorship may drive away venture capital funding

If you do choose to join a corporate incubator, don’t be surprised if you don’t have too many venture capitalists knocking on your door at the end. While VCs won’t necessarily be bothered by the “selling out” aspect of corporate sponsorship, they will be very concerned about having to deal with XYZ conglomerate as a significant investor not only with a sizeable equity stake but also potentially pro-rata rights and big city corporate lawyers to enforce all the initial investor rights agreed to by the start-up. Even if VCs can get over having to deal with the corporate sponsor, many will be concerned with whether the management team has that magical start-up wherewithal that makes them worth investing in. VCs often view companies in corporate incubators as being hand-held and as a result may not have learned the hard lessons necessary to run and scale a successful business.

Conclusion

Joining a corporate incubator or accelerator can be one the best steps a young and potentially successful company can take and should be given serious thought if such an offer should present itself. It is important, however, to understand the risks of doing so and what it can mean for your company’s brand, image and future opportunities as it starts to take-off. Finally, if you do choose to join a corporate incubator, always always always have a well thought out Plan B in your back pocket as large companies are known for pulling the plug on such corporate programs without much notice even with the slightest downturn in quarterly earnings.

 

 

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Regulations to be Aware of When Starting a Peer-to-Peer Money Transfer Company

ZackRobockBlogPicDetectiveTransferring money between friends can be a big hassle, and a number of startups are seeking to offer new peer-to-peer money transfer options.  However, given the fungibility of money and increasing concern with terrorist financing, money laundering and fraud, there are a number of regulatory requirements to be aware of.

Companies in the peer-to-peer money transfer industry are generally referred to as “money transmitters.”  Federally, money transmission is defined as “the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.”  This does not include a company that sells a product or provides a service and accepts money electronically; rather, it applies to the business of facilitating funds transfers from one customer to another customer.  PayPal, Venmo, Western Union, and MoneyGram are some common examples.

First, a money transmitter must comply with state regulations in every state in which it does business – not just the state in which it is organized.  In Michigan, for example, this would entail compliance with the Money Transmission Services Act (“MTSA”), which requires registration and licensing with the Department of Insurance and Financial Services (“DIFS”).  Among other requirements, the MTSA requires that a money transmitter:  (a) have a net worth of $100,000 or more, depending on number of locations (§487.1013(1)); (b) have a surety bond of at least $500,000(§487.1013(5)); and (c) submit a list of all criminal convictions, material litigation and bankruptcy events for each control person of the money transmitter (§ 487.1012(2)).  Money transmitters must pay a $600 investigation fee upon application, plus a $2,500 base license fee, plus an annual license fee set by the DIFS.  Requirements in other states may vary from Michigan’s.

ZachRobockBlogPicMoney

Second, on a federal level, a money transmitter falls under the broader heading of a money service business (“MSB”), which also includes currency exchange, check cashing, traveler’s checks, money orders, and stored value/prepaid cards.  All MSBs must comply with the Bank Secrecy Act (“BSA”), which is designed to prevent and detect money laundering and terrorist financing.  The Financial Crimes Enforcement Network (“FinCEN”) is the federal regulatory agency primarily responsible for BSA compliance.

Under the BSA and related regulations, MSBs must register with FinCEN.  This registration is a bit different than state-level registration; the FinCEN registration is meant to enable MSBs to electronically file certain reports required under the BSA.  MSBs must file currency transaction reports (“CTR”) with FinCEN for any transaction that involves more than $10,000 in currency.  This does not apply to money transfers conducted entirely electronically; it only applies to transactions in which more than $10,000 in physical currency is deposited, withdrawn or exchanged.

The next type of report, a Suspicious Activity Report (“SAR”) is more applicable than CTRs to online money transmitters.  A SAR must be filed with FinCEN if a single transaction (or related series of transactions) appears ‘suspicious’ and equals $2,000 or more.  A transaction is ‘suspicious’ if it appears to:  involve funds derived from or in furtherance of illegal activity; be structured to evade reporting requirements (i.e. the $10,000 CTR threshold); or serve no apparent business or lawful purposes.  An MSB is required to maintain a copy of every SAR filed and the accompanying supporting documentation for a period of five years after filing.  MSBs should also keep records of investigations that do not culminate in a SAR filing in order to demonstrate an effective SAR program.

In addition to SAR-specific recordkeeping, the BSA outlines a number of other recordkeeping requirements, both for recording transactions and identifying customers.  Notably, if the customer (sender or recipient) is not an established customer, then for every transaction, an MSB is required to obtain an identification number (i.e. social security number, alien identification number, passport number) or to record a lack thereof; for in-person transactions, the MSB must also verify the customer’s identity by checking a government-issued identification card.  If the customer is an “established customer” then the MSB need not verify this information for each transaction; however, the definition of established customer requires that customer information – including a social security number (or similar identification) – be kept on file.  ‘Know Your Customer’ (KYC) best practices include verification of customer information at the time of account opening – either by documentary methods (i.e. review of government document) or non-documentary methods (i.e. checking a customer’s Social Security Number against credit reporting agency records); however, an MSB is not explicitly required to verify customer information under the BSA regulations.

Finally, MSBs are required to implement a process to receive, process, and respond to law enforcement requests for information.  Under Section 314(a) of the Patriot Act, certain law enforcement agencies may request information through FinCEN from financial institutions regarding customers or transactions reasonably suspected of involvement in money laundering activities.  An MSB must designate a point person to receive such requests, provide that person’s contact information to FinCEN, and ensure that requests are handled in a timely manner.

 

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New California “Do Not Track” Privacy Policy Requirements

Do Not Track ImageThe use of tracking software by websites is widespread. Advertising companies and social networks use technology such as cookies to track the websites consumers visit and the route they take from one website to another. For instance, tracking technology can tell the difference between whether you got to a website through a Google search or by clicking on a hyperlink in a news article. Companies can then use this information to build a profile on individuals in order to target advertising on different websites that they visit. Advertising companies are then able to discriminate to different consumers based on the profiles the companies build. Additionally, advertising companies are able to make money by selling these valuable profiles to websites.

The use of this type of tracking software is, as probably expected, controversial. Privacy advocates believe this tracking to be an invasion into web users’ privacy and that the companies doing this tracking fail to adequately disclose the full extent to which this tracking is taking place. These advocates are also concerned with the extent of information tracked, which can include highly sensitive and personal data about health issues, location, and finances. On the other hand, advertisers and companies using the data love the technology because it allows companies to target consumers more accurately and allows advertisers to charge more for better data. This data can be particularly valuable for startups looking to increase the number of users and grow their web presence.

As a result of these concerns, privacy advocates have taken some steps to try and remedy these concerns. Software developers have designed software to try and prevent websites from tracking user activity across the web. The technology works by placing a signal on the users computer that tells websites the user does not want to be tracked. This signal is currently ineffective because there is no requirement that advertisers follow the signal. The World Wide Web Consortium (W3C), an organization that sets standards for the web, created a working group composed of privacy activists, advertisers and others, to try and develop a standard approach to “Do Not Track” signals. In September 2013, however, the effort ended in failure when the constituent parties could not agree on an approach and decided to disband.

Despite the failure of the W3C efforts, once again California leads the way in regulating and shaping regulation of online privacy, this time as it applies to “Do Not Track” signals. California has taken an assertive stance in developing regulations concerning online privacy by passing the Online Privacy Protection Act (CalOPPA) and establishing the Office of Privacy Protection as part the California Department of Justice. Given California’s large and tech-savvy population it is incredibly important for startups to keep apprised of and comply with California privacy regulations as they will almost certainly be operating in the state. In October 2013, Governor Jerry Brown signed into law an amendment to CalOPPA that regulates the use of Do Not Track signals by websites operating within the state. The new amendment is applicable to websites that collect “personally identifiable information” which includes things like name, address, email address, telephone number, or other identifiers that allow the website to contact the user and went into effect January 1, 2014. Rather than requiring that websites comply with Do Not Track signals, the law now requires that websites describe in their privacy policy how they react to “Do Not Track” signals, and indicate whether third parties can collect “personally identifiable information”, if they track user activity, in addition to the previous CalOPPA requirements. Websites may also meet the new requirement by posting a “clear and conspicuous hyperlink” to a description of any program that the website uses to manage online tracking and give the consumer the ability to opt-out. As a result, websites are not forced to cease tracking user activity, but simply requires a website to tell the user what they are doing. Websites who do not comply, are subject to a warning from the California Attorney General requiring the operator to comply within thirty-days and also faces the possibility of lawsuits from the state government and private parties.

The new law has come under fire from both sides of the online privacy debate. Some, such as Eric Goldman, a Professor at Santa Clara University School of Law, argue that the law hurts websites and consumers by imposing additional compliance costs on websites, not providing true disclosure because consumers rarely read privacy policies, and failing to cover all tracking technologies. Others, such as Chris Cronin, an information security professional, argue that the law falls short because it is weak and does not require websites to protect user privacy or comply with “Do Not Track” signals. Regardless, given California’s de facto ability to set national privacy standards and the fact that compliance with the new law is simple, it behooves startups to comply with the new recommendations by amending their privacy policies.

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COPPA: Protecting Children’s Privacy Online

COPPA is designed to protect the privacy of children, but complying with COPPA can be difficult for startups.

COPPA is designed to protect the privacy of children, but complying with COPPA can be difficult for startups.  Attribution: Mike Licht.

Do you operate a website or app that is targeted at children? Even if your website or app is targeted at a general audience, do you know that you collect some personal information from children? If you answered either of those questions with a “yes” or even a “maybe,” there is a good chance you are subject to the Children’s Online Privacy Protection Act of 1998 (COPPA). Under COPPA, operators of a website or online service directed to children under the age of 13, or who knowingly collect personal information from children under the age of 13, are generally prohibited from collecting this information without parental consent. While there are exceptions and safe harbors to this general rule, compliance can be quite burdensome for start-ups with limited resources.

The Trouble with Verifiable Parental Consent

The Federal Trade Commission (FTC), charged with regulating COPPA, proclaims, “the primary goal of COPPA is to place parents in control over what information is collected from their young children online.” Hence, compliance with COPPA requires some method of obtaining verifiable parental consent for the operator to use, collect, or disclose a child’s personal information. This is the hurdle that trips up most startups falling under COPPA. As you can see below, the process of obtaining this consent is burdensome and inconsistent with the startup’s efforts to onboard new users with as little friction as possible. One FTC-recommended approach requires operators covered by the rule to perform all of the following:

  1. Post a clear and comprehensive online privacy policy describing their information practices for personal information collected online from children;
  2. Provide direct notice to parents and obtain verifiable parental consent, with limited exceptions, before collecting personal information online from children;
  3. Give parents the choice of consenting to the operator’s collection and internal use of a child’s information, but prohibiting the operator from disclosing that information to third parties (unless disclosure is integral to the site or service, in which case, this must be made clear to parents);
  4. Provide parents access to their child’s personal information to review and/or have the information deleted;
  5. Give parents the opportunity to prevent further use or online collection of a child’s personal information;
  6. Maintain the confidentiality, security, and integrity of information they collect from children, including by taking reasonable steps to release such information only to parties capable of maintaining its confidentiality and security; and
  7. Retain personal information collected online from a child for only as long as is necessary to fulfill the purpose for which it was collected and delete the information using reasonable measures to protect against its unauthorized access or use.

As a writer, I will be lucky if you actually read through all seven steps, let alone comprehended what each required for compliance. Now, imagine trying to advise a start-up to implement each of those . . . yeah, right.

Why You Should Comply with COPPA

While there are exceptions to obtaining prior parental consent, they are too narrow for the scope of this post, and unlikely to have much impact on COPPA compliance. So, why should operators care about being subject to COPPA, and how can they reasonably comply? Violators of the rule can be held liable for civil penalties of up to $16,000 per violation, which can add up quickly and debilitate a cash-strapped start-up from moving forward.

Realistic Solutions for Complying with COPPA

1. Don’t Fall Under COPPA by Clearly Avoiding Children User’s – The cheapest and easiest way to comply with COPPA is to simply not fall under the rule in the first place—don’t target children under the age of 13, and ensure that you aren’t collecting personal information from children under the age of 13.

2. “Age-gate” to Avoid Falling Under COPPA – In order to avoid COPPA’s coverage, consider using one of the following free options that utilize an “age gate” function, which requires a user to enter their date of birth in order to certify their age, before entering a website or app:

  1. If the user is under the age of 13, you can just deny their access to the website or app.
  2. If the user is under the age of 13, you can also allow the user to only access the online service through a “safe-mode” that does not collect, use, or disclose a child’s personal information. This means prohibiting a child from setting up any type of account or profile, and requires close monitoring of a child’s activities. For example, any text or input of any kind from a child must be monitored to prevent identification of the anonymous user profile.

3. Use a Safe Harbor Program – One plausible route for obtaining verifiable parental consent is through the FTC-approved COPPA safe harbor programs. Examples of these safe harbor programs include iKeepSafe, KidSAFE, and TRUSTe. While there seems to be some uncertainty surrounding these programs, the prospect of having service providers handle companies’ COPPA compliance is appealing and most likely the direction we are heading. These programs can serve as a portal for parents to read the privacy policies of multiple websites and provide consent, all in one easy-to-use location. Of course, this comes at a cost.

Understandably, some operators will fall under the umbrella of COPPA due to their business model. In this case, it is highly recommended that you consult a COPPA compliance attorney before launching the online service. However, if it is possible to exclude children from your online service, consider the aforementioned approaches for bypassing COPPA.

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Avoiding Inequitable Conduct and Meeting the Duty of Candor and Good Faith

If entrepreneurs are not careful in their communications with the Patent Office, their valuable patents may later be found to be worthless.

If entrepreneurs are not careful in their communications with the Patent Office, their valuable patents may later be found to be worthless.

What is Inequitable Conduct?

As a fledgling startup, maximizing the value of the company is important when attempting to obtain early funding. For many startups the lion’s share of their value comes from their intellectual property. Obtaining and keeping that IP is critical. With that in mind it becomes crucial for entrepreneurs to consider issues of inequitable conduct and duties of disclosure when applying for patent protection for their intellectual property.

Inequitable conduct is a judge-made doctrine that allows the court to render a patent unenforceable if the patentee engaged in certain prohibited conduct during the application and prosecution of a patent. Inequitable conduct requires the patentee to intentionally misrepresent or omit material information from the patent office, as discussed here. This includes:

  • Failure to submit documents, including material prior art known by the applicant or explain/translate foreign language references
  • Misstating facts or affidavits of patentability
  • Incorrectly or incompletely identifying inventors

Further, the USPTO has enacted Rule 56, which holds that “each individual person “associated with the filing and prosecution of a patent application has a duty of candor and good faith in dealing with the Office, which includes a duty to disclose to the Office all information known to that individual to be material to patentability.”

In the case of withheld prior art, under the Therasense standard, a defendant would need to show that a plaintiff patentee or their counsel:

  • Intentionally withheld or misrepresented information; and
  • The information was material.

To be material the defendant must show that the patent would not have been granted “but-for” the omitted prior art.

The penalty for inequitable conduct is invalidation of the entire patent. In addition, the lawsuit often becomes “exceptional” which can force the losing party to pay the other side’s attorney’s fees.

Defending against a charge of inequitable conduct can significantly increase the costs of litigation and patent ownership, even if one defeats the charges.

How Do I Avoid it?

First and most importantly, it is imperative that a startup ensure correct inventorship on any patent application. USPTO rules require all inventors to be listed on the patent application. An inventor is any person that participated in conception of the invention. That is, anyone who helped come up with the idea and form of the invention. Persons who simply helped build the prototype or who contributed ideas and knowledge that was not used in the version that is being patented need not be included.

Startups often have numerous founders or others who are involved in the conception of an invention. Be sure to keep track of these people and name them on the patent application. Further, do not intentionally omit a person who should be listed as an inventor in an attempt to avoid ownership issues (for example if a professor assisted in creating an invention and the startup is concerned about the University claiming title). While it may be the easier solution now, it risks the entire patent being unenforceable later.

Second, entrepreneurs must be diligent in preparing their application or in working with their counsel to prepare an application to ensure all prior art known is considered and disclosed if relevant. The USPTO does not require applicants to perform prior art searches, so applicants and their attorneys are only responsible for disclosure of prior art that is known to them. However, it is the responsibility of the applicants to ensure that no relevant information is being withheld.

If in doubt about the materiality of a reference, it is always better to err on the side of disclosure. Further, the duty of disclosure extends through grant of a patent, and if any prior art becomes known to an applicant it should be disclosed to the USPTO. Keep in mind that the duty of disclosure extends to the inventors, their counsel, and anyone involved in preparation of the application or anyone to whom there is an obligation to assign the patent. Entrepreneurs should be sure to check with every person meeting those criteria to ensure no prior art is being withheld. Keeping records of any prior art searches and of personnel having knowledge of an invention is extremely helpful when it comes time to apply for a patent.

Finally, the new patent reform act created a new administrative procedure called supplemental examination. This procedure can be used to cure inequitable conduct for a patent that has issued. A patentee may present new information to the USPTO and the examiner will consider whether the patent should have been issued in light of the information. If the patent is allowed in light of the new information, it cannot be later held to be unenforceable due to failure to disclose that information in the original application (but could still be held unenforceable for failing to disclose other information that was not included in the supplemental examination). Essentially it is a patent amnesty program. Entrepreneurs who have already obtained patents and are concerned about inequitable conduct should speak with counsel regarding supplemental examination.

By keeping records of the persons involved in conception of a new technology and their roles, as well as keeping track of what references were consulted or searched, it can save time and headaches when it comes time to apply for a patent and can make all the difference if the patent one days ends up disputed in court. For those entrepreneurs who already have a patent and are concerned about false or omitted disclosures, supplemental examination can be extremely useful.

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Trade Secret vs. Patent Protection for Software Startups

In light of recent changes in the law concerning software patents, software startups should more heavily consider trade secret protection to protect their technological and operational advantages.

In light of recent changes in the law concerning software patents, software startups should more heavily consider trade secret protection to protect their technological and operational advantages.

So you’ve launched a software startup. You know that if you are to have any hope of becoming the next Google, Facebook, or Twitter success story, you need to take steps to protect your technology and your brand. Making the choice to invest some resources into obtaining intellectual property protection can be a great decision, but the specifics of how to carry out such a plan might be a little elusive. The question is what kind of protection do you actually need, and how do you go about getting it.

Two types of IP protection that most startups will want to consider are patents and trade secrets. What works best will vary from startup to startup depending on each ones own unique circumstances. However, there are several factors that all startups will want to consider when implanting an intellectual property protection strategy. First, let’s consider the basic types of IP protection that the patents and trade secrets provide, and then we can better understand factors that might encourage you to choose one or the other.

Patents

One type of IP protection that most people have heard of but few people fully understand is patent protection. There are several categories of patents, including utility patents, design patents, and plant patents. Plant patents and design patents give inventors rights in specific areas as defined by statute. However, the most common type of patent is the utility patent.

Utility patents grant the holder an exclusive monopoly on inventions of “new and useful process, machine, manufacture, or composition of matter, or a new and useful improvement thereof.” For example, someone could obtain a patent on a new and improved hair trimmer as long as it was different than and not obvious in light of previous hair trimmers. Last year, over 500,000 utility patent applications were filed at the U.S. Patent & Trademark Office.

Patents, utility patents in particular, enjoy popularity for several reasons. First, they grant the rights holders a very strong form of protection. This protection – the right to prevent others from making, using, selling, offering for sale, or importing the patent holder’s invention – is given in exchange for a publication that explains how to make and use the invention. After twenty years anyone is allowed to make and use the invention. When considering whether or not to apply for a patent, a software startup should evaluate whether or not the exclusive protection is worth having in exchange for giving up their invention after twenty years. In many instances, this will be a good tradeoff to make given the rapidly evolving world of software and technology.

Another benefit of utility patents is that the patent holders will not lose their rights due to the actions of third parties, assuming that they justly received the patent in the first place. This may not necessarily be true with trade secret protection. For example, a person who has trade secret protection in a manufacturing process can not prevent a third party from independently discovering and using such a manufacturing process. But if the original inventor of that manufacturing process acquired a patent, the third party could not use the process even if they independently discovered it (assuming that the patent holder had a valid patent that was not acquired through fraud).

While there are some significant upsides to obtaining a patent, there are costs as well. One downside that was already mentioned is the limited duration of patents. Another potential downside is the cost and difficulty of obtaining a patent. As discussed in our recent post, in recent years, it has become more and more difficult for inventors to obtain patents on software, and the scope of granted software patents may be more limited. Getting a patent can also be quite expensive. Depending on how many jurisdictions (i.e., countries) your startup is applying for patents in, the price tag can reach into the hundreds of thousands of dollars. See our prior post outlining the costs of obtaining patent protection.

Trade Secrets

Unlike patents, trade secrets are creatures of state law rather than federal law. This means that specific trade secret regimes will vary some from state to state; however, there are generally accepted principles regarding how trade secret law should work. One attempt to compile some of these generally accepted principles is the Uniform Trade Secrets Act. This document defines trade secrets as follows: “’Trade secret’ means information, including a formula, pattern, compilation, program, device, method, technique, or process, that: (i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.” In short, a trade secret is information that is valuable because it is kept secret. State laws prevent the “misappropriation” of trade secrets. This basically means that people aren’t allowed to steal your secret sauce. They can, however, independently create or reverse engineer it. This is one of the main disadvantages to trade secrets.

There are several benefits to weigh this disadvantage against when considering whether or not to rely upon trade secrets as your chosen form of IP protection. One benefit is that trade secrets can be relatively cheap compared to patents. There are no government filing fees for trade secrets, and the main costs result from taking measures to make sure your secret information remains secret. Trade secrets also can last forever assuming the information remains secret. This can be advantageous if you believe your invention will have commercial value for a long time to come.

Choosing Trade Secrets or Patents

One form of protection or the other will not be right for every startup. The following are some factors to consider when choosing between the two: (1) Will the invention be useful beyond 20 years? (2) Is it possible for companies to reverse engineer the invention? (3) Is the invention likely to be discovered independently in the near future? (4) Can you afford more expensive patent protection given your goals? (5) What is the risk that competitors design around a patent? (6) Are you interested in licensing/cross-licensing with competitors? (7) Would you be able to detect if someone was infringing your patent?

Let’s look at a couple of examples in order to understand how these factors can play out.

Example 1:

A software startup has developed a technology that has never been seen before, but as soon as you sell it, everyone will understand how to make it. They believe that this technology will be relevant for 5-10 years, but are not sure beyond that. Finally, the startup thinks there a lot of potential competitors who will likely be interested using this technology.

In this example, the startup would likely want to obtain a patent because all the factors lean in that direction. It will be easy for other competitors to develop similar products once they see the startup’s new technology; this will greatly reduce if not eliminate the value of any trade secret protection. The indefinite duration of trade secrets wouldn’t really be that valuable even if competitors couldn’t reverse engineer the product. The technology will only be relevant for 5-10 years, well less than the time frame protected by patents. Finally, because there are a lot of potential competitors that might be interested in using the technology, the startup could potentially operate on licensing business model to obtain revenue or cross-licenses.

Example 2:

A software startup has made a discovery that they believe is so foundational in nature that they believe it will revolutionize the industry for many years to come. They’re a little low on cash right now, but they expect that to turn around in the next year or two. Finally, the discovery should improve the ease with which current products are made, but the final products themselves won’t necessarily be changed.

In this example, the startup will likely choose to rely on trade secret protection. Given the foundational nature of the discovery (think F=MA2 rather than a bulldozer applying the principal of F=MA2), it is not even clear that the discovery would be patentable.  Further, the startup does not have a lot of money to try and convince the USPTO that the discovery is in fact patentable. Finally, it looks like the manufacturing processes for widgets will change, but this will not be detectable in the final widgets themselves. Thus, it might be very difficult to tell if a competitor was infringing a patent. Relying on trade secret protection will mitigate these concerns and allow the startup to profit for the discovery for many years to come.

It is important to note however, that deciding between a patent and trade secret does not necessarily have to be an either or proposition. It might be possible to go the trade secret route at first, and then obtain a patent further down the road. However, this is a one way street. Once you obtain a patent, you can never go back and rely on trade secret protection. Also, you can split up various aspects of your business. Certain aspects of the business might be appropriately covered by patents while other aspects would be great candidates for trade secret protection.

Conclusion

Startups creating an IP protection strategy should make decisions in light of their business model and technology. If it is not a clear decision to go one way or the other, the startup will need to make a calculated decision as to what factors are more important to them. Finally, when appropriate, startups should consider using patents and trade secrets in a hybrid form of protection.