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The Perils of Contracting Through Third Party Websites

MichelleSargentBlogPicThe internet has a wealth of resources for start-ups, from legal and venture financing blogs to form documents and state entity-formation pages. There are also many pitfalls to leveraging the internet that unknowing and uncounseled start-ups may not identify. One of these is the use of third-party websites to enter agreements.

For example, a start-up wants to use a contractor to develop some code for their mobile application. The start-up finds a website that allows parties to post a project that needs completing and has users make bids to win the project. (There are many such, or similar, websites, such as Freelancer.com, Elance.com, and Guru.com.) The start-up posts its project, and an unknown individual somewhere in the internet world is contracted to complete it.

On its face, this is an easy and low-cost way of finding work for hire. But what may the start-up not consider: Is its intellectual property protected? Is any intellectual property created by the worker assigned to the start-up? What happens if there is a dispute about the completion or quality of the work? What is the worker’s classification for employment and tax purposes?

1.  Worker Classification

Any time a company wants to bring in somebody to do some kind of work for the company, the company must address how to properly categorize the worker for employment and tax purposes. As this blog has previously discussed, in a January 31, 2013 posting by Tasha Francis on Hiring Tips for First Time Entrepreneurs, there are important ramifications to getting the classification correct. And the correct classification may not be the one that matches the start-up’s financial capabilities or expectations. In using third-party websites to locate workers, the classification problem is magnified because (1) there may be no explicit agreement or provision stating how the worker is classified, and (2) it is possible the website loosely uses terms such as “employer” and “employee”—even when categorizing independent contractor relationships.

The purpose of these websites is to allow companies to hire remote, unknown individuals who specifically market and offer their services through the website to perform a specific project, on a specific time schedule, for a specific fee. This seems to create a quintessential independent contractor relationship. Many of these websites’ terms of service, however, explicitly refer to the company seeking services as the “Employer.” And the generic terms of service may not describe the nature of the relationship between the two parties contracting for work—unless the parties independently choose to enter into a separate independent contractor services agreement (the terms of which may not conflict with any terms in the terms of service). Although a start-up may ultimately be protected by the actual nature of its relationship with these electronically engaged workers, the terminology and lack of a defined relationship is just one of many ways relying on a third party may undermine the company’s legal rights and relationships.

2.      Intellectual Property

For many emerging companies, their intellectual property is the company’s main—and potentially only—valuable asset. And seeking to protect this IP is often one of the first steps taken by lawyers representing start-ups. Yet, when an uncounseled start-up engages through a third-party website, it is highly unlikely any of the typical IP assignment or proprietary information protections are contained in the default terms of the relationship.

Now we will return to the company that retains a contractor to develop a mobile application. On the one hand, the company must send proprietary information to the contractor describing its business, what its vision is for the mobile application, specifics for its user interface, the types of users it envisages, etc. Without any nondisclosure agreement, this proprietary information will not be protected from the contractor disclosing it to other parties, or developing the information in third-party products. On the other hand, the contractor will be writing code and developing an interface that will be an integral part of the company’s platform and business plan. But without any intellectual property assignment provision, any copyright and other intellectual property in the work performed by the contractor will not belong to the company. Although it may seem distant to the start-up now, any outstanding, unassigned intellectual property gives individuals a future opportunity to come back and seek something from the company.

It is highly unlikely that a third-party website will contain default provisions sufficient to protect existing company IP or to assign any contractor-created IP. On the contrary, many of these websites include express disclaimers that they are merely acting as a portal and are not subject to liability for any claims under any IP laws. It does not, however, include any IP assignment language from contractors to users, or any default nondisclosure provisions. Therefore, unless a start-up independently identifies the need to draft a separate and independent agreement assigning any IP and protecting the confidentiality of any of its proprietary information, it leaves potential holes in its IP protections.

3.      Dispute Resolution

So what if the relationship created on this third-party website goes wrong, what can a start-up do? Here, there are two main considerations: Does the third-party website impose any dispute resolution conditions on users? And should litigation arise, where would it take place?

A brief survey of the terms of service of several of these third-party websites reveals the existence of mandatory dispute resolution or arbitration provisions. What do these mean? Say the start-up is unsatisfied with the quality of the work performed by a contractor and wants to renegotiate the rate it has agreed to pay for the services based on the poor quality: First, the parties may be required to attempt to independently negotiate and resolve any disputes. They may also, however, be prevented from renegotiating the fee for a project after it has begun. Therefore, the parties would be required to submit the dispute to the third-party website, which may grant itself the full power to resolve the dispute, including the determination of the documents that can be submitted in support of the dispute. Alternatively, the parties may be required to submit to arbitration in which the third-party website selects an arbitration team that makes a binding, irreversible decision on the dispute. In many of the terms of service for these websites, there are no express provisions providing for litigation between users. And insofar as the purpose of the website is to bring together individuals globally to provide services, there is the distinct potential that contractors may be judgment-proof—either geographically isolated or financially unable to be hailed to court in a foreign country to face charges for breach of contract or copyright infringement.

And what if the start-up wants to raise a dispute with the third-party website? There are the obvious broad disclaimers of all kinds of warranties, limitations of liability, and indemnification requirements. But the terms and conditions can also establish that the agreement is subject to foreign law with irrevocable and exclusive jurisdiction in foreign courts. For uncounseled start-ups, the potential pitfalls of being unable to dispute a contract—because litigating abroad is unfeasible—were probably never considered.

These provisions and examples reveal the unforeseen liabilities of entering into agreements through third-party websites. Even for start-ups that may benefit from legal advice in order to draft separate agreements dealing with IP and worker-classification issues, it is likely that the third-party website’s terms and conditions will seek to limit the effect of these agreements to the extent they may be inconsistent with the website’s terms and conditions. And so even extra-website attempts to contractually change dispute resolution procedures may be ineffective. Nonetheless, there are differences in the terms of service across these websites, with some providing for more default, start-up friendly provisions or options to protect IP, classify workers, or dispute services, and at the very least, start-ups may want to consider digging deeper before selecting a third-party service.

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