Contractors & Copyright – don’t be held over a barrel

Most of the time I meet a new client, they’re in some sort of crisis. Often it’s a crisis of their own making, in which they’re so deeply mired in that they can’t self-extract. I greatly prefer to work on constructive projects where problems are anticipated, planned for, and ideally never become reality. I’m sure every entrepreneur feels the same way. Far too often, however, my first piece of work for a business is in dispute resolution rather than project-building. Some mistakes that seem like molehills at the time turn into mountains more quickly than anticipated. One common mistake that many small business owners make is to assume that they own all of the creative works that were made for their business by outside contractors – website and branding, most frequently.

Like your Business Depends On It…

For many companies nowadays, creative works – logos, graphic design, custom-built website code – are at the very core of their business. They can be part of your lead generation, customer services, e-commerce, promotions, and product education. For web-based businesses, much of the business’ actual value is in its “goodwill” – or the je ne sais quoi that makes your business profitable. Your web store ain’t going to generate much profit if it’s not online, well-maintained, and has proper user support, after all. Your brand ain’t going to expand very well into new markets if you’re restricted in how you can use your logo and graphics. If you ever hope to sell the business, pass it on to your kids, or bring investors on board, they’re going to want to know that the value of the business is secure. This is why it’s important to be certain of what your business owns. We do this by getting the rights to use creative work that’s made for your business in the way you want to use it. We law-nerds call that a “license”.

Without a license in place, an unscrupulous contractor can hold your company over a barrel for more money and threaten copyright enforcement proceedings if you use what they created. Shady? Hell yes, but it happens disturbingly frequently. I’ve seen it over and over, especially with coders building custom websites for internet-driven businesses. The designer gets to 80-90% completion so the business is fully committed, then work “stops while we work out licensing terms”. All of a sudden they want an annual fee to use the code, to be hired on to maintain and support the site, or to be paid every time you re-use the logo in a new setting. In the meantime, they lock down the 90% complete work so you can’t access it, and your business hangs in limbo.

That’s why It’s hugely important to negotiate the terms of the license – that is, the things you are and aren’t allowed to do – before you start working with the contractor. That’s the point where you, as the customer, have the most leverage, and can get the terms that best suit your needs. There are lots of graphic designers and web-coders out there – it’s a buyer’s market – so don’t be afraid to shop around. It’s easiest make sure that there are terms of license in the services contract that you sign, or an “assignment” of the rights that you need to deal with the work as needed. Otherwise, you’ll need to negotiate a side agreement. Only fools rush in – as soon as you’ve paid the contractor and work has begun, your leverage decreases. Now they have two things you need – your money, and the creative work – and you have neither.

Copyright

Our first stop on this magical journey into licensing is a quick look at copyright. Copyright is the right to produce or reproduce the creative work or any major part of it, to publish or exhibit the work, to perform it, communicate it, rent it, or to authorize any of the above. It applies to all original literary, dramatic, musical, and artistic works, performances, sound recordings, computer programs, and communication signals, which I’ll call “creative works”. Copyright is designed to protect the creator of the work by giving them the exclusive right to profit from what they made.

Copyright protection comes into being as soon as the work is made, and applies to work-in-progress as well. It’s an automatic thing, so the creator doesn’t have to take any steps to register it in order for the work to be protected. Registering copyright work with the Canadian Intellectual Property Office is evidence of ownership, however. Registered or not, copyright lasts for the rest of the creator’s life, plus 50 years afterwards.

Employee or Contractor?

This article is meant for those dealing with outside contractors. Most small businesses will hire a contractor or company to do their creative work – like I did for my kickass business cards – as there’s not enough work to keep a designer busy as an employee.

If you’re lucky enough to have an employee who’s skilled in the ways of creating things, you don’t need a license or assignment. Any work an employee does in the course of their duties as an employee belongs to the employer. That rule is a fundamental part of the employer-employee relationship. That rule can be opted out of by contract.

An independent contractor, on the other hand, will own the copyright in whatever they create. This is true whether the contractor is an individual, partnership, or corporation. The line between employee and independent contractor can be blurry, and there’s a lot of grey area in the law. It boils down to how much control the employer exercises over the worker. The more control – like setting hours and place of work, ownership of tools, having the chance of profit and risk of loss – the more likely it is that they’re an employee in the eyes of the law.

If there’s a chance that a worker could claim they’re an independent contractor, you’re better safe than sorry. Get a license agreement or an assignment of intellectual property rights in writing.

License

A license is a contract giving permission to do something you’re not ordinarily allowed to do. We deal with licenses all the time – a driver’s license allows you to drive a car; a software license allows you to use a computer program; a liquor license allows a bar to sell alcohol; even a Blue Jays ticket is a license to go to the game and occupy a certain seat. Here, I’m talking about the right to use a copyrighted creative work in the ways your business needs to operate.

So, what things might you want to do? The main “rights” granted in creative works include the right to:

  • Use the work
  • Make copies of the work
  • Modify or improve the work
  • Distribute and redistribute the work
  • Sub-license the work

Certain rights, called “moral rights” will always belong to the designer, and can’t be assigned to another person. Moral rights include the right to the integrity of the work, and the right to be associated with the work (or remain anonymous, as the case may be). The creator can waive their right to enforce their moral rights.

Licenses can be exclusive, meaning that the creative work was made just for you, and nobody else can have it, not even the designer, or non-exclusive, meaning that the designer can re-use or re-license out the same design. Exclusive licenses make more sense when there’s a great deal of custom work involved, the creative work is central to your business, there’s risks your competitors might steal your model, or you’re laying out some serious cash to get the work done. Non-exclusive rights work better for simpler, more generic work – like basic web design or package deals – where there’s little risk of losing out if your competitors have something similar.

The most general of all is an open-source license. Sometimes called “copyleft” or a “permissive license”, open-source means that anyone can copy, distribute, and modify the work for any purpose, and without fees. There are several types out there, with varying limits on what can and cannot be done. Many web programming platforms, such as WordPress and Drupal, are subject to open-source licenses for any “derivative” works – as in, anything that’s made to tack-on to their platform must be distributed as open-source as well.

Pro-Tips

The toughest part in negotiating a license is finding the balance point where your business is protected, but the person doing the creative work has the freedom to use the tricks of the trade they’ve picked up to continue to earn a living. That’s why it’s important to know precisely what is being licensed, and what you’re using it for. The most certain way to achieve that is with a written license agreement.

Here are a few things your business can do to make sure you’re in the best position:

  • Know what you’re going to want to use the work for, and ensure that the designer is willing to give you those rights
  • Research what the industry standards are for licensing or assignment in the designer’s field of work
  • Get the license terms or assignment of rights in writing before you pay the designer, and before work begins
  • Know for sure whether the designer is an independent contractor or employee
  • Host the work-in-progress on your own servers, not the designer’s
  • Work with designers in your own jurisdiction – as enforcing an international contract can be all but impossible

Of course, there’s no joy quite like the joy a lawyer can bring to your life by taking the dreary contract drafting work off of your hands… I happen to know a guy… 😉

 

Mike Hook
Intrepid Lawyer
http://intrepidlaw.ca
@MikeHookLaw

What is a Joint Venture?

Many folks in business bandy about the words “partnership” and “joint venture”, or even a “JVP” (short for joint venture partnership – a made up term like “Leafs playoff tickets” or “government transparency”), without understanding that partnerships and joint ventures are different legal animals. Though the two have much in common, there are a few important differences that, if not understood from the outset, could affect your work together in strange and not-at-all-wonderful ways. If it walks, talks and acts like a partnership it will likely be treated as one, even if the intention was to create a joint venture. Ergo, it’s important to be clear and precise when creating a co-owned business, in order to avoid unexpected complications with tax, ownership of property, or liability.

What’s the diff?

Partnerships and joint ventures are both agreements to do business together between two or more individuals or corporations, with the goal of making a profit. Both are formed and governed by contract between the parties.

Joint ventures usually are usually used for one-off projects. They’re limited in time and scope – you’re not working together on everything, and they’ll often have an expiry date, which allows parties to renew or eject. They’re particularly useful when you’ll all be putting in different skills and assets, in different quantities. Joint ventures don’t create a separate business entity, and generally are not registered with the government. You work together to the extent that’s agreed to in the contract, and that’s it.

Partnerships, which I talked about in this other article, create an ongoing business relationship through a partnership agreement. Partnerships must be registered as a business entity with the government, and are governed by the rules in the Ontario Partnership Act.

Key terms in the contract

Terms common to both joint ventures and partnerships include:

  • Length of the agreement and conditions for renewal
  • What the business will and will not do
  • What money, assets or skills each party is contributing
  • Share of profits and losses, salaries, and expenses
  • Calculation of profits
  • Duties and responsibilities of each venturer
  • Management structure
  • Indemnity between the venturers
  • Dispute resolution

Terms of a joint venture agreement – or JVA – include:

  • Limits on time or scope of work
  • Termination, including how to divide up assets
  • Ownership of co-created assets and intellectual property
  • Assigning liability for actions of the other venturers
  • Accounting between the venturers, record keeping,
  • Bank accounts, and insurance
  • Division of expenses and revenues

Ownership of property

Ownership of property contributed to a joint venture remains the property of each joint venturer. The party who owns the asset may use it for other purposes without the consent of the joint venture unless it’s otherwise agreed.

Assets contributed to a partnership are considered the property of the partnership and not of the individual partners.

Tax consequences

 Your accountant will care a great deal about this stuff, and the tax consequences of the business structure you choose could be substantial. Make sure to ask before you choose one or the other…

Income Tax

The distribution of profits in both is governed by the agreement. Joint venturers assess their taxes based on their own expenses and share of the revenues from the joint venture. Partners in a partnership are taxed based on the net profits of the partnership. The net profits are distributed to the partners according to their share of the partnership, and taxed at the partners’ normal income tax rate.

The choice between partnership or JV makes a big difference if one party is spending more than the others. In a partnership, a party with higher expenditures would not be able to claim that amount individually.

Capital Cost Allowance

Capital cost allowance is a tax deduction that allows a business to account for the depreciation of capital property. Joint venturers may each claim the capital cost allowance individually to maximize their own tax benefits for the depreciation of the assets they put in to the joint venture. In a partnership, the capital cost allowance claimed must be the same for each partner because only the net profit of the partnership is distributed.

Fiscal Year

Joint venturers report their share of income and losses based on each venturer’s tax year. A partnership will have its own fiscal year end.

Corporate partners in a partnership are required to claim income (but not losses) for the period between the end of the partnership’s tax year and the corporation’s tax year.

Liability

Joint venturers are liable for their own debts and obligations, and can limit their liability based on the joint venture agreement. That way a creditor can’t go after one joint venturer for the debts of the other. The venturers can agree to share responsibility for liabilities taken on in the course of the project, or can split them up however they see fit.

Partners in a partnership, on the other hand, are “jointly and severally liable” for the debts, obligations and misconduct of the partnership and the other partners. “Joint and several liability” is a legal term meaning a creditor can go after the other partners to settle one partner’s debt. The liability can be limited by creating a “Limited Partnership” where a “general partner” takes the excess of any liability that the other partners can’t cover. Each other partner is only on the hook for their own debts or misconduct up to a fixed amount. I’ll get into Limited Partnerships in a different article later.

Both joint ventures and partnerships can agree to assume only their own liability, but there is more risk involved in a partnership if the at-fault partner cannot cover the loss.

Summary

Where two or more parties want to join forces together for a one-off project rather than becoming co-owners of a business, a joint venture is typically the way to go. Whichever business structure is chosen, the choice should be clearly set out in the agreement between all parties involved. Though joint ventures and partnerships may have many characteristics in common, the legal differences between the two warrant taking the time to talk to a lawyer and figure out which structure is right for the business at hand.

I’m indebted to my awesome law student intern, Claudia Dzierbicki, for her work in putting together the guts of this article.

 

Mike Hook
Intrepid Lawyer
http://intrepidlaw.ca
@MikeHookLaw

Lawyer Stuff 101 – Contract Negotiations

It’s one thing to have professional advisors – lawyers, accountants, etc. – to point you in the right direction. It’s a whole other thing to know how to use them properly. I’ve found it’s a pretty steep learning curve for most entrepreneurs to figure out how to receive advice from, and give instructions to their lawyer. So, this is the first in a new feature I’m calling “Lawyer Stuff 101” – what a lawyer can do for you in different situations, and how the process should work.

I’ve been harping a lot on contracts lately – generally, and for record labels – since it’s a big part of my practice, so the process of birthing a contract seems a logical place to start. Signing a contract without a lawyer is like doing your taxes without a calculator – just because you can do it doesn’t mean that you should. Get your lawyer involved early in the process, as our kind know more about the points that should be covered in different kinds of deals. It’s easier to ask for something from the start than to go back to the drawing board when you realize that your deal has gaping holes in it.

Lawyers do three main things with contracts – writing them (drafting), reviewing them, and help in negotiating them. I’ll touch on each in turn.

Writing Contracts

Usually the party that’s offering the goods or services is the one who draws up the contract. The way your company does business will dictate a lot of the terms of the contract – how goods are ordered, packaged, shipped, and paid for, for instance – so it makes sense that you’d spell that out for the other party first.

It may seem odd, but it’s usually cheaper to get your lawyer to write a whole contract for you than to go through and tweak something you’ve written yourself. In order to “tweak” your contract, the lawyer’s got to review it first (see reviewing, below), and then rework it to say what you want it to say.

I usually send my clients a list of the things that they should consider for the type of contract they’re writing up, and ask them for a list of the things that they want in it. This often involves talking to the other party and figuring out the who, what, when, why, where, and how of the deal. Once that’s done, I’ll put together a first draft of the contract and send it to the client to review it.

Once you’ve read the draft, there’s usually a phone call or an in-person meeting to go through it, clause-by-clause, to make sure it says what you want it to say. Sometimes just talking through an issue raises other points that need to be added or changed in the contract. I make the changes and send an updated draft. It may take some back & forth to get it just right.

Once you’ve got a contract, it goes to the other side. Depending on what the contract’s about, there may be some negotiation involved before you can put pen to paper. The end goal is for you to have a contract that everyone understands, and says what it’s supposed to.

Reviewing Contracts

Any time you’re presented with a contract, it’s important that you understand what it says before you sign it. Contracts are binding legal agreements, and there can be major consequences – like lawsuits – for breaking them.

It’s up to you, the client, how thorough of a review you want. The thoroughness of review depends on a bunch of things – your budget, and the size of the deal tend to be the biggest factors. A review and legal opinion will be more expensive and more thorough than a general overview and flagging of key issues. The bigger the commitments being made, the more important the deal, or the more money involved, the more important it is to get it right.

When my clients send me a contract for review, I’ll ask them to tell me in their own words the deal that they think they’ve made – so I know whether or not the contract actually says that. For a thorough review, my work starts with a quick read-through, to get familiar with the structure of the contract, and its general terms. I may ask a few follow-up questions at this point, or for copies of other agreements or documents that are referred to in the contract.

The next step is a thorough read-through – word by word, clause by clause – to understand the finer points of the deal. I’m looking to make sure that the contract doesn’t contradict itself (consistency), that it ties in with other documents or agreements, that it’s fair and matches the deal you think you’ve made, that there’s nothing illegal, and that there are no significant or unusual risks (liability) that you’re taking on.

The last step is to give a written legal opinion on the contract. In the opinion I’ll explain how the deal works as written, and point out differences from the deal you thought you’ve made. I’ll flag unusual or particularly risky clauses, inconsistencies, and illegal clauses. The amount of detail in the opinion depends on the thoroughness of review you’ve asked for. Once I’ve sent you the opinion, and you’ve had a chance to read it through (a couple of times, at least), we’ll set up a call or a meeting to discuss it, which often leads to….

Negotiation

Most business contracts have room for negotiation, as both sides want a fair deal that will grow their business. The negotiation process is where you try to add as many of the things that you want to make the deal better for you, and to get rid of the things that expose you to unnecessary risk. That said, risk is inherent in business, and usually each side will take a share of it. How much risk you’re willing to accept is up to you. My job is to let you know that it’s there, and recommend a course of action – but it’s up to you to make the decision. Once you know the risk’s there, you can take steps to minimize its potential impact.

The first step of contract negotiation, which is usually tied in with the discussion of my legal opinion, is figuring out what you want. What are your must-haves, nice-to-haves, and things you don’t care about one way or the other? Then we try to figure out what the other side wants and why they want it, and brainstorm ways to work through potentially sticky negotiating points.

I usually recommend that the business people talk directly, before getting the lawyers involved in negotiations. It could be a quick phone call or email to discuss the main points, and get an agreement in principle on the proposed changes. This “meeting of the minds” between the business decision makers helps to keep the lawyers on track when sussing out the details.

Whoever is proposing changes will then have their lawyer make the changes they want to the contract, and send you back a clean copy and a “black line” version with the changes highlighted. The other lawyer will review those, advise on any variation from the agreement you made with the other party, and any new risks. The contract may get bounced back and forth like this a few times to hammer out the finer points, and the lawyers may need a phone call or two to finish it off. Any changes from the deal you’ve instructed me to get will have to be approved by you.

Conclusion

Putting together contracts can be a drawn out process, especially for complicated business deals. Most lawyers will use some variation of the above process. Start planning well in advance, and get your lawyer involved at an early stage. When it’s all said and done, you’ve got a contract that you can live with, and rely on in case it goes south.

Mike Hook
Intrepid Lawyer
http://intrepidlaw.ca
@MikeHookLaw

Record Label Contracts

Few artists would want to be considered to be “in business” for doing what they do, but like it or not, as soon as you get paid for it, you’re a sole proprietor. For artist-entrepreneurs, the art lies in the creative process – those endless hours working your fingers to the bone, trying to get that sound out of your head, and into others’ ears. Everything else is business. For a record label, owning the rights to do what you need to make your business viable is the key… and ambiguous contracts will come back to bite you in the long run. In this post, I’m going to talk about one of the first high-stakes legal issues a label and recording artist will face – the record label contract.

Contracts, generally:

A contract is a binding agreement where two parties exchange something of value, called “consideration”. The artist gives up certain rights to their creations, while the label helps you get it to market, and hopefully you both make money. Contracts are rarely an issue when everything goes according to plan… but if things go sour, you can bet your bottom dollar (or, pay it to a litigation lawyer…) that the label will use the contract to get as much for itself as it can. So, it is soooooo frickin’ important to understand what you’re signing, and agree to all of it before you sign it.

Contracts are a two-way street – a business relationship that relies on trust, and common interests to succeed. Therefore, there’s almost always room to negotiate – to remove things that you don’t like, and add in things that you want. You may be really good with keys and chords, but not so slick with the legalese – so it’s a smart idea to get a lawyer to help you interpret and negotiate the contract. The best time to look for a lawyer is at the start of your career, before you go too far down the road on the business side of the game. A little money spent at the outset can save you a ton of heartache, expense, and lost income down the road.

More on contracts in this other blog post…

Record label contracts

Every record label contract is different. Major labels may use a 50-100 page document, while indie labels might be as short as 5 pages. The gist of them is the same – the artist sells rights to exploit their songs for profit to the label, in exchange for a cut of the profits. In return, the label puts its money and influence into recording and promoting the album. Record label contracts typically include:

  • Term & territory
  • Rights & exclusivity
  • Money – royalties & recoupment
  • Cross-collateralization
  • Creative control
  • Rights
  • Release commitment

I’ll explain each of these in turn.

Term

The duration of the contract. It’s usually a fixed term (perhaps one year), during which time the artist must produce a certain number of tracks or albums to a reasonable standard.

Multi-album, multi-year deals are usually not set in stone. Typically the contract will cover the first year and first album, and give the label the option to extend it for successive terms. If the first album does well, the label will likely use its option to extend for another. If it tanks, the label probably won’t extend, and may drop you. Most labels won’t make a firm commitment to release anything beyond the first album.

It’s a good idea to set a “long stop” – or a maximum number of years the contract can run for. This gives a successful artist (as labels will likely only keep successful acts) a chance to negotiate a better deal down the road. Six or seven years is advisable.

Even after the term of the contract ends, the record company must continue to pay royalties for the artist’s work it sells.

Territory

This is the geographic area that the label has the right to exploit the work for profit. Most deals these days are “worldwide” or “universal” thanks to the internet. Smaller labels may buy only North American rights, or for certain countries.

Just because the label has rights worldwide doesn’t mean it has to release the work worldwide. Think practically about the reach of the label, and whether or not it can actually push the work in the whole territory. If not, it may be worth carving some areas out of the territory in favour of a local label or distributor, or having the label give up its rights where, after a period of time, it doesn’t release the work.

Rights & Exclusivity

Rights are what the artist sells – or rents – to the label. These may include:

  • Assignment of copyright
  • Ownership of masters and unreleased tracks/versions
  • Use of name and likeness; merchandise
  • Mechanical rights – who owns the underlying work?
  • Profits from off-stage sales

An exclusive right to the work means the label may exploit any recorded performances during the term of the contract – albums, concert videos, live recordings, etc. The artist (or any member of the group) may not record any material for another record company.

Some acts may sign under a specific stage name, which could leave them free to contract with other labels under a different pseudonym.

If the artist wants to do outside projects, such as making guest appearances with another act, a “sideman” provision should be negotiated.

Show me the money!

For the artist, the financial terms of the contract are some of the most important. They can get pretty complicated, so this is where your lawyer and accountant earn their keep. 80% of acts never sell enough albums to see a cent of artist royalty payments, so understanding the math how much will need to be sold for the artist to earn a profit is ever so important.

At its simplest, the math is:

(Artist Royalties) – (Recoupment) + (Mechanical Royalties)

Royalties

Royalties are the act’s cut of the profits. There are two types:

  • Artist Royalties – money paid to the act for its recorded performances – usually defined as a percentage of the sales price (typically between 9-18% of retail)
  • Mechanical Royalties – paid to the publishers/songwriters for the underlying composition

Royalties for music videos, secondary uses (like commercials or movies), and live performances are sometimes included as well. If you want to be certain who owns them, put it in writing.

Artist Royalties

The money paid to the artist when albums are sold, usually a percentage of the wholesale or retail price. 9-18% of revenue sounds alright… but that’s a gross percentage, not net. The label will deduct every expense that it can – recording costs, reserves against returned albums, free goods, packaging costs, and often pay only reduced royalties for foreign, discounted, and TV sales. The artist is usually expected to pay the producer royalty as well, which is usually around 3% – but shouldn’t be on the hook for income advances paid to the producer.

After all of those deductions, the artist has to pay back the label’s costs out of the artist royalties, known as “recoupment”. Once the label recoups all of its costs, the artist gets paid the excess. I’ll talk recoupment in a bit… but long story short, 80% of acts never see a penny of artist royalties.

Mechanical Royalties

The record label has to pay the songwriter for the use of their songs. Mechanical royalties are not recouped, and shouldn’t be cross-collateralized either (below). That means the songwriter gets paid on every song or album sold. For most singer-songwriters, this is the only payment they’ll ever see. Outside writers get paid first.

Mechanical royalty clauses usually limit the number of songs mechanical royalties are paid on, and the per-song amount the label will pay.

Recoupment

Record labels often spend a bunch of money to get an album to market, which the artist pays back through its artist royalties. Once all of the costs are paid, the artist royalties start being paid to the artist. These costs include:

  • Advances – money paid by the label to the artist up-front to cover cost of living, management commissions, legal fees, etc.;
  • Recording costs, which are either a budget or a fund to cover studio time, production, mixdown/mastering, etc.:
    • Budget – a guaranteed minimum amount. If it’s not spent, the label keeps the money; or
    • Fund – an amount is set aside for recording, and anything left over is paid to the artist when the album’s done;
  • Tour support – money spent by the label to promote the tour;
  • Video production costs – are typically paid 50% by the label, and 50% recoupable from artist royalties

These costs are “non-returnable” – which means that if the album doesn’t earn enough artist royalties to pay for the costs expended, the label takes a loss. The label’s other costs – manufacturing, advertising, promotion – should be wholly paid by the label. That’s why it gets its 82-91% cut of every album.

Some labels reach outside of industry norms to find creative ways to get the artist to reduce the label’s risk on an album, including:

  • A clause in the contract that makes the money “returnable” – meaning that the artist must reimburse the label for the entire cost, and
  • Recoupment from other sources – such as mechanical royalties or through cross-collateralization (below).

Both of these are exploitative, and certainly not standard industry practice.

Now, musical interlude:

Cross-Collateralization

Cross-collateralization allows the label to use royalties from one contract (such as publishing, production, other mechanical licenses, or a separate album-by-album deal) to recoup its costs from another.

Creative Control

How much can the label tell the artist what to do? Usually singer-songwriters have more creative control, while groups assembled by a label will get less. Creative control could mean the right of approval, the right of consultation, etc. Creative control rights include:

  • Videos – song choice, concept, budget, editing
  • Producers and remixers – who, costs, royalties
  • Song selection – what gets recorded, and what goes on the album
  • Use of the act’s name and likeness
  • Marketing & merchandise
  • Artwork
  • Secondary exploitation – commercials, movies, etc

Unless it’s stated otherwise in the contract, once the contract ends, so to does the artist’s creative control over the rights they’ve given up.

Release Commitment

What’s the use of putting together an album that nobody will ever hear? It’s often worthwhile for the act to get a firm commitment from the label to make a meaningful release of the album in the territory of the contract, including a minimum budget. If not, the artist may buy back the masters.

Conclusion

So, those are the nuts and bolts of record label contracts. Often there’s a lot more to them, and there’s a ton of little things that can come back to bite you – whether you’re a label or an artist. As with any contract, it’s a smart idea to get a lawyer to help you write or review it, and most importantly to understand what it is that you’re signing. I happen to know a guy… 😉

Rock on.

 

Mike Hook
Intrepid Lawyer
http://intrepidlaw.ca
@MikeHookLaw

The Basics of Contracts

One of the fundamental skills for a business owner is the ability to deal with contracts. Every day in Ontario, thousands of contracts are entered into for thousands of different reasons…. Quite often by people who don’t really understand what they’re agreeing to, and the consequences of not living up to their end of the bargain.

A contract is a binding agreement to exchange value between two or more entities, called “parties”. A contract can be either written or oral, so long as it has all of the essential parts discussed below. Oral agreements are more likely to end up in a he-said she-said if there’s ever a dispute. Most commercial contracts will be in writing so that there is a clear record of what was agreed upon. If there’s a dispute later on, the parties can look at the contract to see exactly what was meant. Certain types of contracts, such as those for the sale of land, are required by law to be in writing.

It’s good business practice to have your key agreements – with suppliers, distributors, franchisees, employees, contractors, and creditors – in writing. It’s also smart to let your lawyer do the writing, or at least review and edit what you wrote to make sure it’s sound. The more money or business risk that’s involved if the contract is broken, the more important it is to have a legally sound agreement from the start. The legal fees up front are far cheaper than a damages award. I’ve seen companies fail because they didn’t get legal help with their major contracts, and when push came to shove, their agreements weren’t binding, and didn’t say what they thought they did.

The essential parts of a contract

  1. Offer and acceptance. To form a contract, one party must make an offer to enter into a legal relationship, which at least one other party must accept. Both parties must willingly enter into the contract, and have the mental capacity to enter into and understand the terms of the agreement. The subject matter of the contract must also not violate any laws… so don’t come to me if you haven’t been paid for your work as an assassin…
  2. Consideration. Each party to the contract must gain value from it. In business this often boils down to the exchange of money for goods or services. The need for consideration is what separates bargains from gifts, which are when one party gives value and gets nothing in return. Gifts and contracts have different legal rules around them.
  3. Meeting of the minds. Both parties must intend to make a contract in the first place, and have a “reasonable” common understanding of what they’re actually agreeing to. This way, misunderstandings or vagueness can be cleared up by interpreting what a reasonable person in the situation would have thought they agreed to.

What does a contract look like?

You’ll usually find the following things in most written contracts:

  1. Identifying the parties to the agreement. Full legal names of who is entering into the contract.
  2. Definitions of important or frequently used terms. This keeps everyone on the same page about what’s being talked about in the contract, makes it shorter, and easier to read.
  3. Intentions or reasons for entering into the agreement. Though it’s usually not a binding part of the contract, it becomes a “guiding light” for anyone reading or interpreting the contract. It shows a meeting of the minds. If there’s a dispute, a judge will resolve vague terms, or unexpected problems with the parties’ intentions in mind.
  4. Representations and Warranties. A representation is a statement of an existing fact that makes the other party to want to contract with you – such as, that you actually own the thing you’re selling.A warranty is a guarantee that you’ll do certain things if things don’t work out as you’ve planned – such as, if the part you sell breaks in the first year, you’ll replace it at no charge.
  5. Terms of the deal. The responsibilities of each party, details about the money to be paid for a good or service, quality expected, delivery schedule, etc.
  6. General terms.  The legal framework of the contract itself – how to end it, what law governs it, dispute resolution, how to give written notice, indemnity, and so forth.
  7. Signatures of both of the parties. Evidence that both parties agree to what’s written in the contract.

What if the contract is broken?

A breach of a contract occurs when one of the parties fails to perform one or more of the responsibilities agreed to in the contract. In situations such as these, the other party will want to be compensated for the losses suffered.  Some remedies include:

  1. Damages. This is the usual solution to a broken contract – called a breach of contract. If the other party breaches a contract, you’re entitled to be put in the position you would have been in had lived up to their end of the deal. This usually means an award of expectation damages – monetary payment to make up for the losses directly resulting from the breach – or sometimes an order for the other party to do what they promised to – specific performance, discussed below.Consequential damages may also be awarded where your losses are not a direct result of the breach, but could have been reasonably foreseen by the party that broke the contract – such as business profits that you didn’t make because they didn’t send you the parts as promised.Punitive damages are additional compensation to punish the breaching party for being really really naughty. They’re rare, and only awarded in cases where a party, such as an insurance company, breaches a duty of “good faith” or acts unethically towards the other party.
  2. Reliance interest.  In cases where the expectation damages are difficult to calculate, the court may award the expenses spent in reliance on the contract going through as promised instead. You can’t have both, as then you’d have been compensated for both lost profits and expenses.
  3. Specific performance. A court order to do what was promised under the contract. It can occur where goods or services are unique, not readily available from other sources, or where money isn’t enough to compensate for your losses.
  4. Rescission. If representations (above) turn out to be false, and the whole contract can be set aside, and the parties will be returned to the position they were before they struck the deal. As in, “I never would’ve signed the contract if I’d known that…”

That’s the quick & dirty on the basics of contracts. I’m indebted to my student intern, Claudia Dzierbicki, for her work in putting together the guts of this article. I’ll get in the process of how to use a lawyer to help you draft and negotiate contracts in another article soon.

 

 

Mike Hook
Intrepid Lawyer
http://intrepidlaw.ca
@MikeHookLaw

Incorporating an Existing Business

I’ve talked about the pros and cons of different business structures in an earlier article, but what happens when you start out as a sole proprietor or in a partnership, and later want to incorporate? The transition needs to be seamless, so that the corporation can step right in to your shoes and carry on business.

This is something I deal with regularly, and unfortunately it’s not a simple process. It’s difficult for a layman to do without some professional advice from your lawyer, and accountant or tax nerd. The details count here – to the point that writing this blog post took about 8 hours of work. Doing it the wrong way could lead to paying unexpected taxes, interest and penalties, muddy the water about who owns business assets, and stick you with personal liability for things that you thought were pushed over to the corporation. Fear not, intrepid entrepreneur – there’s a way through the maze

OK, what’s so friggin’ complicated?

There are three steps to incorporating an existing business:

  1. Incorporation and organization of a new company;
  2. Sale of the business or partnership to the corporation; and
  3. Joint election to defer the paying of capital gains tax.

Each step has its quirks, which I’ll explain below. There are a bunch of other business steps that you should take to make the transition seamless – this handy dandy checklist should help. Every case will be different – but at least you can get an idea of the key tasks. The rest of the article deals with the process on the legal side. Let’s git ‘r done:

1. Incorporation

Take the usual steps to incorporate your company –name search, and filing of the articles of incorporation with the fee payable to the Ministry. If you’ve registered your existing business’ name, and want to use a similar name for the new corporation, you’ll have to file a signed letter, or completed consent form with the articles of incorporation. You may want to include a share price adjustment clause in the articles of incorporation, in case the Canada Revenue Agency (CRA) puts a different value on the sale than you did.

The value of the shares that you’ll own will depend on the sale price. It’s important that the numbers add up, and are consistent between the sale agreement, the documents in the corporation’s minute book, and the election to defer the capital gains tax that you file.

2. Selling the Business:  Tax Rollover

Once your corporation is all set up, it is a “person” (and a taxpayer) in the eyes of the law. It can own property, enter into contracts, and do all that other fun stuff that you do for work. The problem is that the corporation doesn’t actually own anything yet, or have a right to take over your business. You own the corporation, and you also own the assets of the existing business, but they’re different people entirely. In order to merge the two, you’ve got to sell your sole proprietorship to your corporation.

The CRA will want you to pay capital gains tax on the sale. When you started your business, it was worthless. Through your hard work, it has grown in value – accumulating cash, equipment, inventory, contracts, real estate, etc. – which is a capital gain. When you sell the business, the capital gain is realized, and 50% of that amount will be added to your personal income as capital gains tax.

As pleasant as that sounds, you’re allowed to put off payment of the capital gains tax. Since you’re actually only selling the business back to yourself – you’re still are the beneficial owner of the business through your shares of the corporation – you’re not actually realizing the capital gain. You still have to pay it when you actually sell the business to someone else – but you can avoid it for now. This is known as a “tax rollover”. Lawyers, accountants, and various other nerds call this “deferring the realization of a capital gain”. Bottom line is you’ll have more money left to keep your business afloat.

To defer the capital gain, you must sell the business to the corporation at fair market value, in exchange for shares of the corporation. This is done with a “Section 85(1) Rollover Agreement”, which is a contract of sale between you and the corporation. You keep a copy, and a copy goes in the corporation’s minute book. Having a clear agreement on file is very important – the CRA likes to scrutinize these types of sales closely in order to head off tax evasion.

There are two main parts to the rollover agreement – the sale contract, and the financial terms – mostly the value of the assets, and the shares they’re being exchanged for. The sale contract should cover the following points:

  • Agreement to buy and sell
  • Shares and other compensation issued in return
  • Agreement to make a joint election to defer the capital gain under Section 85 of the Income Tax Act
  • Price adjustment clause – in case the CRA decides that the value of the assets is different than you say it is
  • Representations and warranties – that you and the corporation have the legal capacity to buy and sell the assets
  • General provisions – about how the contract is to be interpreted, and so forth

You can find examples on the interweb – Appendix A or B of this article here is a good starting point – though I don’t recommend trying to do this without legal and tax advice. The consequences of screwing it up could cripple your business if you don’t have the cash to pay the tax bill.

The financial terms – usually laid out in a table as an attachment to the contract – can get tricky. The CRA deems the assets of the business to be sold at fair market value. Some assets – especially goodwill – are hard to value. Others have depreciated or grown in value since you got them. Other assets might have a constant value, or cost nothing to acquire, but still generate income. The same goes for liabilities – though typically you don’t transfer many, if any, liabilities in these sales. You should get your accountant to value the assets, and determine the sale price of each class – or the “Elected Amount”. In the contract, you can set a price for each “class of assets” as a group, rather than breaking it down for each item. Still, your accountant should keep the working papers used to determine the amounts declared, in case the CRA asks for justification.

Typically, the following classes of assets will be sold:

  • Non-Depreciable Capital property
    • Some securities or investments
    • Some real estate
    • Trademarks
    • Some patents
  • Depreciable property – property with a definite useful life
    • Furniture, equipment, electronics, tools, spare parts
    • Vehicles and accessories
    • Buildings and the systems in them (HVAC, plumbing, electrical, etc)
    • Fixtures
  • Eligible capital property
    • Goodwill – reputation, customer lists, business name
    • Some securities or investments
    • Incorporation costs
    • Some patents
    • Non-real estate inventory

 3. Joint Election

No, I don’t mean the big issue in the next Federal campaign. It’s actually just more paperwork. Once the rollover agreement is all done and signed, the final step to deferring the capital gain is to file an “Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation.”

This riveting document is the CRA’s Form T2057. It uses much of the same information from the rollover agreement. It’s best to get your accountant to help you fill it out. The CRA will scrutinize the rollover closely. If you screw it up, you can amend the election form, but you can’t revoke an election once it’s filed.

Conclusion

That’s a lot of stuff to deal with for what seems like it should be a simple process. I strongly recommend that you don’t try this at home. It’s a tax-driven transaction – which means that your accountant should be calling the shots on the financial terms, and your lawyer should be papering the details. It’s usually a modest legal and accounting bill, which can protect you from an ugly capital gains tax bill, and the interest and penalties that come with it. Lawyer up!

Good luck out there!

 

Mike Hook
Intrepid Lawyer
http://intrepidlaw.ca
@MikeHookLaw

Non-Competition Agreements in the sale of a business

So, there I was, the dapper lawyer at the cocktail party, entertaining everyone with tales of legal derring-do. All were enthralled by my war story about finding a type-o on page 64 of a contract. “Tell us another!” shouted one. “Yes! Yes! Tell us a tale about something exotic! Something like… non-competition agreements!” demanded another, excitedly. I couldn’t help but to oblige.

Lucky for them, I’d just read the recent decision of the Ontario Court of Appeal where they’d just clarified the law about what makes a non-competition agreement enforceable after a business has been sold. (If you’re a nerd like me, you can read the whole decision here: Martin v. ConCreate USL Limited Partnership, 2013 ONCA 72).

This decision laid out the law on what makes for an enforceable non-compete agreement very clearly. Here are the basics:

  • We start with the presumption that a non-competition agreement is not enforceable, because it’s designed to restrict someone’s freedom to practice their trade.
  • Whoever is trying to enforce a non-compete has to show that it’s a reasonable agreement between the parties.
  • Non-competes in the sale of a business will be less scrutinized than those between employers and employees, as there’s usually equal bargaining power in a sale of a business.
  • Agreements that are signed by people who had legal advice on the agreement before signing it are more likely to be enforceable.
  • Just because it’s a sale of a business and both parties had legal advice doesn’t mean that an unreasonable agreements will be enforceable
  • A reasonable non-competition agreement will be clear, and unambiguous in three major areas:
    • The geographic scope, or area in which the non-compete applies, must be defined clearly
    • The time period that the agreement covers must be reasonable, and have a clear start and end point – and not be tied to a future event that is outside the power of the parties to control (or may never happen…)
    • The activities that are prohibited must be clear and reasonable – only what’s necessary to protect the business interests of the purchaser

A non-compete is a valuable tool to protect a new purchaser from having to fight for business against someone who has insider information on how the purchased business is run. Theoretically, if the vendor is allowed to start a new business in the same area that’s a little leaner, they could undercut the purchaser and put them out of business. The non-compete is designed to prevent this – but is only to the minimum extent necessary.

Of course, I explained to the spellbound crowd, what’s “reasonable” in any case really depends on the circumstances. Non-competition agreements or clauses are the type of thing you should get legal advice on before sticking them in any agreement – especially the sale of a business!

I’m available for legal advice or children’s parties, should ever you need me.

Happy Thanksgiving!

Mike Hook
Intrepid Lawyer
mike@intrepidlaw.ca
@MikeHookLaw