Monday, February 6, 2017

Are Terms of Use and Other Online Agreements Real and Binding Contracts?

It used to be that people would enter into binding agreements by manually signing them. A signature manifested the two required aspects of forming a binding contract: a notice and an assent, i.e., the signatory has read the agreement and agrees to its terms.  No matter that the signatory didn't really understand what he or she has read: the signature created a presumption that the person read the terms and agreed to them.

The Internet, of course, changed all that by enabling people to enter into agreements online, without the use of signatures to show notice and assent.  So, are the online agreements really binding and enforceable?

Types of Online Agreements

First, let's take a look at some types of agreements that do not require a signature.

You have probably heard about a shrinkwrap agreement.  It is a printed form that typically appears on the outside of a box containing software.  Opening the box typically means that you have agreed to the terms of the agreement.  You don't really have ways to negotiate it, but you should be able to return the software if you disagree with the terms and have not yet opened the box.  Sometimes, the software provider cannot fit all of the terms on the outside of the package.  Then, opening the package does not mean that you consent to the terms, but installing the software does.

An online version of a shrinkwrap agreement is a clickwrap agreement.  It is an online contract that typically requires the user to click the "I Agree" button to show consent with the terms of the agreement.  The user cannot download the app or install the software until he or she clicks the "I Agree" button.  Some agreements require the user to scroll down to the end of the agreement before they can click the "I Agree" button.  These are sometimes referred to as scrollwrap agreements and are a subset of clickwrap agreements.

Some internet contracts do not require the user to click the "I Agree" button to show acceptance.  The users are notified of the existence of these contracts and the applicability of the website's terms of use when they proceed through the website's sign-in or login process.  These contracts are referred to as sign-in-wrap contracts.

Online agreements that do not have the "I Agree" button are called browsewrap agreements.  A good example of a browsewrap agreement is a website terms of use or privacy policy.  It typically begins with something like this:

This Terms of Use (together with our Privacy Policy, incorporated herein by reference, the “Agreement”) is a legal agreement between you and [ ] (“[ ]” or “we”). By accessing our website [ ].com (the “Site”), you agree to comply with and be legally bound by the Agreement. If you do not agree, please do not access our Site.      
Users do not have to take any affirmative steps to show their acceptance of a browsewrap agreement.  They give assent by simply continuing to use the site.   However, it is much more difficult to prove notice and assent in a browsewrap agreements because users of a website might not notice the terms of use policy that is hidden in the bottom of the screen.  For this reason, courts have not always deemed them to be enforceable.

A hybrid version of a clickwrap and a browsewrap agreement may be used by some websites if they have two types of users: those who use the information on the website without creating an account, and those who create an account to access enhanced features.  So, a clickwrap terms of use would be used for those creating an account (by asking to click "I Agree" button before the users can create it) and also placing the browsewarp version of same terms of use on the website for those users who chose not to create accounts.

Enforceability of Online Agreements

Now, let's discuss some of the legal issues involved with the enforceability of browsewrap and clickwrap agreements.  As I mentioned before, the two things that courts look at are (i) whether the user had sufficient notice of the terms and (ii) whether the user really consented to these terms.

Clickwrap agreements.  The main problem here revolves around the consent requirement.  Recently, courts have been paying particular attention to the potential of altering terms in the clickwrap contracts.  So, be ready that the court may ask to prove that the user clicked "I Agree" button to a particular version of the agreement or terms of use.  To avoid any problems, companies need to keep records of all versions of their online policies or agreements and be able to prove when each user actually consented to the terms.  The best way would be to have the users consent again after each modification of the agreement.   Recent cases about clickwrap contracts include Dillon v. BMO Harris Bank, N.A., 2016 WL 117513  (M.D.N.C. Mar. 23, 2016)Handy v. LogMeIn, Inc., 2015 WL 4508669 (E.D. Cal. July 24, 2015); Resorb Networks, Inc. v., 30 N.Y.S.3d 506 (Sup. Ct. 2016) and Berkson v. Gogo LLC, 97 F. Supp. 3d 359 (E.D.N.Y. 2015).

Browsewrap agreements.  Enforceability of browsewrap agreements is much more difficult to establish because they don't require any particular action on the part of the user to manifest assent.  So, here the courts have been battling with both issues of whether the users were put on sufficient notice of the terms and whether they actually agreed to them.  Because of the passive nature of "assent", courts focus on the circumstances of customers' use and the question of whether the user had actual or constructive knowledge of the website's policies.  The Court in Nguyen v. Barnes & Noble Inc., 763 F.3d 1171 (9th Cir. 2014) said "Whether a user has inquiry notice of a browsewrap agreement, in turn, depends on the design and content of the website and the agreement’s webpage."  In the past, browsewrap contracts have not been enforced where the link to them was buried at the bottom of the page, or put somewhere in a corner where it was hard to find, or was visible only if you had to scroll down to the next screen, or could access it only after a multi-step process of clicking though non-obvious links.  On the other hand, courts liked websites that had "explicit textual notice that continued use will act as a manifestation of the user's intent to be bound" by the online agreements".

Sign-in-wrap agreements.  These contracts will generally be held enforceable so long as the users have clear unambiguous notice of the terms and an effective opportunity to access those terms at the time they are signing in / logging into the site.

Practical Steps

To summarize, below is my list of recommendations regarding online contracts:

1.  It is best to use clickwrap / scrollwrap / sign-in-wrap agreements rather than browsewrap ones.  This means adding an "I agree" or "I accept" button.

2.  Have users agree to any change to your online policies when they next log in / sign into your website.  For browsewrap version, clearly state in bold on the first page the date when the agreement was last modified.

3.  A hyperlink to the terms of use and other policies should be in large font, all caps or in bold (i.e., not hidden, clearly visible).

4.  A hyperlink to the policies should appear on every page of the website.  As the court in Berkson v. Gogo said, it should not be "buried at the bottom of a webpage or tucked away in obscure corners of the website."

5.  The online policies should be easy to download and print.

6.  It is a good idea to have the users scroll through the agreement before accepting it.

7.  A website with a browsewrap terms of use should have a conspicuous notice appearing on every screen that by using this site, user agrees to the site's term of use.

8.  For clickwrap contracts, - keep records of all versions of the online agreements and policies, and know when each user consented and to which version.  It is best to ask users to consent to each modification of the policies.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

Thursday, February 2, 2017

How to Form a Delaware Corporation (Correctly)

Forming a Delaware corporation is pretty straightforward for those who have done it many times before.  You just have to follow the steps.  Skipping any of them may hurt the founders later on, when they find out that they are not actually the shareholders of their company.  These formation mistakes are typically revealed at the time when the company is undergoing a legal due diligence in advance of a financing event.  How embarrassing it is to have to deal with legal clean-up at that time!

So, I decided to write down the steps I take to ensure that my clients are properly set up from the get go:

Step 1.  Check name availability with the Delaware Division of Corporations.

Step 2.  (Optional but recommended if the company will be using its name as a trademark): Check whether the name is available as a trademark with the USPTO.  Several of my clients had to change their company's name because it was already used as a trademark by some other business.

Step 3.  Obtain a registered agent.  I typically choose Harvard Business Services.  They charge only $50 per year.

Step 4.  File Certificate of Incorporation with the Division of Corporations. Startups authorize anywhere between 5 million and 10 million shares of common stock.  That number has to be included in the Certificate of Incorporation.  It is signed by an Incorporator (usually, an attorney doing the filing).  Attorneys typically have their own forms of the Certificate that they prefer to work with.

Step 5.  Once the Certificate has been filed, prepare an Action of Incorporator, whereby the Incorporator (i) adopts the initial Bylaws, (ii) elects the initial Board of Directors, and (iii) resigns.  This is a simple but yet an important part of the formation process that often gets overlooked.

Step 6.  The initial directors adopt the corporation's initial written consent, whereby they, among other things, (i) elect the officers and (ii) authorize the issuance of stock to the founders.

Step 7.  The founders enter into Restricted Stock Purchase Agreements ("RSPA"s) with the company to purchase the shares at par value, the idea being that at the time of formation the value of the corporation equals to the par value of its shares.  The amounts that the founders have to pay for the shares are very small, less than $1,000 in total, but it is important to make sure the founders actually do give this money to the company and that money is deposited into the company's bank account and accounted for in the books.  The company then issues receipts for the money received from the founders.

Step 8.  If the founders' stock is subject to vesting, the founders must make Form 83(b) election with the IRS.  They only have 30 days to do so from the date of the RSPAs.  There are no extensions.  Failure to do so on time can result in very onerous tax consequences for the founders.

Step 9.  The founders enter into Technology Assignment Agreements with the company, dated as of the date of the RSPAs, transferring to the corporation all IP they have developed for the company prior to its formation.  This is also a very important step.

Step 10.  One final agreement.  At the same time as the RSPAs and the Technology Assignment Agreements, the founders sign Confidentiality and Invention Assignment Agreements that say that all IP that they develop on behalf of the company going forward belongs to the company.  There can be exceptions.  For example, all inventions that do not relate to the company's business, that have been developed not using the company's facilities or equipment during off work hours belong to the employees individually, and not to the company.  This is the case for all companies located in California (even if they are DE corporations), and this exception is widely used in other states as well.

Step 11.  Get the EIN.  This can be done by completing form SS-4 and/or obtaining the EIN online.

Step 12.  Open a bank account.

Step 13.  Qualify the company to do business in the home state (assuming it is actually not located in Delaware).

This in my view completes the incorporation process.  If you have any questions, let me know.

This article is not legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

Wednesday, February 1, 2017

Filing Delaware Annual Report Made Easy

Once a year, all domestic Delaware corporations must file an annual report and pay Delaware franchise tax.  They have to do so before March 1.  Missed deadline will result in a $125 penalty plus 1.5% monthly interest rate on the amount due.  Of course, companies can pay their Delaware registered agent, attorney, or accountant to file.  However, the process is so simple and straightforward that any startup can handle this on their own.

Here is the process step-by-step:

1.  Go to the Delaware Division of Corporations website.

2.  You will need to know your entity number.  You can search for it by corporation's name.

3.  Once you are in, you will need to enter your corporation's EIN.

4.  You will need to confirm / enter information regarding the corporation's address, directors, and officers.

5.  Most importantly, you will need to correctly calculate the amount of tax.  There are two methods used to calculate the franchise tax: the Authorized Shares Method and the Assumed Par Value Capital Method.  You can choose the method that results in less tax.  The lowest you pay with the Authorized Shares Method is $175 (plus a $50 annual report filing fee).  The lowest you pay with the Assumed Par Value Capital Method is $350 (plus a $50 annual report filing fee).
The Authorized Shares Method:

- 5,000 shares or less: $175
- 5,001 to 10,000 shares: $250
- every 10,000 additional shares above 10,000: $75 for each 10,000.
- Maximum payment: $180,000.

The Assumed Par Value Capital Method:

It is based on the number of authorized and issued shares and the entity's total gross assets (as reported on the corporation's tax return - Form 1120, Schedule L).  The tax rate under this method is $350 per million or portion of a million.  For examples, see DE's page on how to calculate franchise taxes here.

The most useful page is the franchise tax calculator.  Using this online calculator provided by the DE Division of Corporation will allow you to try both methods and determine which one results in lesser tax.

For example, a startup has 10 million authorized shares, $0.0001 par value per share, out of which 7 million shares have been issued and outstanding.  The gross assets value is very low, $20,000.

Using the tax calculator, we see that the Authorized Shares Method results in a $75,175 franchise tax.  Oouch!

Using the Assumed Part Value Capital Method results in a $350 tax.  Much better.  So, the total amount to pay would be $400 because you have to add a $50 filing fee.

As you can see, the entire filing takes about 5-10 minutes.  Just don't miss the deadline:

March 1 - domestic corporations, including nonprofits ($25 annual report fee) and PBCs (PBCs pay according to one of the two methods discussed above)

June 1 - LLCs, LLPs, LPs, and GPs ($300 annual report fee)

June 30 - foreign corporations ($125 annual report fee).

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.