About That Software Your Consultant(?) Wrote...

A lot of startups use consultants for various tasks. Independent contractors don’t come with all of the costs (benefits; various taxes and regulatory requirements; etc.) that come with employee classification, and are particularly valuable when there is only a temporary or part-time need for some particular expertise.

Independent contractor law has been in the news quite a bit lately, as the “gig” economy has been growing so fast. Most of the discussion and regulatory action has been around what makes someone an employee regardless of whether the business that hired them classifies them as a consultant (short-hand, in this blog, for independent contractor). 

But there’s another “gotcha” entrepreneurs must consider when working with consultants: who owns the work-product to intellectual property produced by a consultant? Think copyright, as in software, for a very common example. The default answer is ... the business paying the consultant and the consultant. Both parties own the software product and can use it as they see fit to make money. 

The standard way to avoid this outcome is to include a “work-for-hire” provision in the applicable consulting contract. A work-for-hire clause essentially waives the joint-ownership assumption and provides that any software the consultant writes under the contract belongs solely to the employer, from the instant it is created. Not surprisingly, given the stakes, work-for-hire clauses are part of most consulting contracts where producing software or other IP is within the scope of the consultant’s work.

Well, maybe it shouldn’t be. At least not if the consultant is a California resident. (It matters not where the person engaging the consultant is located.)

You see, the good folks who make the rules in California have a rule that says, in so many words, that if a contract purporting to be a consulting contract contains a work-for-hire provision the contract will be, for purposes of certain California employment laws, deemed to establish an employment relationship.

Yikes. That means employment related taxes, unemployment insurance, worker’s compensation, and other such benefits. If your business is not otherwise registered in California, it also means registration with the relevant state entities. A question you might ask is: what is the risk? What are the chances of getting caught up in this due to a consultant trying to apply for unemployment? In normal times, that risk might be low. But the pandemic-related expansions of unemployment benefits have encouraged some to take a shot at filing for benefits where they otherwise might have assumed to be ineligible. The consequences can be significant penalties and interest on top of repayment of benefit amounts.

Fortunately, there are solutions to this “gotcha”. Instead of (NOT in addition to) a work-for-hire clause in a consulting contract, include an “assignment” clause (it’s probably already in your form consulting contract). An assignment clause says, in so many words, that any intellectual property (i.e. the software code in the case of our software consultant) created by the consultant is automatically assigned to the entity engaging the consultant.

Another best practice is to engage a business as the consultant, not an individual. This generally works but can be problematic if the “business” consists of a single individual.

As noted, it’s a good solution. But it’s not perfect. First, with respect to copyright law (and thus software) an assignment provision automatically sunsets 35 years after the software is created, and there is no contractual way around that. Thirty-five years is a long time – but it’s not hard to think of copyrighted material that remains valuable even after thirty-five years.

The second point is a little more nuanced, but for me more problematic. In the case of a work-for-hire provision, ownership vests in the business the instant the software is created. In the case of an assignment provision, the software belongs to the consultant for an instant before it is automatically assigned to the business.

As noted, the difference here is subtle, but important. In the case of a work-for-hire, the business owns the software at the instant of creation even if it never pays the consultant for the work. In the assignment scenario, if a business fails to pay a consultant the software remains the property of the consultant and the business – just as if there was no assignment clause and no work-for-hire clause.

Ok; finally, the answer to the “so what?” question. If you want to hire an individual software consultant who is a resident of California (i) do not include a work-for-hire clause in the contract, but (ii) do include an assignment provision. If you don’t do the first thing, your consultant-in-name will be an employee-in-fact. If you don’t do the second, you and your consultant will be joint owners of the software right from the start.