Capturing IP and the Knowledge That Makes It Valuable

While every business keeps its portfolio of assets, not every business manages its most crucial assets: intellect and knowledge. Indeed, these assets may not easily be measured on a balance sheet, but they are the fundamental resources that maintain a competitive edge in any industry. Certainly, much of these assets goes undocumented and ends up lost, or not even captured. Intellectual property assets created by employees are frequently unnoticed, disregarded, or forgotten. Operating knowledge, without which intellectual property would be valueless, is routinely lost through retirement or attrition. Organizational “know-how” and intellectual creations that increase a company's efficiency must be paramount considerations in the growth and development models of a business. Fortunately for corporate leaders, employee-produced intellectual property, and employee-retained knowledge assets, can be captured and protected from the inception of business.

Distinguish Intellectual Property Assets from Knowledge Assets

To distinguish intellectual property from knowledge is to distinguish information from integrated intelligence. Intellectual property (“IP”) is the appropriated tangible form of information and ideas. In other words, IP is the generic term for ideas which are commoditized and sold or licensed. IP exists if an only to the extent that it is recognized by law, and its marketability is both instigated and limited by its monopolistic character. Property rights are afforded to the creator of IP, such that only the creator may hold the property exclusively, duplicate it, or transfer it. However, in the context of corporate assets, IP is valueless information unless it is integrated and synthesized into valuable operating knowledge. When integrated, it becomes a knowledge asset that is the cornerstone of corporate human capital. This is the competitive edge that a business needs to create and capture.

A hypothetical showing the relationship between IP and knowledge and the importance of capturing both will be instructive. Consider a business (“Company”) that makes, markets, and bottles bourbon and other liquors. John is a software developer that contractually agrees with Company to work in its small IT department for a period of time for the purpose of creating a software program that will computerize the distillation process and condense the time of distillation in half. John spends 3 months on his own computer and creates the perfect program. Company teaches Sarah, a distillery employee of Company, to use the software program so that the distillery machines perform at optimal levels. The software program is the only one of its kind, and Company uses it for 10 years to create a market edge over competitors. Sarah is the only Company employee who knows how to use the program effectively.

There is both an intellectual property component and a knowledge asset component to this example. The program that John has created for Company is copyrightable, and therefore an example of intellectual property. However, there are situational aspects of the contractual relationship between John and Company that will dictate whether John or Company owns the copyright to the program. If Company owns the copyright, then it may exclude its use by other competitors, and therefore the program becomes much more valuable. If John owns the copyright, then John may license or sell the program to other competitors, diluting its value to Company. The details which will dictate ownership of the intellectual property will be spelled out below. These should be noted and heeded to by any business wanting to maintain and manage purportedly valuable assets. The difference could be capitalizing on a competitive advantage or not.

Sarah represents the knowledge asset in the hypothetical. The program is important in itself to further productivity in the workplace, but it is only an idea in a tangible form that is valueless unless utilized efficiently. Sarah is the only employee who understands the computerized control program. It created a competitive advantage only because Sarah could master its complexities and make it work. Sarah's knowledge of John's program represents an important component of human capital that, unless Company recognizes and captures that knowledge before Sarah leaves the company, will be lost, and so will the competitive advantage. Knowledge assets may be captured by a business in different ways, many of which are as simple as observing effective job performance and taking notes.

Ensure Ownership in Your Employees' Creations

It is logical enough that a creator should be the rightful owner of the copyright in his creation. Retaining copyright ownership in the creator encourages innovation and invention by providing a right to any revenue stream produced by the work. In the context of an employer/employee relationship, however, logic is interrupted by a codified rule known as the “work-for-hire” doctrine. U.S. Copyright Law calls for two situations in which an employer, not the creator, is automatically deemed both the author and owner of a copyright. Specifically, “[a] work is made for hire if it either: (1) is prepared by an employee within the scope of his or her employment; or (2) is prepared by an independent contractor and falls within one of the categories of specially ordered or commissioned works specified in the statute, provided that the parties expressly agree in writing that the work is made for hire” (17 U.S.C.A. ' 101). These two situations seem intuitively simple, but case law interpretation and practice tell us that the lines are not so bright.

The first situation hinges on the interpretation of “employee,” which is different depending on the federal circuit in which your state sits. Hiring trends, work conditions, and various payment methods all factor in determining whether the author of a creation is in fact an employee of a company. In 1989, the U.S. Supreme Court finally stepped in to lend centrality to the widely differentiating circuit court interpretations of the term “employee” under the “works-for-hire” provision. The Court asserted that, when determining whether a creator is an “employee,” 13 non-exclusive factors are to be considered: 1) the hiring party's right to control the manner and means by which the product is accomplished; 2) the skill required; 3) the source of the instrumentalities and tools used; 4) the location of the work; 5) the duration of the relationship between the parties; 6) whether the hiring party has the right to assign additional projects to the hired party; 7) the extent of the hired party's discretion over when and how long to work; 8) the method of payment; 9) the hired party's role in hiring and paying assistants; 10) whether the work is part of the regular business of the hiring party; 11) whether the hiring party is in business; 12) the provision of employee benefits; and 13) the tax treatment of the hired party. (Community for Creative Non-Violence v. Reid, 490 U.S. 730, 751-52 (1989)). Some federal circuits have announced that they will follow New York and the Second Circuit, in that the enumerated factors are not equal in every situation, and each case may call for more weight given to individual factors. (Hi-Tech Video Productions, Inc. v. Capital Cities/ABC, Inc., 58 F.3d 1093, 1096-97 (6th Cir. 1995)). Thus, with regard to businesses in these circuits, the “work-for-hire” doctrine does not apply only with the existence of an official employment contract calling the individual an “employee” and putting the employee on payroll. Instead, a case-by-case determination must be made. Most importantly, “employee” status will be found if the employer, and not the hired party, “controls” the circumstances of creation.

For a business owner in one of these circuits, it is important to know the above factors when negotiating for services to be rendered by an individual or another company where intellectual property may originate. Let us revisit the previous hypothetical while applying current doctrine in a “control” jurisdiction. In that example, John may be deemed an independent contractor or an employee of The Company depending on the language of the contract, but more importantly on the conditions of the work to be performed. Although John may be put on the payroll and called an “employee” in his contract, if he has complete discretion over his creation and uses his own resources for a set amount of time to complete the job, then he may be deemed an independent contractor, and the copyright to his software program will be owned by him, and not the Company. If the conditions of work make the issue questionable, there are options to exercise in the course of negotiation. If the hired party might be deemed an independent contractor, then a “work-for-hire” may, indeed must, be contractually exercised or else the work will be owned by the hired party. If the party refuses, then joint ownership of the copyright or a royalty-splitting scheme may be negotiated. In the case that the hired party will, in fact, be an “employee” under the “work-for-hire” doctrine, but refuses to work unless some ownership in the copyright is retained, then a reconveyance of the copyright after a certain period of time may be considered. From the position of the company, the period of time should be as long as a non-compete agreement would be valid (one or two years), or long enough to build a market advantage from the intellectual property. Finally, a license scheme may also be utilized, where the company licenses the right to utilize the copyright to the hired party after his or her work is finished. Under this scenario, there is some leeway as to what rights are licensed and for how long. Most importantly, a company negotiating with a potential hiree should not leave copyright ownership to future interpretation. Instead, know the thirteen factors announced by the U.S. Supreme Court and favorably control those that are relevant from the outset to ensure application of the “work-for-hire” doctrine.

Ensure the Retention of Corporate Knowledge Assets

As discussed above, knowledge assets are gained when human attributes such as synthesis and integration are applied to information and intellectual property assets. These assets are quite often very valuable to a business, but almost never reach the balance sheet nor consideration in a company's valuation. In short, information is useless to a business without knowledge. Nevertheless, knowledge is one of the least understood of all corporate assets. In fact, consultant and corporate theorist, Jerome J. Peloquin, has postulated that “qualitative and quantitative management of knowledge is essential if we are to survive in the global marketplace.” (Jerome J. Peloquin, “Knowledge As a Corporate Asset: Building the Case for Human Capital,” Performance Paradigm, p. 4 (2001)).

According to Peloquin, there are ways a business owner can recognize and retain knowledge within a company. First, a business should create a tangible procedure schedule that must be followed and performed by certain nominally trained workers to complete tasks independently and without assistance. Second, a business owner or officer should take the time to observe efficient and correct job performance by certain workers. Once such is identified, the officer should let other workers observe the same, acknowledging its accuracy. This is proof of accomplishment; the birthplace of efficient workplace knowledge. Once steps to identify and cultivate knowledge within a company have been taken, the value of this knowledge should be quantified by some economic measure. Factors in such a measurement may be the cost of training a new employee to learn the same job performance, or the loss of profitable return if that knowledge were lost. Finally, knowledge assets that are vital to a business may be verified by an independent, certified assessor that is familiar with the industry or market in which the business operates.

Conclusion

Every business keeps a balance sheet, but not every business keeps track of intellectual and knowledge assets. These assets are the real generators of competitive advantage, and recognizing and retaining them may be as or more important to success than any other tangible asset.

Ian McClure is an attorney at Wyatt, Tarrant, & Combs, LLP in Louisville, KY. He can be reached at [email protected].

While every business keeps its portfolio of assets, not every business manages its most crucial assets: intellect and knowledge. Indeed, these assets may not easily be measured on a balance sheet, but they are the fundamental resources that maintain a competitive edge in any industry. Certainly, much of these assets goes undocumented and ends up lost, or not even captured. Intellectual property assets created by employees are frequently unnoticed, disregarded, or forgotten. Operating knowledge, without which intellectual property would be valueless, is routinely lost through retirement or attrition. Organizational “know-how” and intellectual creations that increase a company's efficiency must be paramount considerations in the growth and development models of a business. Fortunately for corporate leaders, employee-produced intellectual property, and employee-retained knowledge assets, can be captured and protected from the inception of business.

Distinguish Intellectual Property Assets from Knowledge Assets

To distinguish intellectual property from knowledge is to distinguish information from integrated intelligence. Intellectual property (“IP”) is the appropriated tangible form of information and ideas. In other words, IP is the generic term for ideas which are commoditized and sold or licensed. IP exists if an only to the extent that it is recognized by law, and its marketability is both instigated and limited by its monopolistic character. Property rights are afforded to the creator of IP, such that only the creator may hold the property exclusively, duplicate it, or transfer it. However, in the context of corporate assets, IP is valueless information unless it is integrated and synthesized into valuable operating knowledge. When integrated, it becomes a knowledge asset that is the cornerstone of corporate human capital. This is the competitive edge that a business needs to create and capture.

A hypothetical showing the relationship between IP and knowledge and the importance of capturing both will be instructive. Consider a business (“Company”) that makes, markets, and bottles bourbon and other liquors. John is a software developer that contractually agrees with Company to work in its small IT department for a period of time for the purpose of creating a software program that will computerize the distillation process and condense the time of distillation in half. John spends 3 months on his own computer and creates the perfect program. Company teaches Sarah, a distillery employee of Company, to use the software program so that the distillery machines perform at optimal levels. The software program is the only one of its kind, and Company uses it for 10 years to create a market edge over competitors. Sarah is the only Company employee who knows how to use the program effectively.

There is both an intellectual property component and a knowledge asset component to this example. The program that John has created for Company is copyrightable, and therefore an example of intellectual property. However, there are situational aspects of the contractual relationship between John and Company that will dictate whether John or Company owns the copyright to the program. If Company owns the copyright, then it may exclude its use by other competitors, and therefore the program becomes much more valuable. If John owns the copyright, then John may license or sell the program to other competitors, diluting its value to Company. The details which will dictate ownership of the intellectual property will be spelled out below. These should be noted and heeded to by any business wanting to maintain and manage purportedly valuable assets. The difference could be capitalizing on a competitive advantage or not.

Sarah represents the knowledge asset in the hypothetical. The program is important in itself to further productivity in the workplace, but it is only an idea in a tangible form that is valueless unless utilized efficiently. Sarah is the only employee who understands the computerized control program. It created a competitive advantage only because Sarah could master its complexities and make it work. Sarah's knowledge of John's program represents an important component of human capital that, unless Company recognizes and captures that knowledge before Sarah leaves the company, will be lost, and so will the competitive advantage. Knowledge assets may be captured by a business in different ways, many of which are as simple as observing effective job performance and taking notes.

Ensure Ownership in Your Employees' Creations

It is logical enough that a creator should be the rightful owner of the copyright in his creation. Retaining copyright ownership in the creator encourages innovation and invention by providing a right to any revenue stream produced by the work. In the context of an employer/employee relationship, however, logic is interrupted by a codified rule known as the “work-for-hire” doctrine. U.S. Copyright Law calls for two situations in which an employer, not the creator, is automatically deemed both the author and owner of a copyright. Specifically, “[a] work is made for hire if it either: (1) is prepared by an employee within the scope of his or her employment; or (2) is prepared by an independent contractor and falls within one of the categories of specially ordered or commissioned works specified in the statute, provided that the parties expressly agree in writing that the work is made for hire” (17 U.S.C.A. ' 101). These two situations seem intuitively simple, but case law interpretation and practice tell us that the lines are not so bright.

The first situation hinges on the interpretation of “employee,” which is different depending on the federal circuit in which your state sits. Hiring trends, work conditions, and various payment methods all factor in determining whether the author of a creation is in fact an employee of a company. In 1989, the U.S. Supreme Court finally stepped in to lend centrality to the widely differentiating circuit court interpretations of the term “employee” under the “works-for-hire” provision. The Court asserted that, when determining whether a creator is an “employee,” 13 non-exclusive factors are to be considered: 1) the hiring party's right to control the manner and means by which the product is accomplished; 2) the skill required; 3) the source of the instrumentalities and tools used; 4) the location of the work; 5) the duration of the relationship between the parties; 6) whether the hiring party has the right to assign additional projects to the hired party; 7) the extent of the hired party's discretion over when and how long to work; 8) the method of payment; 9) the hired party's role in hiring and paying assistants; 10) whether the work is part of the regular business of the hiring party; 11) whether the hiring party is in business; 12) the provision of employee benefits; and 13) the tax treatment of the hired party. ( Community for Creative Non-Violence v. Reid , 490 U.S. 730, 751-52 (1989)). Some federal circuits have announced that they will follow New York and the Second Circuit, in that the enumerated factors are not equal in every situation, and each case may call for more weight given to individual factors. ( Hi-Tech Video Productions, Inc. v. Capital Cities/ABC, Inc. , 58 F.3d 1093, 1096-97 (6th Cir. 1995)). Thus, with regard to businesses in these circuits, the “work-for-hire” doctrine does not apply only with the existence of an official employment contract calling the individual an “employee” and putting the employee on payroll. Instead, a case-by-case determination must be made. Most importantly, “employee” status will be found if the employer, and not the hired party, “controls” the circumstances of creation.

For a business owner in one of these circuits, it is important to know the above factors when negotiating for services to be rendered by an individual or another company where intellectual property may originate. Let us revisit the previous hypothetical while applying current doctrine in a “control” jurisdiction. In that example, John may be deemed an independent contractor or an employee of The Company depending on the language of the contract, but more importantly on the conditions of the work to be performed. Although John may be put on the payroll and called an “employee” in his contract, if he has complete discretion over his creation and uses his own resources for a set amount of time to complete the job, then he may be deemed an independent contractor, and the copyright to his software program will be owned by him, and not the Company. If the conditions of work make the issue questionable, there are options to exercise in the course of negotiation. If the hired party might be deemed an independent contractor, then a “work-for-hire” may, indeed must, be contractually exercised or else the work will be owned by the hired party. If the party refuses, then joint ownership of the copyright or a royalty-splitting scheme may be negotiated. In the case that the hired party will, in fact, be an “employee” under the “work-for-hire” doctrine, but refuses to work unless some ownership in the copyright is retained, then a reconveyance of the copyright after a certain period of time may be considered. From the position of the company, the period of time should be as long as a non-compete agreement would be valid (one or two years), or long enough to build a market advantage from the intellectual property. Finally, a license scheme may also be utilized, where the company licenses the right to utilize the copyright to the hired party after his or her work is finished. Under this scenario, there is some leeway as to what rights are licensed and for how long. Most importantly, a company negotiating with a potential hiree should not leave copyright ownership to future interpretation. Instead, know the thirteen factors announced by the U.S. Supreme Court and favorably control those that are relevant from the outset to ensure application of the “work-for-hire” doctrine.

Ensure the Retention of Corporate Knowledge Assets

As discussed above, knowledge assets are gained when human attributes such as synthesis and integration are applied to information and intellectual property assets. These assets are quite often very valuable to a business, but almost never reach the balance sheet nor consideration in a company's valuation. In short, information is useless to a business without knowledge. Nevertheless, knowledge is one of the least understood of all corporate assets. In fact, consultant and corporate theorist, Jerome J. Peloquin, has postulated that “qualitative and quantitative management of knowledge is essential if we are to survive in the global marketplace.” (Jerome J. Peloquin, “Knowledge As a Corporate Asset: Building the Case for Human Capital,” Performance Paradigm, p. 4 (2001)).

According to Peloquin, there are ways a business owner can recognize and retain knowledge within a company. First, a business should create a tangible procedure schedule that must be followed and performed by certain nominally trained workers to complete tasks independently and without assistance. Second, a business owner or officer should take the time to observe efficient and correct job performance by certain workers. Once such is identified, the officer should let other workers observe the same, acknowledging its accuracy. This is proof of accomplishment; the birthplace of efficient workplace knowledge. Once steps to identify and cultivate knowledge within a company have been taken, the value of this knowledge should be quantified by some economic measure. Factors in such a measurement may be the cost of training a new employee to learn the same job performance, or the loss of profitable return if that knowledge were lost. Finally, knowledge assets that are vital to a business may be verified by an independent, certified assessor that is familiar with the industry or market in which the business operates.

Conclusion

Every business keeps a balance sheet, but not every business keeps track of intellectual and knowledge assets. These assets are the real generators of competitive advantage, and recognizing and retaining them may be as or more important to success than any other tangible asset.

Ian McClure is an attorney at Wyatt, Tarrant, & Combs, LLP in Louisville, KY. He can be reached at [email protected].