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Licensing
Domain Name
New York Law Journal, August 24, 1999
Copyright 1999 New York Law Publishing Company
August 24, 1999, Tuesday
LENGTH: 2123 words HEADLINE: The Legal Advantages of Licensing Domain Names BYLINE: By Jonathan Bick; Jonathan Bick is an adjunct professor at Rutgers University and Pace University schools of law. BODY: The value of an Internet domain name increases dramatically once it
is used. Once a person visits an Internet site, his or her computer
normally stores the Internet domain name in its history file - making
return visits more rapid and more likely. Once e-visitors become familiar
with a domain name, they tend to return. Therefore, failing to suggest
the option of licensing Internet domain names may deprive a client of
some future economic advantage. This is particularly true of generic
Internet domain names. One of the first decisions faced by a company that plans to set up an Internet site is what name to give it. Business names are important to most commercial enterprises, but for Internet businesses they may be even more important because a site name, or domain name, is also its Internet address. Companies therefore want short, snappy Internet domain names that are as close as possible to their recognized names or trademarks. The right domain name is highly valued because there is the potential that millions of Internet users may see it. The best Internet domain names are those that allow Internet users seeking a company to correctly guess its location. The easiest way to get a name on the Internet is through an Internet service provider, or ISP. However, the acquisition of a name this way means a firm has to share its name with the ISP. The alternative, which is to acquire an Internet domain name from another company, results in an intellectual property transfer contract. Attorneys should advise their clients of the danger of allowing a valuable domain name to become moribund through a contract with a defunct Internet enterprise. Attorneys should also advise clients of the relative financial safety of licensing Internet domain names for stock or cash as compared to selling the Internet domain name for stock, and the possible tax advantages licensing has over selling, such as income spreading. Licensing, in lieu of selling, an Internet domain name generally allows the domain name owner to reserve certain rights. This reservation of rights will facilitate the future use of a domain name by an Internet domain name owner, in the event that the e-business using the domain name encounters difficulties. The Internet is still developing and electronic commerce is evolving
at a fast rate, consequently Internet enterprises are more likely to
fail at a greater-than-average rate. The downfall of an Internet business
need not mean the mothballing of a valuable domain name. However, more
often than not this is the case. Consider the following case, brought to my attention by National Internet Source Inc., a leading Internet Service provider. A client acquired a domain name. As part of the formation of an Internet firm, he donated it to an e-business. His Internet firm received start up capital, but despite the client's best efforts the e-business failed. The client closed down his first Internet business and started a new one. The new e-business could have benefited from the use of the domain name associated with the client's prior business because not only was the Internet domain name easy to spell, unique and easy to remember, it also had a high degree of customer familiarity, a direct association with products offered by the old and new firm and was associated with a lot of positive publicity. Unfortunately, the client could not use the Internet domain name from his now-dormant firm because his partners still saw value in the name and blocked his efforts. While some will correctly point out that if a client has registered a name with the Patent and Trademark Office and feels that a particular Internet domain name can be properly associated with it, they can fight for their intellectual property rights as was done by many major corporations. Since late 1995, a policy for dealing with conflicts relating to trademark disputes has been in place. Before that time the Network Solutions Inc., or NSI, would not suspend the use of an allegedly infringing domain name unless ordered to do so by a court. Part of the domain name registration requires the applicant to represent
that the registration of the domain name will not interfere with, or
infringe upon, another's rights, and that the domain will not be used
for any unlawful purpose. An applicant must also promise to "defend,
indemnify, and hold harmless" the Internet National Information
Center, or InterNIC, should he be sued because of the registration.
Today, when a trademark or service mark dispute over a domain name emerges, NSI will suspend the use of that name until the dispute is resolved in court or by arbitration. While the domain name is on hold, it is unavailable for use by any person or entity There are many legal precedents concerning trademark infringement applicable to domain names. As a result, many a domain name owner has been sued by trademark lawyers, branded "cybersquatters" by unsympathetic judges and forced to relinquish their registrations. While cybersquatting may be illegal outside the United States, it is still lawful in the United States, and most entities cannot afford to enforce their intellectual property rights or buy the rights of others. This is particularly true of start up e-commerce firms. Once a domain name seller finds out that the firm to whom he or she has sold a domain name has given up the ghost, there are three things that can be done: begin litigation to get the name, acquire a similar name or buy the name back. It is usually cheaper to buy back a domain name than to start legal action. If a company is determined to pursue the matter through the courts, the legal framework is inconsistent at present. So that route is likely to require a good deal of time and money. In addition, the outcome is uncertain. A typical domain name license grants an exclusive, worldwide, perpetual, irrevocable license to use, execute, reproduce, display, transfer, distribute and sublicense, in any medium or distribution technology, whether known or unknown. It should also grant the right to authorize or sublicense others to exercise any of the rights granted the licensee. An attorney for a domain name owner should give the client some way to terminate the license agreement even if the license is perpetual. The right to terminate in the event of bankruptcy is not an unreasonable provision. Particularly if it is subject to a notice period with a right to cure by licensee during the notice period. The amount of notice and its importance is directly proportional to the value of the domain name. For instance, the owner of a highly desirable generic domain name such as "tv.com" will likely have a greater interest in retaining some interest in an Internet domain name than the owner of a domain name subject to trademark laws. If properly drafted, a license of a domain name will allow the owner of the name to quickly avail himself of the use of that name in the event of a bankruptcy of the licensee. Since domain names are viewed as intangible, the court would apply general principles of bankruptcy law to deny the reclamation claim to an Internet domain name seller. Licensing of domain names allows for greater financial flexibility and tax planning than allowed by the sale of a name. A typical domain name licensing agreement will include a royalty arrangement, which may call for the royalty to be paid in stock, cash or both. It is not uncommon for a minimum royalty payment to be negotiated. The license may be a "paid-up" license if the initial grant
is not irrevocable. A three-to-five-year paid up license is typical,
but a seven-year period is usually outside the limit for obtaining a
paid-up license. If the irrevocable language has been negotiated out
of the license grant, the contract for a paid-up license should include
the fact that the license will be irrevocable at the time it is fully
paid up. Licensing, compared with selling, can provide favorable tax impact upon amounts received by the domain name owner-transferor. That is so because licensing income can be spread out through a greater number of techniques than sales income, including an assignment of the property to a family member or deferral of income by fixed deferred payments, the installment method or contingent payments. Naturally, every taxpayer should consider using all available techniques to minimize the impact of taxation; however, the need for tax planning is particularly acute for individual owners or creators of domain names. The reasons are twofold. First is that these individu-als may be precluded from receiving capital gain treatment because of the Internal Revenue Code, or IRC, Sections 1221 and 123l. Second is the fact that the Internet domain name owner typically receives a large portion of the total income to be derived from the sale of the domain name within a relatively short time. A taxpayer domain owner may be able to use a license to reduce his or her tax liability by making an assignment of the proceeds of a license to a family member in a lower tax bracket. This technique depends upon the fact that the assignment will effectively cause the amounts to be taxable to the family member and not constructively received, and hence taxable to the transferor. To achieve this end, a domain name owner must completely transfer the rights associated with the name to a family member, who, in turn, enters into an agreement to license the domain name to a third party, with no rights retained by the original owner. In such a case the income will be taxable to that family member. Typically, the owner of a domain name who enters into a licensing agreement
does so in return for royalties to be paid in the future, contingent
upon sales of goods from an Internet site. The domain name owner now
owns a property right in the form of his contract. If he or she conveys
only the right to income, without even purporting to convey rights in
the contract itself, the income will be taxable to the owner of the
Internet domain name. However, if both the rights to income and the
underlying rights reserved in the license agreement are transferred,
income should be taxable to the assignee family member. Another vehicle for using a licensing agreement to achieve a tax advantage would be the use of a deferred payment clause in the licensing contract. In this case payments would not and in fact could not be made to the Internet domain name owner until subsequent years. This has the disadvantage that these future payments will be dependent on the financial viability of the purchaser. If the parties do have in mind a fixed amount, the payments can be spread out by the installment sales method of reporting income under IRC Section 453; however proper licensing contract language may allow some flexibility. Had the Internet domain name been sold, no flexibility would have been available. As noted above, domain names are usually sold for a lump sum. Thus another opportunity for reducing the tax liability for a domain name owner is to use the license to have payments spread out over the life of the agreement rather than paid in a lump sum. Royalty payments are of course the most important means of payment and are effective to spread out the income. A final technique may be used to reward the owner/creator of an Internet domain name. A company planning to start a business can give the Internet domain owner an interest in the company as part of the license agreement. While the stock transfer would normally be ordinary income under IRC Section 1221, if the company grew, the Internet domain owner could receive capital gain treatment on the appreciation of his stock. Again, proper licensing contract language may allow some tax timing flexibility, generally unavailable for sale transactions. In summary, entrepreneurs should generally consider licensing their Internet domain names rather than donating or selling them. In the event of a business failure, the entrepreneur could use the name again. Since most companies are unaware of the implications of protecting their domain names and how licensing may result in tax savings, attorneys should advise clients accordingly. GRAPHIC: Illustration, no caption, Illustration by John MacDonald. LOAD-DATE: September 2, 1999 |
