Association Internet Ventures: Minimizing Your Legal Risks

7 min

So your association has been approached by a company offering a healthy non-dues revenue stream and a great new member service. Perhaps it is an electronic marketplace where your members can buy and sell products and services, an online benchmarking service for use by your members, an online job bank for your industry, or some other member benefit that your members (and possibly the general public) will be able to access online (either via your association's Web site or through another site).

You have met with the company's executives, hammered out the core deal terms, and are ready to reduce your oral agreement to writing. How do you structure the deal from a legal and tax perspective? What structure -- and what contract terms -- are going to minimize your association's liability risks and protect its valuable intellectual property? Is it possible to treat some or all of this revenue as tax-free income? These are critical questions, yet unfortunately, the haste to reach lucrative deals has led many associations to gloss over this indispensable step in the process. The result has been association Internet ventures that do not sufficiently minimize the association's liability risks and protect its interests, do not ensure tax-free revenue, and simply are not structured and documented as well as they could be.

The following is a brief (and non-exhaustive) list of ten key legal issues to pay special attention to as your association negotiates and drafts the contract for its next Internet venture:

  • Due diligence and quality control. Do your homework on your potential Internet suitor. Do business background checks; check references; request key legal, financial, corporate, and insurance documents; test ventures set up for other clients. Avoiding negligence in the selection process -- and on an ongoing basis -- is key to avoiding liability for the errors and omissions of the vendor. In addition, be sure that your association retains the ability to review and approve all aspects of the Internet site, including future changes to the site.
  • Independent contractor relationship. While it is certainly permissible for your association to structure the deal as a partnership or joint venture, if you do, you may be liable for virtually everything that happens in connection with the venture. In addition, the character of the income will pass through to your association, eliminating the ability to structure otherwise taxable unrelated business income as tax-free royalty income. Merely endorsing a venture owned and operated by the vendor -- with certain rights, revenues and services flowing to your association -- may be a more desirable approach.
  • Consider using a taxable subsidiary if appropriate. If a partnership or joint venture is desired -- or if the potential liability risk connected with the venture is particularly high -- consider shifting the association's ownership and duties (in whole or in part) to a taxable subsidiary of the association. If properly structured and operated, this will shield your association from liability and can permit the subsidiary to earn unlimited taxable income with no risk to the association's tax-exempt status. The after-tax profits can then be paid to the association as tax-free dividends.
  • Intellectual property and links to other sites. Be sure that the contract provides for: the assignment (or at least perpetual, irrevocable license) to your association of all key copyright, trademark, patent, and domain name rights created under the agreement; your association's ownership and control of the "look and feel" of the Internet site and all content on the site; restrictions on the use of your association's name, logo and membership list by the vendor; the confidentiality and security of association membership data and other information; and a warranty by the vendor that it will use no infringing or otherwise illegal material in the creation or operation of the site. Also be sure that appropriate hypertext links on the site are required (such as a link to your association's Web site), and that all other links are prohibited without your association's prior consent.
  • Term, termination and transition. Like all contracts, the provisions spelling out the initial term of the contract, whether and how the term will automatically renew, and when and how the agreement can be terminated are critical. Be sure that provision is made both for voluntary termination prior to the end of each term and for automatic termination upon certain conditions. Upon termination of the agreement, be sure that your association is able to transition the site, to the extent possible, to another vendor. The intellectual property issues discussed above are often key in this regard, including your association's continued use of the site's domain name.
  • Control of data, confidentiality and noncompetition. Be sure that the contract provides that your association will be the sole owner of all data generated by the site and under the agreement (e.g., valuable click-stream data about your members and their purchasing habits) and that all such data will be subject to strict confidentiality requirements. Be sure that the vendor's right to use such data is limited (as appropriate) during the term of the agreement, and that the vendor has no right to use the data after the agreement is terminated. In addition, the contract should contain a broad confidentiality provision applicable to both parties. Finally, if appropriate, the agreement should prohibit the vendor from entering into a similar agreement with a competing association during the contract term. The vendor may require the same of your association.
  • Performance obligations, performance standards, and technical support. The contract needs to be very clear about the precise obligations of both the vendor and your association under the agreement. Err on the side of being more rather than less specific. In addition, be sure that specific performance standards for the Internet site are detailed in the agreement, and spell out what happens in the event the vendor fails to meet such standards. Also be sure to spell out what technical support the vendor will be obligated to provide to your members or other users of the Internet site (e.g., through a toll-free telephone number or e-mail address), as well as to your association itself, at the vendor's expense.
  • Fees, expenses and payments. The contract needs to be clear and specific about how and when the vendor will be compensated (e.g., by your association or through fees generated by the site), how and when your association will be compensated, and whether and how either party will be reimbursed for out-of-pocket expenses. In addition, it is important for your association to require regular reports from the vendor detailing the revenues and activity of the site, and for your association to maintain the right to review the vendor's relevant books and records for audit purposes. Finally, attempt to structure your association's revenue stream(s) in a manner that will minimize your tax liability. This may require separate agreements for the tax-free licensing of intellectual property and the taxable provision of marketing or administrative services.
  • Antitrust. For antitrust purposes, on B2B sites and other auction-type e-commerce sites where buying and selling will occur, firewalls should be established to prevent each seller on the site from being able to view the prices or fees offered by other sellers. In addition, there should be no limitations imposed on the number of buyers or sellers permitted to utilize the site, and there should be no conditions placed on buyers or sellers that require them to conduct business only through the site.
  • Representations and warranties, liability limitations, indemnification, and insurance. The contract should include sufficient representations and warranties by the vendor that its software, Internet site, and everything else it brings to the venture does not infringe any intellectual property or other rights of third parties, does not violate any applicable laws and regulations, and will perform as promised. The contract also should limit the association's liability and damages to the maximum extent possible. In addition, be sure the contract provides for full indemnification of your association for all of the vendor's acts and omissions, and that this is backed up with insurance maintained by the vendor in specified amounts, with your association named as an additional insured. Also be sure your association's own insurance provides coverage for your risks.