CUSTOMIZING CONTRACTS FOR INTERNET COLLABORATIONS.

A 10-point review process can reduce legal risks and maximize returns.

Many association executives have been approached by dot-com companies offering Internet-based initiatives that promise healthy nondues revenue streams and a host of new member services. Perhaps it is an electronic marketplace where association members can buy or sell products or services; an online benchmarking service, information exchange, job bank, membership directory, or referral network; a turnkey Web site development and hosting program; or another electronic service that association members (and possibly the general public) can access online. Associations and their memberships are highly attractive, captive audiences for dot-com companies; an influential association's endorsement of a potential technology partner's service not only means increased business, but it may mean the difference between the company's success and failure. Conversely, if the venture is successful, it can be highly profitable for the well-positioned association.

Unfortunately, many association partnerships with dot-coms and other technology partners have fallen below expectations--sometimes creating considerable headaches for associations when the relationships sour. Some of this disappointment has stemmed from unrealistic expectations, a slow warming to e-commerce, and a lack of market research into member needs and preferences. But some of it also has arisen from associations' poor planning, negotiation, and execution of contracts with their technology partners.

While many dot-coms have fallen on hard times, there are good reasons for association executives to continue considering Internet ventures that add value for their members and their industries and professions. Certain cautions, however, must be taken in the process. After meeting with the technology company's executives and hammering out the core terms of the potential deal, for example, some association executives are too quick to reduce their oral agreements to writing. In the rush, they may disregard some important questions: 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 nonexhaustive list of 10 key legal issues to pay special attention to as your association negotiates and drafts the contract for its next Internet venture:

1. Conduct due diligence and ensure quality control. Avoiding negligence in the vendor selection process--and on an ongoing basis--is a key step in minimizing your association's liability for the errors and omissions of the vendor. Consequently, you must do your homework when it comes to learning about your potential Internet suitor. Do business background checks; check references; request key legal, financial, corporate, and insurance documents; and test online ventures created for other clients. 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.

2. Consider a confidentiality agreement before negotiations begin. While not essential, it often is prudent for an association to enter into a confidentiality agreement with a potential vendor with which it seeks to do business prior to beginning negotiations with the vendor. Such an agreement can help ensure that the association will not be damaged or put at a competitive disadvantage by the disclosure or improper use of sensitive information or documents.

3. Consider business structure options. While it is certainly permissible for your association to structure an Internet initiative as a partnership or joint venture, if you do, your association may be liable for virtually everything that happens in connection with the venture. In addition, the character of the income--which may be taxable--will pass through to your association.

Before setting up your business structure, consider some other options. For example, if the venture is one that substantially furthers your association's tax-exempt purposes--such as most Web-based educational, research, or benchmarking services, the tax considerations would not weigh against the formation of a partner ship or joint venture structure (although the liability concerns might).

If, however, the venture is an electronic marketplace where your members can buy, sell, or trade products or services, for instance, it generally will be unrelated to your association's tax-exempt purposes. If structured as a partnership or joint venture, the association's income from the venture generally would be taxable. It, therefore, makes sense to consider a structure that can shield income to your association from some or all of this tax. Specifically, establishing a structure that merely endorses a venture owned and operated by the vendor--with certain rights, revenues, and services flowing to your association--may be a more desirable approach, both from a tax and liability perspective.

Another alternative is to establish a for-profit taxable subsidiary of the association. If a partnership or joint venture structure is desired--or if the potential liability risk connected with the venture is particularly high--consider shifting the association's ownership and duties to a wholly or partially-owned taxable subsidiary. 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. Some or all of the after-tax profits can then be paid to the association as tax-free dividends.

4. Review the Internet venture relative to intellectual property and links to other sites. Be sure that the contract provides for: the assignment (or at least perpetual, irrevocable, royalty-free license) to your association of all key copyright, trade mark, 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 con tent 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. To the extent possible, be sure your association can obtain and continue to use (either through an assignment of ownership or a perpetual, irrevocable royalty-free license to use) all relevant Web site names, domain names, logos, copyrighted information, Web site design, and other intellectual property upon termination of the agreement with the vendor. Contract for the vendor's assistance and cooperation in ensuring the smooth transition of this intellectual property back to your association or to another vendor.

5. Spell out the specifics of contract terms. As in all contracts, provisions that define the initial term of the contract, whether and how the term will automatically renew, and when and how the agreement an be terminated are critical. In addition, provisions should be made both for voluntary termination prior to the end of each term and for automatic termination upon certain conditions.

The desired length of the initial term and any renewal terms will vary from case to case, depending upon the relative leverage of the parties, the long-term viability and financial integrity of the vendor, the goals and needs of the association, the risks and rewards to each party over time, and the ability of either party to terminate mid-term, among other factors. In any event, be sure to build in performance and timeline benchmarks to ensure your association's ability to terminate the agreement without penalty in the event such benchmarks are not met. Upon termination of the agreement, be sure that your association is able to transition the site, to the extent possible, to another vendor.

6. Pay attention to data control. Craft the contract to provide that your association will be the sole owner of all data generated under the agreement (valuable information about your members and their purchasing habits, for example) and that all such data will be subject to strict confidentiality requirements. Establish limitations (as appropriate) on the vendor's right to use such data during the term of the agreement (such as to improve the products or services it offers to your association's members, or to analyze its own efficiency or effectiveness), and make it clear that the vendor has no right to use the data after the agreement is terminated. Consider including provisions to permit your association to monitor (where possible) the use of such data following termination, and to impose liquidated damages (a predetermined amount of money damages as an alternative to proving actual damages suffered) on the vendor for any improper usage. 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 any competing associations during the contract term. The vendor may require the same of your association.

7. Set quantifiable standards of Web site performance and technical support. The contract needs to be very clear about the precise obligations of both the vendor and your association relative to the agreement. Err on the side of being more, rather than less, specific. In addition, be sure that defined performance standards for the Web site are detailed in the agreement (such as response time, permitted downtime and error-correction time, delivery time, software specifications, and customer service support requirements). Spell out what happens in the event that the vendor fails to meet such standards, identifying consequences such as the right of your association to terminate the agreement or to demand that liquidated damages be paid to the association. Finally, it is important to spell out what technical support the vendor will be obligated to provide to your members or other users of the Web site (typically through a toll-free telephone number or e-mail address), as well as to your association itself, at the vendor's expense.

8. Establish fees, expenses, and payments. Determine specifically 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 certain 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 association's tax liability. This may require separate agreements for the tax-free licensing of intellectual property and the taxable provision of marketing or administrative services, as discussed above.

9. Build in antitrust protections for e-commerce sites. For antitrust purposes, on auction-type electronic commerce sites where buying, selling, or trading of products or services 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 use the site, and there should be no conditions placed on buyers or sellers that require them to conduct business only through the site.

10. Minimize liability risk through representations and warranties, indemnification, and insurance. An effective contract includes sufficient representations and warranties by the vendor that its software, Internet site, and other elements that it brings to the venture do not infringe upon any intellectual property or other rights of third parties, do 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. Similarly, check that your association's own insurance provides sufficient coverage for your risks.

There is no doubt that the promise of the dot-com world in 2001 is not what it was in 2000 and before. Many Internet companies have failed and others are facing hard times. While analysts may argue about the reasons why commerce has not yet migrated to the Internet as quickly as predictions forecasted, the overall lack of dot-com success must not be lost on associations.

Many associations have been approached in the past by potential dot-com partners with exaggerated revenue predictions and promises. Clearly, much of the return has not materialized. The challenge for associations contemplating technology partners is not only how to carefully select the partners and programs with the highest likelihood of success. Association leaders must also ensure that their contracts for these ventures are drafted in a manner that maximizes upside potential and protects the down-side in the event of failure. Educating the association executive on how to do this is the easy part; negotiating the contract, especially in today's Internet environment, is the greater challenge.

Jeffrey S. Tenenbaum is a lawyer in the Washington, D.C., offices of Venable, Baetjer, Howard & Civiletti, LLP. E-mail: [e-mail].