With top-level domains appreciating at as much as 94% per year by some estimates, it is little wonder that domaining is the new ‘hot’ industry in the internet world. But despite the rapid growth of domaining, there is surprisingly little consensus as to what industry best practices are, or even what laws apply to domaining. In this article we try to sort through the legal and accounting mumbo-jumbo to explain ten of the most important US laws when it comes to domaining and provide some simple and straightforward tips for safely navigating them.
1. Domain Sniffing
“I had a really great domain name idea, which was available when I searched through the registrar, but then five minutes later when I went to buy the name it was gone.” Anyone who has been in domaining for more than a month has heard dozens of versions of that same story. Although not everyone buys that domain sniffing actually exists, there is mounting evidence that domain sniffing exists in some form or another. The real question is, what legal recourse do you have against these sniffers?
What is the Law?
Unfortunately, simply having the idea to register a domain name first gives you no legal claim to the name over the person who actually registered it. So in this case, your best bet is to argue that your privacy was infringed upon or that your proprietary information was taken. The US laws governing electronic privacy and trade secret rights are a patchwork of various laws which often overlap.
Like almost every electronic claim, your first step should probably be to write a cease and desist letter. If you want to write your own (they’re really easy) just use this form. Anything beyond a C&D letter and you’re probably going to need an attorney, which may make the decision to fight economically inefficient.
Privacy Violation:
The key to any good C&D letter is to point to some concrete laws that you believe the sniffer may have violated. In this case, the first stop is probably the Computer Fraud and Abuse Act which really focuses on hackers that actually get onto your computer and / or steal your password or personal information. If you had to use a password or login to run the domain search you should in include a reference to 18 U.S.C. § 1030 (the actual code of the law) in your letter.
Economic Espionage:
The next legal protection is to argue that the domain sniffer may have committed economic espionage of a trade secret, which is a violation of the Economic Espionage Act of 1996
Generally speaking, the Electronic Espionage Act criminalizes theft for economic purposes (which is clearly the intent of domain sniffers) and it applies to US citizens, people operating in the US, or where the offence would have a substantial effect in the US. The relevant code, in case you want to include this in your C&D letter, is 18 U.S.C. § 1831-1839.
Wire Fraud:
If neither of the above two options applies, the best protection is probably “wire fraud” which applies generally to any fraud by wire (which includes the internet). The phrasing of 18 U.S.C. § 1343 (which is the relevant code) is pretty broad and applies where a person has concieved of a scheme to defraud. Fraud is a crime punishable by up to 20 years in prison, so this isn’t the sort of threat you throw around lightly. Make sure you have good cause and make it clear that this is a suspicion based on what you have seen and that you aren’t making an outright accusation at this point.
Misappropriation of a Trade Secret:
The final law that you will want to throw in in almost every domain sniffing C&D letter is a reference to the Uniform Trade Secrets Act (18 U.S.C. § 1832) which has been adopted by 45 states. The precise form of the law differs in every state, so you will have to look up the appropriate code for the relevant state to reference in your situation. Generally speaking, however, the law is as follows:
The act defines a trade secret as information, including a formula, pattern, compilation, program device, method, technique, or process, that:(i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and(ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.
How to Stay Out of Trouble?
Never use a C&D letter to fight for a domain that you believe might have been legitimately obtained. Making wild accusations, specifically criminal accusations, is a good way to get yourself countersued.
Always closely adhere to the standard C&D form. Model Cease and Desist letters are carefully tailored in a way that conveys that you’re serious about getting your domain back, but that doesn’t expose you to liability. So make sure that you cover your bases by using the model format.
Consider that some domaining experts believe that domain sniffing does not actually exist, but is just the jealous reactions of paranoid domainers whenever they miss out on a good domain. Make sure that you don’t contribute to that reputation by claiming that domain sniffing was committed every time you lose out on a domain.
2. TradeMark Issues
People who have never traded in domains before instinctually think that one of the best domaining strategies is simply to buy up trademarked names and then hold out for a big payday when the company who owns the trademark wants to use it. Experienced domainers are not so naive as to think that buying Starbucks.com or Comcast.net before the actual company gets it is a viable business strategy. That said, there is a lot of gray area when it comes to domain name trademark issues, and knowing what the law is can help save you some money.
What is the Law?
The Anticybersquatting Consumer Protection Act, passed in November of 1999, made it easier for individuals and companies to take over domain names that are confusingly similar to their names or trademarks. But because trademark infringement cases were long, drawn out, and prohibitively expensive, few cases ever made it all the way to trial. As a result, the Internet Corporation for Assigned Names and Numbers (ICANN) decided to streamline the process by creating the Uniform Domain Name Dispute Resolution Policy (UDRP). In theory, the UDRP was a big improvement, since it made domain name disputes faster and cheaper, and also created a single three-prong rule for all domain name trademark disputes. In a UDRP case, the party seeking control of the domain need only prove three things:
- The trademark owner owns the trademark,
- The party that registered the domain name has no legitimate right or interest in the name, and
- The domain name was registered and used in bad faith.
While the three prong rule is succinct on paper, in practice, it is far from straightforward. In particular, there is no clear definition of “no legitimate interest” nor “bad faith.” Blatant cybersquatting or typosquatting is clearly illegal under the three part test; such as buying “www.Gooogle.com” and sending Google an email saying that you’re going to put up porn on the site if they don’t buy it from you for $10,000,000. But for less clear cases, such as whether holding “www.Googles.eu” is a violation of Google’s trademark, the UDRP three-prong test provides little guidance.
It’s also important to keep in mind that just because a trademark isn’t formally registered doesn’t mean it doesn’t exist. Trademarks can arise both through registration and through use. Trademarks that arise through use can equally be enforced in the US and in most countries (though not China) against people trying to cash in by using a confusingly similar name.
How to Stay Out of Trouble?
Never register a domain in the name of a known existing trademark. The days when cybersquatting was a viable business plan are long gone, and attempting to do so now is just going to cost you time and money. Make sure to check online for public trademarks, but know that any search you make is likely to provide you with only a partial view of the existing trademarks.
Always remember that just because a company’s trademark is a part of your domain name does not mean you are necessarily in violation of that company’s trademark rights. There are a number of exceptions including fair use, parody, non-commercial use, and non-competing use that may apply. In addition, trademarks are not universal, so the fact that the company holds a trademark in one area does not mean that their trademark necessarily applies to your domain.
Consider that many large companies overstate their trademark claims as a matter of policy. If you are a domainer with a lot of holdings, be prepared for overzealous C&D letters claiming that anything remotely close to their trademark is in violation of the law.
3. What Legal Entity Should I Use?
Many domainers started out with nothing more than a few hundred dollars and an internet connection. So when it came to spending time and money to create a separate legal entity, many domainers just chose to operate under the default legal form DBA, which offers no legal protection. Even now, many domainers remain confused about whether they need to form a separate entity, which one they should choose, and why. Unlike other issues in domaining law, thankfully the laws surrounding entity types are pretty straightforward.
What is the Law?
When you own domains yourself (as opposed to through a legal entity) your personal assets, such as your personal savings, car, etc., are at risk if something goes wrong. So for instance, if you’re being sued for a trademark violation and you lose the case, you could lose your personal assets as well as the company assets. Suffice it to say, forming a separate legal entity for your domaining company is important.
There are a few major options when deciding which entity to form, each of which has its drawbacks.
C-Corporation:
Most Fortune 500 companies are C-Corp’s, which leads many new domainers to believe that it is the right choice for them. For domainers, C-Corps just mean an extra layer of 15% taxes, and probably aren’t desirable unless your company is planning on going public (a.k.a. having an IPO) in the very near future.
General Partnership:
There’s two of you in the company and you call yourselves partners, so the logical choice is to form a partnership, right? Wrong. A general partnership is the ugly stepchild to the LLC and S-Corp, because in a general partnership there has to be one person or entity designated as the general partner. Whoever that is doesn’t get limited liability. Thus, if your company got sued and it was formed as a general partnership, the general partners’ personal assets (personal savings, car, etc.) would all be included in the pot of money that creditors or the people that sue you can get to.
S-Corp:
Given that a General Partnership or C-Corp aren’t likely the best choice for your domaining company, the real choice is between an S-Corp and an LLC. Both offer limited liability to all the members (unlike a General Partnership) and neither has an extra layer of tax (unlike a C-Corporation). S-Corp’s are advantageous because they allow the owners to allocate part of the company income to a salary and part as a profit distribution, whereas an LLC treats all company profits as salary. The distinction is important because a domainer’s salary is subject to a self-employment tax, whereas passive income isn’t. So if you think your company is going to make enough money that it would exceed a reasonable salary for you, and if you are already planning on having employees, which means you’re already going to prepare payroll tax returns, then the S-Corp may be the way to go.
Limited Liability Company (LLC):
LLC’s are the newest legal entities and they provide an advantage over S-Corp’s because you can allocate profits in your company differently than you allocate ownership interests. That means that if you want to keep 100% ownership of your company but give your employees a share in the profits you can with an LLC (but can’t with an S-Corp). They also have the advantage of requiring virtually no paperwork or technicalities like an annual meeting of the shareholders to remain in compliance. The downside is that all of your company profits are treated as a salary, which means you’ll be paying more in self-employment tax than you would under an S-Corp. For most one or two person domaining companies, LLC’s are the way to go. They offer as good of liability protection as any other form, have low tax obligations, and give you some flexibility in how you want to structure profits.
How to Stay Out of Trouble?
Never form a C-Corporation or Limited Liability Partnership unless you have good reason to do so and have checked with an accountant first. The administrative, legal, and tax problems from a small domaining company’s perspective make these pretty terrible options for most.
Always write up a reasonable long-term projection for your business before choosing your entity. Deciding which legal form is best for your company depends not only upon your current situation, but also on the future, and getting it right early is a lot better than trying to fix things later.
Consider that the choice between an S-Corp and an LLC is a technical one which depends a lot on whether you plan to have other employees or not. That means that before you decide between the two options you should figure out whether the people that work for you are considered “independent contractors” or “employees” (discussed below).
4. What State to Legally Form Your Company In
If you poke around the list of Fortune 500 companies, you’ll find that the vast majority are incorporated in Delaware or Nevada. The reason why, is that these states have developed a set of laws which are predictable and which tend to favor corporations and their officers over the people suing them. By contrast, some states lean the other way and tend to favor plaintiffs.
What is the Law?
You can form your company in any state you want, but wherever you do it, you’ll need to have a mailing address. So if you decide you want to take advantage of the pro-business laws in Delaware, you’ll need to cough up about $300 a year in order to pay somebody to be your “registered agent” in Delaware. There are online services which do this, but in essence it just means that you’re paying somebody in Delaware to accept mail on your behalf if the State of Delaware ever needs to contact you (such as when somebody is suing you).
When choosing between Delaware and Nevada, there is very little difference. Delaware has been the historical choice for corporations, but to get in on the act Nevada simply adopted all of Delaware’s corporation law, plus it provided the added bonus of allowing anonymous shareholders, officers and directors by not requiring that corporate information be public record. But if you’re not interested in remaining anonymous, there’s virtually no difference between Delaware and Nevada.
A common rumor is that you can avoid taxes by incorporating in Delaware or Nevada. States tax businesses at different rates; unfortunately, however, your state taxes aren’t tied to where you’re incorporated, but where you operate. So whether you choose to incorporate in Delaware, Nevada, or any other place, you’ll still be paying your home state’s taxes for any money you make.
How to Stay Out of Trouble?
Never attempt to avoid taxes by forming your company in another state. It simply doesn’t work, despite the fact that seemingly everyone who isn’t an accountant or lawyer thinks it does.
Always read up on what legal commentators are saying about the corporate laws in your home state before forming your company. Some states are particularly archaic (e.g. Pennsylvania) and you should probably avoid forming there, despite the added cost.
Consider that a state’s corporate laws are determined by a variety of factors, so there’s no way of predicting absent research which home states are corporate friendly and which aren’t. Some states with a historically strong union presence or states with no real history of any corporations at all tend to be especially bad because the plaintiff’s lawyers bar is so strong relative to the defense lawyer’s bar. That said, the only real way to know how your state stands is to check with a local corporate lawyer.
5. Piercing the Corporate Veil
The primary reason for forming a legal entity and not simply operating your business as a DBA is for limited liability protection. But you only get that protection if the law recognizes your legal entity as separate from you or the other officers in your company. Thankfully, the law governing whether to disregard your separate legal entity, also known as “piercing the corporate veil” is a single test.
What is the Law?
As a general rule, there are three situations in which a court will disregard your separate legal entity and decide that your personal assets should be included along with company assets to pay a lawsuit or creditor’s claim:
- when the entity is operated as the owner’s alter ego;
- when the corporation is under-capitalized; and
- to prevent fraud.
The “alter ego” prong is the most dangerous for domaining companies. In practice, a court is looking for situations in which the owner treats the company bank accounts and records as his own personal bank accounts and records. It is most commonly found when there is only one owner of a company, and where the owner is constantly dipping into company funds to pay personal debts and not keeping good records of these transactions. Essentially, the “alter ego” rule says that if you don’t treat your company assets as separate from your own, the courts won’t either.
The “under-capitalized” and “prevent fraud” prongs are far less commonly invoked, and thus the requirements meeting those tests are less clear. Generally if you aren’t pulling every dollar out of the company as soon as its made so that your company is constantly teetering on the point of failure, then you meet the “under-capitalized” prong. The final prong, “to prevent fraud” is just a general catch-all prong which allows courts to disregard a legal entity when they feel like someone has complied with the letter, but not the spirit, of the law.
How to Stay Out of Trouble?
Never borrow money from the company for personal expenses if you can avoid it. If you have to do it, make sure that you keep very accurate records of how much was borrowed, and when it was paid back. To be safe you should also charge yourself a reasonable interest rate for the money borrowed.
Always keep separate financial records for your personal accounts and your business. When purchasing or selling a domain make sure to do so in the company’s name, not in your own, so there is never any doubt who is transacting.
Consider that even if you keep meticulous records and otherwise treat your company as a separate entity from yourself, the “prevent fraud” catch-all test will always provide wiggle room for a court to disregard your separate legal status. So you may want to consider not owning 100% of your company, as companies with divided ownership interests are almost never legally disregarded by courts.
6. Is your business a “business” or just a “hobby”?
Starting a domaining company involves some initial cash outlays to buy your first round of domains, but often the revenue doesn’t come until much later. Therefore, domaining companies commonly lose money their first few years. Just because a company loses money, doesn’t mean it’s not a legitimate company; after all, most of the airline companies lose money in their initial years of operation. But for the IRS, showing losses in more than two out of any five years is an automatic trigger that your business will be treated as a “hobby” for tax purposes.
What is the Law?
For domaining companies in particular, it is important to be treated as a “business” and not a “hobby” because you cannot deduct the losses from a “hobby.” That means that you will not be able to use the losses in the early years of your company to offset the profits you make as the company matures, ultimately subjecting your company to paying much more in taxes.
The IRS has made the “more than two out of any five” rule because they want to discourage people from creating fake companies just to get tax deductions. Without the rule, for example, someone might start a “food review” company which never turns a profit, but through which the person can deduct all of their meals as business expenses. But since there are obviously a lot of legitimate companies that lose money in more than two out of any five years, there is a set of alternative indicators which a company can use to show that it is in fact a “business” and not a “hobby.” The alternative factors are as follows:
- You carry on the activity in a businesslike manner.
- The time and effort you put into the activity indicate you intend to make it profitable.
- You depend on income from the activity for your livelihood.
- Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business).
- You change your methods of operation in an attempt to improve profitability.
- You, or your advisors, have the knowledge needed to carry on the activity as a successful business.
- You were successful in making a profit in similar activities in the past.
- The activity makes a profit in some years.
- You can expect to make a future profit from the appreciation of the assets used in the activity.
How to Stay Out of Trouble?
Never make any formal representation that your company is “just a hobby.” Your company is a for-profit company, and your financial records should indicate your intent to reach profitability.
Always include in your annual financial records an indication that you are aware of your your company’s lack of profits and detail your plans for achieving profitability. Whether your plan is as simple as waiting until your domains have appreciated enough to sell them, or as complex as changing your business structure, it is importan