Recently, one of our solo founder clients approached me to draw up some short agreement for some (student) unpaid interns he was considering bringing on with his startup. In this post, I touch on some of the things I explained to him after (very professionally, of course) telling him he might want to re-consider his company’s plan. If you’re a startup founder considering “hiring” unpaid interns to come and work at your new company, it is important that you understand the potential legal and business risks first.
Is your startup’s unpaid internship even legal?
Yes, many business owners never even bother to consider this first, critical question regarding their new or established internship program.
The answer is a very legal “probably, but it depends”. While not necessarily illegal in and of itself, the law (and the United States Department of Labor (DOL)) will look at who is the primary beneficiary of the unpaid internship arrangement. So long as the unpaid intern, and not the employer, is the primary beneficiary of the program then, yes, it is probably legal.
But how is “primary beneficiary” even measured? Obviously, this is a rather subjective issue, which is why the DOL will examine your unpaid internship through a seven-part “primary beneficiary” test. If an analysis of these seven points leads to the conclusion that you the employer are actually the primary beneficiary, then the Department will find the unpaid intern to be an employee what was entitled to minimum wage. Before you ask or scroll down for it, the specific elements of the PB test are beyond the scope (and point) of this article, so just do an internet search for “DOL primary beneficiary test” or, better yet, consult with an experienced employment lawyer.
Therefore, if your startup were to keep interns unpaid and then were later to be investigated by DOL (however unlikely, but weird stuff can and does happen), then the potential for back wages owed plus interest and penalties imposed could add up some. Maybe not such a big deal financially for a startup flush with cash or in their later funding rounds, but potentially a serious hit to those companies just getting off the ground.
Lastly, I’m sure there are many business owners who will argue that their unpaid student interns are receiving college credit as part of their participation, so of course the unpaid intern is the primary beneficiary. However, keep in mind that DOL does not accept receipt of college credit as a valid explanation for why the internship is unpaid.
Unpaid Internships and Work Made for Hire
Frankly, this issue may have deserved top billing in this article, since it might be an even bigger problem for certain startups considering accepting unpaid interns to perform tasks that involve creating original works (like, say, a UX design or software application) that will be a core asset of your company going forward.
Since unpaid interns are by their very definition uncompensated for their efforts, they are not likely to be found to be employees under the Fair Labor Standards Act of 1938. As such, it is therefore equally unlikely that your unpaid intern that is helping you out with your website’s back end work would be considered as an employee for the purposes of the definition of “work made for hire” under the Copyright Act.
As many of you are aware, work product that is prepared by an employee in the scope of her or his employment is in almost all situations work made for hire. This is the easiest and least complex of the work for hire scenarios. However, it is when an employee isn’t actually an employee that things can get very fuzzy fast. And fuzzy is never a good place for your startup (or any business, for that matter) to be in, legally speaking.
Moreover, when work for hire disputes end up in court, judges and juries typically take into account such evidence as employment status and compensation. An unpaid intern not receiving compensation and of dubious employment with your company would run the very real risk of her work product NOT being considered a work made for hire.
Thus, whatever your unpaid interns might be producing for you (e.g., code, artwork, design layout, etc.) that would be utilized by your startup may not actually be owned by your company. Practically speaking, this might mean that you would either have to (a) litigate the matter, which is not cheap or fun, or (b) have to either buy the disputed work product outright or, at a minimum, negotiate some form of license to use the given work (also, probably not cheap or fun).
Now you and your fellow founders might be thinking, “we’ll just have them all sign confidentiality or non-disclosure agreements!” and, yes, you could certainly try and play things out relying strictly on this. However, the big problem with this plan is that, for any contract to be valid and enforceable, there has to be consideration. This is one of those Contract Law concepts you learn as a 1L that is a fancy way of saying that there must be some type of benefit or value received by each side as part of any binding deal.
For consideration to be valid it helps that it be adequate. In other words, if it isn’t abundantly clear what value or benefit the unpaid intern is receiving from the arrangement, then the NDA which the unpaid intern was told to sign as a condition of their starting work could not only be challenged by the unpaid intern later but very possibly tossed by a trial judge.
What If We Bring Them on as “Independent Contractors”?
Setting aside the problem that your company is still not compensating the unpaid intern (just tinkering with titles), this approach runs into at least two potentially serious problems.
From the intellectual property law side, the work made for hire doctrine as it pertains to ICs only applies to nine specific categories of works, which is marvelous if you are having that unpaid intern take part in, say, a “motion picture”, or an “instructional test” or even an “atlas”.
However, if, as in the case of at least one of my startup clients, the internship involves the development of a software application to be used by the company, you may have a major problem, since software code and similar works are not one of the nine categories and, frankly, really don’t fit neatly into any of them.
However, with an employer-employee relationship, there is no need to try and legally shoehorn software source code and the like into one of these nine categories.
As I’ve written about in other posts, the second problem with calling your unpaid interns “independent contractors” is the risk of being determined to have misclassified what was really an employee as an independent contractor by not only the DOL, but (here in Arizona, anyway) the Industrial Commission, not to mention the Internal Revenue Service, all of which can impose fines, require payment payroll taxes not paid, in addition to hefty interest and penalties.
While most all business owners prefer unpaid to paid (especially when it’s them doing the paying), the risks of the unpaid internship need to be carefully weighed against the potential costs. Even a small but reasonable hourly wage or stiped would give your student intern a financial stake in your business and a feeling of ownership over their work product.
Best of all, some minimum amount or stipend at or above minimum wage should provide your startup with sufficient “cover”, in addition to likely happier, more productive “interns” out of it. Interns who can, not coincidentally, now sign a scaled-down version of your employment agreement, complete with robust NDA (which will now be more enforceable) and perhaps even a proprietary inventions assignment agreement to make a nice backstop to the work made for hire doctrine (which, to keep it real, technically only applies to Copyright).
On the other hand, if your company is determined to bring on its interns in an unpaid capacity, at least make sure you do it right. Put understandings about compensation and commitment in writing. Make sure there is consistent, verifiable training and instruction. These should involve transferable skills. Avoid displacing existing workers or merely assigning the unpaid intern grunt work (i.e., sh*t duty). Keep and maintain a careful log of the intern’s hours and overtime. Everything should be signed by both the intern, their supervisor and, if possible, their academic advisor or point of contact.
Ben Bhandhusavee is the Managing Attorney for BHANDLAW, PLLC, a startup, technology, and e-commerce law practice advising founders and management teams on company startup, corporate and technology transactions, e-commerce, as well as Internet privacy concerns. The firm serves corporate and individual clients throughout Arizona, the United States, and internationally. Our offices are conveniently located along the Camelback corridor in Phoenix’s financial district. For more information about our Company Startup practice, feel free to reach out using the contact form on the right or call us at (602) 222-5542 to schedule a meeting. Connect with Ben on LinkedIn or Avvo.