by Lee Gesmer | Dec 10, 2012 | Contracts, Corporate Law
An interesting “David v. Goliath” jury trial is scheduled to begin in Massachusetts U.S. District Court Judge Patti Saris’s Boston courtroom this week. The case has received a fair amount of press coverage, but not nearly enough in my opinion. (Steven Syre Boston Globe column today, July 2012 NYT article).
The events in Baker v. Goldman Sachs date back to the heady days of the dotcom era. In short, James and Janet Baker (pictured here) spent much of their careers pioneering speech recognition technology which they commercialized under their company Dragon Systems, based in Newton, Massachusetts. The Bakers were legendary in the Massachusetts tech community in the 1990s – home-based technologists who came up with a promising-today, sky-is-the-limit-tomorrow technology.
In 2000 they sold Dragon for almost $600 million to Lernout & Hauspie, a Dutch company. Unfortunately, they were paid fully in Lernout stock, and almost immediately after the sale Lernout was discovered to have been cooking its books. The stock went to zero, and so did the consideration the Bakers received for their company. For the Bakers, this was a business catastrophe of mythical proportions. One day they owned an immensely valuable company that that owned technology they had spent decades developing. The next day they had sold the company in exchange for almost $600 million of Lernout stock. Within a few months, their company was gone and their stock worth nothing.
While several Lernout executives ended up with stiff prison terms in Belgium this was small consolation to the Bakers. Their technology is owned by Nuance, which sells it under the product name “Dragon NaturallySpeaking.” The Bakers’ technology has had steady success under Nuance. Reportedly, it is a component in the Apple iPhone’s Siri product.
Goldman Sachs was the “investment banker” for Dragon’s sale to Lerner, and the question is, why didn’t they discovery that Lernout was a shell game? 
The gist of the Baker’s case is that Goldman (which received $5 million in fees) breached various legal obligations to Dragon by failing to discover that Lerner was “all hat, no cattle.” According to Steven Syre’s column, after Dragon’s salel to Lernout The Wall Street Journal simply called purported L&H customers and discovered they weren’t doing business with Lernout, something the Bakers claim that Goldman should have uncovered as part of its due diligence before the sale. In fact, it appears that Lernout’s Asian business—a significant part of its overall revenues—was a sham. Lernout had fabricated almost $400 million in income.
To make matters worse, the Times article asserts that Goldman assigned a young (20s and 30s) and inexperienced team to handle the deal. The Bakers’ court filings claim that Dragon and the Bakers fell victim to a massive fraud, that there were many “red flags” that Goldman failed to pursue in due diligence, and that had Goldman done the job it promised to do, the sale never would have occurred. In fact, the Bakers claim that Goldman had discovered problems with Lernout on behalf of another client, and failed to disclose these problems, or raise its level of investigation based upon this knowledge.
The full story is complex, and involves many different actors at Dragon, Goldman and various accounting and law firms. The question of who should have discovered Lernout’s fraud involves more finger-pointing than the presto movement in a piano concerto for four-hands. Of course, the Bakers (local scientists with significant bona fides) are far more sympathetic than the Goldman witnesses, many of whom left Goldman shortly after the sale to Lernout closed in June 2000. It remains to be seen whether they can hold their own as trial witnesses. Goldman Sachs’ credibility? Well, the Bakers must hope they draw a jury that reads the business pages.
While in the eyes of a non-lawyer the facts (as alleged) appear to favor the Bakers, Goldman has a number of technical legal defenses, and while it’s had little success with them before Judge Saris, presumably it hopes to prevail on them on appeal. For example, it argues that it was not responsible for the due diligence that would have uncovered the irregularities in Lerner’s sales numbers — Dragon’s accountants were responsible for this task. It claims that Lerner’s fraud was essentially undiscoverable by Goldman. It’s trump card is that the Bakers are caught in a legal catch-22: since Goldman Sachs’ engagement letter was with Dragon (the corporation), the Bakers lack legal standing as individual shareholders. And, since Dragon was merged into Lernout (and therefore for reasons arising out of bankruptcy law had no right to sue), Goldman is immune from liability to Dragon. Since neither the Bakers nor Dragon has standing, Goldman has no liability. Thus far the Bakers have been able to side-step this argument (arguing, for example, that they are third-party beneficiaries to the contract), but this issue remains unresolved, and could prove to be a get-out-of-jail-free card for Goldman.
The parties’ joint pretrial memo, outlining the many legal and factual issues, is linked below.
It is surprising that this case has not yet settled (the vast majority of civil cases—estimated as high as 95%—do). However, cases often settle “on the courthouse steps” or during trial. In fact, the trial judge in this case has been known to require party principals to hold a settlement conference following opening statements at trial. The idea is that once the parties get a look at a real jury, and hear the opposing attorney’s opening statement, they may adjust their expectations and reach a settlement.
If this case doesn’t settle it is almost certain to raise interesting and important investment banking legal issues both during trial, and on appeal to the First Circuit. Presumably, Goldman Sachs has revised its engagement letters.
Update: The jury found against the Bakers at trial.
Baker v. Goldman Joint Pretrial Memo
See also Baker v. Goldman Sachs, 656 F. Supp. 2d 226 (D. Mass. 2009) and an as yet unreported 2012 decision Baker v. Goldman Sachs (D. Mass. October 31, 2012).
by Lee Gesmer | Nov 29, 2012 | Noncompete Agreements
Employee non-compete agreements are unenforceable under California statutory law, but that hasn’t stopped many California tech companies from finding a back-room work-around.
In October 2010 I wrote a short post discussing the FTC’s complaint that a number of California companies had illegally agreed not to solicit each others employees – so-called “no-poach” agreements. (Apple, Google, Have You No Shame? Really!).
Now, two years later, the DOJ has filed a suit against eBay which, the suit claims, entered into a no recruit/no hire agreement with Intuit. Intuit is one of the companies caught engaging in this practice in 2010, and is subject to an agreement not to do so. To make matters even worse, according to the DOJ press release the agreement was entered into at the highest levels of both companies – Meg Whitman (then eBay’s CEO) and Scott Cook (CEO of Intuit).
These companies have huge in-house legal departments (not to mention Big Law outside counsel). But, the fact that the Justice Department views these types of agreements as per se illegal seems to have escaped them. Or, perhaps the benefit of these agreements (if a company is caught) is worth the cost.
by Lee Gesmer | Nov 29, 2012 | Contracts
Custom software development agreements that go awry and end up in litigation are notoriously difficult cases.
The reasons for this (to name just a few) are the finger-pointing (“your fault, no yours”), the complexity, ambiguity or incompleteness of the functional/technical specifications, the presence of third-party developers or hardware vendors (who can also be blamed), and the obscure, technical nature of the cases, which make them distasteful to judges and dull to juries.
Massachusetts U.S District Court Judge Richard G. Stearns issued a rare decision in one of these disputes last week. The case, Liberty Bay v. Open Solutions, involved loan origination software developed under a standard, milestone payment-based License Agreement. After a four year development project plagued with difficulties the Client terminated the agreement and the software Vendor filed suit, seeking the balance owed under the license agreement. The Client, for its part, wanted a refund of monies paid and additional consequential damages. Each side asked the court to issue summary judgment in its favor, and Judge Stearns wrote a decision addressing the contentions.
The background of the case is typical of thousands of similar projects. The project went off-schedule almost from the start. After a series of delays and defective deliveries the Client terminated the agreement and demanded a refund of monies paid to date. The Vendor asked for more time, and the Client agreed to provide it. However, subsequent attempts to deliver a working product were also unsuccessful.
Finally, the Vendor informed the Client that it would not continue to work on the project unless the Client caught up on scheduled payments that were past due. When the Client refused to make these payments the Vendor stopped work and the Client terminated the License a second time, following which it filed suit seeking damages.
Judge Stearns’ treatment of the case illustrates some of the pitfalls in software development disputes. Sadly for the Vendor, it was on the losing end more often than not.*
*While the case was decided under New York law (as specified in the License Agreement), New York and Massachusetts contract law are similar in most respects.
First, the court held that while the Client had waived the time for performance provided in the License Agreement by permitting the Vendor to continue to work on the project after the first termination letter, the extension was not “indefinite,” but only for a “reasonable amount of time.” The judge concluded that after the Vendor had failed to deliver after an additional year had passed this implied extension had expired, putting the Vendor in material breach of the agreement.
Second, the judge rejected the Vendor’s argument that the Client had waives its right to seek a refund after gaving the Vendor a “second chance” following the first termination. The Client did not waive its right to object to subsequent breaches of the same term (that is, failure to deliver a working product).
Third, while the Client was in breach of the payment schedule prior to the “go-live” (or final delivery) date, the Vendor tacitly approved an extension of the Client’s payment obligations when it continued to work without being paid according to the contract schedule. Therefore, the Client’s non-payment was not a defense to its breach of contract claims. If the Vendor had informed the Client that it was working “under protest” the Vendor might have had a stronger argument on this point, but it’s failure to do so doomed this argument.
Although the Client won on these issues, it lost on another. The License Agreement contained a common provision limiting the Client’s damages to monies paid and (belt and suspenders), prohibiting it from recovering consequential damages. Therefore, its claim for lost profits and “lost employee time” were barred. It was limited to recovering monies it had paid under the agreement, probably poor consolation for the loss of use of the system, the investment of management time and the likely higher cost of starting over. The decision makes no mention that the License Agreement provided for the recovery of attorney’s fees, and therefore this unknown amount must be subtracted from the Client’s recovery.
Software contract litigation can be exceedingly complex. This case barely touches on the potential issues. For an article discussing some of these issues in more detail see — Litigating Computer-Related Breach of Warranty Cases.
Liberty Bay v. Open Solutions
by Lee Gesmer | Nov 20, 2012 | Noncompete Agreements, Social Media
It’s not often that a Massachusetts Superior Court decision gets national attention, but if you search for Invidia, LLC, v. DiFonzo (Mass. Super. Ct. Oct. 22, 2012) you’ll see that legal blogs around the country have picked-up on this obscure case.
Why? Because anything that involves the intersection of law and social media gets attention.
In this case, the issue that attracted attention was whether a hairdresser employed by a beauty salon in Sudbury, Mass. “solicited” her former employer’s customers in violation of a noncompete/non-solicitation agreement. What did Ms. DiFonzo do to trigger this claim? She posted news of her job change on her Facebook page. The court held neither posting news of her new salon, nor friending several customers, constituted solicitation.
Professor Eric Goldman has a lot to say about this case, including his question of how widespread litigation in the hair salon industry improves social welfare. And, he quite rightly gloats over the fact that an agreement like Ms. DiFonzo’s would not be enforceable in California, which has prohibited employee non-competes by statute.
Not noted by most commentators outside of Massachusetts is the judge’s tentative conclusion that the customer “good will” this hair dresser developed with her customers may belong to her, not her salon. Most of Ms. DiFonzo’s customers seem to have been developed by her while working at the old salon, which makes this holding somewhat unusual. Goodwill is usually found to belong to employees who bring customers with them to their job (in which case, they are allowed to leave with them).
Salon owners across the state must be pulling our their hair in frustration over this aspect of the decision.
The former employer’s motion for preliminary injunction was denied on multiple grounds. According to my count, its hairdressers 2, salon owners 0 this year.
Invidia, LLC, v. DiFonzo (Mass. Super. Ct. Oct. 22, 2012)
by Lee Gesmer | Nov 16, 2012 | CFAA
Last month I wrote a post titled “Online Agreements – Easy To Get Right, Easy To Get Wrong.” In that post I discussed two cases in which the plaintiff had failed to take appropriate steps to necessary to impose terms and conditions on its customers.
A recent case decided by the federal district court for the District of Pennsylvania provides yet another example of how sloppy online contracting can doom a claim based on an online agreement.
The case, CollegeSource, Inc. v. AcademyOne, Inc., (E.D. Pa. October 25, 2012), involves the practice colloquially referred to as “screen scraping” — that is, copying information from displayed webpages, usually in large quantities for commercial use. See, e.g., Ef Cultural Travel Bv v. Explorica , 274 F.3d 577 (1st Cir. 2001) (describing screen scraping).
It’s easy — legally and technically — to prevent this by prohibiting it in the site’s online terms and conditions. Doing so allows the site owner to assert not only state-law breach of contract, but the potentially more advantageous federal Computer Fraud and Abuse Act (“CFAA”). However, the site user must agree to the terms and conditions.
Unfortunately for CollegeSource, it didn’t get this quite right. Specifically, CollegeSource offered three services. Two of the services required that the user accept a “browsewrap” subscription agreement that expressly prohibited scraping (“you agree not to . . . scrape or display data from the Content for use on another web site or service”). However, the third service did not require users to agree to this restriction. Think of this as two doors locked, one open. CollegeSource’s contract-based argument that the subscription agreement applied to the third service failed to persuade the district court judge. The result: no breach of contract and no violation of the CFAA.
CollegeSource, Inc. v. AcademyOne, Inc.
