Startup Toolbox

Jay Parkhill June 30th, 2008

HBS Working Knowledge newsletter has a Q&A with a Harvard professor who examined a specific kind of right of first refusal, where one party has the right to buy an asset at a fixed price, but can also swoop in if the asset is offered to a third party at a lower price.

The article explains that this works against the right holder, because it lets the seller tell the third party “buy at this (high) price or not at all.”

When Rights of First Refusal Are a Bad Deal — HBS Working Knowledge

The best part of the whole article is the answer to the question “why do people use these types of rights if they work out so badly for the right holder?”  The answer:

Contracts are big, complicated things with lots of clauses, some of which get exercised rarely if at all.

Words to live by for sure.

• contracts

Jay Parkhill April 23rd, 2008

A family vacation and a few important pieces of work that couldn’t be postponed meant that this blog got short shrift last week. Here are a couple of great tidbits from the blogosphere that I was finally able to focus on since getting home.

HBS Working Knowledge - Who Owns Intellectual Property?

Harvard Business School’s Working Knowledge newsletter has a good read on intellectual property in the digital age. It should really be called “How Do You Adapt When You Know Your IP is Going to Be Co-opted?”. Among other points, it notes that the (RED) campaign was expressly designed to be picked up freely by companies. The implication seems to be that it is similar to the GPL concept in software, where the license is free, but users of the software are restricted in what they can do with it downstream. In GPL’s case, the end product must generally also be free. In (RED)’s case proceeds must go to The Global Fund. Whether this is true or not, it is a nice example of an effort to promote viral growth of a brand among businesses as well as consumers.

I note as well that the HBS newsletter has conflicted feeling about the ownership of its own content. Most articles do not allow comments; a few are expressly designed to invite them. This article, appropriately, is one. HBS gets good comments. It should allow them more frequently, even if it meets losing some control over the content it puts out.

E-Commerce Law: Federal Court Upholds YouTube’s Terms of Use

This one is a bit wonkier. The relevant facts are that someone sued YouTube in Washington State even though the Terms of Use on YouTube’s site (you’ve read them, right?) specifically say that actions must be brought in San Mateo County, California. The court said that by using the site, plaintiff Bowen had agreed to the terms, including the choice of law provision.

This is another data point in the ongoing “legal discussion” of the validity of shrinkwrap, clickwrap and web site terms of use provisions. There is no ability to negotiate terms in any of these situations, so there is always some question whether certain provisions over-reach. In this case, the court decided that Bowen had expressly agreed to the terms with knowledge of them, and the San Mateo provision was therefore valid.

I still haven’t actually read the case, so I will reserve judgment on the facts- esp. whether Bowen was *actually* aware of the terms of use, or whether he just clicked “yes” at the appropriate moment.  If the former it’s caveat emptor (visitor?) unquestionably, but if the term was in there and he clicked yes without really reading then this case doesn’t move the line at all reasonableness of non-negotiated click-through terms.

I like that, I should say.  Non-moving lines are extremely helpful to those of us that depend on clickwrap and clickthrough agreements to get products in the market.

• YouTube , contracts

Jay Parkhill March 13th, 2008

When your business enters an open-ended relationship with another company, there are two ways to manage the term. First is to provide that the agreement will terminate automatically unless renewed, and second is the opposite- the contract renews automatically unless is it specifically canceled. Each method has its pros and cons. Here are some ideas to consider:

Automatic Termination
All contracts should be periodically reviewed for value to the company. One way to make sure this happens is to provide that the contract must be actively renewed or it is deemed to lapse. The problem here is that it requires memory and attention to manage. I would not recommend this to any but the most detail-oriented of clients who have a great calendar system to track review/renewal dates and a person capable of staying on top of them all.

However, for certain special transactions such as limited-term trials, this can make sense. The risk, of course, is that one forgets to renew, realizes several months later that the company has incorporated someone else’s technology into a product and is then in a poor negotiating position when the time comes to set the general availability pricing.

Automatic Renewal
This is far easier to manage, for obvious reasons, and I recommend it as the default. The trick here is that most automatic renewal contracts allow termination (without cause) only within a set period, such as 60 days prior to the renewal date. Miss the window and you could be stuck with the deal for another year. A calendar of these dates- at least for big-ticket contracts- is still highly recommended.

With automatic renewals, it is also crucial to check the “emergency exits”. What are the grounds for “for cause” termination? Once invoked, can the other side cure the breach? Is that desirable or would it be better just to let everyone walk away?

Good Practices in the Real World
In both cases, the challenge is not get caught by surprise. As a company grows the volume of contracts and renewal dates gets larger as well. Again, I suggest a calendar (or a spreadsheet) of key dates and a person charged with keeping it updated.  In most cases, renewal is a non-issue unless there are problems with the relationship.  An ounce of planning here can avoid a pound of headaches.

• contracts

Jay Parkhill February 14th, 2008

I’ve been reading DC Toedt’s notes on “350 Things I Wish I Knew as a First-Year General Counsel”. He has a number of very good, practical observations about how to be an effective attorney- and not a “Sales Prevention Department”.

One that made me laugh was to remember that “the most useful function of a letter of intent—arguably its only proper function—is to establish that the parties do not intend to enter into a contract at that time.”

In other words, it’s a contract to say that there is no formal contract. The comment is hyperbole, of course- the parties do intend to enter a contract at a future time or they wouldn’t bother with the LOI to begin with, but there is a lot of truth to it at the same time.

I ‘ve definitely seen deals go bad between the LOI and the final agreement. Most LOIs say explicitly that they are non-binding, but having the signed piece of paper can have some kind of placebo effect that gives people undue confidence in the strength of a relationship.

I actually had one client that got a signed LOI, proceeded to hype it for all it was worth and told a bunch of investors that the final agreement was a mere formality. The investors chose to wait for the final agreement before committing, and when the other side backed out it was very embarrassing for everyone. I don’t think the company ever recovered.

So yes, letters of intent are great to have. Just don’t bet the company on one.

• contracts

Jay Parkhill November 10th, 2007

Attorney/entrepreneur D C Toedt posted a thought-provoking piece on his blog called the “Pathclearer” approach to commercial contracts. The premise, as articulated by an attorney at English brewer Scottish & Newcastle, is that commercial agreements and one-time transactions are different beasts, but lawyers erroneously tend to treat them the same.

An M&A transaction, for example, is a one-time occurrence. Details are tremendously important because if something goes wrong the only practical recourse may be litigation.

A commercial agreement, on the other hand, is the start of a relationship. For the most part, both sides will perform happily so long as it benefits them, and poorly or not at all if it doesn’t- i.e. there is no way in the real world to force a relationship to work if one side doesn’t want to be in it.

That being the case, Pathclearer asks if simpler and shorter agreements might work better in many cases. Start with a bare agreement to work together and add in only what is necessary to make the parameters clear.

I love this approach, and for many reasons. The Pathclearer article points to a great example of a relationship bound up with such a complex set of documents that even after both sides agreed the relationship wasn’t working they couldn’t change it because they couldn’t figure out with certainty what the terms of the deal actually were.

Even more to the point, this sort of “blank slate” approach might (we hope) let people think about the issues that are actually important rather than wordsmithing the fine points (such as the example of hours spent by the lawyers trying to define “beer” precisely).

At the same time, would a company (or a lawyer- such as me, perhaps) look hopelessly naive trying to put this idea into practice? I can see the Pathfinder idea working very well in certain situations and causing enormous consternation in others where the experiences of the opposite side lead it to feel that every detail matters (as I have found to be the case with many large organizations).

Rather than a specific plan of action, then, I take the Pathclearer approach to heart as a philosophy. I believed in the idea before I saw the article, or I probably wouldn’t have paid much attention. Still, it is useful to think about the purposes of the Pathclearer concept, and approach commercial agreements with those thoughts in mind:

*Identify the business concerns before reviewing the agreement
*Focus on the key issues. Remove or ignore stuff that doesn’t matter
*Avoid tinkering with the language that isn’t critical
*Reduce and simplify as much as possible

• contracts , lawyering , legal

Jay Parkhill August 31st, 2007

Every web site of any substance has a “Terms of Use” policy, if for no other reason than to make sure that the site operator can restrict illegal, offensive or otherwise undesirable activity. I doubt many people would have trouble with this.

But what happens when the operator needs to change the terms?

Boring Legal Stuff- the Abridged Version
The Ninth Circuit held last month that simply telling users the terms can be changed at any time may not be good enough. In Douglas v. Talk America, AOL sold its long distance phone business to Talk America. Talk America posted revised contract terms unilaterally, Douglas sued and the Ninth Circuit drily noted that “Parties to a contract have no obligation to check the terms on a periodic basis to learn whether they have been changed by the other side”.

It’s the Notice, Stupid
Talk America charged a fee for its services, it changed the contract after AOL and Douglas had formed it and it declined to offer notice of the changes- putting the burden on users to check back (how often?) for changes (visible how?). It’s the last point that seemed to seal the deal for the Ninth Circuit. It is patently unreasonable to expect consumers to re-check every site where they hold accounts, and to compare use terms line-by-line for changes (assuming they retained a copy of the old terms against which to compare).

So Where Does that Leave Us?
Prof. Eric Goldman points to several alternatives, none particularly attractive, that businesses can use to avoid this problem. Of the three (”starting over”, notice of the change with implied right to terminate, and don’t change the terms at all except for new users), sending notice of changes seems like the most practical. I know I have gotten notices like this from eBay and other businesses.

More than likely most users won’t even read the notice, but the process is bound to produce a certain amount of anxiety, especially for companies that aren’t yet established. Spam filters make it harder to ensure that the notice gets full distribution as well, but 100% receipt is not mandatory either (no difference here from paper mailings from your bank). Still, there’s a certain circularity to it- once the contract has been formed there is no sure-fire, legally watertight way of changing it short of terminating every account on the site and starting fresh.

As a practitioner, my response to this is to draft terms of use extremely broadly, hoping that will help my clients to iterate without turning business and user-communications issues into legal ones. It’s no brilliant legal reasoning, but at least it lets companies focus on the bottom line- keeping users happy and the platform running smoothly.

• Web , contracts

Jay Parkhill August 9th, 2007

Someone pointed me to this interesting column on the inner thought process of developers- the tension between building an application to fail fast or fail slowly. Here’s an analogue from the legal world.

One type of language I have seen a bunch of that drives me crazy is “by way of example”. Sometimes certain ideas are hard to capture precisely and people fall back on “by way of example” to help add clarity, such as “by way of example, during a leap year Februay 29 will not be considered in accounting for . . .”I don’t like this. My goal in drafting any document is to capture the meaning simply and clearly. That’s not to say I succeed all the time and occasionally ideas are so complex that a good example can paint the picture that replaces 1,000 words. It’s a tool to use sparingly, though- not a shortcut or a substitute for clear drafting. If I find myself reaching for the “example” too often, I must not be putting enough effort into capturing the ideas properly.

Leaving out the example with inexact language may be like failing quickly- though the consequences may be litigation rather than restarting the program.  Undesirable either way.  Adding the example may let the agreement fail slowly- getting the language right and using examples sparingly where really necessary let the agreement be flexible enough to accommodate changes in user circumstances.

• Tips & Tricks , contracts , legal