The ConnectU/Facebook legal saga is truly astounding.  Imagine a mature Oak tree.  Now give the it properties of Kudzu vine (the “vine that ate the South”).  Each branch of this tree is another lawsuit involving ConnectU, Facebook, the principals, and their lawyers.

Now, a new branch has burst forth.  Wayne Chang has sued ConnectU and its lawyers in Superior Court Business Litigation Session in Suffolk County, Boston, claiming that Chang is entitled to as much as 50% of the value of the ConnectU/Facebook settlement (so called, since ConnectU has challenged the finality of the settlement).

You can read about the ConnectU/Facebook saga here, or wait until the movie comes out.

Here is the complaint in the Chang case, and apologies to Robert Earl Keen.

Chang v. Winklevoss Complaint

… says Professor Eric Goldman, in his apologetically belated comments on Harris v. Blockbuster Inc., (N.D. Tex. April 15, 2009).  I discussed this case briefly in April, shortly after the decision was published.  To reprise, the court held that an arbitration clause in Blockbuster’s online t’s and c’s was unenforceable because Blockbuster was permitted to unilaterally amend the contract without notice.

Prof. Goldman’s take on it (in addition to the title of this post), is -

This language has a significant risk of killing the entire contract, which would strip away a lot of very important provisions that should be/need to be in the contract. So far Blockbuster has only lost its mandatory arbitration clause, but it’s possible other important risk management clauses (warranty disclaimer, liability limits, dollar caps, etc.) will similarly fall. If those clauses fail, let the plaintiff feasting begin!

Professor Goldman has commented on a Ninth Circuit case to similar effect, Douglas v. US District Court ex rel Talk America, (9th Cir. 2007).  After discussing that case (which is very similar to Blockbuster), he stated:

Although I don’t have any great practice-oriented recommendations based on this opinion, I do hope this opinion will help contribute to the demise of the “check back frequently for amendments” provisions in online user agreements. I’ve always considered those among the worst excesses of the dot com era.

Here’s an interesting case out of the U.S. District Court, Northern District of Texas.  In Harris v. Blockbuster the court refused to enforce an arbitration provision in Blockbuster’s online click-wrap agreement. The reason was that Blockbuster’s click-wrap contract was unilaterally modifiable by Blockbuster.  Here is the key paragraph, which is still on the Blockbuster Online site as of today:

These Online Rental Terms and Conditions are subject to change by Blockbuster at any time, in its sole discretion, with or without advance notice. The most current version of the Online Rental Terms and Conditions, which will supersede all earlier versions, can be accessed through the hyperlink at the bottom of the blockbuster.com site. You should review the Online Rental Terms and Conditions regularly, to determine if there have been changes. Continued use of your BLOCKBUSTER Online membership constitutes acceptance of the most recent version of the Online Rental Terms and Conditions.

Yep, I’m sure many Blockbuster subscribers check Blockbuster’s online T&Cs regularly to see if they’ve changed.  Shame on you if you don’t!

The court wrote:

The Court concludes that the Blockbuster arbitration provision is illusory . . . .  There is nothing in the terms and conditions that prevents Blockbuster from unilaterally changing any part of the contract other than providing that such changes will not take effect until posted on the website. The Court concludes that the Blockbuster arbitration provision is illusory . . . .

There are a lot of online contracts like this, and if the N.D. TX decision is good law (which is questionable), their enforceability it in question.

The terms “unjust enrichment,” “restitution,” “quasi-contract” and “constructive trust” cause the average lawyer to recoil with apprehension (although she doesn’t show it, of course). We were forced to grapple with some of these ancient legal concepts in law school, but we quickly migrated to more modern legal principles, and although we may have remembered the terms (any lawyer worth his salt can throw around the terms unjust enrichment and restitution), the depth of knowledge of most lawyers on these topics is shallow at best. We were relieved when we could move on to things like the Uniform Commercial Code, which dates back only to the early 1950′s.

In fact, it’s easy to trace “unjust enrichment” and related terms back as far as the 1600s, and earlier. A search on Google Book Search reveals a volume titled “Unjust Enrichment in England before 1600.” References to Roman Law are also not difficult to find. When you start dealing with legal principles forged during the Middle Ages or Roman times, you know it’s going to be difficult.

Imagine, then, how QLT, Inc., a Canadian-based biopharmaceutical company, felt when it learned that it had been sued in federal court in Massachusetts and that the outcome of the case hinged on the application of these ancient legal doctrines? That was the situation that QLT faced. Even worse, QLT found itself in the courtroom of U.S. District Judge William Young, one of those rare judges who never backs down from a challenge, and probably mastered Latin so he could read the ancient legal texts in the original.

In early January the U.S. Court of Appeals for the First Circuit issued a decision, affirming a $100 million-plus judgment against QLT. The facts of the case are complex, but the First Circuit summarized them nicely in the opening paragraph of its 64 page decision:

These appeals require us to grapple with the metes and bounds of Massachusetts unjust enrichment and restitution law. Like many such cases, the present case involves one party’s conferral of a valuable benefit during ongoing contract negotiations, followed by an irreparable breach in the bargaining process. What makes this case unusual is that its subject matter — the development of a blockbuster pharmaceutical — poses challenges in valuing the benefit conferred, . . . . Defendant QLT Phototherapeutics, Inc. (“QLT”) appeals a jury finding that it was unjustly enriched because plaintiff Massachusetts Eye and Ear Infirmary (“MEEI”) conferred on QLT several benefits during the course of the development of Visudyne, a successful (and highly profitable) treatment for age-related macular degeneration (“AMD”), a leading cause of adult blindness.

The Court of Appeals decision is a tour de force on the law of unjust enrichment in Massachusetts, and although not binding on the Massachusetts state courts, is likely to be the guiding case in this area until something more authoritative comes along from the Massachusetts state courts. After a recitation of the well-known legal standard for unjust enrichment (see the three-part standard at bottom**), where the case got interesting was when the court held that:

• the “benefit conferred” under this doctrine did not require proof of a “trade secret.” The First Circuit affirmed Judge Young’s decision to allow the jury to to proceed to an unjust enrichment verdict based on the plaintiff’s ownership of merely “confidential information.” “Confidential information” and “trade secrets” are two different things, with confidential information generally being things such as pricing or marketing plans – information of some value, but usually ephemeral in nature. Trade secrets tend to be proprietary formulas, algorithms, things that are of lasting value and importance. However, the First Circuit held that mere “confidential information” could be used to support a claim of unjust enrichment. This holding is noteworthy, and it opens to door to a category of claims that would have been precluded had the court held otherwise. Unjust enrichment may not stand where the benefit is publicly available information, but almost anything short of that can be deemed confidential, and will support a claim.
• The First Circuit held that while a plaintiff may not recover its lost profits under a theory of unjust enrichment, it could force the defendant to disgorge its profits. Although Massachusetts courts have not spoken on the issue of profit disgorgement in the context of quasi-contracts, the First Circuit held that it was “likely” it would rule as described. Thus, the court clarified the measure of damages in unjust enrichment cases, again to the benefit of plaintiffs.

Read the case  here: Mass Eye and Ear Infirmary v. QLT Phototherapeutics, Inc.

(** The elements of unjust enrichment are: (1) a benefit conferred upon the defendant by the plaintiff; (2) an appreciation or knowledge by the defendant of the benefit; and (3) acceptance or retention by the defendant of the benefit under the circumstances that would be inequitable without payment for its value.)

For more years than I can remember we’ve been warning clients that an employee handbook can create unintended legal obligations.  A case decided by the Supreme Judicial Court late last year (December 2008), serves as a reminder of this hazard. The court found that a sick day policy contained in a handbook bound the Mass Turnpike Authority to pay certain benefits.

The case attempts to leave the issue of whether a handbook creates a binding obligation open to a case-by-case analysis (especially when it comes to promises of employment to at-will employees, where it seems less likely that a handbook can get employers in trouble), but the fact remains that this is an area fraught with risk. Who even wants to go through the hassle and expense of defending one of these cases, when they are so easy to avoid? Placing a prominent “disclaimer” at the front of the book will do the job:

“This handbook is is presented as a matter of information only and its contents should not be interpreted as a contract or other form of obligation between the firm and any of its employees”

Rarely does the law make avoiding a legal headache so simple.

Link to the case: LeMaitre v. Massachusetts Turnpike Authority (SJC, 2008).

[Update, November 7, 2011]: Almost 3 years later, and still no law.

Here is the full text of a bill filed last week that would make noncompete agreements unenforceable in Massachusetts, at least as to employees (as contrasted with noncompete covenants entered into in connection with the sale of a business, the other major category of noncompete covenants):

AN ACT TO PROHIBIT RESTRICTIVE EMPLOYMENT COVENANTS Section 1. Section 19 of Chapter 149 of the General Laws of Massachusetts is hereby amended by inserting at the end the following new paragraphs:

Any written or oral contract or agreement arising out of an employment relationship that prohibits, impairs, restrains, restricts, or places any condition on, a person’s ability to seek, engage in or accept any type of employment or independent contractor work, for any period of time after an employment relationship has ended, shall be void and unenforceable with respect to that restriction. This section shall not render void or unenforceable the remainder of the contract or agreement.

For the purposes of this section, chapter 149, section 148B shall control the definition of employment.

Whoever violates the provisions of this section shall be liable for reasonable attorneys fees and costs associated with litigation of an affected employee or individual.

This section shall be construed liberally for the accomplishment of its purposes, and no other provision of the General Laws shall be construed in a manner that would limit its coverage. Nothing in this section shall preempt tort or contract claims, or other statutory claims, based upon an employer’s use, or attempted use of an unlawful contract or agreement to interfere with subsequent employment or contractor work.

This section shall apply to all contracts and agreements generated after the effective date of this act.

Section 2. Section 42A of Chapter 93 of the General Laws of Massachusetts is hereby amended by striking the words ‘in violation of the terms of such agreement’ where they first appear.”

Section 1. Section 19 of Chapter 149 of the General Laws of Massachusetts is hereby amended by inserting at the end the following new paragraphs:

Any written or oral contract or agreement arising out of an employment relationship that prohibits, impairs, restrains, restricts, or places any condition on, a person’s ability to seek, engage in or accept any type of employment or independent contractor work, for any period of time after an employment relationship has ended, shall be void and unenforceable with respect to that restriction. This section shall not render void or unenforceable the remainder of the contract or agreement.

For the purposes of this section, chapter 149, section 148B shall control the definition of employment.

Whoever violates the provisions of this section shall be liable for reasonable attorneys fees and costs associated with litigation of an affected employee or individual.

This section shall be construed liberally for the accomplishment of its purposes, and no other provision of the General Laws shall be construed in a manner that would limit its coverage. Nothing in this section shall preempt tort or contract claims, or other statutory claims, based upon an employer’s use, or attempted use of an unlawful contract or agreement to interfere with subsequent employment or contractor work.

This section shall apply to all contracts and agreements generated after the effective date of this act.

Section 2. Section 42A of Chapter 93 of the General Laws of Massachusetts is hereby amended by striking the words ‘in violation of the terms of such agreement’ where they first appear.”

Section 1. Section 19 of Chapter 149 of the General Laws of Massachusetts is hereby amended by inserting at the end the following new paragraphs:

Any written or oral contract or agreement arising out of an employment relationship that prohibits, impairs, restrains, restricts, or places any condition on, a person’s ability to seek, engage in or accept any type of employment or independent contractor work, for any period of time after an employment relationship has ended, shall be void and unenforceable with respect to that restriction. This section shall not render void or unenforceable the remainder of the contract or agreement.

For the purposes of this section, chapter 149, section 148B shall control the definition of employment.

Whoever violates the provisions of this section shall be liable for reasonable attorneys fees and costs associated with litigation of an affected employee or individual.

This section shall be construed liberally for the accomplishment of its purposes, and no other provision of the General Laws shall be construed in a manner that would limit its coverage. Nothing in this section shall preempt tort or contract claims, or other statutory claims, based upon an employer’s use, or attempted use of an unlawful contract or agreement to interfere with subsequent employment or contractor work.

This section shall apply to all contracts and agreements generated after the effective date of this act.

Section 2. Section 42A of Chapter 93 of the General Laws of Massachusetts is hereby amended by striking the words ‘in violation of the terms of such agreement’ where they first appear.

If enacted, this proposed law would wipe out close to 200 years of Massachusetts law enforcing (in the “right” circumstances, and consistent with equity) covenants not to compete. Massachusetts would join California and a few other states in refusing to enforce these agreements by order of their state legislatures. While I’m not betting on passage, you never know ….

[Update: the decision discussed below was reversed by the First Circuit in October 2009.  Decision here]

So, you have a great little business, and a large company wants to acquire it. The buyer argues that payment for your company should be determined by an “earn-out” — the buyer’s sales of your product will determine the purchase price (in whole or in part) based on an agreed-upon formula. “Perfectly normal,” your lawyer assures you. “Seen it done in 8 acquisitions out of 10,” he says. You say nothing – your lawyer knows the ropes, right?

But, as Massachusetts federal district court Judge William Young made clear in his recent decision in Sonoran Scanners v. PerkinElmer, if you (the seller, in this case tiny Sonoran Scanners) expect the buyer (in this case the much larger PerkinElmer) to market your product (leading to sales and payments to you under the earn-out formula), you’d better make sure that the contract spells out the actions the buyer is expected to take to promote the product. Otherwise, you risk the fate that Sonoran Scanners experienced after it sold its business to PerkinElmer – PerkinElmer did little or nothing to promote the product properly during the five year earn-out period, sales were almost zilch, and in the end Sonoran Scanners was paid nothing.

It’s true that sometime you just gotta sell, and you have to take what you can get. That may have been the situation in this case – the decision doesn’t tell us. But if that’s not the case, it’s just not enough to assume that the buyer will promote your product, and if it doesn’t help much to argue breach based on “implied” contractual terms, breach of “good faith,” and other “soft” legal theories, as Sonoran Scanners did in this case. In all but the most extreme cases, “implied” will get you nowhere – if the judge doesn’t throw your claims out of court before trial (as Judge Young did to the plaintiff in this case), the jury almost certainly will. Why do you have to argue “implied” contract terms , most jurors will ask. If you were counting on the buyer of your company to make an effort to sell your product after the acquisition, why wasn’t it express?

Bottom line: avoid earn-outs when possible, but if you can’t make sure you have a good, strong contract, in black ink on white paper (preferably in a bold, large font), that nobody can misread, misinterpret or deny. That contract should state as precisely as possible what the buyer will do to promote and sell your product during the earn-out period. Most sellers know this, but sometimes the opportunity to sell a business for what the seller naively hopes will be a big payday if all goes well, when combined with the hard-nosed negotiating tactics of many buyers, can blind the seller to the risks of assuming the buyer will act in the seller’s best interests.

Judge Young’s decision in PerkinElmer is a good guide to the law in this area. As usual, Judge Young does a thorough job of analyzing the issues and educating businesspeople on what they can expect if they’re forced to go to court in this situation. In the end, Judge Young left Sonoran Scanners with a couple of minor claims, but 90 percent of Sonoran’s case was dismissed before trial on summary judgment. It would be surprising if the case doesn’t settle at this point, with PerkinElmer holding the stronger hand.

• Link to the decision here