One Word in Contract Boilerplate Could Cost $1 billion. That’s a Lot More Than The Legal Fees. And All for a Doll.

Summary:  Raise your hand if you have read or drafted an agreement with:

(a)        A proprietary rights assignment provision;

(b)        A provision with a long list of examples or other “things” assigned;  or

(c)        Both.

Well, the 9^th Circuit just yanked from Mattel its claim for roughly $1,000,000,000 (that’s a billion dollars) in its slugfest with MGA over IP infringement arising from the Bratz doll.  That decision turns in part on scrutinizing the assignment language in an employment agreement (I admit:  The entire opinion did not turn on just one word).  The court looked at the meaning of one word:  “inventions.”  Then the court looked at the list of terms that were supposed to explain that word in that provision.

As many lawyers who draft agreements will see, that word—and the list used to explain that word—is what most lawyers find in their templates for assignment provisions.  Call it boilerplate.  In the future, call it a drafting mistake not to pay attention more closely to that metal.  And remember ejusdem generis from your 1^st-year contracts class.

(As of the date of this post the opinion had not been provided a standard citation.  You can find it at http://bit.ly/bdqtrQ.)

There is some “messy” language about the application of California Labor Code Section 2870.  I think that the court got the analysis wrong (but it’s largely in footnotes).  We’ll comment in passing on this point.  Also, the court applied its own (and widely disliked) Apple v. Microsoft “extrinsic/intrinsic” test for infringement.  We’ll save that for another lawyer to address.

By the way, this post is not about the case itself but about its lessons for lawyers and their clients about agreements.  And one lesson is:  Make sure that the language really, really covers what you want covered.

Introduction

OK, so a Mattel employee quits Mattel and joins another company and there makes a doll that becomes the “Bratz” toy line that whacks Barbie in the marketplace.  (MGA eventually acquires the rights.)  Mattel sues MGA in federal district court, claiming, among other things, that the employee had assigned all his rights by operation of the proprietary rights assignment provision in his employment agreement.  The district court agrees and finds for Mattel (and on several other bases not relevant to this post).  MGA appeals and the 9^th Circuit Court of Appeals vacates the judgment (for all that money) and remands (sends it back) to the district court.  Technically, the Court chastised the lower court for failing to take into account more evidence on critical points and to make findings of fact on these matters.  So, if it goes to back to that court (rather than gets resolved through settlement), then we can expect a more robust discussion of these matters.

It’s Just a Word.  Welllll . . ..  Can You Say “Ejusdem Generis” (and pronounce it properly)?

Reviewing the agreement on a de novo basis (never a good sign for the lower court), the 9^th Circuit quotes some of the relevant language from that assignment provision:

I agree to communicate to the Company as promptly and fully as practicable all inventions (as defined below) conceived or reduced to practice by me (alone or jointly by others) at any time during my employment by the Company. I hereby assign to the Company . . . all my right, title and interest in such inventions, and all my right, title and interest in any patents, copyrights, patent applications or copyright applications based thereon. (Emphasis added.) At 10532-3.

The opinion then quotes the contract definition of inventions:

[T]he term ‘inventions’ includes, but is not limited to, all discoveries, improvements, processes, developments, designs, know-how, data computer programs and formulae, whether patentable or unpatentable.” At 10533.

(We regularly see a definition that doubles and even triples that list.)

The Court looks at whether or not the word “inventions” includes “ideas.”  And without even mentioning the age-old phrase, ejusdem generis, the Court at least quotes one application of the hoary rule:  “[C]ourts avoid constructions that would make “a particular item in a series . . . markedly dissimilar to other items on the same list[.]”  At 10533.  Just before that quote from a previous case, the Court notes that “ideas” differ quite a bit from the list in the agreement.  (Note to readers:  Make the comparison yourself).

Oops. I’ll bet the lawyer who wrote that agreement is squirming;  I’ll double up on the bet that Mattel and MGA lawyers are now digging through their files on all employment agreements.  Uh-oh.  (And I’ll triple that bet by arguing that most other lawyers who draft those types of agreements—and clients who use those agreements—have not yet started to pay attention. But wait:  I’m not a betting man.)

Yikes!  It gets worse.  The Court later takes note that Mattel actually signed agreements with other employees (and probably independent contractors) by which inventions and ideas are assigned.  Uh-oh.  I think some lawyers may be looking to create an ABA Lawyer Protection Program.  Or perhaps look for a career in another industry.

So What?

The Royal We empathize with the Mattel lawyers.  That language is in so many agreements in the technology world that it has become boilerplate not closely scrutinized.  Many lawyers assume that those at the client with technical expertise have vetted the applicability of that language.  Budget and time pressures from the client often force a lawyer into a kind of “issue triage,” relying upon the wisdom presumably intrinsic in the language having been applied without challenge in thousands of previous uses of that provision.

None of this makes it right.  Every lawyer should know that ejusdem generis compels one to use clear drafting to specify precisely what is to be covered.  One simple way of explaining one application of that rule is that the more items are added to the list then the narrower the applicability of that list.  Don’t quote me, though.  Say what you mean in the language.  If the employee is not going to be involved in, say, computer programming or databases then why would one include “data computer programs and formulae?”

And every client should check this language to make sure that it is clear in what it actually covers.  Is it ideas and inventions?  Now, We are not convinced that ideas can indeed be assigned (it depends upon the jurisdiction).  But that’s a discussion a client should have with its lawyer.  And that’s a discussion for which the client should happily pay the legal fees.  Is it worth the risk of losing a billion dollars in damages to save a few thousand dollars?

Wait, There’s More.

We are truly baffled that the Court did not address in more detail the applicability of California Labor Code Section 2870.  Perhaps it was briefed and perhaps the lower court did not find it necessary to address the issue.  Quoting again from the 9^th Circuit opinion

shall not apply to an invention that the employee developed entirely on his or her own time without using the employer’s equipment, supplies, facilities or trade secret information except for those inventions that either (1) relate at the time of conception or reduction to practice of the invention to the employer’s business . . . or (2) result from any work performed by the employee for the employer.’ ” Footnote 5 at 10538 (Emphasis added in blog post)

As far as we can tell, the exceptions to that rule should protect Mattel.  Mattel made Barbie.  The employee was working on Barbie.  Uh-huh.

Whatever the outcome of the case, the reasoning of the opinion should get lawyers who draft to sharpen their pencils.  And re-read their notes from 1^st-year contracts classes.

Our thanks to the legal eagles at Law.com whose Corporate Counsel newsletter alerted us to another development in this case.

James C. Roberts III is the Man(www.globalcaplaw.com)aging Partner of Global Capital Law Group and CEO of the strategic consulting firm, Global Capital Strategic Group. He heads the international, mergers & acquisitions and transactional practices and the industry practices concentrating on digital, media, mobile and cleantech technologies.  He is currently involved in opening the Milan office.  Mr. Roberts speaks English and French and, with any luck, Italian in the dist(www.globalcapstrat.com).ant future.  He received his JD from the University of Chicago Law School, his MA from Stanford University and his BS from the University of California—Berkeley.  You can reach him at jcrext@globalcaplaw.com.

The Global Capital firms counsel domestic and international clients on strategic and legal issues inherent in the deployment of intellectual & financial capital—a merger or acquisition, foreign market expansion, a strategic alliance, a digital content license, a mobile deal, foreign and domestic labor and employment policies, starting a new entity or raising capital. Clients range from global Fortune 100 corporations such as Deutsche Bank and News Corporation and its subsidiaries, MySpace.com and Fox Interactive Media, to start-ups.  Industries represented include digital media, Internet, software, medical and biotechnology, nanotechnology, consulting firms, environmental technology, advertising, museums and other cultural institutions and manufacturing.

New Case Law ID’s Legal Landmines in Preliminary Negotiations.

Summary:  Two recent decisions (in Delaware and Georgia) point out legal landmines when negotiating with potential business partners.  Even though the decisions point in opposite directions, they also point out the need for clear drafting.  One is about LOIs:  Make it clear what is binding and what is not and terms like “good faith” actually have a meaning.  The second, in Georgia:  Make certain your NDAs are well-drafted especially when revealing trade secrets, e.g., draft for limited disclosure for limited purposes and with constraints on competing products.

The Details.

Two companies entered into an LOI under Delaware law and one of the two claimed that the other party did not act in good faith in accordance with the terms of the LOI and breached the exclusivity and confidentiality provisions.  Please note that this was a decision only for a preliminary injunction.

In the second situation (this one an appeals court decision in Georgia), a company with a good idea (and some code) approached a couple of other companies about developing and selling a software product based on that idea and code.  The first sale would be to a large insurance company known by all of the parties.  So, the parties signed NDAs.  Well, oops:  Two parties decided to create their own product that was pretty similar to what was being developed and they went on to try to sell it as planned.  But guess what?  Both the trial court and the court of appeals held that there was no breach of the NDA (which was itself badly drafted, according to the court).

So What?

So, when it comes to an LOI, it is not an unenforceable “agreement to agree” but an actual agreement with specified rights and obligations.  As the Delaware opinion stated, parties “[. . .] enter into [LOIs] for a reason.  They don’t enter into them because they are gossamer and can be disregarded whenever situations change.  They enter into them because they create rights.”  What to do?  Well, this court opinion says that parties can specify what is binding and what is not binding.  Naturally, the opinion applies only to Delaware law but its principles extend to just about any LOI or term sheet.  In particular, once a document is found to be an agreement, then covenants of “good faith” are incorporated into the deal.  Pay attention.

As to NDAs, too little attention is paid to their precise terms—in other words, someone exhumes an earlier version and replaces the names of the parties.  This is not smart.  For example, specify—and we mean really specify—the purpose(s) to which the confidential information can be used.  Define “confidential information” so that the person providing that material can control the information.  This also means that one needs to make it clear whether or not copies of the confidential information can be provided and who has access to that information.

OK, OK, so we sound like a broken record:  Pay attention to the agreements and, almost as obvious, make sure that the behavior of both (or all) parties comports not just with the agreements but also to expectations.  Agreements are only a part of the relationship;  behavior is another large part.

James C. Roberts III (jcrext@globalcaplaw.com) is the Managing Partner of Global Capital Law Group and CEO of the strategic consulting firm, Global Capital Strategic Group.  He heads the international, mergers & acquisitions and transactional practices and the industry practices concentrating on digital, media, mobile and cleantech technologies.  He is currently involved in opening the Milan office for Global Capital.  Mr. Roberts speaks English and French.  He received his JD from the University of Chicago Law School, his MA from Stanford University and his BS from the University of California—Berkeley.

Global Capital (www.globalcaplaw.com) counsels domestic and international clients on legal issues inherent in the deployment of intellectual & financial capital—a merger or acquisition, foreign market expansion, a strategic alliance, a digital content license, a mobile deal, foreign and domestic labor and employment policies, starting a new entity or raising capital. Clients range from global Fortune 100 corporations such as Deutsche Bank and News Corporation and its subsidiaries, MySpace.com and Fox Interactive Media, to start-ups.  Industries represented include digital media, Internet, software, medical and biotechnology, nanotechnology, consulting firms, environmental technology, advertising, museums and other cultural institutions and manufacturing.

“Reasonableness” Now Reasonably Defined.

Summary:  Every corporate lawyer has drafted “best efforts” and similar contract provisions but often without much thought to the meaning and most certainly without a lot of guidance from US case law.  Now the UK High Court has provided some guidance, with some particularity.  Equally interesting, the opinion clearly indicates that at least that court will go beyond the four corners of the document and look at the conduct of the distributor relative to overall conditions of and business efforts in the relevant industry.  This makes sense, insofar as “reasonable” requires some examination of the real world.  In the end, this opinion helps in the US.  Somewhat.  And why?  Because important phrases with little meaning to the drafting lawyers now have to obtain more substance within the agreement itself.  This also gets to our drafting philosophy—that a contract is also a roadmap for the non-lawyers to use in guiding the relationship.  It is also critical reading for anyone with agreements governing UK (and EU) distributors.

The Details.

What corporate lawyer hasn’t drafted a “best efforts,” “reasonable efforts” or “commercially reasonable efforts” contract provision?  And what such lawyer hasn’t scratched his or her head about the legal meaning of these phrases?  Oddly enough, there is not much guidance from US case law.  So now, we have the UK High Court offering a pretty detailed analysis of the UK law equivalent—“reasonable endeavours.”

The case is CEP Holdings Ltd & CEP Claddings Ltd v Steni AS.  Basically, Steni manufactured cladding (building siding) distributed in the UK by CEP and they terminated the distribution agreement on the grounds that CEP had breached the “reasonable endeavours” provisions of that agreement.  The distributors sued them for the termination.  (UK and EU distribution agreements are notoriously difficult to terminate but we will not discuss that part of the larger context here.)

Clean Up Your Act. Well, the court disagreed that the supplier had been in the wrong after the court looked at the business conduct of CEP.  Interestingly, the court took note of the sales performance during an up market:  The relevant market went up roughly 18% while CEP sales declined roughly 62%.  The court noted that much of the decline was attributable to a “lack of an adequately structured, and directed, sales and marketing organization[.]”  To the facts of the case, the court pointed out that everything rested on one man and internal processes were pretty informal.  In our view, it looks like the court did not like the sloppiness of the distributor as well as the lack of communications (rolling sales reports are mentioned).

The opinion included some guidance in the abstract.  In a nutshell:  Plan; promote, monitor, communicate (with your supplier); and improve your sales team if things go bad.  Probably paramount among these matters is regular and meaningful communications with the supplier (e.g., rolling sales reports).

So What?

Let’s look at the consequences—i.e., what should be drafted.  Perhaps the agreement should specify just what those “commercially reasonable efforts” are and are not.  In other words, one could include language that says something to the effect that “such efforts do not include the preparation of reports beyond those specified in this Agreement or promotional efforts beyond those normally conducted by Distributor.”  Put in the positive, one could include an attachment that enumerates the specific marketing efforts to be undertaken.

Communications is often handled in US agreements by a reporting provision that spells out in some detail the sorts of reports needed by the supplier on a regular basis.  This begs the question, then, whether that provision needs to be expressly tied to the “commercially reasonable” standard, as suggested in the language above.

A “contrarian” approach for domestic agreements might be to leave everything out and rely upon a comparison by the courts to the outside world, thereby leaving the definition of “reasonableness” to the court.  This may make some sense.  The absence of case law may support this proposition.  Moreover, the courts are notoriously reluctant to look at specific business practices and an industry as a whole (excluding for the moment egregious corporate behavior in other areas).

We, however, would be disinclined to take the contrarian approach.  Better to specify (in an attachment) the marketing efforts to be undertaken.  However, in California, there may be a risk of an “accidental franchise” if the supplier imposes too many conditions, including, for example, both a marketing plan and employee training.  (We’re just as surprised as you are about that one, by the way.)  That is one of the reasons that we like such efforts to be tied to the normal marketing efforts of the Distributor.

It’s a Small World. And besides, many distribution agreements now cross borders and jurisdictions.  Many companies have distributors in the UK or elsewhere in the EU.  They will be affected by this decision.  And they should be.  True, this opinion does not carry much (if any, by some views) weight in this country for domestic agreements.  That fact does not mean that its utility as a guide for drafting should be ignored.  And there are many agreements already in existence guiding UK and EU relationships with the vague language now subject to scrutiny under this case.

Contract as Roadmap. You have heard us before say that a contract should be a roadmap for non-lawyers responsible for maintaining the relationship.  An attachment that elaborates—or gives the right and responsibility to the parties to elaborate—marketing (including co-marketing) efforts goes a fair amount of the way towards achieving just that goal.

The Debate on Data: The Ad Industry Chimes In.

Summary:  With congressional and administrative attention now on the online advertising industry, the industry is responding with “principles” to continue self-regulation.  Whatever the outcome of the debate now underway, TOUs and EULAs will change.  To the business side of digital companies, these are boilerplate:  To the lawyers, they should be seen as what they are–binding agreements with end users and that have serious consequences if they are too one-sided.  You can read the entire report atwww.iab.net/behavioral-advertisingprinciples.

The online advertising industry has responded to the February 2009 FTC Staff Report on the topic (which is called “behavioral advertising”).  That industry created a report on “principles” for managing these data.  These principles represent an attempt to maintain the self-regulation structure now in effect–something that has not made regulators happy (rightly or wrongly).

You can read the report at the URL above.  Here is our take on the principles:

• Ad Industry Mobilization–the mere fact that disparate industry associations have gotten together is good news, because these people have great experience and expertise to apply to a topic that is really pretty nuanced.

• No More Fine Print–well, everyone can dream.  It is not so much that the industry will eliminate dense legalese in TOUs, but that the language is supposed to be drafted to be transparent–providing genuine guidance that end users can understand.

• Actual Innovation–The report includes one innovation:  an “approval” toolbar on browsers.

• De-identification of data–this is the one we like the most.  Finally, the ad industry is beginning to recognize that the data can be extremely valuable in their aggregate form, without recourse to knowing about the actual individuals.  Pay attention to this one.

• Sensitivity–This principles recognizes that not all data are created equal and some are more sensitive than others.  Think of medical records.

• Material Changes–gone will be the days of unilateral retroactive changes to TOUs.  Actually, this is just a recognition that the Federal Trade Commission (FTC) will win on this point and that courts are moving in that direction, as well (See blog on Blockbuster case).

So What?

From a legal perspective, this will add more pressure on companies to change their TOUs, but from a strategic perspective, it is one more piece of the evidence of the growing appreciation–not of the data themselves but of their complexity and vast value.  In other words, it is no longer an either/or debate:  either the industry gets to collect everything or nothing.

Therefore, think about what kinds of data your company wants about use (and not necessarily about each end user).

(See some TOUs, etc., we have drafted: www.npbn.com and www.photospin.com for some examples.)

Blockbuster Blows its EULA–and You Should Care.

Summary:  You might not have read it here first but you have read it here often:  Courts are taking on—and deciding against—what they consider to be unfair terms in EULAs or TOUs.  In this case, it was the federal district court for Northern Texas, finding that the arbitration clause was illusory.  It is important to note that this case, in our opinion, does not stand alone but adds more case law attacking the terms of these online agreements.  These cases are—and in particular this case is—consistent with one of the principal points central to the new FTC staff guidelines.  The message:  Complicated TOUs put the client at greater risk.

Introduction

In Harris v. Blockbuster, the court for the Northern District of Texas held that the arbitration provision of the online agreement for the use of Blockbuster was illusory.  Dicta suggest even broader implications for the decision, but that alone was enough to cause some concern (we do not yet know if there will be an appeal, though it is probable).

As far as the court was concerned the main problem with Blockbuster’s online agreement was sort of a double-whammy.  The agreement stated that Blockbuster could change the provisions at any time—which would, of course, mean that changes with retroactive effect would, in the opinion of Blockbuster, be enforceable.  In this case, some disputes arose and Blockbuster then added an arbitration provision, which was to apply retroactively and thus eliminate much of the risk (from a trial).

So What?

So, online agreements (what we call EULAs and TOUs) with retroactive changes inserting (or affecting) arbitration provisions will run afoul of this opinion—of course, in that district.  Moreover, the opinion carries some weight with other claims about online agreements.  Many online agreements—perhaps a majority, perhaps many more—have such provisions enabling the publisher (in this case Blockbuster) the right to make retroactive changes to the terms.  Suddenly, then (if you believe in Chicken Little), these provisions are at risk.

Ammunition & Guidance. Really, though, the opinion builds on a string of previous opinions that, taken together, provide both substantial ammunition for plaintiffs’ assaults on these agreements and, if you think about it, guidance on what to include—and exclude—from online agreements.

It is not necessarily a bad thing.  The FTC staff report gives pretty clear guidance on what can be done:  If a party wants a right to changes, then they should not be retroactive and the user must have some kind of right to agree (or not) to those changes going forward.

This is not some rogue court.  The cases cited include some in the Fifth Circuit and some in Texas itself.  With some serious contortions and impressive legal reasoning, one could distinguish this case from the facts and holdings of those precedents.  But it is not so simple.

In just the last several years, quite a few courts have taken on the online agreements.  They include courts in the Ninth Circuit and in Pennsylvania.  The reasoning can be distinguished but not here.  They all come to a smell test:  Does this really smell like a contract?

These cases fall within an even longer line of opinions regarding the nature of agreements between corporations and consumers.  As the FTC staff report pointed out (with copious footnotes), “fine print” cases have a long history.  And it is a history where the “victor” has swung from the consumer to corporations and back.  Now, with the new administration, with the FTC’s stiffer attitude about consumer rights (rightly or wrongly), and with these cases, we can expect history’s pendulum to swing the other way.

Conclusion

Write “Gooder.” These agreements do not have to be so dense and they do not have to have such onerous terms.  The right of retroactive modification was a term just waiting to be shot down.  Too often, lawyers just copy and paste a TOU from another site.  Or, perhaps they have to justify their legal fees on a topic that is perceived by clients as unimportant boilerplate.  Whatever the reason, this case should be a shot across the bow that attorneys put their clients at greater risk with such legal intricacies as we now see in EULAs.

Perhaps we’ll get some online agreements that are actually well-drafted;  that do not read like fine print;  and that provide better terms.  But then, we believe in the Easter Bunny, too.