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 9th 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 1st-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 9th 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 9th 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 9th 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 1st-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.

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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.

We often circulate what we call “QuickBlasts,” which discuss, very briefly, what we think are interesting or important developments. Below is the text of one such QuickBlast–on a major case from the Delaware Supreme Court:

Fiduciary Duties Expanded & Director Independence Examined

The Gantler v. Stephens decision by the Delaware Supreme Court on January 27, 2009 changes the game, so to speak, for directors and officers liability, among other things.  While the decision relates to board action involving an abandoned merger, the decision will affect many significant actions by directors and by officers.  Taken with other recent Delaware decisions (e.g., Lyondell), it should be clear that the Delaware courts are tightening the screws on those who run companies.   In a sense, the court once again reminds the corporate world that reality matters.

In a Nutshell.

Very briefly: The Delaware Supreme Court reversed a lower court’s ruling and denied a motion to dismiss a challenge by a shareholder (who was also a former director).  The board had engaged an investment bank that had found some potential acquirers.  At some point during due diligence the board abruptly abandoned discussions with the potential acquirers.   Several weeks later the board chose to reclassify the shares (essentially taking the company private).

So What?

And almost as briefly, here are some of the reasons the opinion matters:

1.  Independence Is Based on the Facts. The decision makes clear that the Delaware courts will closely examine the facts and not only the form of the actions by the directors.   In this case, that close scrutiny arose with the court’s examination of the basis for certain directors to claim independence.   (They found that independence was not supported by the facts.)   The good news is that a decision on a transaction can be defended if board independence withstands scrutiny.

2.  The Business Judgment Rule Applies. The standard for review is the “Business Judgment Rule,” rather than the more stringent Unocal standard. Unocal applies only when a board engages in “defensive” actions and this one was not a defensive action.  As the court said, under the Business Judgment Rule “[. . .] the board is entitled to a strong presumption in its favor, because implicit in the board’s statutory authority to propose a merger, is also the power to decline to do so.”  This lower standard will apply only if the assertions of disinterest and independence of the board members can be supported by the facts.

3.   Officers Are on the Hook, too. Put simply, officers of Delaware corporations have the same fiduciary duties as do directors.  This is quite significant.

4. “Careful Deliberation” Means Just That. The proxy statement issued for the transaction stated that the board had carefully deliberated on the possible merger but the court looked closely (again, those pesky facts) and found that this was simply not so.   Saying it was so just made it worse.   This meant that the defense of shareholder ratification collapsed because the shareholders who approved it were not adequately informed.

The Juicy Bits.

This is not the place to analyze the opinion in detail (after all, these are called “QuickBlasts” for a reason).    So, we’ll make a few more comments and keep monitoring events as they unfold. Here’s what we think is interesting.   The court determined that the Company’s inside director was not independent because he knew that at least one potential acquirer intended to replace the board members.   In addition, the court also found that two directors were not truly independent because their local businesses provided a substantial amount of services to the company.   Hence, our point about facts and the reality of “independence.”

As for the fiduciary duties of officers, Gantler is the first time that the Delaware Supreme Court has made a clear statement of this rule.  To some this comes as no surprise.   But, what’s troubling is that officers do not have the protection under Delaware statute granted to directors.  This could get a bit dicey.   Nonetheless, officers now need to understand such principles as conflicts of interest and the duty of loyalty.   Some of us would say, well, it’s about time.

Closing Comments.

One could say that Gantler represents the Delaware courts again reminding the corporate world about reality, especially in corporate governance—i.e., independence—but also, this time, the fiduciary duties of the officers.   In other words, the courts there understand that officers wield a lot of influence while also, potentially, being subject to all sorts of “temptations” that directors cannot consider.   Now, essentially, everyone who runs a company—officers and directors alike—are judged by the same standards.   Not bad for a day’s work of the Delaware Supreme Court.

James C. Roberts III, Esq.

jcrext@globalcaplaw.com

http://www.globalcaplaw.com