July 17, 2007
Facebook: The Next Urban Decay?
Posted by Gordon Smith

Urban Decay is a wonderful case about the obligations of founders to each other at the earliest stages of a company's existence. Facebook's founder, Mark Zuckerberg, is enmeshed in a lawsuit with some former friends from Harvard (Cameron Winklevoss, Tyler Winklevoss, and Divya Narendra), who founded a company called ConnectU. This case is scheduled for a hearing next week, and it could turn out to be the next Urban Decay.

According to a complaint filed in the Federal District Court for the District of Massachusetts, the ConnectU founders "engaged Mark Zuckerberg to complete the computer program software and database definitions" for a social networking site. Zuckerberg was given access to ConnectU's code, as it stood in late 2003. The ConnectU founders now claim that Zuckerberg misappropriated trade secrets, infringed on copyrights, breached a contract, breached an implied covenant of good faith and fair dealing, breached fiduciary duties, and committed fraud -- among other things -- in the founding of Facebook.

The plaintiffs did not allege the formation of a partnership (the successful claim in Urban Decay), despite these allegations in the complaint:

Divya Narendra asked Zuckerberg if he would like to be part of a website that Narendra and his team were developing.

Zuckerberg agreed to be a member of the harvardconnection.com website development team ..., to develop the [code], and to help launch, promote, and operate the site and business, in exchange for a beneficial interest in the website, including a monetary interest in any revenue or other proceeds or benefits from the website....

Had the plaintiffs been aiming at partnership formation, they would have benefited from an agreement to share profits, not revenues. Under the facts pleaded, it's not clear whether Zuckerberg would be a partner, but that looks like an agency agreement (which gives rise to fiduciary obligations).

The plaintiffs also failed to rely on the opportunity doctrine (perhaps because they had not formed a business entity?), but the complaint alleges that Facebook's launch "usurped [a] valuable business opportunity."

As it stands, the case is procedurally muddled. In a memorandum supporting Zuckerberg's motion to dismiss, Zuckerberg's lawyers offer arguments based on statutes of limitations and pleading requirements, and they contend that ConnectU does not own the claims because the company was not founded until later. (ConnectU addresses most of these issues in a prior filing.) If ConnectU can overcome these initial hurdles, we could have an interesting case on our hands.

Thanks to Valleywag for flagging the lawsuit and providing a gallery of wannabe Facebook founders.

Entrepreneurs, Fiduciary Law | Bookmark

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Comments (2)

1. Posted by Mike W. on July 17, 2007 @ 13:07 | Permalink

Man, that complaint has holes any lawyer could drive a truck through. As someone that deals with these sorts of transactions on a day to day basis, this makes me cringe:
1. No confidentiality agreement;
2. No development agreement and thus no agreement to assign intellectual property created to connectu.com folks (this seems particularly troubling since all the IP would be owned by the creator, Zuckerberg); and
3. No non-compete agreement.

Also, one wonders if there is consideration for an oral/implied contract in most cases. The complaint harps on naked promises to finish the work made by Zuckerberg. The monetary incentives didn't really come until later.

Ugly.


2. Posted by Gordon Smith on July 17, 2007 @ 13:39 | Permalink

Mike, You are absolutely right. The plaintiffs are confronting some pretty grim facts, but that's what makes the case so interesting to me. The failings you note are pretty common in the early stages of company formation, and it's interesting to see how courts handle these situations.

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