Part 1 Case Overview: What Entrepreneurs Can Learn from the Facebook Ownership Litigation

I just got back from vacation and I finally had a chance to read the legal complaint and alleged contract in the Facebook ownership debacle.  I love a juicy cautionary tale, especially when billions of dollars are implicated.

In this blog, I’ll discuss some of the potential issues in the case and what entrepreneurs can learn.  This post will give a case overview and my next post will discuss the lessons.

Case Overview

(Ceglia v. Zuckerberg, 10-CV-00569, U.S. District Court, Western District of New York (Buffalo))

If you haven’t heard the story, Facebook, Inc. and its founder Mark Zuckerberg were recently sued in New York for enforcement of a contract granting the plaintiff, Paul Ceglia, an 84% ownership interest in Facebook, Inc.  The plaintiff is also seeking 84% of all monies realized by Defendants from 2003 to the present.

Since the estimated value of Facebook is in the billions, this litigation may be going on for years if Facebook doesn’t win on its statute of limitations or laches defenses.  (Basically, Defendants are claiming that it’s too late for Ceglia to bring his contract enforcement action.)

Ceglia alleges that he hired college student Zuckerberg to write software code for two projects in 2003 and that Zuckerberg signed an agreement that sets out the terms.  The alleged contract states that it covers work for both a “StreetFax Database” and Zuckerberg’s “project with the working title The Face Book.”

Ceglia submitted evidence that he paid Zuckerberg a $1000 for this work.  This is a paltry sum given the estimated value of Facebook today but sufficient consideration under the law to have an enforceable contract.  Courts in general don’t look at the adequacy of consideration but in any event $1000 may have seemed like a lot to a college student.

The Alleged Contract’s Ownership Terms

As an intellectual property lawyer, I think this alleged contract is very, very poorly drafted.

It’s crazy!

In the alleged contract, there are dozens of fundamental contract drafting errors, inconsistencies and some bizarre and convoluted clauses—the signs of a contract drafted by an amateur.  Consequently, the lawyers will have lots of language to fight over and it will be an expensive nightmare to litigate.

Although the alleged contract is titled ”Work For Hire Contract,” it appears from the contract language that the drafter didn’t understand this copyright doctrine or its implications.

Section 9 of the alleged contract titled “Proprietary Rights” states:

“It is acknowledged that this is a work made for hire agreement and that all Intellectual property rights or patent rights are that of Streetfax Inc. . . .”

This will be yet another fertile area for dispute in the case.  Copyright protection automatically arises when source code is created and belongs to the author.  In some limited cases in an independent contractor situation, the Copyright Act may transfer ownership of the work to the person paying for the work.  This “work made for hire” doctrine is complicated and restrictive.  The work must fit within one of the enumerated statutory categories.  (See my post discussing this copyright doctrine.)  The language in this contract is a mess.  The alleged contract fails to include appropriate legal language and it doesn’t have a standard fall-back copyright assignment provision for the software.

And strangely, the scope of the ownership clause is both broad and narrow.  It’s also fundamentally unclear.  The alleged contract states:

“It is agreed that Purchaser [Ceglia] will own a half interest (50%) in the software, programming language and business interests derived from the expansion of that service to a larger audience.”

None of the key terms like “software,” “programming language” or “business interests” are explicitly defined in the contract.  And what the heck does “expansion of that service to a larger audience” mean?  If this case continues, the lawyers will no doubt spend a lot of time debating the meaning of these vague terms.

Zuckerberg’s lawyers will likely be arguing that “software” noted in the contract has nothing to do with the “software” related to Facebook.com.  And what is the difference between “programming language” and “software”?   The defense lawyers will also likely argue that Zuckerberg didn’t even have any “business interests” at the time of the contract.

Definitions in software agreements are critical for clarity. The meanings of key terms are usually explicitly spelled out and the corresponding terms are thereafter capitalized in the document indicating a defined term.  The terms and their usage in this alleged contract are a hodgepodge.

Moreover, the bizarre kicker in the alleged contract is the penalty clause for delayed completion for the Face Book website:

“The agreed upon completion for the expanded project with the working title ‘The Face Book’ shall be January 1 2004 and an additional 1% in the business will be due the buyer for each day the website is delayed from that date.”

It seems bizarre that anyone would agree to such a vague and outlandish penalty term.  But it’s arguable that a naive college freshman would.

This alleged contract is quite simply a mess.  Although poor drafting alone doesn’t make a contract invalid, it will provide the defense lawyers with fuel to litigate this to death.

Defendants’ Defenses

Ceglia won’t own anything without a valid contract so it’s no surprise that Zuckerberg’s initial defense was to deny the existence and validity of the contract.  Was it forged?  Did Zuckerberg really sign it?

Eventually, if Facebook doesn’t win on its statute of limitations or laches defense, experts will likely debate both issues.  It doesn’t help Ceglia’s credibility that he’s been in some legal hot water lately, arrested and charged with fraud.

It also doesn’t help Zuckerberg’s credibility that his former Harvard classmates sued him on claims that he stole their business idea and code and turned it into Facebook.  This case was quietly settled but it implies that Zuckerberg may have had a weak understanding of intellectual property law and a cavalier attitude toward the intellectual property rights of others.

It’s important to note that Zuckerberg admits that he worked for Ceglia writing computer code when he was in college.  These facts will work in Ceglia’s favor.

A second layer of defense for Facebook is to deny that Facebook Inc. or its website falls within the subject matter of the contract.  The vagueness and ambiguity of the contract language will help the Defendants.  Moreover, Zuckerberg claims he hadn’t even thought of Facebook when he worked for Ceglia.  Commentators are quick to point out that Zuckerberg didn’t even register the Facebook domain until a year after the date of the contract.  Of course the commentators assume that domain registration is the very first thing that a budding entrepreneur would do.  This is a big assumption and very weak evidence that Zuckerberg hadn’t thought of the name, developed the idea, or written any related software code.   If he really signed the alleged agreement, it is clear evidence of his naivety and legal ignorance and not evidence of a savvy entrepreneur who would quickly register a domain for a new idea when he first thought of it.

Moreover, the fact that Zuckerberg worked on something called Facemash between the time he worked for Ceglia and starting Facebook doesn’t mean squat either.  Entrepreneurs often have multiple ideas they are pursuing and skip between projects.  Many don’t work on projects in a linear fashion.

There are plenty of issues to keep the parties’ lawyers very busy with legal research including whether you can give away part of a business before it’s incorporated.

Discovery

The discovery process will be critical in this case. The broad reach and scope of discovery in the US is astonishing.  Each party can get copies of electronic and paper documents in the possession, custody or control of the other side that are relevant to the claims. This includes emails and source code that go back for years including archived documents.  Some parties go to great lengths and hire forensic computer technicians who can unearth documents that the owners thought were destroyed.  It sometimes feels like electronic information can live forever.  Documents in the previous ownership dispute are also likely relevant and discoverable.

If either party is a pack rat who kept much material from 2003, this case is going to get very interesting.  One of the key issues is whether Ceglia has any software code in his possession that matches code that is in any version of the Facebook application. Ceglia kept the contract in a file for years so who knows if he kept any old computer disks or hard drives with the early versions of “The Face Book” project.

Although it is unlikely that much of Facebook’s original code is in its current website, Facebook or Zuckerberg may possess early versions of the code somewhere, which will be subject to discovery.  It’s not uncommon for a founder to keep archive tapes.  But considering that Zuckerberg was sued previously regarding claims of ownership he may have cleaned house and destroyed old, incriminating records.

Finding code from both parties that match would be a big win for the plaintiff.

Given the former litigation between Zuckerberg and his classmates, the geneology of the Facebook software may prove very interesting.

This case will be fun to watch.

Stay tuned for a discussion of the lessons entrepreneurs can learn from this case in my next post.