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Learning from others mistakes – startup legal battles

Learning from others mistakes – startup legal battles

// February 28, 2019

Startup disputes are not surprising to anyone. When developing a new product, fierce competition on making its access to market exists. In addition, finding the right financing is of primary importance for young startups. Accordingly, it seems natural that both – internal disagreements in the startup between its founders or employees, and external conflicts with investors or even state authorities arise.

In 2017, the news broke all over the world that following several years of litigation, Reggie Brown, the third co-founder of Snapchat, was definitely eliminated from startup business. The dispute began back in 2013 when Reggie Brown filed a lawsuit against the other two co-founders of Snapchat—Evan Spiegel and Bobby Murphy. In the lawsuit, Reggie Brown claimed that he was the one who came up with Snapchat’s core idea of disappearing photos. Regardless, he was forced out of the company’s management by the other co-founders. A three-year dispute was settled when two Snapchat co-founders agreed to pay Reggie Brown a total of over USD 157 million. This dispute recalled the dispute between Mark Zuckerberg and the Winklevoss twins over the misappropriation of the Facebook idea and has once again drawn attention to the protection of intellectual property at the very beginning of the creation of a startup.

However, the dispute over intellectual property may not necessarily arise between the founders of a startup only. For example, in autumn 2018, the University of Waterloo initiated legal proceedings against a Canadian startup, Salient Energy. Salient Energy has developed technology that made possible for zinc-ion batteries to be recharged thousands of times. According to the University, the patented technology that was born and developed in the University’s startup incubator belonged to the University. At the end of 2018, Salient Energy settled with the University and the startup assigned its patent rights to the University. The University, in turn, granted Salient Energy a worldwide license to use the battery technology.

Absence of a well-thought-out intellectual property strategy is often critical for young startups. Startups invest their time in business and marketing plans but leave aside the most valuable property —the core idea of the startup.

Another significant category of disputes arises between a startup and third parties such as investors. A glaring example is provided by a dispute that arose in 2018 between a startup, Gladius Network and a Ukrainian investor Krypton Blockchain Holdings. Gladius Network created a blockchain technology that protects systems from cyber-attacks. Ukrainian investor started to show interest in making an investment. After a year of negotiations, the startup and the investor took the matter to the US District Court for the District of Columbia in Washington. Gladius Networks sought a declaratory judgment. It wanted the court to find that the Memorandum of Understanding signed between the parties, which provided that Gladius Network would transfer 10% of the shares of the company to Krypton Blockchain Holding for a USD 600,000 investment, was void and unenforceable. According to Gladius Networks, the Memorandum is not legally binding, whereas Krypton Blockchain Holdings claimed to have acquired 10% of the shares in the startup. Although the outcome of the dispute is still unclear, it is a great reminder for startups how important each document and its wording is while communicating with investors.

Startups by no means are protected from the disputes with state authorities either. In 2016, the U.S. Department of Labor launched administrative proceedings against Palantir Technologies. Palantir Technologies is a U.S. software startup specializing in the analysis of big data. The lawsuit alleged that Palantir Technologies discriminated against Asian job applicants. Although in 2017 Palantir Technologies reached an agreement with the U.S. Department of Labor it came at a price—the startup had to pay USD 1.7 million.

How to Settle the Dispute

Taking a dispute to the court could mean the end of a young startup. Investing time, money and energy in a dispute could ruin a business that has just started to grow, as well as relationships between founders and investors. It is apparent from the previous example that parties are eager to reduce the risk of an unfavorable court decision and resolve such disputes while settling. Thus, before even directing your claim to court it is useful for both the startups and the investors to consider a possibility of resolving a dispute in an alternative manner.

Parties can try an alternative dispute resolution known as mediation. In the mediation, a neutral mediator helps the parties to clarify all the details of the conflict and reach a consensus. The mediator has no power to adopt a binding decision on the parties, yet a consensus reached in mediation and set in an agreement is legally binding like any other agreement between the parties. Mediation could be useful in resolving disagreements between the founders of a startup. As mediation is a confidential process, no one would know about the conflict. This would prevent adverse effects on the startup’s image, which is crucial, especially at the beginning of its growth.

If the dispute is not resolved by mediation, arbitration is another alternative to consider. In arbitration, the parties refer the dispute to an arbitrator – a chosen neutral third party. The arbitrator, having heard the case, makes an award that is binding and can be enforceable. Contrary to dispute resolution in a national court, arbitration is a confidential process. Thus, the fact of the dispute itself, the parties and the subject of a dispute remain confidential. This factor is very helpful for a young business/startup to avoid unwanted public attention, since the publicity of existing dispute may negatively affect the image of the company or the product developed.

In arbitration, the parties may choose the arbitrators who will be examining the dispute. The possibility to select the arbitrators is highly attractive to startups. In case of a dispute over specific technological issues, the parties may choose an arbitrator who is a specialist in the relevant field. Such arbitrator would have experience and knowledge in resolving disputes that are similar in nature which could contribute to a more rapid and thorough examination of the existing situation. Contrary to arbitration proceedings, in a national court, a judge will be designated at random and possibly will have no specific knowledge necessary for the specific dispute. Awards made in arbitration cannot be appealed on the grounds of substantive law, therefore the final decision is made faster, avoiding costs of litigation in several instances, as it is the case while litigating in national courts.

However, whatever resolution method is chosen—arbitration, mediation or litigation in national courts—the dispute which has arisen often indicates that not everything has been done to prevent the dispute from arising. The above-discussed examples of disputes show that very often the cause of the dispute could have been easily prevented. For instance, if Salient Energy had adequately protected their intellectual property and Gladius Network had negotiated with the investors using clear wording, explicitly providing the rights and obligations of the startup and investors, the above disputes potentially would not even have arisen. Hence, while in the first months or year of the startup is more occupied with developing the product and attracting investments, not having a solid legal framework may cost in the future more than a young startup would want to think of when starting to implement its idea.

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