100 Feet Up

In researching something, I happened upon an article in CIO Magazine from March 2007: "Outsourcing Contracts: Clause Control," by Stephanie Overby. The article talks about several clauses that outsourcing customers might want in their service contracts:

• Benchmarking - the right to renegotiate pricing if a benchmark survey shows that the contract pricing is significantly above market
• Most favored customer [ugh] 
• Cost-plus pricing
• In-sourcing / re-sourcing right
• Continuous improvement
• Mandatory reference - the outsourcer must use the customer as a reference at least X times a year

An executive asks and is given for confidential sales information, marked as “confidential” and with a request not to distribute it. Not long afterwards, he quits and takes a similar position with a competitor of his former employer. Shortly after that, on his own initiative, he gives the confidential information to his new employer. That gets him fired by his new company, and then charged with criminal theft of trade secrets by the U.S. Attorney’s office.

In a nutshell, that’s what allegedly happened with Atul Malhotra, who has been indicted for giving IBM confidential information to HP. See the write-up in Wired magazine and the charging document filed in court.

Saul Hansell at the NY Times concludes that Google is in violation of the California Online Privacy Protection Act of 2003 because it doesn’t "conspicuously" display a link to its privacy policy. 

Excerpt: "… a 2004 analysis by law firm Cooley Godward Kronish doesn’t list any other option for conspicuous notice other than placing the privacy policy itself or a link to it on a site’s home page. And the California Office of Information Security and Data Protection offers this recommendation to Web sites:

Use a conspicuous link on your home page containing the word “privacy.” Make the link conspicuous by using larger type than the surrounding text, contrasting color, or symbols that call attention to it.

Some lawyers are concerned that if they outsource legal work to non-U.S. firms, they could be jeopardizing the attorney-client privilege because of the U.S. Government’s position that it is free to monitor communications with foreigners.  See this Legal Times article about a lawyer suing for a ruling on that point.  (Pedro Ruz Gutierrez, Law Firm Files Suit to Bar Outsourcing of Client Data [sic], Legal Times, May 27, 2008)

If you’re a software vendor, you need to know about this recent Autodesk case, holding that typical software "license" transactions are in fact sales of copies, which the purchaser is free to re-sell under the First Sale Doctrine in copyright law. 

If the court’s reasoning is upheld on appeal, software vendors might find themselves legally unable to stop their customers from reverse-engineering the software.

They might also have a more difficult time asserting trade-secret rights in the executable code.

Court smacks Autodesk, affirms right to sell used software

I couldn’t disagree more strongly with my friend Ken Adams’s comment that, apart from the opening recitals, “in a contract you don’t reason or explain. You just state rules.” That’s way too categorical a statement for my taste. Contracts are read and followed by people, not by computers, and people sometimes need to be persuaded to do the things they’re theoretically supposed to do. That’s where it can be extremely helpful to record reasons and explanations into a contract.

Suppose Company A signs a contract requiring it to do X. It won’t necessarily happen that way automatically. One or more people need to make X happen, and those people might balk at doing so:

• Company A’s management might decide they want the company to do Y instead of X because of changed circumstances.
• Or it might be that Alice at Company A negotiated the contract, but her colleague Allen is now responsible for making X happen, and Allen thinks doing X is a bad idea.

If Company A’s lawyer can think of even a faintly-plausible rationale for not doing X, the odds are that the company will simply fold its arms and say “nope.” (I speak from hard experience on this score.)

That’s where reasons and explanations can come in handy: If the contract explains the business reasons that Alice committed the company to doing X, there’s a better chance that Allen will understand her reasoning and go along with her commitment.

The same is true in contract litigation: Judges sometimes need to be persuaded too. This is especially true if there’s more than one way to read the contract — again, this is where reasons and explanations can come in very handy.

Famed Internet entrepreneur Marc Andreessen teamed up with two corporate lawyers to publish some lessons already learned from Microsoft’s attempt to take over Yahoo. For example:

• Staggered three-year board terms, with only one-third of the board members being elected each year, would have made it easier for Yahoo to resist a hostile takeover.  With a staggered board, Microsoft probably would have had to win two or even three successive annual proxy fights to completely take over Yahoo.

(Of course, staggered boards are a bête-noir of some shareholder activists who have been pressuring public companies in recent years to switch to annual election of the entire board.)

• Multiple classes of stock, presumably with Yahoo’s co-founders controlling at least one other class of stock, would have required Microsoft to win over a majority of the shareholders of each class. According to Andreessen, Google has a dual-class structure that gives co-founders Larry Page and Sergey Brin, along with CEO Eric Schmidt, an effective veto over any takeover or other transaction requiring shareholder approval. Andreessen says, "You can bet that this is being noticed by the founders of every technology company that might go public from here on out."

Denver-area venture capitalist Brad Feld tells of a board call yesterday for one of his companies. The CEO left the other board members thoroughly confused. (That’s never a good thing for any subordinate reporting to a superior, let alone for a CEO reporting to his board members.) The lesson learned was one that most executives can identify with, from both sides of the table:

I talked to the CEO today just to check in. We had a good call and we both reaffirmed that all was cool. He said he’d learned something important - that if he was just going to “think out loud” during a board meeting that he should preface this with a statement indicating this. I agreed that this was the right conclusion - that I’d much rather he “think out loud” vs. feel compelled to figure it out all.

My experience has been that outside board members are much happier when executives label their information as fact, projection, conjecture, speculation, etc. It helps the listeners assign the information they’re getting into the proper pigeonholes. It also gives the speaker an air of competence, which is certainly something a CEO wants when talking to his/her board.

If your company has subsidiaries in other (U.S.) states, you need to think about whether those states can make you pay taxes on the income of other members of the corporate family. As a rule of thumb, the more separation there is between businesses, the lower the odds of being forced to pay out-of-state income taxes.

The U.S. Supreme Court hinted this week that doing inter-company business on arms-length terms may strengthen the case against out-of-state taxation. The parties to the case were Ohio-based MeadWestvaco Corporation ("Mead") and the state of Illinois. Mead realized $1 billion in capital gains when it sold off its Illinois subsidiary Lexis/Nexis.  Illinois taxing authorities assessed a $4 million state capital-gains tax.  Mead paid under protest and sued for a refund. 

The Supreme Court held unanimously that Illinois isn’t allowed to levy the tax unless it can prove on remand that Mead and its subsidiaries operated as a "unitary" business. I’m not a tax lawyer, so I won’t try to go into the details of Justice Alito’s (very readable) opinion.  The New York Times article thought it was noteworthy that Justice Alito specifically mentioned the arms’-length nature of Mead’s intercompany business dealings with its subsidiary Lexis/Nexis; the opinion says:

Lexis was subject to Mead’s oversight, but Mead did not manage its day-to-day affairs.

Mead was headquartered in Ohio, while a separate management team ran Lexis out of its headquarters in Illinois.

The two businesses maintained separate manufacturing, sales, and distribution facilities, as well as separate accounting, legal, human resources, credit and collections, purchasing, and marketing departments.

Mead’s involvement was generally limited to approving Lexis’ annual business plan and any significant corporate transactions (such as capital expenditures, financings, mergers and acquisitions, or joint ventures) that Lexis wished to undertake. In at least one case, Mead procured new equipment for Lexis by purchasing the equipment for its own account and then leasing it to Lexis.

Mead also managed Lexis’ free cash, which was swept nightly from Lexis’ bank accounts into an account maintained by Mead. The cash was reinvested in Lexis’ business, but Mead decided how to invest it.

Neither business was required to purchase goods or services from the other. Lexis, for example, was not required to purchase its paper supply from Mead, and indeed Lexis purchased most of its paper from other suppliers. Neither received any discount on goods or services purchased from the other, and neither was a significant customer of the other.

MeadWestvaco Corp. v. Illinois Dept. of Revenue, No. 06–1413, slip op. at 4 (U.S. Apr. 15, 2008) (extra paragraphing added)