Double Standard

Recently in class I mentioned that at times it can be a good business decision to default on one’s loan obligations, and that doing so is not necessarily a sign of poor moral character. I recognized that my students–undergraduates all, mostly sophomores–have neither the business nor life experience to truly grasp my point, and even if they did they would not necessarily agree with it.  It’s legalistic, based as it is on non-recourse financing, bankruptcy reorganization, rejection of executory contracts, and other remedies that show a binding promise is not necessarily binding. It was not essential to our discussion and I didn’t belabor the point.

I thought of it again upon read James Surowiecki’s “Living by Default” in the December 19 & 26, 2011 New Yorker. (Keeping current with The New Yorker would require that I cut back on working, working out, sleeping, or other reading.) Surowiecki mentions that American Airlines chose recently to file for bankruptcy:

Declaring bankruptcy will trim American’s debt load and allow it to break its union contracts, so that it can slim down and cut costs. American wasn’t stigmatized for the move. Instead, analysts hailed it as “very smart.” It is now generally accepted that when it’s economically irrational for a company to keep paying its debts it will try to renegotiate them or, failing that, default. For creditors, that’s just the price of business.

Seeing that strategic defaults are an acknowledged business risk dealt with by contract terms, negotiations, and restructured business deals, Surowiecki asks why more homeowners with underwater mortgage debt don’t walk away from their loans?

The bursting of the housing bubble has left millions of homeowners across the country owing more than their homes are worth. In some areas, well over half of mortgages are underwater, many so deeply that people owe forty or fifty per cent more than the value of their homes. In other words, a good percentage of Americans are in much the same position as American Airlines: they can still pay their debts, but doing so is like setting a pile of money on fire every month.

It’s a valid question. Surowiecki provides a few practical answers–dealing with the consequences a loan default is hard work, many homeowners have unrealistic views of the their home’s value–but says the biggest problem is the social stigma of defaulting on one’s home mortgage:

According to one study, eighty-one per cent of Americans think it’s immoral not to pay your mortgage when you can, and the idea of default is shaped by what Brent White, a law professor at the University of Arizona, calls a discourse of “shame, guilt, and fear.”

If you are interested Surowiecki makes the point far better than I made it in class discussion.

Ceglia’s Case Crumbling

The Wall Street Journal reported that Facebook has filed papers in Paul Ceglia’s case claiming 84% ownership of the company stating “[t]he purported contract at the heart of this case is a fabrication.” Facebook admitted that years ago founder Mark Zuckerberg performed software coding for Ceglia, explaining the existence of email correspondence between Zuckerberg and Ceglia.  The only reason I thought there was a chance this could be more than a deluded or duplicitous plaintiff’s transparent grab at someone else’s riches was that Ceglia was represented by DLA Piper, a law firm one would not expect to crawl into bed with a low-life con man.  (High-life con men might be another story.) In late June DLA Piper withdrew as Ceglia’s counsel for reasons undisclosed, but clear between the lines: Ceglia’s suit was baseless.  It should just be a matter of time before the court disposes of it for good.

Paul Ceglia’s Sinking Ship

Two months ago I posted about Paul Ceglia’s lawsuit claiming a 50% ownership stake in Facebook.  The suit’s timing and evidentiary support were suspect and Ceglia is a dubious character, but I did not dismiss his case out of hand because he was represented by DLA Piper, which I described then as “one of the bluest of blue-chip international corporate law firms.”  No longer.  DLA Piper withdrew from the case for reasons undisclosed.

Now I’m comfortable dismissing it.

Another Facebook Lawsuit

Hours after reports of last week’s 9th Circuit decision rejecting Cameron and Tyler Winklevoss’s lawsuit against Facebook came news of another legal challenge to Mark Zuckerberg’s stake in the social network site. The suit had been under the radar–it earned little credibility when it was filed last summer–but last week an amended federal court complaint put Paul Ceglia’s claim in a new light.  This story from the New York Times reports that Ceglia claims to have entered a programming-services contract with Zuckerberg a year before Facebook was formed that gives Ceglia 50% ownership in the company.  At first I yawned over this suit as just one more delusional claim following a wildly successful book/movie/company (“Harry Potter was my idea!  I wrote the first draft of Rent!”).  Ceglia’s legal problems, including fraud charges brought by the N.Y. attorney general, supported my conclusion that this suit must be without merit.  Then I saw the firm representing Ceglia.  It’s not, as I expected, some solo practitioner desperately seeking headline but DLA Piper, one of the bluest of blue-chip international corporate law firms.  Firms like DLA Piper do not typically take cases like this without scrutiny (or without a deep client pocket, which I doubt Ceglia possesses.

So, who knows what to make of it.  Is this suit mere bug splatter on Facebook’s windshield or does Ceglia’s paper trail actually prove his claims?

Winklevii Lose Their Appeal

Yesterday the Ninth Circuit Court of Appeals issued its decision in Tyler and Cameron Winklevoss’s lawsuit, dismissing their attempt to void their settlement agreement with Facebook.  The twins claim Mark Zuckerberg stole their ideas for the website that became Facebook, and sued.  The history of the litigation is somewhat tangled (the 9th Circuit briefly summarizes it in the first few paragraphs of its opinion) but it comes down to the parties’ agreement to settle the suit by Facebook paying the twins $20 million in cash and giving them shares of Facebook stock–now worth about $200 million.  Some time later the twins sued again to overturn the settlement agreement, claiming Facebook concealed material information about the stock’s value.  The trial court rejected their claim and they appealed to the 9th Circuit, which was not swayed by their arguments.  After rejecting each in turn the court offered this summary:

The Winklevosses are not the first parties bested by a competitor who then seek to gain through litigation what they were unable to achieve in the marketplace. And the courts might have obliged, had the Winklevosses not settled their dispute and signed a release of all claims against Facebook. With the help of a team of lawyers and a financial advisor, they made a deal that appears quite favorable in light of recent market activity. See Geoffrey A. Fowler & Liz Rappaport, Facebook Deal Raises $1 Billion, Wall St. J., Jan. 22, 2011,at B4 (reporting that investors valued Facebook at $50 billion—.33 times the value the Winklevosses claim they thought Facebook’s shares were worth at the mediation). For whatever reason, they now want to back out. Like the district court, we see no basis for allowing them to do so. At some point, litigation must come to an end. That point has now been reached.

The New York Times reports that the Twins will seek en banc review of the decision.


Proof versus Right

Yesterday’s class on contract law prompted a number of students to ask variations on the same question:  why does the law allow oral contracts?  Wouldn’t one of the parties just lie in court about the contract’s terms?  You can restate the question more broadly to ask why do courts allow witness testimony?  Whether it’s two parties to an oral contract offering competing testimony about the contract’s existence or terms, or two divorced spouses in a child custody proceeding offering competing testimony about their relationship to the child, or a supervisor and employee offering competing testimony in a sexual-harassment suit, the issue is the same.  A short answer is that our law has always allowed oral contracts unless the contract’s subject matter is governed by the Statute of Frauds, in which case the contract must be evidenced by a writing.  If the terms are disputed then the law’s adversarial process deals with it as it does with any competing oral testimony.  Attorneys subject the witness to direct and cross-examination and the jury or judge evaluate the witnesses’s credibility with the tools we use every day to decide whether to someone is telling the truth:  body language, tone of voice, eye movement, nervous tics, uneasy laughter, etc.

This question involves what I call the proof versus right problem:  do not confuse whether a person can prove her case at trial with whether she suffered a legal wrong and has a cause of action.  In Introduction to Law I focus on the substantive issue–whether a person’s legal rights have been violated–not the proof issue–how difficult will it be to prove a fact at trial.  Do people lie in court?  Yes.  Do people get away with lying in court?  Yes, but most people don’t lie particularly well.

Your Company Stinks, and I Own Half of It

First, from, comic relief:

Facebook hated as much as airlines, cable companies
Customer satisfaction poll puts Facebook in the bottom 5 percent of businesses

Facebook, the most visited site on the Internet , may also be the most despised: A new poll says the site scored 64 on a 100-point scale, which “puts Facebook in the bottom 5 percent” of private sector companies “and in the same range as airlines and cable companies, two perennially low-scoring industries with terrible customer satisfaction,” according to results of a survey released today.

Second, from, a WTF story:

Facebook founder may have given up ownership stake

A seven-year-old contract signed by Facebook founder Mark Zuckerberg granting a New York businessman an ownership stake in Zuckerberg’s then-fledgling Web project may be real, a Facebook lawyer acknowledged Tuesday in federal court hearing.  “Mr. Zuckerberg did have a contract with Mr. Ceglia,” Facebook lawyer Lisa Simpson told U.S. District Judge Richard Arcara in Buffalo, N.Y. . . . Ceglia’s attorney, Terrence Connors, said that his client hired Zuckerberg — then an 18-year-old Harvard freshman — to work as a coder on a street-mapping database Ceglia hoped to create. The contract they drew up covered both that work and an investment in a side project Zuckerberg said he had in the works, according to Connors. That side project grew into Facebook, the world’s largest social networking site. Ceglia agreed to pay Zuckerberg $2,000 for the job.

Ceglia sued in New York state court, where the trial judge entered a TRO preventing Facebook from transferring assets.  Facebook removed the case to federal court, which suspended the TRO.

This is a head-scratcher.  The inertia of mundane reality suggests Ceglia’s claim is too outlandish to have merit.  Yet Facebook acknowledges that there may be a real contract between Ceglia and Zuckerman.  Does the contract prove Ceglia’s claim?  Does it promise Ceglia 50% ownership of Facebook in exchange for Ceglia’s promised investment? I’d like to see the contract.  I’d also like to know this:  why did Ceglia wait so long to file his lawsuit?  Did “sue Zuckerberg for $5.5 billion interest in Facebook” inadvertently slip to the bottom of Ceglia’s to-do list?

Changed Contractual Expectations

Say you purchase a brand-new $3 million house adjacent to a golf course in a luxury country-club development.  The developer requires all house purchasers to buy country club memberships for $175,000. You comply, relying on a clause of the club membership agreement that obligates the club to reimburse the membership acquisition fee in full, in cash, without interest, within 30 days of a member’s written notice that it intends to terminate its membership.  The club membership agreement also contains a clause that allows the club to change the agreement’s terms at any time.

A few years go by, during which real estate values fall by 50%.  A number of the development’s unsold houses remain on the market at reduced prices and club membership is below projections, causing the club to raise annual member dues to cover operating expenses.  You did not bargain for this mess and want to quit the club and sell your house.  A year ago the club’s board changed the terms of the membership agreement to provide that the club will reimburse membership acquisition fees only if the club acquires three new members for each member who leaves, and then only by paying 10% of the fee in cash and the balance by an interest-only promissory note maturing in five years.  The board complied with all of the membership agreement’s procedural requirements when changing these terms. You notify the club’s board that you are quitting the club, intend to sell your house, and expect repayment of your $175,000 membership acquisition fee in cash within 30 days, as required by the membership agreement terms in effect at your time of purchase.  In response the board says it will reimburse your acquisition fee in accordance with the new terms.

What are your rights?

The Wachovia Tug of War

Discussing the claim of tortious interference with contract recently in class I noted the difficulty plaintiffs face in persuading a court that a defendant’s conduct crossed the line between tough but legitimate competition and unlawful interference.  I used to spend time on it in class–when I taught at Babson I employed Pennzoil v Texaco as fodder for moot court–but weaned it from discussion because after Pennzoil v Texaco the case law got pretty thin.

That may change if the Wachovia litigation has legs.  Last Monday Citigroup announced it would buy Wachovia for $2.2 billion, or about $1/share, in a deal backed by the federal government in the face of Wachovia’s imminent collapse.  On Friday Wells Fargo announced that it would buy Wachovia for $15 billion, or orver $7/share.  Citigroup cried “foul,” claiming the FDIC encouraged Wells Fargo’s bid after helping broker Citigroup’s deal days earlier.  Over the weekend Citigroup sought a court order enjoining the Wells Fargo deal, which Wachovia and Wells Fargo opposed.  The parties raced between New York state court (in the person of a state trial court judge who heard arguments from his country home in Connecticut), the New York federal district court, and the New York Court of Appeals in inconclusive attempts to trump each others tactics, agreeing today to put all litigation on hold until Wednesday while they try to negotiate a resolution.  It’s a high-stakes legal contest involving some of the country’s top litigators duking it out against the background of the most turbulent financial markets in over 70 years.

Plaintiff: I gambled and lost

In its chapter on contract legality the textbook we use in the business law class discusses the case of Soheil Sadri. Sadri went to Las Vegas, gambled, lost, and gave the casino a check for $22,000 to cover what he owed. He then returned to California, stopped payment on the check, and was sued for the underlying debt to the casino. (Note the use of the passive voice in the preceding sentence–it contains a clue.) A California Appellate Court ruled for Sadri, holding that a contract for payment of gambling debts violated California public policy and was void.

When I mentioned the case today a student asked why the lawsuit was in California, with its anti-gambling policy, instead of Nevada. Here’s why: The plaintiff was not the casino to whom Sadri wrote the check. The casino assigned its breach of contract claim against Sadri to a collection agency based in Sacramento, California. Creditors sometimes sell claims for money owed at a discount to their face value. The creditor gets ready cash without the risk, expense, and delay of a lawsuit; the collection agency gets to keep whatever it collects from the debtor–which, if it discounted the purchase price correctly, is more than it paid for the claim. The collection agency sued Sadri in California because it was home to both Sadri and the collection agency.

Could the agency have sued Sadri in Nevada? Yes, but to hear the lawsuit the Nevada court would have to determine that it could exercise long-arm jurisdiction over Sadri in Nevada. Since the basis for the suit was a promise Sadri made to a Las Vegas casino to pay $22,000 the Nevada court should have been able to exercise long-arm jurisdiction and hear the case. Would Sadri have lost at trial in a Nevada court? Probably. The reported opinion does not indicate that Sadri had any basis to contest the debt in Nevada.

A judgment for the collection agency in Nevada would not necessarily spell the end of the legal wrangling. If Sadri refused the collection agency’s request to pay the damages awarded by the Nevada court, the collection agency would have to enforce the judgment against Sadri in California. Under the Full Faith and Credit Clause of the U.S. Constitution a California court must enforce a valid judgment obtained in the courts of another state, even if it violates California public policy. How, then, can we explain the result in this case? The answer is that the collection agency sued Sadri in California to enforce a Nevada cause of action, not a judgment of a Nevada court, and the Full Faith and Credit Clause does not require a state to honor a cause of actions of another state that violates its own public policy.

A final note: given the importance of the gaming industry to Nevada’s economy, we might expect Nevada to have protected the right to sue in its courts to enforce gambling debts for many years. It is surprising to learn–I was surprised, anyway–that Nevada has had a statute allowing state court lawsuits to enforce gambling debts only since 1983.

See Metropolitan Creditors Service of Sacramento v Sadri (15 Cal. App. 4th 1821, 1993 Cal. App. LEXIS 559, 19 Cal. Rptr. 2d 646 Court of Appeal of California, First Appellate District, Division Five, 1993)