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With so many venture capital investments in the doghouse, is it any surprise that some of those dogs are beginning to bite back? Lawyers close to the venture capital scene warn that some venture capital firms may face potential legal flash points as the dot-com carnage worsens and the hard-pressed entrepreneurs whom they’ve lavished with money and managerial support begin turning against their benefactors. Consider the case of Urban Box Office Network Inc., the once-promising parent of trendy multimedia hip-hop site UBO.net, now in Chapter 11. The New York-based company filed suit last week against Interfase Capital Partners of Austin, Texas, a potential backer, and its affiliated fund, Eco Opportunity Fund. UBO maintains that Interfase reneged on a signed stock-purchase agreement that would have provided UBO with $20 million of an anticipated $35 million Series D financing round this summer. UBO CEO Adam Kidron said the rest of the funding in the round was expected to come from previous investors Flatiron Partners and Allen & Co., both of New York. But that was contingent on UBO receiving the money from Interfase. The company is seeking at least $20 million, the financing amount, in damages. According to the complainants’ letter submitted before the U.S. Bankruptcy Court, Southern District of New York, on Aug. 29, Interfase agreed to purchase $20 million in stock in a draft term sheet, “subject to various conditions,” including satisfactory completion of due diligence by Interfase and execution of a formal stock purchase agreement. Even though it knew that UBO was running short of cash, Interfase, led by partners Steven Hicks and Scott Hyten, signed a stock purchase agreement Sept. 20, according to the complaint. On Sept. 29, Interfase advanced $3 million to UBO in interim financing. But that was that. The complaint said Interfase “breached their obligations … by refusing to consummate” the stock purchase transaction, and declining to advance UBO any more money. As a result, UBO claims, it was forced to shut down its operations, lay off more than 300 employees and file for bankruptcy. Interfase partners were not available for comment. With only four employees left, UBO is attempting to assemble a restructuring plan to present to the court in February, Kidron said. It received no additional cash from existing investors other than a debtor’s imposition financing of $1.8 million, which Kidron said was used for employee expenses. The case is “unprecedented” in that it’s extremely unusual for a potential investor to back out of a “binding” stock purchase agreement, said UBO lawyer Michael Chodos, in Palos Verdes Estates, Calif. UBO’s other lawyer is Jonathan Wolfert at Kaplan, Thomashower & Landau LLP of New York. WHAT HAPPENED? One possibility, according to Richard Gilden, a business and technology partner at Brobeck, Phleger & Harrison LLP, in New York, is that certain conditions for closing the purchase agreement may not have been satisfied. “You have to look at the contract. But just to walk away from a binding contract is usually” enough to trigger a lawsuit, he said. Whether or not UBO has a case remains to be seen, but Larry Gottesman, a bankruptcy partner at Brown Raysman Millstein Felder & Steiner LLP, said that by filing the suit in bankruptcy court, UBO may, in fact, receive a more favorable hearing than it would have in any other court, “particularly if there are creditors who are left holding the bag. Bankruptcy is frequently a search for deep pockets. And VCs have big ones.” Will the suit trigger similar suits on the part of entrepreneurs left in the lurch? UBO’s Kidron doesn’t think so. “Everybody’s too scared,” he said. “[Venture capitalists are] a very close-knit club.” Brown Raysman’s Sarah Hewitt, a technology partner, agrees. “Usually, they try to broker an agreement where everybody may not be totally happy, but at least it’s amicable,” she said. Gottesman doesn’t see such suits spreading either. “A lot of dot-com bankruptcies or failures have not left a lot of debt, so there’s less incentive to bring this kind of expensive litigation,” he said. On the other hand, says Gottesman, UBO has nothing to lose if it can pursue its financial claim on Interfase as “part of the assets of its estate” in bankruptcy court. Other lawyers by no means rule out a rise in lawsuits, given the current do-or-die climate that is changing the dynamics between entrepreneurs and their venture investors. “There’ll be controversies in the coming months, and some of it will be in the courts,” said Gilden. John Hughes, a business partner with Boston’s Hutchins, Wheeler & Dittmar, believes that the venture crowd has a potential exposure to liability as a result of the market crash. Because VCs have been left without easy exit strategies in the form of public offerings or mergers, they have already begun to “exercise their rights to more control over their portfolio companies,” he said. Typically, he said, these rights are exercised through more direct participation in management and decision-making, where much of the discretion previously was left to startups. That, in turn, will lead to greater friction between entrepreneurs and their backers, in his view. Said Hughes: “The tension between venture capitalists and the founders of a portfolio company will be even greater” in the foreseeable future. Copyright (c)2000 TDD, LLC. All rights reserved.

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