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In the brick and mortar business world, companies with competing or complementary businesses sometimes choose to form a joint venture by combining parts of the two businesses. Normally, the businesses are contributed to a new entity owned by the joint venture partners, and the serious negotiating issues include ownership shares, capital contribution requirements, board and management participation, and exit provisions that usually allow one joint venture partner to buy the other partner’s interest in the venture in designated future circumstances. In the new economy, companies tend to cooperate in a much less formal manner. Strategic alliances are frequently pursued by Internet companies to swiftly build their business without the delay and expense that would be required to develop the capabilities supplied by their alliance partner. Creating a strong on-line brand is easier for the first movers in a category, and strategic alliances with highly visible partners (or with media companies willing to contribute advertising exposure) may assist in generating the buzz associated with a “category killer.” The obvious cooperative benefit between content providers and Web sites with customer traffic is just one of a multitude of strategic relationships being forged to take advantage of the digital transformation of virtually all business activities. Another common combination is a “click and mortar” alliance, pairing an on-line business with brick and mortar suppliers of products or services that are useful or necessary to satisfy the demands of its on-line customers. Often, the parties to these alliances begin their discussions with no clear sense of who should be paying whom for the privilege of working together, and sometimes the arrangements do not involve any cash payments between the parties. Another difference in cyberspace transactions is the pace; with everything being done at Internet speed there isn’t time for lengthy negotiations of detailed legal documents. Much more emphasis is placed on the swift completion of a term sheet or letter of intent describing the summary business terms of the proposed strategic relationship. Even the formal legal agreements that are later prepared are expected to be short, simple documents, uncluttered by provisions covering long-shot potential problems and unburdened by the pages and pages of boilerplate that seem to append themselves to most legal agreements. Even more troubling for an old world lawyer, as a result of pressing to move forward at Internet speed, dot-com clients regularly seek to document relationships that are at the very earliest stages of formulation. Often the desired document will amount to little more than an agreement to cooperate in good faith to establish a mutually beneficial means of pursuing some vaguely defined business objective. Every first-year law student who has completed the mandatory Contracts class knows that an agreement to agree is unenforceable, but business considerations may mean that clients will want such an “agreement” formalized and announced to the public — in some cases the business objective is largely achieved by getting the press release onto the newswire. The challenge for a lawyer asked to draft an on-line strategic alliance agreement is compounded by the fact that there is rarely a model form agreement available in the form books or word processing system as a starting point for these arrangements — these unique deals cannot be documented by simply marking up the agreement for the most recent similar transaction. Real creativity and drafting skills are necessary to reflect transaction terms that even the parties may not have fully discussed or considered — this is not a task that can reasonably be handled by an inexperienced lawyer unfamiliar with real-world business issues and on-line business models. Contract drafting experience must be combined with an understanding of on-line business operations and relationships, or the resulting document can miss the point entirely. SOME DOS AND DON’TS At the risk of oversimplifying an area that defies definition or a clear set of drafting rules, the following dos and don’ts are worth considering in connection with on-line strategic alliances. DDue Diligence of Other Partner’s Alliances. Due diligence for strategic alliances involves many of the standard items common to other types of deals, such as contract review, analysis of intellectual property rights and an examination of the prospective partner’s track record and finances. Since business partnering is so prolific in the dot-com world, attorneys also need to pay close attention to the alliances which partners-to-be may have with other companies, which often may be competitors (actual or potential). It is essential to review these deals to see how they might affect the scope and operation of the planned alliance. For example, geographic limitations imposed by another agreement may thwart expansion in an important market. Concurrent use of scarce resources (including, specifically, customer eyeballs) for other alliances may reduce the effectiveness of the proposed deal. Confidentiality provisions may prevent one side from gaining access to crucial technical data developed or licensed by the other partner. Conversely, partners need to make sure other agreements do not impose an obligation to disclose technological advances which may be jointly developed or which your client considers essential to remain confidential. Alliance or partnering deals often contain a “most favored nation” clause. These provisions obligate one side to give the other the benefit of a later-negotiated deal which contains better terms with a third party. Prospective partners should check for these terms to analyze whether an agreement might result in unintended benefits to a previous partner that may also be a competitor. DDue Diligence of Potential Claims Against the Other Partner. Part of the due diligence process should include examining the potential that your partner might get sued for doing the proposed deal. Even if a potential litigation is not likely to succeed, any lawsuit can scare off customers and other investors or third-party contractors, derail management focus, demoralize employees (especially those who may have to be deposed) and slow down crucial momentum. In addition to reviewing the partner’s other alliance agreements before finalizing a deal as discussed above, the lawyer should ask to review any documentation, and seek contractual representations, concerning arrangements with third parties which may not have been consummated or which may have terminated (and also any third-party arrangements binding upon employees of the partner, such as non-competition or confidentiality obligations to a prior employer). In one instance in which we are currently involved, a prior deal (which was never finalized) contained non-competition and confidentiality clauses. Although the previous letter of intent was clearly terminated, once the subsequent deal was signed, the former potential partner (a competitor of the new joint venture) sued, alleging a breach of these provisions and improper use of alleged trade secrets. The merits of any such litigation may be secondary to the competitive aspects of the suit, and due diligence disclosure or contractual protection may help to reduce these risks. Attorneys should also ask their own clients about former partners and negotiations to uncover potential threats. While discovery may not eliminate possible litigation, disclosure to the other alliance partner in the current deal may avoid embarrassing surprises and act to strengthen a united front posture if a claim is later asserted. DDue Diligence on Financial Capabilities. A prospective strategic alliance partner may seem like a perfect fit, but a partner without sufficient financing to live up to its end of the bargain could spell trouble, and the risk of being entangled in a bankruptcy or workout situation is to be avoided if possible. With the capital markets now providing financing much less freely to technology companies, it is all the more important to be satisfied that a potential alliance partner has the financial staying power to deliver on the contemplated terms. DCheck Intellectual Property Carefully. Many alliances involve the contribution of technology by one partner and content by the other. Since intellectual property forms the heart of most dot-com deals, it is essential to evaluate both the technology component of the partner-to-be’s business (search and linking mechanisms; display and retrieval methods; encryption and security features) and the content component (design, pictorial, graphic and text elements; databases). For both the technology and content assets to be contributed to or used by the alliance, a partner needs to ensure that (i) the contributing party has full rights to the property to be transferred or licensed, (ii) the contributing party has the right to transfer or license the assets free of any third-party rights, (iii) the assets will not give rise to any claims for infringement of intellectual property rights from any third party, and (iv) the property is or can be adequately protected against infringement by competitors. In an increasingly global economy, partners should also evaluate whether trade names, trademarks, patents and copyrights will be needed on an international basis and undertake appropriate overseas due diligence prior to completing the transaction. DInclude Performance Benchmarks. The pressure to move fast, get the agreement signed and add your partner’s logo to the strategic alliance page of the business plan can result in a variety of later difficulties if not planned carefully. Partners always enter into agreements armed with columns of rosy projections, detailing the millions of “hits” to be generated and the multiple revenue streams which will, of course, follow. The agreement is usually for at least a year, often two or three, with “evergreen” renewal provisions extending the term unless one side breaks it off before the end of the term then in effect. The upper levels of management spend substantial time reviewing and negotiating the terms before giving the green light. Once the deal closes, the partners often leave implementation to the technical staff and turn their attention to the next deal. Ten months later someone thinks to look at the numbers, and to their collective amazement find only a few thousand hits and negligible revenues. Management quickly scrambles to check the termination clause in the agreement to see if there is any way to get out of this clunker and move to a relationship with a more productive partner. One method to avoid this scenario is to build in short-term performance benchmarks to measure progress along the way. Often the parties only prepare a detailed schedule to measure technology developments, rather than operational results. However, delineating measurable performance criteria can serve two purposes. First, this gives a partner a way to terminate an unsatisfactory arrangement without waiting for the year-end anniversary. Second, and perhaps more important, the milestones can serve as an early warning system to detect, and hopefully correct, problems before they lead to the urgent need to get out of the deal. Click-throughs, revenue and other appropriate measurement benchmarks should be prepared and sent out quarterly (or, if appropriate, monthly). Results should be sent to senior management on both sides. The parties should schedule regular meetings at the outset so operating results are not an unpleasant surprise only noticed when it is too late to save the partnership. DProvide Funding and Reimbursement Obligations. Where a strategic alliance is to be conducted without the formation of a joint venture entity or other vehicle for the payment of expenses, detailed provisions may be necessary concerning the sharing or reimbursement of expenses incurred in furtherance of the alliance. It may be that one of the alliance partners will be incurring and paying a disproportionate share of the out-of-pocket costs incurred for alliance activities and should be reimbursed pursuant to an agreed procedure. This is particularly true in instances where one partner is committing to develop or improve technologies or is contributing most of the personnel to develop alliance products or promote the alliance. The partners may also want to allocate corporate overheads to alliance activities, which can be much more contentious and difficult to draft in a protective and fair manner. Provisions will usually be included to allow a review or audit of reimbursable expenses, but it is a very bad sign indeed if the relationship of the parties deteriorates to the point where these provisions come into play. Don’t:Risk Losing Your Important Employees. The people in the trenches that are working on both sides to make a strategic alliance succeed will, if things are going well, develop close working relationships with, and will become aware of the skills and work habits of, the strategic alliance partner employees with whom they have contact. One of the most valuable assets of any business is its key employees, who walk out the company’s door every night (or somewhat less frequently in some cases). One danger of a strategic alliance is that the alliance partner may conclude that a more effective means of achieving its business objectives would be to simply hire one or more employees and take the alliance’s activities in-house. To protect against this risk, a strategic alliance agreement should contain provisions prohibiting each alliance partner from hiring any employees of the other alliance partner (unless the partner consents) during the term of the alliance and for a period of time (perhaps one year or 18 months) after the alliance is terminated. These provisions should, like the agreement’s confidentiality and intellectual property provisions, be subject to specific performance remedies allowing for an injunction against any breach. With these provisions in place, the alliance partners will not have any improper motivations or temptations as they develop strong working relationships across company lines. Don’t:Forget to Consider Antitrust Implications. Many on-line strategic alliances represent or include cooperation between competitive businesses, including most specifically the on-line business-to-business exchanges that are being created to permit e-commerce transactions in many industries. U.S. government antitrust authorities have indicated that they will be scrutinizing those arrangements to be sure they do not involve any anticompetitive activity in violation of applicable antitrust laws. In the same way as is true of industry trade associations, an on-line alliance or exchange which includes major competitors can raise serious issues concerning the legally permissible level of information sharing (particularly price information) and cooperative activity among competitors. So, in circumstances that involve these issues, don’t forget to involve an antitrust specialist at an early stage to analyze the compliance risks and to develop structural means of keeping all parties clear of antitrust complaints. Don’t:Grant Exclusivity Lightly. In the new economy (even more so than is the case for brick and mortar businesses), a company’s market position or reputation may be fleeting. In this environment, there is substantial risk to granting exclusivity to an alliance partner. The general cultural perspective of the World Wide Web is free access, and the normal instinct of entrepreneurs in this space is to form relationships with as many third parties as possible to increase exposure and connectivity. Exclusivity provisions, however, can easily stand in the way of attractive future business opportunities. If the negotiating position requires concessions in this area, it becomes important to limit the scope of what is being promised exclusively to the alliance partner. Worldwide exclusivity should be avoided in almost all circumstances, since there are few potential partners that have the worldwide capabilities and reputation to warrant exclusivity; a dominant market position or reputation in the U.S. does not make a company the right alliance partner in other parts of the world where it is likely to be unknown. Where exclusivity is part of the deal, the negotiation of contract language that defines the scope of exclusive relations will be important. It may be that what begins as a request for exclusivity can be moved to a commitment not to do business with designated competitors of the alliance partner. Another way to address the issue is to provide for exclusivity to continue only if performance goals are achieved and maintained. Don’t:Make Long-Term Commitments Without Exit Opportunities. The benchmarks discussed above offer one means to exit a non-performing alliance, but parties are well advised to structure other alternatives. This is particularly necessary if the agreement calls for additional capital contributions or expenditure outlays by one party which may, with 20-20 hindsight, seem inadvisable down the road. In addition to the alliance not meeting one or both party’s expectations, the parties may become deadlocked over a fundamental issue such as strategic focus, senior management of the venture or technological incompatibility. Some alliances attempt to solve this problem by implementing a phased set of dispute resolution methods. First, the line managers have a set period of time to negotiate a solution. If they do not, the issue is kicked upstairs to a senior executive on each side. If they cannot agree (again, within a short time frame), the parties go to mediation with a neutral party to try to bring both sides together. Should meditation fail to solve the problem, an ultimate solution is triggered, such as a mutual buy-out provision. While in theory a series of increasingly higher-level resolution mechanisms sounds appealing, our experience suggests that in practice this method is artificial, cumbersome and can actually delay speedy disposition. As noted above, we suggest regular scheduled performance reviews to measure achievements, combined with not locking the alliance into a multi-year obligation unless the alliance meets the needs of both sides. If a fundamental dispute arises which is crucial to the venture or if both sides come to a deadlock, we suggest simply that a senior executive on each side attempt to negotiate a resolution within a fixed period. If they cannot come to terms, the agreement should provide the ability to terminate. Termination clauses will vary depending on the nature of the alliance, but typically fall into two broad categories. In cases where the parties have formed a separate entity, it is common to use a mutual buyout provision along the following lines: one side names a price at which it is willing to buy out the other. The other party then has a choice of accepting the offer or buying the other party out at the offering price. This is most often used in 50-50 ventures but can be adjusted pro rata to account for unequal ownership stakes. Other agreements could provide a one-way buyout offer in accordance with a previously fixed formula (i.e., multiple of trailing 12 month revenues), or at a later-negotiated price, or at a fair market valuation determined by an independent third party. In instances where there is no separate entity, the parties generally face simpler problems. Tally and pay up what is owed, and each side goes its own way. A key item for both sides to consider, however, is what to do about the intellectual property. This is crucial both for IP contributed initially and that which is developed or improved during the course of the alliance. The parties should consider and specifically set out who has the post-agreement rights to alliance-specific trademarks, data bases, Web site designs, customer lists and historical data, and improvements to contributed programs and technologies. In some instances, it may be appropriate for the party with ownership rights to license selected items to the other party on a nonexclusive, nontransferable basis for a particular scope of use, while in other cases it may be appropriate to exclude access to the former partner. How IP rights are divided may differ depending on the circumstances of the termination, with provisions penalizing a partner that breached the alliance agreement or failed to meet its performance benchmarks. ONE FINAL RULE There is one final important rule to remember, and that is that all of the above dos and don’ts should be ignored in appropriate circumstances. Every strategic alliance is a unique situation and requires deal-specific contract formulation. A client’s objectives may require completing an alliance even if the alliance partner insists upon the inclusion of non-standard provisions, the deletion of standard provisions and/or business or legal terms that would be non-negotiable in other circumstances. It is not good lawyering to inflexibly protect a client from risk with the result of precluding the client from success. Rather, the client must be permitted to make the risk assessment after receiving balanced advice from the lawyer, and then the lawyer should implement the deal struck by the parties with the most protective contract provisions that can be negotiated. All at Internet speed, of course. Welcome to the brave new world of dot-com legal practice. James E. Abbott and Alan J. Bernstein are partners in the media and technology practice group at Carter, Ledyard & Milburn.

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