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'Frivolous' Facebook Lawsuit May Have a Leg to Stand On

By Erika Morphy
Jul 13, 2010 1:32 PM PT

Facebook has been blindsided by a lawsuit that could have triggered an upheaval in its ownership structure, or at least a massive legal fight -- if it had been filed a few months ago, that is.

'Frivolous' Facebook Lawsuit May Have a Leg to Stand On

Still, the modicum of legal uncertainty created by the case must be giving top executives at the social networking Grow your business with social media management services from Deluxe! giant some concern.

New York Web designer Paul Ceglia filed suit against Facebook and company CEO Mark Zuckerberg alleging that a contract entered in 2003 entitles him to as much as an 85 percent ownership stake in the company. He has been granted a temporary restraining order preventing Facebook from transferring assets while the case is open.

According to the suit, a contract signed by Ceglia and Zuckerberg gives Ceglia a 50 percent stake in a site that eventually became "Thefacebook.com." Ceglia received US$1,000 for his work -- along with the promise of an additional 1 percent interest in the business every day after January 1, 2004, until the work was completed.

TheFacebook launched in January 2004, officially becoming Facebook.com the following year with the purchase of the new URL.

Zuckerberg has been challenged about Facebook's origins before, by former Harvard University classmates. That case was privately settled.

Facebook has called Ceglia's claims "frivolous" and says it intends to fight them.

Out of Time

Given that Ceglia has a contract, he might have had a strong case -- if the statute of limitations for contract disputes had not run out, Tanya Gendelman of Tanya Gendelman Law Offices told the E-Commerce Times. "That may be a big problem for them, especially if the terms 'Facebook' and 'TheFacebook' have been used interchangeably at any point."

Under New York law, written and oral contracts have a statute of limitations of six years. That was also the case in Massachusetts when Zuckerberg was at Harvard, noted Washington, D.C.-based tech attorney Raymond Van Dyke.

The existence of the contract might have given this case might a stronger chance in court had it been filed earlier. Previous cases involved oral agreements, Van Dyke said, and thus carried less weight in court.

The bottom line is that Ceglia and his attorneys will have considerable explaining to do as to why this "agreement" was not proffered long ago, he continued, as FaceBook grew exponentially.

"The statute of limitations laws represent sound public policy, affording protection against stale claims," Van Dyke noted.

Breach of Contract

That said, this is not necessarily an open-and-shut case for Facebook. The fact that the judge froze Facebook's assets suggests there may be extenuating circumstances favoring Ceglia, Gendelman pointed out.

Also, Ceglia may be planning to argue that the statute of limitations didn't start until the contract was breached, which would have set the clock ticking in 2004, said Scott & Scott partner Julie Machal-Fulks.

There is room for that argument in New York law, she told the E-Commerce Times.

As for the last-minute challenge, that too makes sense -- at least, it can be argued in court, said Jonathan Askin, associate professor of clinical law at Brooklyn Law School.

"Logically, these ownership challenges only occur after a company has value or is on the verge of success. Why would anyone sue a company before it has value?" he asked.

This is why it is essential for every startup to lay out its ownership and control issues as early as possible in the company's lifecycle, Askin told the E-Commerce Times -- before the company has any significant assets or prospects.

"Typically, these controversies center around a startup's failure to have each founder, employee and consultant assign all intellectual property -- typically copyright control over the computer code -- to the company," he observed. "Too many companies start with a handshake or a hug and a feeling of brotherhood in a dorm room and end up with virulent vitriol in the courtroom."


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