PayPal Booted Out of State, Under Legal Siege

It has not been a very good week for PayPal. First, theonline payment company was forced to delay its initialpublic offering because of a lawsuit filed by rival CertCo. Just days later, the state of Louisiana ordered PayPal to stop doing businesswith its residents without a license.

Although the company faces the threat of regulation from several other states, Louisiana was the first state toorder the company to stop transferring money to and fromresidents until it obtains a money transmissionlicense.

If PayPal fails to abide by that order, itcould be fined US$1,000 per day by the state.

PayPal said it will “comply promptly and suspend theability of Louisiana residents to make paymentsthrough our service,” although it reserves the right tocontest the order.

Louisiana residents accounted for just 0.9 percent ofpayments sent and 0.7 percent of payments receivedthrough PayPal in the first nine months of 2001.

State Regulation

New York also has informed PayPal that it considers thecompany to be involved in unauthorized banking. This accusation posesa potentially bigger problem than the Louisiana setback. New York customersaccounted for 6.4 percent of total payments sent and6.8 percent of payments received in the first ninemonths of 2001.

California and Idaho also have notified PayPal thatit may be operating an unauthorized banking business.

PayPal said it has taken steps toaddress the concerns of all three states. InCalifornia, for instance, the company has stopped sendingpayments to international accounts.

“They don’t have to worry about Louisiana, but they dohave to worry a lot about California and New York, andwhether this sets a precedent for other states,” Gartner analyst Avivah Litan told the E-Commerce Times.

California, in particular, is a bellwether state and isespecially concerned about consumer rights, Litan added.

Most states regulate nonbank payment systems. ThoughPayPal has said it believes its business is subject to thoseregulations only in its home state of California, the company hasreceived licenses in Oregon and West Virginia, has filedapplications in four additional states and intends tofile in 10 more.

Cutting It Close

The CertCo lawsuit is not particularly unusual, according to Litan. “It’s common practice to file a lawsuit right beforean IPO, because that’s when a company is most likelyto settle,” she said.

However, the lawsuit’s hair’s-breadth timing — it was filed February 4th, just three days before PayPal’s stock was to begin trading — surprised Litan.

“CertCo’s tardy allegations and rush filing of itsunmeritorious lawsuit has disrupted PayPal’s initialpublic offering, resulting in damages to PayPal,” thecompany said in a filing with the U.S. Securities andExchange Commission.

Because of those circumstances, PayPal asked the judgeto declare the lawsuit an exceptional case, whichmeans PayPal could receive attorney fees from CertCo.

Costly Trial

Litan said CertCo’s patent is “incredibly broad. Iknow a lot of processors in the payment industry, andit could apply to each and every one of them.”

A trial would be a financial hardship, even if PayPalemerges victorious. “Even if we prevail, the litigation could betime-consuming and expensive to defend and couldaffect our business materially and adversely,” PayPalsaid in the filing.

If PayPal loses the suit, it could be forced to pay triple damages for past patent infringement aswell as CertCo’s legal fees. The company also would haveto obtain a license in order to keep offering any features found to have infringed on CertCo’s patent.

1 Comment

  • Although great research was done on the Paypal IPO, what I miss in all the analysts’ comments on the postponed Paypal IPO, is what may really be behind the suit by Certco: The fight for the US market by ING and Deutsche Bank.

    Maybe it is worth researching?

    The public facts are that:

    – Deutsche Bank was the major investor in Paypal in the first and second rounds

    – ING (NOT Deutsch Bank) was the major investor in the third round

    – ING and DB are two of the world’s largest banks that compete in Europe and the USA

    – ING set up Paypal’s European p2p-network, replacing the original announced p2p-deal in Europe through DB’s partner ECash.

    – ING has an aggressive strategy to expand in the USA (f.e. ING Direct) so you can imagine that DB would not especially like all this cozyness between ING and Paypal using DB’s own money in Paypal to gain an advantage on DB.

    – DB must have insider knowledge of Paypal’s operations and patent issues from having been a Paypal investor from day one. So they have the means to thwart the ING/Paypal venture.

    – Deutsche Bank has a board member on the board of Certco. So this director is a potential means of going after Paypal and is in place.

    Isn’t it likely, knowing these facts, that they are not coincidental and that the suit by Certco is all about the battle between ING and Deutsche Bank and that Paypal is just being used for this?

    The question is if the CEO of Paypal is good enough to play these banks against each other and come out winning.

    battle of giants

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