Sep 5, 2019
Litigation and disputes are expensive, time consuming and can have negative consequences for an emerging and high growth company’s reputation, especially as it tries to scale. Yet as your company grows, the threat of litigation is sometimes unavoidable. Taking steps to minimize your litigation risk and being well prepared to confront a dispute should it arise are crucial.
Emerging and high growth companies must also contend with litigation risks that might differ from larger companies, so seeking expert legal counsel is important for managing and guarding against any liabilities. This presentation by Craig Lockwood, a partner in Osler’s Litigation and Dispute Resolution Group, and Eric Morgan, an associate in Osler’s Litigation and Dispute Resolution Group, explains disputes in the emerging and high growth company context and offers practical tips for managing litigation risk. Available in both webinar and PowerPoint format, the goal of this presentation is to help you navigate and understand the following issues:
- Negatives of litigation
- Areas of potential disputes
- Documenting arrangements and expectations
- Document retention and organization
- Ways of resolving disputes
- Third-party funding
Transcript
Slides: Disputes 101 for Start-ups
For more information, please contact Craig Lockwood or Eric Morgan.
This presentation is part of Osler’s Emerging and High Growth Companies 101 series, designed to help emerging ventures navigate through the various issues and legal requirements they will encounter throughout their growth cycle.
Video transcript
MODERATOR: So we're going to get started. I think we might have a few people filter in over the next few minutes. But I want to introduce you to our presenters today, so we have Craig Lockwood and Eric Morgan. So Craig is partner in our litigation group here and Eric is a senior associate. I'm assuming those work together down there.
CRAIG LOCKWOOD: Safe assumption.
MODERATOR: I know, I said to them very kindly before we started that I was like, I secretly hope I never have to call you guys because I work in our Emerging and High Growth Companies Group here. And if we call litigation, it means something has gone wrong. And I was like, don't take it personally, but I really hope we never work together in our careers.
So today they're going to run you through just some of the kind of Dispute 101 things to know. Specifically, in the start-up context because, obviously, you guys have daily concerns that are a bit different than some companies that you might grow into will face.
So I think you guys are going to talk about a little bit of some of the main, I guess, concern areas where location often pops up for start-ups and kind of what you can do to one, be prepared for that because sometimes it's inevitable no matter how great a job you're doing. Two, just kind of the best things to keep in mind if do end up facing it. So I'll let you guys take over. Do you think we'll have time for questions at the end?
CRAIG LOCKWOOD: Yeah, for sure, for sure. And we're going to be pretty fluid in this, so if you've got questions as we go, by all means, jump in. We're going to be efficient as well so we'll get you out of here under the half hour.
But basically the purpose of today is just-- it's not doom and gloom story, what we're trying to do is give you some practical tips on how you can structure your affairs in a way that minimizes litigation risk and also makes your lives a little easier.
The reality is litigation is unavoidable. It's frankly, a hallmark of success. So as companies get to a certain level, they become targets for litigation. And I often say to clients, especially in this space, that the first time you get sued means you're doing well because somebody's decided to take notice of you and take a run at you. So it is unavoidable, but it can be managed.
And the best thing you can do is sort of have it in the back of your mind as you're sort of developing and growing. And so that when that day does come and you unfortunately have to meet with someone like me that you're well prepared.
So I mean, the negatives of litigation are probably self-evident, but for those of you who have not been through them, we sort of put them into three buckets. One is it takes a ton of time. And it's not just the time of litigation, it's the distraction time, it's the opportunity cost. So your executives, your people on the ground who are trying to build your business, grow it, are going to be distracted because they're going to be sucked into discoveries. They're going to be reviewing pleadings. They're going to be doing all the things that you don't want them to be doing. And the more time they spend on that, obviously, the less time they can devote to developing the business.
It's expensive. It's always expensive. And that that's irrespective of the merits, and what I mean by that is if you get sued with a totally frivolous claim, it's still expensive to defend. It takes time. It takes money, and you've got to respond to it. So you know, the more efficient you can be, obviously, the better.
And then lastly, the reputational concerns. Particularly, entities that are looking to get funding. One of the big things that funding companies look to and investors look to is, is there exposure, is there risk, are they embroiled in litigation. So oftentimes, we'll find clients in this space will settle not because, frankly, they think they're liable at the end of the day or that there's material risk but because they just need to get rid of it. Because the opportunity cost of losing an investor, losing investment because of a claim that's sitting out there is far worse than actually defending the client.
So with that in mind, we thought we'd give you an overview of the types of litigation that can arise. And we're not going to go into detail here, but just sort of what we see most often in this space. And ways you can sort of manage your affairs to limit your exposure and to limit the distraction.
Litigation itself, you can be sucked into it in a couple of ways, both in your personal capacities or in your capacity as a shareholder, and typically that's in the context of a shareholder dispute. So probably the thing we see most often is people fighting over ownership of a company.
Everybody is happy to sort of go along in an ad hoc way until success starts to creep up and then people start looking at their finances and start laying claim, rightly or wrongly, to greater or lesser interests and then shareholders who previously got along often don't. And I say that not to be pessimistic, but that's just the reality. So we see that probably more often than anything else.
And then a directors and officers. Oftentimes, especially in the emerging company space, the people on the ground are the directors and officers and there's a certain type of liability that's attracted to directors and officers under the statute and otherwise.
So those are the sort of hats you'll be wearing when you get exposed to it. And of course, the company itself will get dragged into it, and oftentimes, that's another way of you getting dragged into it.
As I said, probably the single, biggest fight we see is over ownership. And that can manifest itself in a whole bunch of different ways. I'll say candidly, the most common is option grants and equity interest that are granted in lieu of compensation sweat equity, I'm sure you guys are all familiar with it.
Oftentimes, that's done informally. It's done in the heat of the moment in the fly. You know, someone promises somebody else a certain stake in the company or options, it doesn't necessarily get papered properly, or even if it does get papered properly, people understand it differently.
And that leads to litigation because as I say, once the company sort of hits that next threshold and succeeds, all of a sudden what were sort of notional option grants that didn't really have value at the time, suddenly have real dollars associated with them. And that can become very contentious.
So the big lesson there-- and we'll get into it more-- but the big thing there is if you're granting equity or if you're granting an ownership stake or options or anything of the sort, make sure it's paper. And properly papered. And the best way to do that, frankly, is talk to the guys in the HT group. I mean, they do this, they're the best in the business. And they can help you on that.
And I know it may seem like a little bit of motherhood there and everybody sort of says, well, of course, that's obvious. But the reality is there's papering, and there's papering in the sense that we want to make sure that it gets done properly because I can't tell you the number of fights we've seen over what could have been avoided if it had just been properly documented.
Funding is another big one, obviously. And by that I mean not only sources of funding, but also the terms of funding and equity investments. That's another hot topic. And again, the answer again, comes back to make sure everything is properly papered, everybody's on the same page, everybody understands what their rights and obligations are. Because if things get to a certain point, at the end of it, money's the reason everybody sues. And that's really what it comes down to-- money and reputation. And funding is the heart of all of this.
And then there IP and reputation. And generally, what that means is as I said before, one of the hallmarks of success in this area is your first claim, your first piece of litigation. I'm sure you're excited to hear that. But the reality is IP fights crop up as soon as somebody recognizes you as a threat in the marketplace or as having value.
So if somebody is content to go along until all of a sudden they think your IP now has value, they will sue you for that value. Even if it's frivolous, they will try to take a run at you because what was before a no-name all of a sudden has some market value. There's reputation to it. It's got goodwill, and people will take a run at it and try to say that they have a stake in it or you're infringing on their IP. And again, not to be repetitive, but it's all comes back to the same thing.
Now, IP is a little different in the sense that your fights over IP, you know, you can't really predict where that's going to come from. But I can say to the extent that you are going to use branding, any sort of IP, you want to make sure that it's properly documented and that you do it properly and get everything registered because the last thing you want is to have a billion idea that somebody else comes along and says thanks a lot, but that was my idea or that was my branding or that was my IP.
And then you lose your stake in it. So if you paper it up front, it protects you at the back end. And with that, I'm going to pass it off to Eric to talk about privacy.
ERIC MORGAN: Thanks very much, Craig. So with privacy is a risk if your enterprise is handling any kind of personal data that you might have. Each province has slightly different laws about it, and each province also has a privacy commissioner. So it's a risk both in terms of the regulatory oversight as well as private litigation around it.
It might be customer's information, it might also be employee's information as well. And it can be a source of class actions around privacy breaches and just individual lawsuits as well. And there's media attention around it since privacy is such a growing and changing issue in Canada.
One thing to think about is do you handle personal data as part of your business. Is it part of your business model or could you potentially suffer a one off breach? And what can you do to prevent that?
Another source of potential disputes is employment. So similar to some of the disputes that Craig was talking about, who is an employee, how are you documenting what your relationship with them is. Terminating employees, compensation and benefits, non-competes once people leave-- what are they allowed to do and not do. And when they leave, do they take confidential information with them, is that an issue that you might have as well.
And I think there's another 101 seminar that our employment law people do, Steve Dickie, in this series, so he's a great source for information there.
And then just other aspects of your business, other commercial relationships you're involved with that might go sour. So leasing-- if you're leasing property, are you sharing workspaces with other enterprises, how is that relationship governed. Suppliers, customers, advertisers, all the sort of normal commercial relationships that you might have disputes in.
CRAIG LOCKWOOD: So I said before I wasn't going to repeat myself but, obviously, that's not true because this is exactly what I've been talking about. But as I say, the single biggest fight that we always, always get into-- or the single biggest cause of litigation is inadequate or improper documentation.
And what I mean by that is, generally speaking, a lot of the times in this space when companies are starting out, it's a handshake deal, it's an email. And what we see very commonly is people will take agreements they find on the internet-- either the pro forma ones that you can get from various websites, or frankly, they see an agreement in another context and just sort of take the Word document and apply it. It may seem like a good idea at the time, it may seem like you're saving money because you don't have to pay a bunch of money for lawyers to draft up an agreement that, frankly, you think is pretty simple and cut and dry.
And I understand the inclinations to why you want to do that, but I can tell you, it will cause you headaches in the long run. It will cost you money. Because every agreement is different in the sense that you can sort of standardize it to a degree and the guys in the HT group have done a fantastic job of doing that to maximize cost savings. But everything has to be tailored to the circumstances and if you don't, you will end up in situations that just will be needless headaches for you, frankly.
And so in terms of the context that can arise, I mean, as I've already talked about, granting equity, granting ownership interest, that's probably the biggest one. So if you're giving someone rights to your company or interests in your company, make sure you know exactly what you're giving them on exactly what terms and to what end and how that can be exercised. Because that in and of itself is probably the single biggest dispute.
But again, commercial agreements with other parties, employee agreements, anything that, frankly, puts a third party sort of at odds with the company. So you've got the company and yourself on one hand, any contract with anybody else should be properly documented.
And I know that sounds very obvious, but cutting corners in that context will be your single biggest mistake because it will come back and bite you. Because all it takes is a missing word or a missing clause or missing provision and it could be extremely costly.
And the other thing to remember, of course, is a lot of the times these things develop organically. You don't really turn your mind to it at the time. I don't know if you guys follow the Extreme Venture Partners litigation that recently sort of played out in the courts-- and I don't propose to get into it-- but I only highlight it for one reason, because that was an example where you had everybody sort of operating in a single office space. Ideas being traded, different people representing different interests, wearing different hats at different times, and everybody sort of thinking that they were at ad metum in terms of what they were working on at what particular time and who had what information.
And the reality is, as you may have seen it play out, there was a significant, significant liability imposed because certain people did certain things wearing one hat when they should have been wearing a different hat. And I'm sure at the time it came about because it was, effectively, an incubator, and there were multiple people in the same space sharing ideas. None of it was documented, none of it was structured-- or at least the way it should have been-- and the end result was millions of liability.
And if people had taken a few extra steps-- and again, I'm not pointing fingers, it's very easy to look back with rose colored glasses-- but the reality is if you had properly documented things, it may have turned out differently. It may not have, but it's a good example of what happens when you don't turn your mind to the documentation.
ERIC MORGAN: So if you're generating all these documents or emails, things like that, one thing you have to keep in mind is about retaining them and organizing them. So producing documents in litigation is a major step, and it can be quite costly.
Under the court rules, if you do get into litigation, you have to turn over to the other side all relevant documents. And relevant is broadly interpreted, documents is also broadly interpreted. So it can be hard copy documents, soft copy electronic documents, voicemails, texts. It's very, very broad.
So the litigation process is so interested in that because documents are the best contemporaneous evidence. You have people testifying and it gets shaped by the circumstances and what they remember. Documents are all contemporaneous. They show what was happening at the time.
So I said, it can be quite expensive if you do get into litigation at that step. And so the better organized you are, the easier time you'll have if you have to do it. And it's also a way of sort of short circuiting if you want to do settlement negotiations, things like that, that we'll talk about later.
So think about do you have document retention policies, and/or how are your documents organized. Do people know what those policies are and how are they being followed? Do people do business, do they do work on personal devices? Where are those devices kept and who owns them and who keeps them afterwards?
Something to pay attention when you're migrating IT systems, if you implement a whole new system, what have you done with all those old documents? Did you archive them? Did you keep them? And how easy are they to access?
And this is all on top of you might have contractual duties as well. Some of your contracts might require you to keep records for a certain amount of time. So it's something just to think about. And with electronic communication, the volume of documents is just so massive that it's really something you need to keep on top of, stay organized, and again, think proactively about.
So I'm now going to talk about if you do get into a dispute, just kind of overview of what the different processes are, how might you resolve them. So the first one is just traditional court litigation. Now it's in public, generally, unless the court orders otherwise. It can be slow, but it results in an enforceable order that you can take and you can show anyone.
But it also is subject to appeal so it's a very thorough process but possibly slow and expensive. It does, though, offer all the different orders that a court can give you, including injunctions, where you are trying to stop someone from doing something. It's much easier to get that through court than through another process.
You can also try to resolve a dispute through mediation, either as a first step or part of the way through a court process. And a mediation is really a structured facilitated negotiation. So you are in one room, the other party's in another room, and often, there's a mediator who just does shuttle diplomacy back and forth. Tries to get the parties to, over a day, or possibly more, reach an agreement as to how to move forward in terms of the dispute.
Lastly, you can think about other forms of alternative dispute resolution, such as arbitration. And arbitration is generally confidential. It's like litigation in that it's a dispute resolution process where you've got a third party, an arbitrator, who plays the role of the judge who decides what happened, who's right, what the law is and how to go forward.
It can be faster than litigation, not always you can never guarantee that, but it can also be more tailored to what is the real issue between the parties. And it might also be required, again, in some of your contracts. And boilerplate arbitration clause is often put into contracts where parties don't want to go through the sort of public scrutiny of a court process.
CRAIG LOCKWOOD: And lastly, we thought we'd end on a high note. We structured this around the premise that you will be the target of litigation. Obviously, it's equally likely that you will want to enforce your rights. And, frankly, litigation is one of, not the primary means, of enforcing rights where you get into a fight with somebody else.
And so just as a starting premise, it's important to know your rights. Obviously, again, this comes back to documenting everything, but talk to the HT group, talk to us. We're always happy to have a casual conversation about whether you've got a claim, whether you think it's worth enforcing the claim. I mean, it's always a cost benefit analysis, right? I mean, you've got entitlement-- or at least asserted entitlement on one hand-- on the other hand, you've got the headache of being tied up in litigation, paying lawyers fees, paying whatever other costs associated with that.
So it's not an easy decision, but to be honest, knowing your rights and protecting your rights is probably going to be one of the most important things that you do in this space, because, frankly, that's what it's about, right? I mean, as you grow, as you develop your business, you want to be able to make sure that you reap the benefits of that and that nobody else can, right? And nobody else can take your ideas, nobody else can take your business.
And you will, unfortunately, get into fights. You'll get into fights with suppliers. You'll get into fights with market competitors. You'll get into fights with former employees, co-founders, shareholders, everybody, funders. They're all your friend until they're not. And I say that not to be pessimistic, but it's important to be at least mindful of your rights and to enforce them where appropriate.
And one of the ways you can do that, which is a fairly new phenomenon for Canada, is through third party funding groups. And there's a couple that have come to Canada. IMF Bentham is the one that comes to mind. Most commonly, we do work with them.
And what they are, they are basically funding entities that, if you go to them and you say, I've got this claim, I don't want to spend 10 million bucks fighting this, will you bankroll it, and you can take a piece of the recovery at the back end. And they have a very, very sophisticated group who will sit down and assess your claim and figure out whether it's worth it and they will provide financing on terms.
And it gets very complicated, but the reason we raise it is because you have a lot more avenues available to you today than you did even 10 years ago. And the third party funding mechanism is probably one of the best because they recognize that a lot of these start-ups in particular, they don't have liquid cash, they don't have a lot of resources to pay for lawyers, but they may have an extremely valuable claim or want to assert the rights that has value to it.
And so, they provide an opportunity to pursue those rights without bankrupting the company, frankly. Again, it's not for everybody, it's not for every situation. And you have to assess it, but it's good to at least know it's out there.
And more generally, it's good to talk to the group here, as I say, talk to us. Find out what your rights are and find out whether it's worth it. There's a lot of ways to, as Eric just pointed out, there's a lot of ways to enforce your rights that don't require you to go to court.
And I know there's this trepidation about being in a public fight, and I get it. And oftentimes, that's sort of the death knell for a lot of these start-ups is having a public fight and having their dirty laundry aired. There are ways you can get around that.
Again, well-structured agreements that have mandatory arbitration, for example, binds everybody up and it's a confidential process and nobody can sort of watch the fight unfold, which, that in and of itself has tremendous value. But again, that only works if you, at the outset, properly paper things and bind parties to the arbitration process because you can't force someone into arbitration unless you have a foundational agreement that forced them in there. Otherwise, you're stuck in the court process.
And a lot of the times, I will say, there are strategic entities out there that will start what we call strike suits. And the reason they do it is because they know that, particularly companies that are looking for funding, just want the litigation to go away. So they'll start frivolous claims looking for a quick and dirty payout, and you know, it's exhausting, it's frustrating. But if you can tie them up in the early stages to an arbitration, then they lose their force because they lose their leverage over you because it's not in the public domain anymore.
So that's sort of from my-- I'll let Eric close. But my takeaway, in case it wasn't obvious, is papering things up front and just know what your rights are and what your avenues are. And as I say, the best thing to do is if you're at all uncertain or if you're at all concerned about a particular thing, pick up the phone, call somebody here. We're happy to chat about it and talk you through it and let you know what your options are. I mean, just know what your options are and be informed and you'll figure out what's best for you and we can help you.
ERIC MORGAN: Yeah, so I hope that's given you some proactive strategies and proactive mindset to have around litigation. Again, hopefully, you never you never see us again. But if, again, as Craig says, we're always happy to chat. You don't need to be facing active litigation to be thinking about litigation. It's just a reality of doing business.
So if you've got any questions, happy to take them.
CRAIG LOCKWOOD: Go ahead.
PARTICIPANT: Yes, so I had a question in regards to if you're issuing equity or shares, should you be doing or issuing the paper in terms of what those terms are or other instances where the receiver can then give you the terms used in terms of how they want those shares or offers. Is there a preference?
CRAIG LOCKWOOD: Yeah--
PARTICIPANT: Is it dependent the power of the ask. I'm assuming if it's--
CRAIG LOCKWOOD: I was about to say, yeah.
PARTICIPANT: A large accelerator or investor, they're going to be driving it, but in this particular case, it's a partnership, but the partner does have more leverage in a bigger business and they want to determine how to structure the shares.
CRAIG LOCKWOOD: Right. So I'll give you my answer then Eric can tell me why I'm wrong. But the short answer is it's always better to be the drafting party. You always want to be the party who structures the arrangements because it gives you the freedom to structure it in a way that's beneficial to you.
The reality is it often determines where the power lies, in the sense that those with the power usually have the pen. And they've got the leverage.
So I mean, invariably, it's going to be a give and take, and it's going to be back and forth. And again, not to keep plugging them, but talk to the group here. You know, they've got ways of structuring things that are pretty pro forma such that there shouldn't be a lot of debate around some of these things. It's pretty standardized, a lot of these things are boilerplate. But at the end of the day, there's going to be a give and take, and usually the party with the power, or the leverage, usually gets the final say on the terms.
But if you can sort of standardize it to the amount possible such that you use industry standard, hopefully it, hopefully, it wouldn't matter who's actually starting the document.
ERIC MORGAN: Yeah. I'd say the same thing. Holding the pen gives you a lot of power. And--
PARTICIPANT: Is there a cost advantage on either/or? I mean, is viewing cheaper then drafting? Or is that--
CRAIG LOCKWOOD: Probably not.
PARTICIPANT: --part of the document.
CRAIG LOCKWOOD: I mean, the reality is no. If what you're saying is it cheaper to let the other side spend the time creating the first document because they have to do more typing, no, no. At the end of the day, your fees associated with it are going to be the same. And frankly, they're going to be a rounding error relative to the risk that you're managing, so you want to be protected up front. So I wouldn't do it on the basis of saving legal. I know it sounds self-interested, but I don't draft them anyway, so I'm good.
ERIC MORGAN: Yup.
PARTICIPANT: So you made some tatoos. And we have designs that are curated from the audience that sometimes infringe on IP [INAUDIBLE]. It says for whole lawsuit and [INAUDIBLE].
CRAIG LOCKWOOD: Yeah. Sure, we see this a fair bit, particularly in the online space, but I haven't been in the tattoo space. But it's same principle, which is you typically get a cease and desist letter from the entity that owns the IP. You know, they'll give you x number of days to comply. That's usually a shot across the bow.
And then the question is will they follow up a litigation. That's another cost benefit analysis, right, in the sense of people fire off cease and desist all the time. That doesn't necessarily mean there'll be peaceful litigation, but I can tell you the instant you get a letter like that, you should talk to somebody because not responding could be catastrophic. I'm not saying you have to respond to everyone, but you just want to make sure you know what you're doing before you disregard a cease and desist.
PARTICIPANT: And another question in terms--
CRAIG LOCKWOOD: Sure.
PARTICIPANT: --of privacy and terms of conditions relative to an online marketplace. How early should you have those in place? Should you have it once you're fully-- at least in the market or should you even have that if that if you have beta and you have maybe a small, close group of clients on the platform? I want to kind of get an understanding of critical privacy policy.
CRAIG LOCKWOOD: I think once you start taking personal, private information, the scale of it just probably determines your liability and your risk. But you should be having those terms up front before you start taking the information.
PARTICIPANT: Is there a risk point though where you get to the point where you have to or is it, like-- I mean, it's very expensive to have privacy policy when you have let's say, one big client. Obviously, when you scale it, you need to but when you have first bigger client, it's pretty expensive with the [INAUDIBLE].
CRAIG LOCKWOOD: Yeah. Although it's, again, it's an upfront cost that, hopefully, if you don't think of it as just for the one client, if you do scale, it's an investment in that.
PARTICIPANT: So as soon as possible.
ERIC MORGAN: Yeah.
CRAIG LOCKWOOD: Yeah. It's an easy answer, but it's the right answer, which is the sooner the better, right? Because--
ERIC MORGAN: Yeah.
CRAIG LOCKWOOD: --the moment you have any privacy information in your possession, you're exposed to risk x, right? The number of clients determines the degree of exposure.
And then you've got issues, you've got the privacy commissioner, you've got regulatory considerations as well and that's irrespective of number of clients, right? So you can have a single person's personal information, and if you're offside of the privacy commissioner, that in and of itself could be dangerous, so.
Anything else? All right. Well, as I say, we're more than happy to chat anytime, give us a call. If you guys give them a call, you probably already do but they know a heck of a lot more than we do. But happy to chat. Thanks very much guys.
ERIC MORGAN: Thank you.
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