Tag Archive for settlement

Understanding “Without Prejudice” in terms of confidentiality

August 12, 2009 Current Affairs No comments

    The dispute between Edge Games/Tim Langdell and Mobigames has devolved into a bit of a media disaster, but it has brought about several issues worth discussing. In light of Edge Games recent publication of settlement communications, perhaps the most glaring issue at the moment is confidentiality. In several of those communications, Edge Games (ironically) points out that because the communications were submitted under the heading “Without Prejudice”, they should not be disclosed to third parties.

    “We reserve all or rights in this matter, and note this communication is sent under banner of ‘without prejudice’ which means it cannot be used in any legal proceeding and should     not be revealed to any third party, the press, or etc”—July 28, 2009 communication from Edge Corp. to David Papazian

    In one communication Langdell suggests that sharing the communication with the media is in violation of U.S. Law.

    ”You quoted on a public forum from a communication that was sent to you under a “without prejudice” header which is not in accord with US law (and it was on a US website). Please     be aware you are not permitted to quote from such correspondence that is written as part of settlement resolution, as all this correspondence between us has been.”—June 3, 2009 communication from Tim Langdell to David Papazian.

    The irony in all this being that Dr. Langdell and his company subsequently disclosed ALL communication under the heading “Without Prejudice” to third parties through its “Edge Studio” website. However, this raises the question of whether the phrase “Without Prejudice” offers any kind of protection, what kind of protection it provides, and whether other statements or contractual provisions would better serve the problem of confidentiality in settlement disputes.

    The heading-phrase “Without Prejudice” in a communication between two opposing parties has a relatively specific application, which has its roots in English Common Law. This application is, under current federal and state evidence law, somewhat redundant. “Without Prejudice” implies that anything contained in the communication is intended for settlement purposes only and cannot be used against either party as evidence or precedence in the event of litigation. The purpose of this statement is to facilitate candor between the parties because it is in the interest of public policy to facilitate the settlement of disputes without court action. The words are intended to free parties from the concern that the admissions and statements made by them in the course of settlement will later be used against them in court. See Am. Eagle Outfitters, Inc. v. Lyle & Scott Ltd., 2008 U.S. Dist. LEXIS 96375 (W.D. Pa. Nov. 26, 2008)

    In today’s usage the phrase does little more than suggest that the communication is, in fact, intended for settlement. As a legal term of art it provides minimal protection under the predominant weight of US law due to Federal Rules of Evidence 408 and its mirror rule in almost every state’s evidence laws. These rules automatically render compromise and settlement communications inadmissible. Under Rule 408, “conduct or statements made in compromise negotiations regarding the claim, except when offered in a criminal case and the negotiations related to a claim by a public office or agency in the exercise of regulatory, investigative, or enforcement authority,” are not admissible evidence.

    Furthermore, using the phrase “Without Prejudice” when it is clear that the communications have gone beyond the point of possible settlement makes the use of the phrase ineffective. If a court could imply that the use is an empty one and the communication does not reflect conduct intended for settlement or compromise purposes, the court will ignore it and any admissions or statements contained therein may be used against either party.

    However, use of “Without Prejudice” in a communication doesn’t render the communication confidential or imply it as such. Generally speaking, settlement communications are only confidential by law if they relate to a court-ordered settlement conference or mediation conference and local rules render communications during and relating to those conferences confidential. In those cases, using “Without Prejudice for purposes of Settlement” may be useful to show that the communication is made in connection with a mediation conference or a court-ordered settlement conference. However, communications made prior to an official proceeding may not be subject to the same protections.

    In communications such as those between Mobigames and Langdell made prior to mediation or court-settlement, confidentiality hinges on an agreement between the parties to keep that information confidential. This may be accomplished via a confidentiality/non-disclosure statement at the end of each communication prohibiting the distribution, disclosure, and copying of communications relating to possible settlement. Better yet, leave such communications to your attorneys. An attorney isn’t allowed to disclose communications arising from representation, nor may they make disclosures to the media or public that may prejudice a case. Furthermore, it would probably reduce the chances of those communications getting as personal and antagonistic as the ones between Mobigames and Langdell.

Richard Garriott Sues NCSoft for $24 Million

May 6, 2009 Current Affairs 10 comments

    According to Kotaku Richard Garriott filed suit against NCSoft yesterday in the Western District of Texas (U.S. District Court) as a result of his stock option agreement with the company. This presents an interesting opportunity to introduce the concept of stock options in employment contracts. It also presents an ideal case study of why paying attention to your boilerplate (the "miscellaneous" provisions of a contract, like jurisdiction, choice of law and force majeure) is extremely important.

    Stock Options

    A stock option is a contract between an employer and an employee that grants the employee the right, but not the obligation, to purchase a designated number of shares (usually a set number of common shares) of a company at a designated price. This is typically the market price at the time the agreement is made. Simply put, a stock option agreement "freezes" the stock price for employees and allows employees to purchase shares at that same rate when the company's stock increases. The employee can purchase those stocks or any percentage thereof at that price and at any time during the exercise period, provided the stock option in those shares (the right to purchase) has vested. The stock option can vest all at once (for instance, five years after employment begins) or over a period of time (e.g., 25% after the first year, 50% after the second and so on).

    Stock options can be incentive based (ISO) or non-qualified (NSO). The ISO offers more favorable tax treatment—there is no income tax on the stocks; if the stocks are held after the exercise for a period of one year or more any profit made from a future sale is treated as a long term capital gain. The only tax that the employee may have to pay on the stocks is an Alternative Minimum Tax. In an NSO the difference in price between the market value at the time of exercise and the stock option price are treated as taxable income. In most cases you want your stock options to be treated as ISO—otherwise you're liable for a potentially exorbitant income tax every time you exercise your option.     

Note: There are a variety of compensation packages involving stocks and stock options that you may believe are stock option agreements but do not require to pay for the stock in order to exercise your rights under the agreement. This isn't the case, and for tax purposes it's good to know what kind of compensation you're getting. If you would like to know what you actually have, look through the list here.

    Garriott's Stock Option Agreement

    Garriott was entitled to receive 120,000 shares of NCSoft common stock at 126,200 Korean won (approximately $99 U.S.). Under the terms of the Agreement the stock options could be cancelled under a few different circumstances:

     1) termination of employment during the vesting period (which ended in 2003);

    2) voluntary departure after the vesting period if the options aren't exercised with 90 days after departure;

     3) gross negligence caused by Garriott that damages the company, 4) breach of the stock option agreement by Garriott; or

     5) the company's bankruptcy or dissolution.

    Garriott's stock option agreement satisfied all of the requirements to be treated as an ISO. He was an employee at NCSoft, the exercise period was within 10 years after the grant date, and the exercise price was the market price at the time the agreement was made. However, there are other requirements for ISO tax treatment— the employee must retain the stock for one year after exercising or two years after the grant date, and the options must be exercised during employment or within three months after employment terminates.

    Garriott's Complaint

    Garriott's complaint raises four causes of action: Breach of Contract, Fraud, and alternative cause of action for Fraud (that the firing itself was fraudulent) and Negligent Misrepresentation. There are a few problems with Garriott's complaint. I'll start with the substantive issues first.

        Substantive Problems

    The facts asserted in the complaint allege that Garriott was fired by NCSoft and his termination was involuntary. He also claims that NCSoft produced "false documentation" to support the claim that the termination was voluntary. The complaint alleges that NCSoft wrote the Open Letter from General British that appears on the Tabula Rasa website. It also concedes that at the time Garriott found nothing wrong with the letter. This is a bit a departure from the rest of the complaint, because the open letter certainly makes it sound like he made the choice to leave:

    "Many of you probably wonder what my plans are, now that I have achieved the lifelong dream of going to space. Well, that unforgettable experience has sparked some new interests that I would like to devote my time and resources to. As such, I am leaving NCsoft to pursue those interests."

    The language of the open letter places the impetus of the departure on Garriott. The fact that the complaint openly admits that he had no problem with it may hurt his case. Perhaps acting like it was voluntary and letting people believe it was voluntary, in his mind, didn't actually make it voluntary. However, it certainly won't help him if the case reaches discovery.

    Garriott's complaint alleges that because his termination was treated as "voluntary" by the company he was forced to exercise his stock option at a time when the market price was suffering due to the economic downturn. He contends that as a result of his termination he lost the benefit of the bargain of his agreement, and that if his termination had been treated as "involuntary" he would have retained his stock options until 2011. He also alleges that the forced exercise of the stock options, "worth tens of millions of dollars" (pro tip: you don't need to capitalize and bold the same statement multiple times in your complaint. Ever), caused him to lose millions of dollars in value (see?) and forced him to sell tens of millions of dollars of NCSoft shares in the current economic climate. 

    The complaint also raises an interesting tax problem—it alleges that apart from the direct financial loss sustained as a result of the involuntary termination, Garriott was forced to suffer hundreds of thousands of dollars in costs (see how annoying it gets?) How is not addressed and the claim itself is a bit misleading. The taxable income for an NSO is the difference between the stock option price and the market price. If the market price was trading at less than the stock option price, there is presumably no income tax liability. If the options were treated as an ISO, the options wouldn't be subject to an income tax at all. Furthermore, under the US Tax Code Garriott would have been forced to exercise those options within three months after termination whether the dismissal was voluntary or involuntary. Failing to do that and holding onto the stock options for two more years while the stock increased would expose Garriott to some serious tax liability at the time of exercise, because the options would be treated as NSOs. If he exercised via cashless exercise the tax liability is even more confounding– the amount earned (and the taxable income) from a cashless exercise is the difference between the fair market value at the time of sale and the exercise price — in this case, the cashless exercise would have sold the stock at a loss, which should typically have a positive effect on your taxes.

    Procedural Problems

    This is why reading your boilerplate is incredibly important. There are a few relevant procedural issues in this case. Choice of law, jurisdiction, and attorneys' fees are the most obvious.

    The contract is governed by Korean law. None the less, the complaint relies on a Texas statute to support a claim for attorneys' fees. This doesn't really work because choice of law provisions govern the entire contract, and the statute in question only allows attorneys' fees for contract disputes—the fraud and misrepresentation claims aren't within the purview of that particular statute. Jurisdiction is also an issue—the provision in this case is a bit more ambiguous because the Seoul District Court has "non-exclusive" jurisdiction. The lack of exclusivity may have been negotiated, and it could create a problem by allowing the case to be heard anywhere with personal jurisdiction over the defendant. However, forum non conveniens
allows a court to refuse to hear a case that would be better handled in the hands of another court. The fact that an appropriate court is stated in the contract and the contract is governed by Korean Law may tempt a Texas jurist to refuse to hear a matter that should be brought in a Korean court.

    It should prove to be an interesting (albeit short lived) case, if it goes anywhere.

    

Update: NCSoft's corporate site provides Stock Information. If you're curious. Apparently NCSoft's stock began to fall a while back and is only now beginning to steadily ramp up– their stock is on the rise for the first time since 2002. It's been steadily increasing since February and is currently trading at about $112 a share. At the date around when Garriott's stock options would have been cancelled were they not exercised, it was trading at about 66,000 won, or around $52. Another interesting factoid– when Garriott's stock options were 50% vested the stock price was near its highest.