A High-End Audio Horror Story
Tom befriends Rollo Rich, an audiophile and a young Trustafarian. Rollo impulsively promises to fund Tom's new speaker. Rollo thinks it will be nifty to attend events as an industry insider rather than as a consumer. He also thinks it will be way cool, dude, to upgrade his home stereo at industry accommodation prices. Rollo, convinced that Tom's dream speaker will take the industry by storm, goes to bed at night fantasizing about that golden month—it can't be too far off—when his new loudspeaker will be on the cover of both The Abso!ute Sound and Stereophile.
Tom quits his job. Rollo forms Via Nova Loudspeakers, Inc., with Tom and Rollo each owning 1000 shares of stock. But apart from the incorporation itself, no other legal documents are prepared. The incorporation documents themselves are so skeletal that there is no provision covering whether Rollo's cash infusions are loans to the corporation (Rollo thinks they are) or contributions to capital (which is what Tom thinks they are).
The time bomb begins ticking. In the absence of a genuinely mutual understanding, reduced to writing and signed by both, Rollo thinks that every dollar he puts in will be paid back to him, and Tom thinks that every dollar Rollo puts in is simply matching Tom's intellectual-property contributions (footnote 1).
The first thing that happens, almost as soon as Via Nova's first press release is e-mailed, is that Tom's former employer sues Via Nova for wrongful interference with advantageous business relationships and theft of trade secrets. Tom's former employer never had Tom under contract, and Tom's former employer's case on whether the identities of the companies they buy parts from are legally protected "trade secrets" is also extremely weak. But there is no question that Tom's dream speaker was sketched out on company time, so Rollo's lawyers urge him to settle. There goes a quick $50,000.
Fast-forward through a few years of ever-mounting expenses, increasing disillusionment, and a speaker that is always just one or two revisions away from being ready for review by the major audio magazines. Rollo has run through his ready money, and the Trust Department has put him on a tight leash. Tom then begins to moonlight as a freelance designer. He even encourages the companies for whom he spiffs up speaker designs to use his name in their advertising. After all, he has to think about his own brand equity.
Rollo seeks an injunction against Tom's designing for anyone else and sues the other companies that Tom has done designs for, claiming wrongful interference with advantageous business relationships and theft of trade secrets. Having started the company with one business lawyer, who handled the incorporation and nothing else, and who now can represent neither, both Tom and Rollo have to hire their own lawyers at $30,000 retainers, to start with.
Here's what should have been done but wasn't. Splitting the Via Nova, Inc., capital shares 50/50 was a sweet, sentimental, and totally stupid gesture. Rollo was putting up all the money. He should have owned 100% of the company. He should have tied Tom to a firm but fair employment contract that would have made clear that, in consideration of a guaranteed salary and the opportunity to build the loudspeaker of his dreams, Tom would assign all his inventions and designs to Via Nova; and furthermore, that Tom would not moonlight for other companies, or compete for a reasonable time after leaving Via Nova's employment.
Of course, there should have been a provision that, once Via Nova became profitable (ha!), Tom would be awarded a block of stock as an annual bonus, the number of shares depending on the company's profitability, and cumulatively not exceeding 50%. The papers should have specified other things as well: that Rollo's cash infusions were to be documented, interest-bearing loans; which management and sales responsibilities Rollo was to fulfill; a remedy for Tom if Rollo got bored and went to Hawaii to surf and decided not to come back; buyout terms in case of death or disability; and etc., etc., etc.
It almost goes without saying that experienced, independent lawyers should have separately advised Tom and Rollo from the outset. Or even before.
Tom Swift and Rollo Rich are not the only denizens of that Circle of Hell reserved for The Overly Enthusiastic But Inadequately Advised. How about the US company that found out that one of its European agents had reverse-engineered one of its products and was now building and selling it locally? How about the manufacturer that found out that its first importer had registered as its own trademark the manufacturer's logo, and who then threatened that if the manufacturer switched importers, they would sue the new importer for trademark infringement? Or the European company that didn't think to take out a design patent on the unique look of its loudspeaker enclosures, and later found a Taiwanese knockoff doing very well, thank you? How about the small manufacturer that was told by a major customer simply to fax back the purchase order with whatever they could not ship crossed out, and was later threatened with a breach-of-contract suit? Or the small company that discussed licensing its new technology to a larger company over a nice dinner at a Consumer Electronics Show, only to find out later that, during dinner, they had unwittingly provided enough hints to allow reverse-engineering? Or the US importer who discovered that a company he represented had been selling directly into the US behind his back?
What all of these situations have in common is that business was conducted either on a handshake or on the basis of inadequate documentation. I am never in favor of overlawyering a situation. I also believe that mistrust can turn into a self-fulfilling prophecy. But a modest amount of slowing down, thinking about the worst case as well as the best case, and seeking competent, unconflicted, specialized legal advice can save immeasurable heartache and tons of money.
John Marks (email@example.com) is a graduate of Vanderbilt Law School. His comments are general and entirely hypothetical in nature, and are no substitute for consultation with an attorney in your own jurisdiction who is experienced in the subject matter.
Footnote 1: In the eventual and inevitable litigation, Tom will take this position as well as the logically inconsistent position that he was only an independent-contractor consultant; therefore, he can give the designs he did for Via Nova to a new company that a new friend has set up for him. Acrimonious litigation in the wake of the implosion of a small business that started out with such fair hopes is, I think—apart from acrimonious divorce—as close as one can get in this life to the scene in Dante's Inferno between Ugolino and Ruggieri in the Ninth Circle of Hell.