Federal Securities Laws applied to ICO’s – Initial Coin Offerings

BITCOINNew “coins” or tokens and their platforms are all the rage.  Bitcoin, Bitcoin Cash, Ethereum, Litecoin, Zcash, Dash, Ripple, Monero, the list goes on and on and new ones keep popping up.  The new coins are either entirely their own platform or they are derivations, i.e. spin-offs of one of the existing virtual currency platforms.

The IRS took the position in 2014 that Bitcoin and coins like it were property, and not currency.  Interestingly, it did this as it referred to Bitcoin and other coins as “virtual currency.”  The classification of Bitcoin as property has certain effects on its treatment with respect to tax issues. The IRS has a decent FAQ on this here.

It was only a matter of time until the SEC weighed in.  Especially because the promoters of these new coins started calling the birth of new coin platforms as ICO’s (“Initial Coin Offerings”), and heavily advertising them to the public, such as Floyd Mayweather’s promotion of the Stox ICO on social media platforms, from which ICO he said he was going to make a “sh*t ton of money”.  That’s the type of situation and language that gets the SEC up in the morning.

Now under the federal securities laws (which I have described with respect to virtual world items in the past), an offering of “securities” must be done only after registration of such securities or pursuant to an exemption from registration.   The main issue present with these ICOs is whether the virtual currency is a “security” or not.   This would bring up the “Howey Test”, from SEC v. Howey Co., 328 U.S. 293 (1946), which can be summarized as whether the individual investing the funds into a common enterprise expects profits to come solely from the efforts of others (there are some other factors used in the test as well, but that’s it in a nutshell).  Usually the people pumping money into these ICOs are not the ones working on the platform (usually blockchain type information exchange platforms), and without that involvement it may come down to the investor’s expectation – are they expecting the money they invest to go towards the growth of the platform which would increase the popularity and hence value of the platform’s coin?  If so that may be an issue. What a coin (or sometimes called a “token”) is still has not been fully defined, and the characteristics of each coin or token vary by platform and change over time.

The SEC issued an Investor Bulletin that said that some ICOs depending on the circumstances “may” involve sale of securities.  It should be taken as a warning. While the application of the securities laws to coins and ICOs is a gray area, there is a line somewhere and the first very public ICO to cross it without registration or use of an exemption (which is doubtful if public advertising is used and investment is taken from anyone, regardless of circumstances), the SEC may come after.  Watch out Floyd, you may not be too worried about Conor McGregor but you should be of the SEC.

Browsewrap License Cases: Other

  • Hubbert v. Dell Corp., 2005 WL 1968774 (Ill. App. Ct. 2005) (court upheld arbitration clause in Dell’s for cause regarding alleged false claims made by Dell to online purchasers of the computers. Court found different colored hyperlinks on each page like a multipage contract).
  • Hines v. Overstock.com, Inc., 668 F. Supp.2d 366 (E.D.N.Y. 2009) (both arbitration and forum selection clause invalid due to no actual or constructive notice)
  • Van Tassell v. United Mktg. Group, LLC, 795 F. Supp. 2d 770 (N.D. Ill. 2011) (holding arbitration provision was unenforceable where it was included website’s conditions of use but difficult to find, because users had to scroll all the way down home page, click on Customer Service link, then scroll down and click another link to find it).
  • Friedman v. Guthy-Renker, LLC, 2015 US Dist LEXIS 24307 (C.D. Cal. Feb. 27, 2015) (where two plaintiffs clicked on checkbox that only referenced credit card terms prior to purchase, arbitration not binding; for plaintiff who clicked on checkbox which had a link to the terms the arbitration provision was binding)
  • Cvent, Inc. v. Eventbrite, Inc., 739 F. Supp. 2d 927 (E.D. Va. 2010) (terms of use not valid as they were buried at bottom of first page and on no other page).

Browsewrap License Cases: In re Facebook Biometric Information Privacy Litigation, 185 F. Supp. 3d 1155, 2016 U.S. Dist. LEXIS 60046, (N.D. Cal. 2016)

In In re Facebook Biometric Information Privacy Litigation, 185 F. Supp. 3d 1155, 2016 U.S. Dist. LEXIS 60046, (N.D. Cal. 2016):

  • A class action against Facebook was filed pursuant to the Illinois Biometric Informration Privacy Act (BIPA). Parties agreed to transfer case to N.D. California, but wanted Illinois law (and not CA law) to apply.
    • Plaintiff’s alleged that facial and other recognition used by Facebook violated BIPA
  • Facebook argued that its choice of law clause in its current Terms of Use required the use of CA law.
  • There were three plaintiffs at issue and court reviewed the sign up procedure for each (2005, 2008 and 2009).
    • When Facebook updated its Terms it emailed a notice to all user’s email addresses and the next time each user logged on, they saw “jewel” notification in their personal newsfeed alerting to the change in such documents but no affirmative action was required by each user).BUT said the general and individualized notice was enough, that the agreement was effective, but that in the situation it would not apply CA law.
  • The Court said that the notice provided by Facebook was enough to have a binding choice of law provision (seemed to like the “personalized” nature of the news feed notice).
  • But the Court then still chose to apply IL law as opposed to CA.

Browsewrap License Cases: Nguyen v. Barnes & Noble, Inc., 763 F.3d 1171 (9th Cir. 2012)

In Nguyen v. Barnes & Noble, Inc., 763 F.3d 1171 (9th Cir. 2012):

  • B&N was unsuccessful in enforcing an arbitration provision in its online Terms of Use.
    • Court found that there was no evidence of Nguyen having actual notice of the Terms of Use or acknowledgement of same.
    • Found that under circumstances a reasonably prudent user would not be on inquiry notice of the Terms of Use
    • Court said Terms of Use where hard to find and barely noticeable.
      • Said “inquiry notice” turns on “design and content of the website and agreement’s webpage.”
  • This case was followed by e.g., Long v. Provide Commerce, Inc. 245 Cal. App. 4th 855 (Cal. Ct. App. 2016) (refused to compel arbitration, stated that to put users on notice you need conspicuous hyperlink plus notice that it contains binding terms. A conspicuous notice alone is not enough).

Browsewrap License Cases: Jerez v. JD Closeouts, LLC, No. CV-024727-11, 2012 WL 934390 (N.Y. Dist. Ct. 2012).

In Jerez v. JD Closeouts, LLC, No. CV-024727-11, 2012 WL 934390 (N.Y. Dist. Ct. 2012):

–The court held that a terms of sale provision found on the “About” page of the website was not enough to enforce the forum selection clause.

  • Plaintiff ordered products ($6,000 worth of tube socks) over the Internet, and sued claiming there were defects.
  • Seller moved to dismiss claiming the forum selection clause required the dispute be heard in a Florida state court, and Plaintiff claimed he never saw clause.

–Court found the clause was not reasonably communicated where it was “buried” and “submerged” on the website, and could only be found by clicking on an “inconspicuous” link to the company’s About Us page.  Seller’s attempt to have the terms incorporated by reference in a printed contract and letter agreement were not enough for the court.

  • Court relied on Specht and Carnival Cruise Lines.

–Similar holding in Cvent, Inc. v. Eventbrite, Inc., 739 F. Supp. 2d 927 (E.D. Va. 2010).

Browsewrap License Cases: Ticketmaster Corp. v. Tickets.com, Inc., 2003 U.S. Dist. Lexis 6483 (C.D. CA., March 7, 2003)

In Ticketmaster Corp. v. Tickets.com, Inc., 2003 U.S. Dist. Lexis 6483 (C.D. CA., March 7, 2003):

–Tickets.com used deep links to Ticketmaster’s interior pages, in violation of Ticketmaster’s terms of use which were on its homepage.

–Relying on Register.com and Pollstar, the court held that a contract can be formed by use of a website, provided the user, at the time of use, has knowledge of the site’s terms and conditions that provide that such use constitutes an agreement to be bound.

  • Court relied on “cruise ship” case law precedent. It analogized interior web pages to the back of a cruise ship ticket’s venue clause, where user has actual or presumptive knowledge.

–Court found that Tickets.com used Ticketmaster’s site with full knowledge of the terms, and upheld such terms in the breach of contract action.

Browsewrap License Cases: Pollstar v. Gigmania, Ltd., 170 F. Supp. 2d 974 (E.D. CA 2000).

In Pollstar v. Gigmania, Ltd., 170 F. Supp. 2d 974 (E.D. CA 2000):

–Pollstar kept track of concert information on its website, which any user could download by accepting the terms of Pollstar’s license.

»License prohibited commercial use of information.

»License was not on Pollstar’s homepage, but on different page of its site.

»Visitor is alerted to existence of Pollstar’s license only by reason of a small grey print on grey background (with a link to terms, but other links on homepage were blue)

–Gigmania downloaded information from Pollstar’s site and used it on its own site for commercial purposes. Pollstar sued to enforce terms.

–The court refused to enforce the terms of the license agreement because it found that the link to the license was hard to read based on the way it was presented.

  • Notably, the court did not rule that the license agreement was unenforceable, only that the website did not give users adequate notice of it.

Browsewrap License Cases: Register.com v. Verio, Inc., 356 F.3d 393 (2d Cir. 2004).

Below is a brief overview of Register.com v. Verio, Inc., 356 F.3d 393 (2d Cir. 2004):

–Register.com sued Verio for violating the terms of use of its WHOIS database, which Verio used to get information on who registered domain names with Register.com to offer web services to the registrants.

  • As part of receiving the information from WHOIS, Register.com’s terms stated that the domain name registrant information, which consisted of email, phone number and mailing address, could not be used for marketing purposes. The terms of use were, however, proffered after the domain name registrant information was presented to the user of the WHOIS database.

–VERIO claimed there was no contract as it never agreed to the terms, and in any event any user of the WHOIS site could receive the information before seeing the terms.

  • The court said that this argument may only have worked if Verio used the WHOIS database once, but Verio did it every day with full knowledge of the terms.

–The Second Circuit held that Verio’s continued use of Register.com’s WHOIS database constituted consent to Verio’s terms of use, expressly  rejecting Verio’s argument that they were not enforceable because the user had not clicked an “I agree” icon.

 

Browsewrap License Cases: In re Zappos.com, Inc. Customer Data Security Breach Litigation, 893 F.Supp. 2d 1058 (Dist. Ct. Nevada 2012).

Here is a brief summary of the case In re Zappos.com, Inc. Customer Data Security Breach Litigation, 893 F.Supp. 2d 1058 (Dist. Ct. Nevada 2012):

–Users sued in multiple forums for damages due to a security breach.

  • Zappos filed a motion to compel arbitration in Las Vegas pursuant to its terms of use agreement, which was a typical browsewrap agreement which also gave Zappos the right to amend any of the terms as it saw fit.

–Zappos had a hyperlink on each page of its website to the terms but it was hard to see, being the same size and color as other insignificant links, and located ¾ of the way down the page.  The website never prompted or directed a user to the terms even when purchasing a product or opening an account.

–Court concluded that the plaintiffs may have never seen the terms, so in no way could be deemed to have actually or constructively agreed to them. No assent, no contract.

  • Sidenote: The Court also held the arbitration provision was an illusory contract (and therefore not enforceable) because Zappos was able to amend the Terms as it saw fit at any time. See Grosvenor v. Qwest Corp., 854 F. Supp. 2d 1021 (D. Colo. 2012) for this same holding.

M&A Deals: What is a “Cap” and a “Basket”?

victorian-297856_960_720This is a follow up post on our series of merger and acquisition issues.  If you are selling your company you’ll be faced with the prospect of indemnifying the purchaser for any damages they suffer in connection with the sale.  Now such indemnification may arise for a number of reasons, such as an unknown debt or lien that was on an asset you sold, a claim that an employee or third party made against the company or an asset which you did not inform the purchaser of, or a number of other issues.  These are usually breaches of the representations and warranties that sellers have to make to the buyers in the asset purchase agreement.   For example, the seller will represent (i.e. state as true at the time of signing or closing or both) that there are no debts owed by the company or liens on the company assets.  If the deal closes and a lender or lien of the company did exist, its a breach of that representation, and the seller is liable to the buyer for any resulting damages.

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