Mergers and Acquisitions In a Dot.com World

by E. Lee Reichert

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Perhaps the greatest influence on the American business landscape in the past few years has been the Internet. Traditional "bricks-and-mortar" companies1 face numerous issues as they decide whether and how to use this new technology. The development of the Internet also has spawned a new generation of companies that operate exclusively in cyberspace. Recently, another business model-"clicks and mortar" or "bricks and clicks" companies-has emerged, in which an Internet-based company relies on e-commerce as a key component of its business strategy and maintains a traditional storefront for the distribution of products or services.

In the past few years, Colorado and the United States have also experienced an unprecedented boom in merger and acquisition activity. Empirical evidence suggests that acquisition activity in this country during this time period has been even greater than during the late 1980s, a period often referred to as the heyday of mergers and acquisitions. While the late 1980s was dominated by mega-mergers and leveraged buyouts financed in large part by junk bonds2, the current wave of mergers and acquisitions has been driven by a larger number of smaller and middle-market transactions and involves several industry consolidations.3

Not surprisingly, the development of the Internet and the boom in acquisitions and mergers are intersecting in a growing number of cases, as companies begin to acquire businesses that operate in cyberspace in whole or in part. This article provides an overview of the legal issues on which attorneys should focus when advising clients involved in such transactions. Although this article emphasizes the acquisition process, many of the general issues discussed may be relevant in other business contexts with respect to e-commerce companies operating in cyberspace.

Due Diligence

Often, the first step in determining whether to pursue the acquisition of a business is to perform financial and legal due diligence to help determine the proper price and structure of a purchase. This process usually continues during the negotiation of the definitive acquisition agreement and is one of the most important elements of an acquisition. Without accurate and complete information, attorneys preparing definitive agreements and negotiating transactions cannot address potentially significant areas of concern and liability.4

Request Lists

Over the years, business attorneys have developed extensive request lists to assist them in conducting due diligence. Many of the listed requests are written in broad terms (for example, any contracts, any licenses or permits, any employment policies) to pick up items of particular relevance to companies that operate in cyberspace. Nevertheless, because new types of Internet-related agreements, licenses, and assets have become prevalent over the past few years, purchasers' attorneys should review and update their standard due diligence request list. By specifically listing such items on a due diligence request list, purchasers are more likely to focus the sellers' attention on similar items the sellers should disclose.

For example, purchasers' attorneys should specifically ask for the following types of agreements: Electronic contracts entered into by the acquisition target Website design or development agreements Website hosting agreements Web-linking or framing agreements with other websites5 Content licensing agreements Access agreements for web content providers Joint venture, strategic alliance, or affiliate agreements Web marketing or advertising agreements Co-branded website agreements Software license agreements Source code agreements (including source code escrow agreements) Invention assignment agreements Nondisclosure or confidentiality agreements.6

As with any due diligence review, attorneys should check these agreements to determine whether the proposed structure of the acquisition will trigger notice or consent requirements under assignment or "change in control" provisions.

Much of the value of a company that performs a significant portion of its business on the Internet comes from the company's intangible assets, particularly its intellectual property rights. As a result, it is critical for purchasers to make sure they have a good understanding of all of the acquisition target's intellectual property rights (including the website) and the potential liability issues associated therewith.7 Therefore, purchasers' attorneys should request a list and documents related to, as well as any applications or reservations for, the following items: websites, domain names, e-mail addresses, customer lists, trademarks, service marks, trade names, and copyrights. As part of the due diligence review, purchasers should also consider obtaining the following information from sellers:

Reports documenting traffic on websites

Lists of e-mail addresses that have accessed websites

Privacy, copyright, trademark, and disclaimer statements posted on websites

Terms and conditions of use of websites Internet and e-mail usage policies for employees

E-mail retention and destruction policies Internet firewalls

Procedures to monitor other e-commerce companies' use of the acquisition target's trademarks

In addition, purchasers' attorneys should make sure standard due diligence requests produce sufficient information to evaluate potential liability issues that are of special concern for cyberspace companies. Purchasers' attorneys should focus on specific issues, such as foreign qualifications, tax matters, prior financings and issuances of securities, employees, and product or service warranties. Each of these areas is addressed in the "Representations and Warranties" section below.

Other Due Diligence Issues

Sellers typically are required to make certain disclosures as part of the definitive acquisition agreement, either pursuant to attached Disclosure Schedules or a separate Disclosure Letter.8 As a result, sellers' attorneys should be equally aware of the issues discussed in the preceding section when assisting clients in preparing the Disclosure Schedules or Disclosure Letter and advising clients about potential liability issues.

The Internet has created new issues for attorneys performing due diligence on a company operating in cyberspace, but it has also made due diligence easier. Because the website of a company engaged in e-commerce activities frequently includes background information about the company, its business operations, strategic partners, and other parties with whom the company has business relationships, it can provide useful information to attorneys performing due diligence and allow for more focused follow-up questions and requests.

Valuation

Typically, attorneys are not involved in the valuation process when their clients decide to purchase an operating business. Nevertheless, attorneys should make sure their clients understand that some of the traditional acquisition models used for valuing mature businesses may not apply when valuing Internet-based companies.9 Valuing intellectual property, which frequently comprises much of the value of e-commerce companies, is difficult.10 Other factors that can play a role in the valuation of such companies include the company's ideas, relevant market, management team, and value ascribed in prior financings.

Although it may be somewhat counterintuitive to rely on prior financings for valuations, purchasers who consider this factor must perform careful financial due diligence to ensure they understand the pricing used in the acquisition target's earlier financings. Perhaps the best guidance attorneys can provide to clients who want to acquire a cyberspace company is to make sure the individuals (whether company insiders or outside professionals) performing the valuation and financial due diligence have prior experience in evaluating similar companies.

Structuring

Due to the difficulty associated with valuing an Internet-based company, many purchasers use different structuring techniques to minimize the risk of an inaccurate valuation. The techniques themselves are not revolutionary. For example, many purchasers provide for deferred consideration in the form of an earn-out formula in the acquisition agreement or, instead, enter into an interim joint venture, strategic alliance, or affiliate arrangement until they have a better basis and track record for valuing a company's financial performance.

In structuring earn-out formulas, the parties should pay attention to traditional issues, such as: (1) caps and floors on the amount of the earn-out, (2) provisions addressing how the acquired business will be operated during the earn-out period, and (3) auditing standards for the relevant records during the earn-out period. However, attorneys also must be prepared to understand additional issues associated with cyberspace company earn-outs, in which the payments are based on new measuring devices, such as the traffic on a website or the number of new independent contractors who are signed up to become members of a website of a service provider.

For example, when an earn-out is based on the traffic to a website, it is important to use precise language for the appropriate method of measurement, which may be described in a number of ways, such as users, visitors, or hits to the website. Although the term "hit" is commonly used as a measurement for traffic on a website, a "hit" technically refers to a single request for a file.11 Requesting a single page may involve calling up several different files, thereby registering several "hits" for a single visit, which may or may not be what the parties intend to use as the measuring device for the earn-out. What the parties may really want when measuring traffic on a website is the number of times a web page is requested (that is, an "Eyeball Return Rate") or the number of unique e-mail addresses that requested the web page (that is, a "Unique User Rate").

In addition, when an earn-out formula is based on the traffic to a website, purchasers should include provisions to ensure that sellers do not artificially inflate the number of users or visitors through their own visits to the website or other surreptitious means. The parties will also need to address whether they will use an independent third party or tracking software to monitor the relevant measuring device for the earn-out formula.

Acquisition Agreement

Once the parties are in general agreement about the business terms and structure of an acquisition, attorneys typically begin the process of drafting and negotiating the definitive agreement. Although the basic structure of acquisition agreements does not vary in transactions involving cyberspace companies, some issues warrant special attention. These issues are briefly discussed below.

Assets Acquired

It is important to ensure that an acquisition agreement properly describes the specific intellectual property rights a purchaser is acquiring, particularly when the transaction has been structured as an asset purchase. When defining the assets being acquired, purchasers should draft the language as broadly as possible. A sample clause to include in the definition of the "Assets" could read: "all domain names, associated and other e-mail addresses, websites, and other intellectual property rights relating to the Internet (including the website located at http://www.newco.com and all information posted on such website), together with any other domain name registrations." A seller's attorney will want to make sure that the definition of the "Assets" a purchaser is acquiring is not overencompassing, particularly because many of the representations and warranties in a typical acquisition agreement will refer to this defined term.

Representations and Warranties

When modifying and negotiating the standard representations and warranties for a transaction involving a cyberspace company, a number of issues should be considered. The representations and warranties contained in an agreement that was previously used for the acquisition of a bricks-and-mortar business (particularly one involved in high-technology activities) may be sufficient in certain areas in which the representations and warranties have been drafted broadly.12 Nevertheless, purchasers' attorneys should carefully review intellectual property, foreign qualification, taxation, securities, employee, and product and service warranty issues (before and after completing due diligence) to determine whether additional representations and warranties are necessary. Similarly, sellers' attorneys should review the representations and warranties in these areas when evaluating potential liability for their clients and determining when it may be necessary to negotiate for "materiality" or "knowledge" qualifiers.13

Intellectual Property:

Because much of the value of a company that operates a significant portion of its activity in cyberspace is contained in the intellectual property of the business (which includes the website operated by the company), it is critical that the acquisition agreement's representations and warranties ensure that: (1) the seller has the necessary right and title to its intellectual property, (2) such intellectual property does not infringe on the intellectual property rights of any other party; and (3) all websites are operated in accordance with all laws and proper commercial practices.

With respect to ownership issues, the representations and warranties should ensure that sellers own and can validly transfer all intellectual property rights and that no party has retained any rights to any intellectual property being acquired.14As in any acquisition, purchasers also should ensure that no liens or encumbrances exist on any such intellectual property rights. A typical UCC search may only be the starting point with regard to such items.

In addition, purchasers should obtain a general and broad representation that none of the intellectual property being acquired infringes on the intellectual property rights of any other party and that the seller has not received notice of any such possible infringement.15In particular, the use of domain names has spawned a number of trademark infringement lawsuits.16The use of a particular domain name for a website could also result in liability claims under the recently enacted Anti-cybersquatting Consumer Protection Act, which amended the Lanham Act.

The Anti-cybersquatting Consumer Protection Act, which was signed into law on November 29, 1999, makes it illegal for a person to "register, traffic in, or use" a domain name of another person if the domain name is a trademark (or confusingly similar to the trademark) of another person, and the person who registers, traffics in, or uses the domain name has a "bad faith intent to profit" from that trademark.17

Moreover, to the extent that a domain name is the exact same name as, or confusingly similar to, the trademark of another party, a party may not be able to continue to use the domain name under the current domain name dispute policies of some of the entities in charge of registering domain names.18Finally, the use of a domain name or the use of a "meta-tag" within a website can infringe on the common-law or registered trademark rights of a third party.19

As a result of the potential liability in the intellectual property area, and depending on the specific nature of the websites being acquired, purchasers also should consider obtaining specific representations. These include the following: (1) the seller has the right to list and display the name, trademarks, logos, symbols, or any other intellectual property of any party that is displayed on the seller's website; (2) no trade secrets of any party are displayed on the seller's website; (3) the seller has the right to provide links to any other website to which the seller's website is linked and/or to frame items from other websites to the extent any information has been framed;20 (4) the domain name for the seller's website is not a trademark of any other business; and (5) the seller's website does not use trademarks or other proprietary rights of any other business as meta-tags.

Finally, purchasers should obtain representations that the intellectual property being acquired has been developed and operated in accordance with all applicable laws and regulations and that all websites have appropriate protection in place to prevent unauthorized modification or alteration by third parties. As a matter of disclosure, purchasers also may want to obtain representations and warranties as to the traffic on any website that is being acquired. In drafting and negotiating such representations, attorneys should bear in mind the issues discussed above regarding earn-out provisions based on traffic at a website to make sure that the representation is properly drafted so as to obtain the most relevant information.

Foreign Qualification

When a corporation does business outside of the state in which it is incorporated, it may be required to obtain a "foreign qualification" (that is, obtain a certificate of authority and appoint a resident agent there on whom process may be served). Whether a corporation is required to be qualified in a foreign jurisdiction usually depends on whether it is "doing business" in that state under that jurisdiction's applicable foreign qualification statutes, as they are interpreted by that state's courts.

Determining whether a traditional bricks-and-mortar business is properly qualified as a foreign corporation is often difficult because it involves a facts-and-circumstances analysis of the activities the company is engaged in and requires a review of different laws in various jurisdictions. The foreign qualification question is even more difficult in the context of cyberspace companies because it raises many unresolved questions regarding jurisdiction and local governmental authority over the Internet.

Because the risks of failure to qualify properly as a foreign corporation can be significant in some states, it is not an issue that attorneys advising companies that operate in cyberspace can ignore. Moreover, this issue arises regardless of whether an acquisition is structured as a merger or stock transaction (where there could be exposure to purchasers due to the way the seller previously operated the business) or an asset purchase (where there could be exposure for the way purchasers will operate the business following the closing). As a result, attorneys for the parties to the acquisition should negotiate the appropriate representations and warranties regarding foreign qualification in order to allocate the risk.

Taxation

The taxation of transactions conducted over the Internet raises jurisdictional issues similar to the foreign qualification issue and is another evolving area of the law.24The uncertainty over how taxes should apply to e-commerce activities led Congress to enact the Internet Tax Freedom Act of 1998 ("Act").25The Act places a moratorium on the enactment and enforcement of sales taxes on Internet access, or other taxes that discriminate against e-commerce, until October 1, 2001. The Act also created the Advisory Commission on Electronic Commerce ("ACEC") to "conduct a thorough study of Federal, State, local, and international taxation and tariff treatment of transactions using the Internet and Internet access and other comparable intrastate, interstate or international sales activities."26The ACEC's final report is due in April 2000.

The ACEC's last meeting, which was held in December 1999, highlighted the deep division among commission members regarding the Internet sales tax issue.27Many anti-tax groups argue that taxation of e-commerce transactions would slow the economic growth that the Internet has generated. However, numerous brick-and-mortar businesses are clamoring for a level playing field, and many tax regulators and other legislators perceive that a traditional tax base is being lost as undocumented transactions take place over the Internet. As a result of the sharp disagreement, this issue likely will not go away in the near future.

Although a business operating over the Internet may not be required to pay certain taxes pursuant to the Act, depending on the nature of its business activities, it may be subject to other taxes, including income taxes. Therefore, it is important during the due diligence process for purchasers to investigate the taxes that a seller has paid by reviewing a seller's federal, state, and local tax filings.

Purchasers can have successor liability for unpaid sales and use taxes under the laws of many jurisdictions (including Colorado), even if the transaction is structured as an asset purchase. Significant contingent liabilities also could exist if tax returns were not filed properly or if taxes are paid where the acquired company has an obligation to pay such taxes as a result of its business activities.28Thus, purchasers should make sure the acquisition agreement includes proper representations and warranties with respect to tax issues.

Securities

Cash-short, Internet start-up companies often rely on warrants or stock options as a primary incentive to attract initial investors, employees, and consultants to their ventures. This is understandable, given the huge upside that can result from such options (particularly incentive stock options) in a scenario in which the business is rapidly increasing in value. However, in many cases, these options are granted by companies without appropriate consultation with attorneys experienced in securities laws at the time of their grant or the establishment of the plans pursuant to which such options are granted.

As a result, attorneys involved in an acquisition of an Internet-based company should pay close attention to the issuance of prior securities (especially stock options), particularly when the deal is structured as a stock purchase or merger, or when the seller has previously offered to sell its securities over the Internet. In such cases, the representations and warranties in the acquisition agreement should cover compliance with all federal and blue-sky laws and corporate requirements associated with the offering and issuance of the securities, and should cover adoption of the underlying stock option plans.29

Employees

Purchasers of Internet-based start-up companies often want to maintain relationships with the seller's employees and independent contractors because these individuals are critical to the success of the business and represent important intellectual capital. Therefore, purchasers must pay particular attention to liability issues that could arise with respect to such employees.

Compliance with overtime laws is one area in which there could be significant liability, particularly because an incorrect classification could lead to a subsequent class action on behalf of all similarly situated employees by the Department of Labor ("DOL") or by current or former employees. It is common for start-up companies to pay every employee a salary (and no overtime), without properly investigating whether such employees are exempt from overtime requirements. At the same time, the expectation at many start-up companies is that employees will work long hours to get the venture off the ground.

In evaluating whether employees are exempt from overtime requirements, attorneys for high-technology companies often need to review the relevant statutes and underlying regulations issued by the DOL for computer-related occupations.30Under these regulations, software designers may be exempt from overtime requirements, whereas many computer programmers may not. Accordingly, purchasers may want a specific representation and warranty regarding compliance with overtime laws.

Similarly, many start-up companies hire independent contractors instead of employees to avoid paying for workers' compensation insurance, payroll taxes, overtime, and employee benefits. However, under applicable IRS regulations, consultants are considered independent contractors only if they truly are independent.31Therefore, to the extent a seller has improperly classified people as independent contractors, there could be significant liability for overtime payments and employment taxes.

A final area of potential liability for purchasers results from the common practice described above of granting stock options to employees as an alternative to higher base salaries or bonuses. Employees who are terminated prior to the vesting of their options are more likely to bring a wrongful termination lawsuit when the company has undergone rapid growth and the options are worth a significant amount. Purchasers should consider a specific representation and warranty that a seller has no reason to believe any such claims exist, including any notice of such claims.

Product and Service Warranties

One area of contingent liability that traditionally concerns purchasers of operating businesses relates to product or service warranties (whether express or implied) for which there may be successor liability. This concern is heightened for purchasers of cyberspace companies because such companies may not have been as vigilant in placing applicable warranty limitations or disclaimers on their websites, or they may have unintentionally created additional warranties through website content. Purchasers should ensure that an acquisition agreement provides appropriate protection for product and service warranty issues that may exist as a result of the operation of all websites being acquired.

Indemnification

The legal issues related to indemnification that traditionally represent a significant portion of the acquisition agreement negotiation do not pass over the Internet (but that would expressly allow the restricted party to operate a competitive traditional bricks-and-mortar business outside of the location of the principal place of business of the purchaser) should constitute a reasonable geographic limitation for purposes of determining the validity of a noncompetition covenant. In such a case, a number of areas would remain in which the restricted party could compete in the same general business as the purchaser, just not through the same medium.

Given the ability of the Internet to reach into any jurisdiction from any location, and the overriding policy purposes that permit noncompetition covenants in connection with the sale of a business,36 a provision restricting activities on the Internet would seem to be a reasonable "geographic" limitation. This is particularly true for companies that operate solely over the Internet. However, attorneys are cautioned that there appear to be no cases that have adopted this position to date.

Because this is another evolving area of law as it applies to companies operating in cyberspace, attorneys involved in acquisitions must be careful when drafting noncompetition covenants. A more conservative approach is to set forth a carefully defined geographic area, in which the seller cannot directly or indirectly compete.37Alternatively, purchasers could try to satisfy the geographic scope requirement by having seller covenants: (1) not to establish a place of business in a certain specific geographic area and (2) not to sell to any customers in specific jurisdictions in which the purchaser now, or in the future, conducts its business.

Regardless, purchasers' attorneys should have the relevant parties acknowledge the following: (1) the purchaser intends to conduct the operating business it is acquiring as an Internet-based business; (2) consumers will be able to access the purchasers' website from any location; (3) the monetary barriers to establishing and engaging in a competitive business over the Internet are relatively small; and (4) the geographic limitations contained in the noncompetition covenant are reasonable, given the foregoing considerations. Moreover, purchasers should include traditional severability and reformation clauses to allow a court to "blue-pencil" the noncompetition covenant rather than void it in its entirety,38 as well as to provide for reasonable time limitations on the covenant.

Another traditional approach that can provide some additional protection to purchasers of Internet-based companies is to include a nondisclosure covenant with regard to confidential information being acquired from a seller, or a nonsolicitation covenant, either in the acquisition agreement or in a separate ancillary noncompetition agreement.39A nonsolicitation clause probably cannot prohibit solicitation of all customers of such a seller (because that presumably would apply to anyone who could access the website), as often is the case with traditional bricks-and-mortar businesses. However, purchasers could restrict the ability of such a seller to solicit employees of the business the purchasers are acquiring and/or other parties with whom the seller has business relationships, and thereby provide purchasers with some added level of legal comfort.

Employment/Consulting Agreements

Because a significant portion of the value of many companies that operate in cyberspace is contained in the intellectual property of such businesses, Internet-based companies are particularly vigilant in protecting their confidential and proprietary information.40Businesses accomplish this in a variety of ways. For example, e-commerce companies may ask their employees and consultants to execute one or more confidentiality, nondisclosure, noncompetition, or invention assignment agreements. To the extent that any of the equity owners of a business will act as employees or consultants for purchasers, purchasers should take the same precautions they take with other employees and consultants.41

As a starting point, purchasers who want to protect fully such intellectual property should have equity owners who will work for them execute the standard-form confidentiality and nondisclosure agreement(s). In addition, to the extent purchasers engage any of the equity owners as consultants or independent contractors (as opposed to employees), purchasers should ensure that any work product created by such persons is treated as "work- for-hire" or otherwise properly assigned to the purchasers.

Many cyberspace companies also include a noncompetition covenant in their standard employment and consulting agreements. Under applicable Colorado statutory provisions, noncompetition covenants are expressly permitted for the protection of trade secrets. They also are permitted for executive and management personnel and officers, as well as employees who constitute professional staff to executive and management personnel. In either case, the noncompetition covenants in these areas must contain reasonable geographic and time limitations.42

Parties are not prohibited from executing a separate noncompetition covenant in connection with the sale of a business, such as one that runs for three years after the closing of the acquisition, or an employment agreement, such as one that runs from six to twelve months after the termination of employment. Therefore, it is fairly common for a seller's equity owners, who will act as employees or consultants for the purchaser following the closing, to execute separate noncompetition covenants.

In drafting noncompetition covenants for employees and consultants of a company operating in cyberspace (whether in the context of an acquisition or otherwise), attorneys should not only be aware of the issues discussed above, but also note that Colorado courts appear to interpret the geographic and time restriction requirements in employment and trade secret areas more narrowly than they interpret sale-of-business requirements.43Moreover, given the rapid speed at which the business of Internet-based companies can change, courts likely will carefully scrutinize time limitations on noncompetition covenants in the employment area.44Finally, attorneys drafting noncompetition covenants for consultants should be careful to tailor them to fall within the trade secrets exception.45

Boilerplate Provisions

The fact that the companies involved in an acquisition operate in cyberspace may affect the boilerplate provisions of all acquisition documents. Attorneys should review the boilerplate clauses in the definitive purchase agreement and ancillary documents to ensure that such provisions remain applicable or desirable, particularly with respect to jurisdiction, governing law, and dispute-resolution clauses.46

Two issues litigated most heavily by cyberspace companies in recent years have been whether, and to what extent, the business in question has subjected itself to the jurisdiction of the courts of a specific state as a result of such e-commerce activities.47The jurisdictional tests differ from the test for whether a company must be qualified as a foreign corporation (discussed above).

Based on the cases that have been decided to date, it appears that general principles of jurisdiction will be applied to Internet companies on a fact-specific, case-by-case basis. However, as a result of the ongoing evolution in the jurisdiction area as applied to Internet-based companies, attorneys should carefully consider the provisions in these areas (if any) that are appropriate to include in an acquisition agreement and the ancillary documents thereto.

In addition to jurisdictional issues, attorneys should be wary of governing law provisions insofar as the laws of some jurisdictions, as applied to companies that operate in cyberspace, may be lagging behind the evolution of such laws in other states. Similarly, the parties may want to consider submitting disputes arising under certain of the acquisition documents to an arbitrator who has specific knowledge and expertise in transactions involving the Internet or e-commerce matters.

Finally, it has become increasingly common for the notice provisions contained in agreements to provide for notice by e-mail in lieu of or in addition to traditional methods of notice. Before including such online notice provisions in acquisition documents, attorneys should ensure that such notices are reliable and legally admissible in the relevant jurisdictions.

Additional Foreign Qualification Issues

As noted above, attorneys for purchasers need to determine whether, as a result of an acquisition, their clients should qualify to do business in a foreign jurisdiction where they might not have been previously required to be qualified.48In qualifying as a foreign corporation, a "Dot.com" company, such as Newco.com, Inc., may face some unique difficulties.

Most foreign qualification statutes contain a provision that requires a company's corporate name to be either "distinguishable on the records of the secretary of state" or "not deceptively similar to" the name of any other corporation already incorporated as a domestic entity or qualified as a foreign business entity in such state.49Regulatory authorities in certain jurisdictions may take the position that merely adding ".com" to the end of the corporate name "Newco" is not enough of a difference to permit foreign qualification under the name "Newco.com, Inc." where a "Newco, Inc." or "Newco, LLC" already exists in that state.50

The flip side of this issue is that even if "Newco.com, Inc." is able to qualify as a foreign corporation under its official corporate name, there may be no statutory prohibition to prevent a "Newco, Inc." from subsequently incorporating or qualifying as a foreign corporation in such jurisdiction. However, even if a Dot.com company is able to qualify under its official corporate name, the company should be advised that it could incur liability to an existing business under common-law unfair competition, deceptive trade practice, or trademark infringement principles for using such name.51The foreign qualification issues discussed here can also arise in the initial incorporation of a Dot.com company.

Finally, attorneys need to be cognizant of the foreign qualification issue in rendering legal opinions on behalf of a client who operates in cyberspace. Although it appears that third-party legal opinions are requested on a less frequent basis in mergers and acquisitions, such opinions remain an important and necessary component of many acquisitions.52Attorneys are frequently requested to opine that their clients are duly qualified in all states in which the nature of their client's business makes such qualification necessary. Due to the issues discussed in this article, attorneys representing companies involved in Internet activities should carefully consider the type of opinion, if any, they are prepared to render with respect to the foreign qualification issue, whether the legal opinion is delivered in the context of an acquisition, a financing, or otherwise.53

Conclusion

As with any new technology, the development of the Internet has led and will continue to lead to certain refinements in numerous areas of law. Although many laws make little distinction between traditional bricks-and-mortar businesses and Internet-based companies, others are in a state of evolution. Similarly, although many of the traditional issues with which merger and acquisition attorneys are accustomed to dealing continue to arise in the acquisition of businesses that operate in cyberspace, some unique issues also arise.

Given the increasing general acceptance of Internet technology as a tool for businesses, these unique issues likely will begin to show up in virtually all future mergers and acquisitions, particularly for transactional attorneys practicing in Colorado because of the prevalence of Internet-based companies in this state. Therefore, to advise and obtain adequate protection for their clients, Colorado business attorneys should appreciate and understand these Internet-related issues fully.

NOTES

1. "Bricks and mortar" is the term used in the popular press to refer to traditional companies that do not operate over the Internet.

2. Some of the more famous acquisitions during this time period were the RJR-Nabisco merger, the Phillip Morris-Kraft transaction, and the battle waged for Paramount.

3. One increasingly prevalent form of consolidation acquisition is referred to as a "roll-up" or "put together." This involves the acquisition of several smaller companies in the same industry to reach a critical mass necessary for a simultaneous initial public offering of a single company comprised of all of the smaller companies. See generally Negotiated Acquisitions of Companies, Subsidiaries and Divisions (New York, NY: Law Journal Press, 1999) at 10-1 to 10-13; Model Stock Purchase Agreement with Commentary (Chicago, IL: American Bar Association, 1995) at 237-40 (hereafter, "Model Agreement").

9. See Krendl, "Acquisitions-A Business and Legal Overview," § 1.9 in Mergers and Acquisitions: Business Strategies for Accountants (New York, NY: John Wiley and Sons, Inc., 1995) and Sapperstein, "Valuing an Acquisition Candidate" in Mergers and Acquisitions: Business Strategies for Accountants (1999 Supp.) for a discussion of traditional valuation methods (e.g., discounted cash flow analyses and pure asset valuations).

10. See generally Misrack, "Valuing Intellectual Property: The Science and the Art," 26 The Colorado Lawyer 85 (Aug. 1997).

11. See Web Linking Agreements: Contracting Strategies and Model Provisions (Chicago, IL: American Bar Association, 1999) at 24-25 (hereafter, Web Linking Agreements).

12. A standard "compliance-with-laws" representation likely would cover (1) new laws that currently are being codified to apply to companies that operate in cyberspace and (2) any licensing requirements that arise as a result of conducting such activities over the Internet. However, to the extent attorneys are aware of such state-specific laws that may affect a seller engaging in e-commerce activities, attorneys may want to review a seller's compliance with such laws during the due diligence process. E.g., a retail company that accepts orders from California residents through its website must comply with California Business and Professions Code § 17538(d). This statutory provision requires that the company post its legal business name, physical whose website can be found at http://www.register.com. Effective January 3, 2000, the Uniform Domain Name Dispute Resolution Policy, which was adopted by the Internet Corporation for Assigned Names and Numbers ("ICANN"), applies to all domain names. The new policy, which differs significantly from the prior policy of Network Solutions, Inc., can be obtained from ICANN's website, located at http://www.icann.org. See generally Adler, Gilbert, and Crane, "Domain Name Registrants Have New Rules to Follow," The National Law Journal, C6 (Jan. 31, 2000).

19. A "meta-tag" is a field that ordinarily cannot be seen by the human eye, but can be read and indexed by Internet search engines. The court in Playboy Enterprises, Inc. v. Calvin Designer Label, 985 F.Supp. 1220 (N.D.Cal. 1997), determined that the hidden use of the words "Playboy" and "Playmate" in the defendant's meta-tags constituted infringement.

20. In many cases, a party obtains consent to link or frame through a web-linking or web-framing agreement. See Web Linking Agreements, supra, note 11.

21. See generally What Constitutes Doing Business? (CT Corporation System 1995). Colorado's foreign qualification statutory provisions are set forth at CRS §§ 7-115-101 to -303.

22. If an Internet-based corporation located outside of Colorado conducts no business activities in Colorado (other than engaging in e-commerce by soliciting orders from Colorado residents through its website that require acceptance of the orders outside this state), it would appear that such a corporation would not be required to register as a foreign corporation in Colorado. See CRS § 7-115-101(2)(f).

23. Depending on the specific jurisdiction, the potential repercussions of failing to register can include denial of access to courts, invalidity of contracts, monetary fines and penalties, and personal liability for officers or directors of the corporation. See What Constitutes Doing Business?, supra, note 21 at 7-26.

24. See generally Millstein et al., supra, note 16 at 9-2 to 9-29; see also Web Linking Agreements, supra, note 11 at 26.

25. Pub. L. No. 105-277 (1998).

26. Id. at § 1102(g).

27. See Hickey, "E-Commerce Prompts Sales Tax Reform," The National Law Journal, B14-15 (Dec. 6, 1999); Hoover, "Clinton Aims to Make Peace in Internet War," The Denver Business Journal, 9A (Dec. 10-16, 1999).

28. See CRS § 39-26-117; see generally "Successor Liability in Asset Acquisitions: State Tax Issues," Successor Liability in Asset Acquisitions, 63-74 (Chicago, IL: American Bar Association, 1997).

29. See 17 C.F.R. § 230.701 for Federal Rule 701 regarding stock options. See generally Friedman, Securities Regulation in Cyberspace (New York, NY: Bowne, 1988).

30. See 29 U.S.C. § 213(a)(17); 29 C.F.R. § 541.303. The DOL recently concluded in an advisory letter that overtime payments should include the value of options in base pay. See "Stock Options Facing Threat," The Denver Post, 2A (Jan. 23, 2000). This could significantly impact cyberspace companies if it is not withdrawn.

31. See Rev. Ruling 87-41.

32. For a general discussion of the issues related to indemnification, see "Model Agreement," supra, note 8 at 184-89 and 204-05; Kling and Simon, supra, note 8 at 15-25 to 15-27 and 15-36 to 15-40.

33. See Krendl and Krendl, "Noncompetition Covenants in Colorado: A Statutory Solution?," 52 Den.L.J. 499 (1975); see also Patterson and Funk, "Covenants Not to Compete in the Sale of a Business: Protecting Goodwill," 26 The Colorado Lawyer 31 (Dec. 1997).

34. CRS § 8-2-113(2)(a).

35. See Krendl, supra, note 4 at § 5.20. See, e.g., DBA Enter. Inc. v. Findlay, 923 P.2d 298, 304 (Colo.App. 1996); Gibson v. Eberle, 762 P.2d 777, 779 (Colo.App. 1988); Boulder Medical Center v. Moore, 651 P.2d 464 (Colo.App. 1982); Harrison v. Albright, 577 P.2d 302, 305 (Colo. App. 1977).

36. The primary purposes for allowing noncompetition covenants in the sale of a business are to protect the goodwill of the company and prevent immediate competition when purchasers have paid valuable consideration for the business. See Patterson and Funk, supra, note 33 at 32.

37. For example, the geographic scope could be limited to the United States. Obviously, the more restricted the geographic scope, the more likely a court is to enforce it as reasonable.

38. See Barrows v. McMurtry Manufacturing Co., 131 P. 430 (Colo. 1913); see generally Krendl and Krendl, supra, note 33 at 515-18.

39. Although noncompetition covenants must contain reasonable geographic and time restrictions, courts have split on whether nondisclosure and nonsolicitation covenants must contain similar restrictions. See Lawrence and Baranowski, supra, note 6 at 3-12 to 3-13. By placing the separate nondisclosure/nonsolicitation covenants in the acquisition agreement, purchasers may be able to prevent a court from confusing these provisions with the noncompetition covenant contained in an ancillary noncompetition agreement. But see Colorado Accounting Machines, Inc. v. Mergenthaler, 609 P.2d 1125, 1126 (Colo.App. 1980) (which properly recognized the distinction between noncompetition and nondisclosure covenants).

40. See Knox, "Cyber Startups Must Weave a Web of Secrecy," The Denver Post, D1 (Oct. 21, 1999)(use of confidentiality and nondisclosure agreements by Wisen.com, Inc., an Internet-based company in Golden, CO, now known as ServiceMagic, Inc.).

41. See generally Francis, "Avoiding Intellectual Property Pitfalls When Hiring High-Tech Employees," 27 The Colorado Lawyer 85 (Feb. 1998).

42. See CRS § 8-2-113(2)(b) and (d). See also CRS § 8-2-113(2)(c), which permits a contractual provision that provides the recovery of the expense of educating and training an employee who has served an employer for less than two years.

43. See Krendl and Krendl, supra, note 33 at 530-32. In National Graphics Co. v. Dilley, 681 P.2d 546 (Colo.App. 1984), a case arising in the employment context, the Colorado Court of Appeals upheld a trial court's determination that a noncompetition covenant without time or geographic limitations was void on its face, and further determined that the trial court did not abuse its discretion by refusing to reform the covenant.

44. In Earthweb, Inc. v. Schlack, 71 F.Supp.2d 299 (S.D.N.Y. 1999), the court declined to enforce a one-year noncompete agreement, stating, "[w]hen measured against the information technology industry in the Internet environment, a one-year hiatus from the work force is several generations, if not an eternity." See generally Garofalo and Fishberg, "Noncompete Agreements," The National Law Journal, B7 (Jan. 17, 2000).

45. Read together, the two Colorado court decisions addressing noncompetition covenants for independent contractors, Colorado Supply Co. v. Stewart, 797 P.2d 1303 (Colo.App. 1990) and Smith v. Sellers, 747 P.2d 15 (Colo.App. 1987), suggest that for a consultant's noncompetition covenant to be valid, it must fall within one of the statutory exceptions other than CRS § 8-2-113(2)(d), which exception is limited to employees. Accordingly, to increase the likelihood of enforceability of a covenant in a consulting agreement, it should be specifically designed to protect trade secrets.

46. In a related Internet area, the ABA has advised attorneys that traditional governing law and choice of forum clauses may produce unintended consequences if disputes arise under an agreement. See Web Linking Agreements, supra, note 11 at 43.

47. See Millstein et al., supra, note 16 at 11-4 to 11-16.1.

48. For example, purchasers may be required to become qualified when they acquire the assets of a company located in a foreign jurisdiction in which they had no prior business contacts, or as a result of such acquisition, the purchaser now has employees or leases space in such jurisdiction. See What Constitutes Doing Business?, supra, note 21 at 67- 69 and 96-97.

49. See, e.g., CRS § 7-104-101(2)(containing "deceptively similar" standard). The Model Business Corporation Act deliberately rejected the "deceptively similar" approach, and instead requires a corporate name to be "distinguishable upon the records of the secretary of state" from other corporate names. This language is derived from § 102(a)(1) of the Delaware General Corporation Law. See Krendl and Krendl, Colorado Business Corporation Act Deskbook 1999-2000 Edition 80 (St. Paul, MN: West Group, 1999); see also Model Business Corporation Act Annotated (Frederick, MD: Aspen Publishing Inc., 1984 and 1999 Supp.) at 4-1 to 4-13.

50. The Colorado Secretary of State's Filing Manual offers little guidance on this issue. See Colorado Deskbook, supra, note 49 at 518-22. In this author's experience, the Secretary of State will accept for filing the name of a company when the only difference is the addition of ".com" to the corporate name.

51. See Gregg Homes, Inc. v. Gregg & Co. Builders, Inc., 978 P.2d 146, 148 (Colo.App. 1998) [holding CRS § 7-104-101(2) did not abrogate the common law elements of unfair competition]; see also Model Business Corporation Act Annotated, supra, note 49 at 4-20 to 4-23. Colorado's deceptive trade practices statute is set forth at CRS § 6-1-105.

52. For some general discussions of third-party legal opinions in the context of acquisitions, see "Third Party 'Closing' Opinions," 53 Business Lawyer 592 (1998); Krendl, supra, note 4 at § 5.2.1; "Model Agreement," supra, note 8 at 313-321.

53. It may be more appropriate for attorneys to opine as to the jurisdictions in which the company is qualified as a foreign corporation, or to at least limit the opinion with the qualifier "except where the failure to be qualified would not have a material adverse affect on the company." The TriBar Opinion Committee, which was formed more than twenty years ago to study legal opinions, has stated that the former approach is the preferable one in rendering a foreign qualification opinion, although it also has suggested that "the opinion process could be streamlined without any meaningful detriment to opinion recipients if absent special circumstances the practice of rendering foreign qualification and foreign good standing opinions were discontinued and opinion recipients were to rely directly on the certificates themselves." See "Third Party 'Closing' Opinions," supra, note 52 at 646-47.

Column Ed.: David P. Steigerwald of Sparks Willson Borges Brandt & Johnson, P.C., Colorado Springs-(719) 475-0097

This newsletter is prepared by the Business Law Section of the CBA to apprise members of the Bar of current information concerning substantive law. This month's article was written by E. Lee Reichert.

This article originally appeared in the March 2000 edition of The Colorado Lawyer, volume 29, number 3, and is reprinted with permission.