When Competitors Consider Joint B2B
Exchanges Tax, Contractual, Other Matters Must Be Carefully Thought
Through
by Lori S. Smith and Noel D. Humphreys, Initial
Decisions Competitors that jointly form a business-to-business (B2B) exchange must consider numerous business and legal issues. These include not only antitrust matters, but questions of structure, financing, management, personnel, marketing, software ownership, trademarks, access to trade secrets, dispute resolution, termination and exit strategy. With the continued growth of the numbers of B2B exchanges there are estimates that the 700 exchanges now in existence may rise to 5,000 within two years these issues are being considered almost daily. Although business and legal counsel can provide a good deal of concrete advice, the still-developing business models lack obvious solutions in many cases. Initial Decisions Business executives interested in forming a B2B have a number of important initial decisions to make about their business models. For example, organizers must decide whether to develop a "horizontal" site, where the marketplace is not targeted to a particular industry, or a "vertical" one, which covers specific industries from top to bottom. In addition, promoters must decide whether the marketplace will act as a principal, taking title to goods offered for sale. In some marketplaces, once a purchaser clicks a mouse to purchase goods from an exchange's database, the exchange will order the items from the manufacturer or distributor, take title and pay for the goods, regardless of whether the purchaser ultimately pays for the items ordered. This model presents financing and collection risks for the exchange. However, this model also may simplify transactions for buyers, permit them to buy from one source goods from multiple vendors, reduce customer paperwork and allow customers (especially larger corporate buyers) to control buying in accordance with the buyer's own internal rules and procedures. On the other hand, instead of acting as intermediary sellers, other marketplaces merely match buyers and sellers. They may foster online communities by providing locations for "chat rooms," sharing of industry news and information and posting of requests for proposals. These corollary uses can generate revenue for a B2B from such sources as sales of virtual "storefronts" on the sites, product advertising, job advertising, sales of books, videos and training and from cobranded sites. Pricing mechanisms further complicate the picture. Some sites offer goods at established prices while others offer goods at auction. Still other exchanges offer a so-called "reverse auction," in which a putative purchaser publishes its needs and sellers bid to fill them. In fact, some B2Bs offer all three transaction styles. Another matter to address at the outset is the jurisdiction in which the marketplace is organized. Tax, regulatory and finance considerations affect the decision, as do the nature of the business at which the marketplace is aimed and the location of the likely users of the site. Some marketplaces may lend themselves to tax haven jurisdictions. Organizers should also consider relevant product liability law. Comparable considerations relate to the jurisdictions where a marketplace will ship goods. Parties interested in creating a B2B exchange must consider the structure of the enterprise. Toward that end, they should weigh the relative merits of proximity with a dominant market force against the benefits of openness. Put differently, should the B2B maintain a close connection with a particular Fortune 500 company or should it be a more independent and separately organized entity? A separate corporation also may make it easier to comply with the antitrust laws and to raise capital. Relationships with strategic partners or suppliers require balancing financing, compliance and marketing considerations. Capital needs, credit risk, and interest in going public also may affect a B2B's form. Organizers should also anticipate conflicts with existing distributors. A review of existing distribution arrangements for exclusivity and other restrictions may require legal advice. Contract, Contract Marketplaces can involve substantial numbers of parties. Written agreements should govern their relationships. First, agreements should fully define who owns the equity interests in a B2B and their rights with respect to those interests. This may be a key element in the organizational success of a marketplace. For example, the site could establish a warrant pool of a certain percentage of the company's capital stock to reward strategic partners for sales at the site. As a corollary, the agreement should carefully describe any purchase or transactional obligations of the founders, and the sanctions that will attach to any failure to fulfill those requirements. Agreements should also address dispute resolution, termination rights and exit strategies for the owners. Many sites contract for third-party or outsourced services. Many "vertical" marketplaces enable or facilitate users' obtaining financing, payments, logistics or transportation. Agreements must be drafted to govern these arrangements. The sharing of information among exchange's customers and its participants' back offices is important to a B2B's success. Many B2B participants have enterprise resource planning (ERP) software. With input from the B2B marketplace, the participants' ERP systems can automate various elements of inventory management, billing and accounting. Confidentiality agreements are key to this sharing of information. Finally, the ability of a B2B to fulfill orders is important for more than simply marketing and customer relations. Recently, in fact, the Federal Trade Commission fined seven retailers in amounts ranging from $45,000 to $300,000 for failing to deliver promised goods during the 1999 holidays. To avoid trouble, managers may consider outsourcing fulfillment, which requires carefully drafted contracts. Privacy, Security Issues Every B2B marketplace must address privacy concerns. B2Bs need careful statements and policy implementation about the uses they make of customer information, balancing public clamor, legitimate expectations, software abilities and their own business needs. Significantly, different jurisdictions have different rules about information collected. For example, the European Union restricts use of collected transactional or personal information more than the United States does. It remains to be seen whether the U.S. government will promulgate rules to govern the information that a marketplace can collect, but some organizations regularly decry collection and dissemination of information gathered surreptitiously as Web site users buy, sell or explore over the World Wide Web. In addition, businesses will want to know that no competitor is gathering information about its Web activities or its plans, inventories, prices or needs. Security issues and privacy concerns overlap. A marketplace must protect transactional and personal information from unauthorized access, whether from hackers, insiders or intentional disclosure. Many of the same kinds of protocols and devices that can be used for privacy purposes also can be relied on to protect data from intrusion from these other sources, as well as protection from viruses and "denial of service" attacks. A B2B marketplace may find robust encryption of information useful, and digital signatures, which are generated using encryption software, can provide important controls and verification. However, U.S. laws control export of some encryption software. Outside the U.S., rules on encryption vary, and mere possession of encryption software may be a crime. Confidentiality agreements also are necessary for individuals involved in any marketplace. It is important for B2Bs to recognize, though, the enforceability of such agreements may differ from jurisdiction to jurisdiction. Intellectual Property Apparently, none of the leading marketplace vendors has obtained a critical patent on processes involved in digital marketplaces. Therefore, B2B sites rely, in large measure, on copyright protections, as well as trade secret law and confidentiality agreements. Because it is important that customers trust the marketplace, service marks and trademarks are key to the intellectual property of a digital marketplace. Moreover, a trade secret owner may wish to protect secrets by emphasizing restrictions on access to real secrets, rather than relying on contracts. Of course, some countries' laws differ from those of the United States, and the laws of many jurisdictions may be important in any particular case. Antitrust Concerns Federal officials already have begun investigating electronic marketplaces, with antitrust issues at the top of their agenda. This apparently already has led at least one exchange -- MetalSite L.P. -- to always have an antitrust lawyer in attendance at board meetings. Generally speaking, to comply with antitrust laws, sites should be open, independent and neutral. A site should ensure that all user groups have timely access to information. A marketplace should not favor one group over any other. This also will help to attract participants and will encourage them to regularly transact business on the exchange. A specific antitrust concern, obviously, is that businesses that collectively own a digital marketplace could fix prices. Price-signaling may concern antitrust regulators as much as price-fixing. Price-signaling occurs, for example, when a dominant buyer or seller announces a price, and others in the market align their prices to the leader's price. In some marketplaces, signaling can occur when buyers can see offers of all other buyers. One possible remedy may be to organize the B2B to permit a seller to see offers from all buyers, but to permit a buyer to see only its own offer. Or, in an auction environment, the exchange could allow bidders to know where they rank in the auction, but allow them to see the highest offer only when it is topped by the bidder's own bid. A competitor-owned B2B marketplace should adopt and follow thought-out antitrust guidelines. Among other things, these rules should govern how the exchange handles information it collects about buyers, sellers and their transactions. The rules also should provide for periodic audits of practices by a third-party vendor such as a consulting, auditing or law firm or by a privacy-compliance certifier. Such an audit may have the additional benefit of generating confidence in the exchange. A marketplace with an advisory group of buyers and sellers may further its antitrust compliance, while enhancing its marketing and client relations. In addition, a competitor-owned B2B exchange should consider whether to avoid employing individuals with preexisting ties to the owners, or to the industry. The marketplace should consider requiring senior-level employees to sign non-compete agreements limiting their ability to work in the industry (or for participants in the exchange) after leaving the B2B, which also may promote antitrust compliance. There will, of course, be limits on the scope and enforceability of such agreements that will vary by jurisdiction. Finally, when large industry players band together to form a digital marketplace, they may have to make a Hart-Scott-Rodino filing with the Department of Justice and the Federal Trade Commission. Similar filings also may be called for in other countries. Internet Tax Competitor-owned B2B exchanges face a variety of issues under state, federal and foreign tax laws. Congress imposed a moratorium on new internet taxes in the United States, but marketplaces may be responsible for collecting state sales taxes in some U.S. jurisdictions on certain internet sales. Many retailers have been struggling with the issues of where and whether "bricks-and-mortar" locations create adequate nexus to trigger the obligation to collect and remit sales taxes on Internet sales. Exchanges also may find it necessary to keep track of whether goods are purchased for resale. The jurisdiction of organization of a marketplace and the jurisdictions where the marketplace delivers goods affect the nature and amounts of taxes involved. Different jurisdictions may have different rules concerning the type and extent of involvement required to create a tax obligation. For example, analysis is needed to determine whether mere use of a domain name with a particular country's extension establishes enough nexus to create an obligation to pay tax in that country. Other Regulatory Issues Marketplaces may be subject to laws and regulations relating to particular industries. For example, there are regulations generally applicable to the handling or distribution of alcoholic beverages, guns, explosives and common chemicals such as weed killer. There also are rules that apply to sale of such products as chemicals, pharmaceuticals, controlled substances, human and biological reagents, medical and in vitro devices and nuclear chemicals. The application of these rules has to be analyzed in various contexts. Suppose, for example, that a B2B takes title to the goods it sells without taking possession. It may have to depend on suppliers and vendors to meet packaging, distribution, labeling, record-keeping and licensing requirements. In addition, it may be forced to rely on others to investigate whether purchasers have appropriate licenses, permits and expertise to receive regulated products. Laws on these politically charged topics change frequently. A site may have to comply with the laws of each jurisdiction where goods are received and might want to consider hiring a person to supervise regulatory compliance. In addition, marketplaces may need to tailor disclaimers, disclosures and record-keeping to particular jurisdictions and should recognize that some countries, such as France or Canada, may have language requirements that apply in particular circumstances. Conclusion The relative novelty of many of the business issues involved with the creation and operation of a these exchanges exchange, and the need to apply new -- and established -- laws to these exchanges, require careful thought by business people and their legal advisers. Indeed, continuing developments in this area make it clear that only those B2Bs that keep abreast of the changing environment in which they operate are most likely to succeed. Akin Gump is a legal firm with more than 900 lawyers worldwide, including more than 200 lawyers and other professionals in their technology practice group. They have a significant depth and breadth of capabilities whether their clients are a garage start-up seeking funding or incubation, a post-first-round enterprise seeking introductions to strategic partners, or a major multinational in need of sophisticated counsel. New media, e-commerce, microelectronics, Internet solutions, software, telecommunications, biotechnology or any of the dozens of other digital age domains - Akin Gump is knowledgeable in your space, and ready to provide the solutions you need, when you need them. BIOs: Lori S. Smith is a partner, and Noel D. Humphreys is senior counsel, in the corporate and technology practice groups of Akin, Gump, Strauss, Hauer & Feld, L.L.P., in New York. They represent software, Internet and other emerging technology companies in a wide variety of matters. For additional information on this topic, you can contact them at lsmith@akingump.com or nhumphreys@akingump.com. As appeared in the September 18, 2000 edition of the
New York Law Journal
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