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Kevin Smith

Smacked Again

17 September 2002

A pair of lawsuits could hinder the future merger between PayPal Inc. and online auction giant eBay.

In a Securities & Exchange Commission filing last week, PayPal reiterated it was fighting a class-action lawsuit filed on behalf of shareholders who believe the merger price of PayPal stock is undervalued and should be increased before a final deal is closed. The proposed merger is set to reach the $1.5 billion mark, but PayPal investors feel that amount isn't enough.

The class-action suit was nothing new, but the company also shed light on a new case that could create a bigger roadblock to the pending merger.

PayPal acknowledged that First USA Bank, America's third-largest credit card company, filed a patent infringement case against PayPal on Sept. 6. The case was filed through the federal court system in the District Court of Delaware, according to the SEC report.

PayPal is accused of violating First USA Bank's "Cardless Payment System" patents.

An official with First USA Bank's parent company, Bank One Corp., told IGN today that the company couldn't comment on any possible litigation or court case.

Officials with PayPal didn't immediately return numerous phone calls and e-mails.

First USA's patents are for a system that enables users to make financial transactions without having to remember account information. The Bank One tool creates a method for assigning an alias, such as a phone number and a personal identification number, to a credit card to eliminate the need for the physical presence of a card during a transaction.

First USA received two patents for the system, the first one in May 2001 and the second in January 2002.

According to PayPal's SEC filing, the suit seeks to enjoin PayPal from offering services that infringe the patents and to obtain damages to compensate First USA for the alleged infringement.

PayPal said in the report that it intends to fight the charges.

"First USA has not provided any information beyond the summary allegations in its lawsuit regarding how PayPal is infringing their patents," the statement reads. "PayPal is reviewing these patents and their prosecution history and intends to contest the suit vigorously."

Since its inception in late 1999 as a viable payment option for selling and buying items on eBay, PayPal has grown into a system with 18 million members--one that was widely accepted throughout the interactive gaming industry.

As part of the merger with eBay, though, PayPal notified merchants in late August that the system would no longer be used for sports books and that Internet casinos would be cut off in October 2002.

The patent infringement case could hold up the merger with eBay because eBay would be vulnerable to any patent claims against PayPal over Internet payment systems, according to the merger agreement submitted to the SEC in July.

PayPal says it hasn't violated any patents, although it has acknowledged the possibility of an intellectual property dispute over its core technology.

The shareholder suit could be a hindrance too, but it has been widely speculated that the per-share price could be negotiated before a final proposal goes before shareholders.

Shareholders who filed the suit feel the eBay offer is "grossly inadequate" because sales on the auction site account for nearly 70 percent of PayPal's business and argue that eBay pressured PayPal to sell out at a bargain price.

Shareholders are expected to vote on the merger with eBay on Oct. 3. Officials with the company have said publicly that even if the share price remains the same, they are confident that enough shareholders will vote for the merger.

Under the proposed merger, PayPal shareholders would receive 0.39 shares of eBay for every share of PayPal. eBay's offer valued PayPal at $23.61 per share, or $1.5 billion, on the day of the announcement, and the price has roughly held since then.

The Bank One lawsuit also might not be enough to block the deal, but eBay will have to consider the cost of defending such a suit if it moves forward with the merger.

The patent infringement case is just the latest in impediments for the merger. PayPal cut online sports books off from its system after an investigation from New York Attorney General Eliot Spitzer showed evidence of possible legal action against PayPal.

In August, PayPal paid that state $200,000 and agreed to stop processing payments by its New York members to online gambling sites. If the merger is completed, eBay plans to stop online gambling payments altogether.

Smacked Again is republished from
Kevin Smith
Kevin Smith