High stakes in Skype legal wrangle

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When a group of prominent investors announced plans to purchase Skype from Ebay for $1.9bn this month, analysts and insiders presumed it had the blessing of Skype’s founders, Niklas Zennstrom and Janus Friis.

Mr Zennstrom and Mr Friis still control the core peer-to-peer technology that powers Skype, the internet calling service. That became clear this year when Joltid, a company they partly own, filed a lawsuit against Ebay claiming it had broken the terms of the agreement that licenses that technology back to Skype.

Moreover, Mike Volpi, one of the lead investors in the consortium bidding for Skype, had served on its board, maintained a long friendship with its founders, and was serving as chairman of another one of their new companies, the online video service Joost.

It seemed inconceivable that Mr Volpi would be acting other than with their full support.

The fact that JPMorgan backed the consortium’s offer for Skype, and presumably did plenty of due diligence, did something to assuage skittish observers.

But those reassurances were shattered this week. On Monday, Mr Volpi was ousted as chairman of Joost, and the company said it would investigate his actions as chairman and previously chief executive.

Then on Wednesday, Joltid filed a copyright infringement suit in the Northern California US District Court naming as defendants Mr Volpi, the other potential investors in Skype – including Index Ventures, Andreessen Horowitz and Silver Lake Partners – as well as the Skype team and Ebay.

In 33 pages of acerbic language, the suit details how, according to Joltid, Skype obtained unauthorised copies of the P2P technology’s source code, modified it without permission from Joltid, and distributed it to third parties.

The suit claims Joltid became aware of these violations in 2007, and had been pursuing a resolution with Ebay. When that failed, it filed the suit against Ebay in March in a London court. That case is ongoing and expected to be heard next year.

“Their allegations and claims are without merit and are founded on fundamental legal and factual errors,” said Ebay. “We remain on track to close the transaction in the fourth quarter of 2009.”

Mr Volpi could not be reached for comment.

The new suit was brought on by what Joltid sees as a broader range of defendants. As a rationale for extending its claim against the new investors, Joltid argues that because the terms of the deal required that Skype remained operational until the deal closed, and because members of the investor group would help manage Skype in the interim, they too were guilty of infringing on Joltid’s copyright.

The lawsuit singles out Mr Volpi, characterising him as the mastermind of the deal. “Exploiting his personal and professional relationships,” it alleges.

The stakes are high. Skype is now the largest international voice carrier. It has nearly 500m active users, and brought in $551m last year. Ebay has said it expects Skype to earn revenues of $1bn by 2011.

What Mr Zennstrom and Mr Friis truly want is still unclear.

While it would come as a shock to Skype’s half-billion users, if a judge sided with Mr Zennstrom and Mr Friis, Skype could fall silent.

At that point, with the ability to renegotiate a deal or keep Skype offline, the founders would perhaps have achieved what they were after: the one thing more valuable than money – power.

Questions over the Joltid code

The success or failure of the $1.9bn acquisition of Skype by a group of venture capital investors rests on a key question: how replaceable is the software that makes the internet telephony system run?

The code that is so vital to its functions is owned by a separate company, Joltid, a British Virgin Islands-domiciled company, founded and partially owned by Skype’s founders, Niklas Zennstrom and Janus Friis. When Ebay bought Skype for $2.6bn in 2005, the rights to the Joltid software – called Global Index – were not part of the deal. Ebay only had a licence agreement to use the code.

If Joltid wins its pending court case against Skype, and the latter can no longer use the code, it may have to stop operating – unless it can build its own, new code to completely replace that which is under dispute. Software experts believe this may be difficult.

The code was written by Bluemoon, a software development company in Tallinn, Estonia. Global Index is fairly distinct, and does not need a large database to run. This has allowed Skype to, at the peak of each day, connect more than 16m people for messaging and voice calls over the internet.

Ebay itself has fluctuated in its assessments of how well a work-around would function, most recently giving a fairly positive statement on progress.

If it does not work, the consequences for half a billion Skype users will be devastating.

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