The Social Network: Lessons from the Mediation That Resolved the Dispute Over the Founding of Facebook

Those who saw the award-winning film, The Social Network, are familiar with the dispute between Mark Zuckerberg and the Winklevoss twins (and their business partner, Divya Narendra) over the founding of Facebook. What many fans of the movie might not be aware of is that the Zuckerberg-Winklevoss dispute was resolved through mediation.

This historical tidbit came to my attention while reading a recent Massachusetts state appellate court decision affirming dismissal of contract and tort-based claims asserted by software developer Wayne Chang against the Winklevosses in connection with the settlement of the Zuckerberg-Winklevoss dispute. Chang v. Winkelvoss, 95 Mass. App. Ct. 202 (April 24, 2019) The Chang-Winklevoss litigation is a footnote to the more substantive fight over Facebook, but adds some interesting color.

After Zuckerberg launched Facebook in February 2004, the Winklevosses reached out to Chang to help increase the user base of the Winklevoss’s competing social networking website, ConnectU (originally launched as the HarvardConnection). Chang had previously founded i2hub (a peer-to-peer, file-sharing platform).

In late 2004, Chang and the Winklevosses agreed to incorporate i2hub’s software into ConnectU’s website, and form a jointly owned holding company called the Winklevoss Chang Group (WCG). But the relationship later soured over various financial and ownership disputes, and the parties eventually agreed to terminate their collaboration. As a result, neither WCG nor any other joint entity was apparently ever formed, and i2hub was never integrated with ConnectU. By the end of 2005, the parties’ communications make it clear that they were going their own separate ways as if no partnership had ever existed.

Meanwhile, in September 2004 — about a month before the Winklevosses contacted Chang — ConnectU had sued Facebook in Massachusetts federal court alleging theft of trade secrets and other claims. Chang never became a party in the Massachusetts action, although he was named a defendant in a later California action commenced by Facebook in August 2005 against ConnectU alleging that one of the websites developed by Chang had misappropriated Facebook’s proprietary code and user data.

In a February 2008 mediation, Facebook and ConnectU settled all of their outstanding disputes. Facebook received 100% of ConnectU’s stock in exchange for paying the Winkelvosses and Narendra $20 million in cash and one million shares of Facebook (purportedly worth $35.90/share at the time).

In December 2009, Chang sued the Winkelvosses alleging that his 50% interest in WCG entitled him to 50% of the proceeds of the settlement with Facebook. As noted above, the trial court dismissed certain of Chang’s claims (and granted summary judgment to the Winklevosses on others), and the Massachusetts state appellate court affirmed.

But let’s turn back to the mediation of the Zuckerberg-Winklevoss dispute, which was not without some drama.

ConnectU and Facebook had been litigating for nearly four years, but after just a day of mediation, all the parties signed a short handwritten “term sheet and settlement agreement” providing for the deal described above, i.e., 100% of ConnectU’s stock in exchange for $20 million in cash and one million Facebook shares. The agreement further provided for mutual releases, and critically for our purposes, stated that “[t]he parties agree that they may execute more formal documents but these terms are binding and this document may be submitted into evidence to enforce this agreement.” (emphasis added) (for the complete term sheet, see Facebook, Inc. v. ConnectU, Inc., No. C 07-01389 JW, 2008 WL 8820476, at *1 (N.D. Cal. June 25, 2008), aff’d, 640 F.3d 1034 (9th Cir. 2011)).

As often happens when mediations conclude with an abbreviated writing that must then be formally documented, discussions broke down when the parties failed to agree on the language in the final deal documents. Facebook subsequently moved to enforce the barebones settlement reached at the mediation, while ConnectU argued it was unenforceable because (i) it lacked material terms, and (ii) had allegedly been procured by fraud (specifically, the Winklevosses accused Facebook of substantially overvaluing its shares during the negotiations). The district court determined that the settlement was enforceable and the Ninth Circuit affirmed. Facebook, Inc. v. Pac. Nw. Software, Inc., 640 F.3d 1034 (9th Cir. 2011).

The Ninth Circuit’s decision addressed two important issues that frequently arise in mediations.

#1: When is a Mediated Settlement Enforceable?

After parties reach agreement at a mediation, everyone assumes the dispute is over, and the parties can get on with their lives. To meet those expectations, it is critical to determine when a handwritten or typed term sheet executed at the conclusion of the mediation is enforceable even if the parties later fail to agree on definitive deal documents. The general understanding is that a mediated settlement is enforceable if it contains all of the material terms of the deal. But how does a court determine what terms are “material”? Addressing that question, the Ninth Circuit observed:

A term may be “material” in one of two ways: It may be a necessary term [such as price], without which there can be no contract; or, it may be an important term that affects the value of the bargain. Obviously, omission of the former would render the contract a nullity. But a contract that omits terms of the latter type is enforceable under California law, so long as the terms it does include are sufficiently definite for a court to determine whether a breach has occurred, order specific performance or award damages. This is not a very demanding test. (emphasis added).

As noted above, the Winklevosses and Facebook had agreed in their term sheet that “[t]he parties agree that they may execute more formal documents but these terms are binding and this document may be submitted into evidence to enforce this agreement.” According to the Ninth Circuit, this clause left no doubt that the parties meant to bind themselves to the swap of ConnectU stock for cash and Facebook stock, even though it was understood that other material (i.e., important but not absolutely necessary) aspects of the deal would be papered later.

The Ninth Circuit further observed that the Settlement Agreement specified how the parties would draft other terms missing from the term sheet: “Facebook will determine the form & documentation of the acquisition of ConnectU’s shares consistent with a stock and cash for stock acquisition.” This approach was valid under California law, which permits responsibility for drafting documents to be delegated to one party (so long as the delegation is constrained by the rest of the contract and subject to the implied covenant of good faith and fair dealing), and provides that if the parties then fail to agree on documentation, the court may fill in missing terms by reference to the rest of the contract, extrinsic evidence and industry practice.

#2: Are Mediation Communications Admissible to Establish Fraud During the Negotiations?

 The Winklevosses also sought to overturn the settlement on the ground that Facebook deliberately misled them during the settlement negotiations into believing that its shares were worth $35.90, even though Facebook knew that its shares were, in fact, worth only $8.88 (based on an internal tax-related valuation). Therefore, instead of receiving one million Facebook shares, the Winklevosses asserted they should have received roughly four times as many shares.

To support this claim, the Winklevosses proffered evidence of what was said and not said during the mediation. The district court excluded this evidence and the Ninth Circuit agreed, noting that, before the mediation commenced, the parties signed a fairly tight confidentiality agreement providing in relevant part:

All statements made during the course of the mediation or in mediator follow-up thereafter at any time prior to complete settlement of this matter are privileged settlement discussions … and are nondiscoverable and inadmissible for any purpose including in any legal proceeding…. No aspect of the mediation shall be relied upon or introduced as evidence in any arbitral, judicial, or other proceeding. (emphasis added).

The Ninth Circuit ruled that this language precluded the Winklevosses from introducing any evidence of what Facebook said, or did not say, during the mediation. Absent such evidence, the Winklevosses could not show that Facebook misled them about the value of its shares during settlement negotiations.

In short, the Ninth Circuit held, mediation confidentiality cannot be breached even to establish fraud.