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PayPal Booted Out of State, Under Legal Siege

By Elaine X. Grant E-Commerce Times ECT News Network
Feb 12, 2002 10:43 AM PT

It has not been a very good week for PayPal. First, the online payment company was forced to delay its initial public offering because of a lawsuit filed by rival CertCo. Just days later, the state of Louisiana ordered PayPal to stop doing business with its residents without a license.

PayPal Booted Out of State, Under Legal Siege

Although the company faces the threat of regulation from several other states, Louisiana was the first state to order the company to stop transferring money to and from residents until it obtains a money transmission license.

If PayPal fails to abide by that order, it could be fined US$1,000 per day by the state.

PayPal said it will "comply promptly and suspend the ability of Louisiana residents to make payments through our service," although it reserves the right to contest the order.

Louisiana residents accounted for just 0.9 percent of payments sent and 0.7 percent of payments received through PayPal in the first nine months of 2001.

State Regulation

New York also has informed PayPal that it considers the company to be involved in unauthorized banking. This accusation poses a potentially bigger problem than the Louisiana setback. New York customers accounted for 6.4 percent of total payments sent and 6.8 percent of payments received in the first nine months of 2001.

California and Idaho also have notified PayPal that it may be operating an unauthorized banking business.

PayPal said it has taken steps to address the concerns of all three states. In California, for instance, the company has stopped sending payments to international accounts.

"They don't have to worry about Louisiana, but they do have to worry a lot about California and New York, and whether this sets a precedent for other states," Gartner analyst Avivah Litan told the E-Commerce Times.

California, in particular, is a bellwether state and is especially concerned about consumer rights, Litan added.

Most states regulate nonbank payment systems. Though PayPal has said it believes its business is subject to those regulations only in its home state of California, the company has received licenses in Oregon and West Virginia, has filed applications in four additional states and intends to file in 10 more.

Cutting It Close

The CertCo lawsuit is not particularly unusual, according to Litan. "It's common practice to file a lawsuit right before an IPO, because that's when a company is most likely to settle," she said.

However, the lawsuit's hair's-breadth timing -- it was filed February 4th, just three days before PayPal's stock was to begin trading -- surprised Litan.

"CertCo's tardy allegations and rush filing of its unmeritorious lawsuit has disrupted PayPal's initial public offering, resulting in damages to PayPal," the company said in a filing with the U.S. Securities and Exchange Commission.

Because of those circumstances, PayPal asked the judge to declare the lawsuit an exceptional case, which means PayPal could receive attorney fees from CertCo.

Costly Trial

Litan said CertCo's patent is "incredibly broad. I know a lot of processors in the payment industry, and it could apply to each and every one of them."

A trial would be a financial hardship, even if PayPal emerges victorious. "Even if we prevail, the litigation could be time-consuming and expensive to defend and could affect our business materially and adversely," PayPal said in the filing.

If PayPal loses the suit, it could be forced to pay triple damages for past patent infringement as well as CertCo's legal fees. The company also would have to obtain a license in order to keep offering any features found to have infringed on CertCo's patent.

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