Empty promises

A legal wrangle between diamond retailers highlights the perils e-commerce companies face when they rush into marriage

By Patrick Danner

Odimo.com Inc.’s acquisition of DiamondDepot.com has been anything but a gem for the Sunrise company. At least that’s what Odimo claims in a lawsuit it filed last month against the New Jersey family that sold it an 85 percent stake in DiamondDepot, an online diamond retailer, for $6.7 million.

Odimo, majority owned by Israel’s Steinmetz Diamond Group, was seeking an online presence to sell diamonds and jewelry when it struck a deal in November with the owners of DiamondDepot — the Gupta family of Jersey City, N.J. What Odimo got instead, it claims, was a “valueless company” that stole elements of an unnamed competitor’s Web site for use on the DiamondDepot site.

“At the end of the day, my client … got virtually no benefit from what it had purchased,” charges Samuel I. Burstyn, Odimo’s lawyer in Miami, along with Miguel M. de la O and Daniel L. Leyton of de la O & Marko. Odimo had no choice but to build an online company from scratch, he adds. DiamondDepot’s operations were relocated to Sunrise in December and two months later the Web site’s name was changed to Odimo.com. In May, the domain name changed again when Odimo purchased Diamond.com for an undisclosed amount.

While Odimo’s allegations represent just part of the dispute with the Guptas, the case highlights problems expansion-minded companies face when buying e-commerce businesses. The rush to grow, the pressure to meet or exceed investors’ expectations, and the difficulties of analyzing the value of assets owned by dot-coms — namely intellectual property — raise the question of whether companies are getting what they pay for.

Lawyers and e-commerce consultants believe the race to merge with or acquire online businesses will only lead to more lawsuits like Odimo’s. Such legal battles may only accelerate the pace at which these companies consume cash, possibly hastening their demise.

“This is a very new area,” says Laurie Holtz, a forensic accountant with Miami’s Rachlin Cohen & Holtz. “Litigation is behind the curve of these acquisitions, so we won’t see the ramifications of these acquisitions [for a while]. They don’t sue the day after they acquire them.”

Still, the litigation wave is coming, Holtz says, if for no other reason than there is a lot of money at stake.

A lot of the problems in such deals arise from companies glossing over the legal or finer points of the transaction, not so much to save money, but in their desire to get online and secure an edge over competitors, says Jose I. Rojas, a lawyer at Holland & Knight.

“What is happening is folks are rushing to get online and doing it in a sloppy way, either ignoring the legal issues altogether or shoddily addressing those issues,” says Rojas, who specializes in e-commerce and technology.

Burstyn agrees: “There is such a premium on being first in the marketplace that companies can’t always spend the time on the amount of due diligence we’ve seen in other markets.”

The speed at which companies are moving to complete deals is, in part, driven by the need to demonstrate to investors that goals are being met, says Gary Manheimer, president of Burn World-Wide Ltd., an Internet development and consulting firm in Miami. Often, the thinking is mergers and acquisitions need to occur to secure additional capital down the road.

“When companies get significant amounts of money, they’re expected to do something with it,” Manheimer says. “In doing so, sometimes they don’t have the time to make the most calculated decisions.”

Harold Gubnitsky, chairman and chief executive of Semtor Inc., an e-business consulting firm in Weston, blames the shaky due diligence on the failure of companies to look in the right areas.

“Traditional models for mergers and acquisitions are focused on profits and losses and the accounting perspective, but that only tells part of the story,” Gubnitsky says. “With new dot-coms, you really have to look closely at the brand, the online customer relationship and [what differentiates] the technology, as well as the people and the chemistry with the acquired team.”

It’s not enough to have a lawyer or an accountant go over a company’s books. Dot-coms require professionals with savvy technical know-how to analyze the software or hardware to ensure what works today will be useful in the future.

“Are they doing the diligence?” asks Marc Auerbach, a lawyer with Kirkpatrick & Lockhart in Miami. “I think more times than not they are. But then the question is are they bringing in the right people to do the due diligence, or do they have the technical people to analyze the technical work product? My speculation is there are more problems in this area than in whether they are doing the due diligence.”

In the Odimo.com case, Burstyn places the blame on the Guptas for allegedly falsely portraying the financial health of DiamondDepot.com. Odimo’s suit alleges DiamondDepot understated its debts and failed to disclose “improper self-dealings” with the Guptas’ bricks-and-mortar businesses.

“One of the risks in buying a company — as opposed to buying the company’s assets — is you have to believe representations made by the seller,” Burstyn says. “If the seller lies to you, no lawyer in the world can protect you from fraud.”

But Larry Stumpf, the lawyer defending the Guptas against the suit filed in U.S. District Court in Fort Lauderdale, disputes allegations that his clients lied.

“There’s absolutely no evidence, that I’m aware of, that the Guptas made any misrepresentations or failed to disclose any information,” says Stumpf of Akerman Senterfitt & Eidson. “This looks like a case of a substantial investor trying to redo the deal after the deal has been fully negotiated and closed.”

In fact, the Guptas filed suit in April in U.S. District Court in New Jersey alleging the family was defrauded by Odimo. They claim it was Odimo’s “secret intention to force the Gupta family out of the corporation.” Neeraj “Roger” Gupta had been promised the No. 2 post at Odimo behind chief executive Alan Lipton, says Stumpf. Instead, the suit claims, Gupta was “relegated to a small, windowless back office, with no titles or responsibilities.” Gupta was terminated in March.

Lipton wouldn’t comment about the legal wrangling with the Guptas. Neeraj Gupta couldn’t be reached for comment. Vijay Gupta, Neeraj’s father and a defendant in Odimo’s suit, declined comment.

Odimo already has received $125 million in funding from various conglomerates, but for a lot of other dot-coms, legal battles are something they can ill afford, notes Rojas of Holland & Knight.

“Obviously, the last thing a dot-com wants is to be tied up in expensive litigation, accelerating their burn rate,” he says.



Web Published Friday, August 18, 2000
Published in Daily Business Review on: Thursday, August 17, 2000