Napster On The Brink Of Disaster?

In wake of top executives' resignations, sources speculate company may soon file for bankruptcy protection.

The future of Napster may be in peril after company founder Shawn Fanning and three other top executives resigned Tuesday, fostering speculation that the former file-sharing frontrunner may declare bankruptcy.

Fanning and CEO Konrad Hilbers, who held the position since July, issued their resignations following Napster's board of directors rejecting a buy-out offer from media conglomerate Bertelsmann, according to a Napster spokesperson. Napster's COO Milt Olin and chief counsel Jonathan Schwartz also vacated their posts.

Bertelsmann and Napster had been negotiating for months, with the media giant offering $16.5 million for the company, according to the Los Angeles Times. Napster's board of directors missed Monday's deadline to accept the proposed sum, which prompted the resignations.

"We regret that the Napster shareholders were unable to reach an agreement regarding the offer from Bertelsmann, however we believe in the value of peer-to-peer technology," read a Bertelsmann statement to the press. "We are hopeful that Napster's brand and technology will be able to realize its potential as a compelling consumer proposition."

Hilbers issued a company-wide memo yesterday, according to the Napster spokesperson, explaining the reasoning behind his decision. "I am convinced that not pursuing the offer is a mistake and it will lead the company to a place where I don't want to lead it."

That place, presumably, is bankruptcy. Napster, from its inception, has never generated any income since it has always been a free service. Bertelsmann had loaned the company $85 million over the past several months, and with the file-sharing service still inoperable (though a beta version is available to selected users), Napster had no perceivable way to pay it back. The Los Angeles Times reported that sources close to Napster expect the company to file for bankruptcy protection within days.

"We deeply regret that we have not yet been able to find a funding solution that would allow Napster to launch a service to benefit artists and consumers alike," a Napster statement read. "We will be looking at additional steps in the coming week to further reduce expenses."

Although the deal fell through, Bertelsmann may wind up inheriting control of Napster and/or its technology if Napster files for bankruptcy, given its debt to the Germany-based company.

Napster's board of directors hardly presents a unified front. Original Napster investor John Fanning, Shawn's uncle, tried to oust fellow board members Hank Barry and John Hummer, of venture capital firm Hummer Winblad, with a lawsuit. On Tuesday, it was dismissed by a Delaware court.

Napster hasn't been operable since July, when it shut itself down after a court ordered it to block the trading of copyrighted material, which it could not do effectively (see "Judge: Napster Must Stay Down Until Filters Are Perfected").

Following the court's ruling, the five major-label conglomerates sued Napster for copyright infringement, and later launched their own music-download sites: Musicnet, owned by BMG, EMI and AOL Time Warner; and Pressplay, owned by Sony and Universal. Both are subscription based. The lawsuits are still pending.

Phil Leigh, an analyst with investment firm Raymond James & Associates, told the Associated Press that the rejection of Bertelsmann's offer was a result of Napster's original investors wanting immunity from damages in the labels' copyright infringement lawsuit as part of the deal, and Bertelsmann wouldn't agree to that stipulation. The Napster spokesperson could not comment on the board's decision to reject the offer.

In January, Napster offered 20,000 users the opportunity to test-drive a beta version of its new and improved file-sharing service, which is expected to be subscription based.

A college freshman, 18-year-old Shawn Fanning, created Napster in early 1999 from his dorm room at Northwestern University.

For a feature interview with Shawn Fanning, check out "Napster: Shawn Fanning Speaks."