Jul 20 2012

Friday News: Harlequin sued in a class action for underpayment of royalties

By Jane • Publishing News • • Tags: ,

Harlequin

 

Introduction

Thanks to all who gave me the heads up although Wicked Pixie was the first so she gets the credit.  The lawyers for the Harlequin Class Action suit set up a website and loaded a file stamped copy of the petition yesterday.  I went through it and will summarize it for you.  The suit is for books signed to contract between 1990 and 2004 and covers only digital royalties.

Two Bit Summary

For purposes of this lawsuit, there are two main players: Harlequin Enterprises (hereinafter “HQE”) and Harlequin Switzerland.  The Harlequin authors bringing this suit assert that for all intents and purposes HQE and Harlequin Switzerland are essentially one corporation and therefore, they are entitled to 50% of the net proceeds received by HQE for the sale of their ebook instead of the 50% of net proceeds received by Harlequin Switzerland that they are now paid.

Example

The lawsuit, using an $8.00 figure (not sure why they use that instead of an actual cover price like $4.95 but whatever), asserts that the authors are entitled to $2 per sale instead of the 24 to 32 cents they currently receive.  Let’s use actual dollars here because I think that the value of the damages is important in evaluating risk. The digital list price of Judith Arnold’s “Father Found” is $4.99.  The discounted price is $4.19 at Amazon.  Assuming no other costs in the net receipts calculation and that Harlequin gives Amazon a 50% discount, the lawsuit is asserting that the author is owed $1.24 versus the $.24 to 32 cents that Arnold receives now.

Longer Summary

This lawsuit covers contracts between 1990 to 2004.  The date, I believe, is because after 2004 there was a specific provision for ebook royalties.  For contracts betweet 1990 and 2004, authors are being paid for royalties under a clause known as “All Other Rights” which I will talk about below.  While some books were published digitally prior to 2011, the main concern would be for sales of digital books that coincided with the Harlequin Treasury launch in 2011.

The authors claim on behalf of all Harlequin authors similarly situated that Harlequin Switzerland corporation is an entity created solely to enjoy certain tax benefits. Harlequin established one Swiss company called Harlequin Enterprises BV (hereinafter “Swiss 1″) in 1983. In 1994, Harlequin established a second Swiss entity called Harlequin Books S.A. (hereinafter “Swiss 2″) Together the two Swiss companies have about 10 employees (5 each says the petition).  The petition asserts that Harlequin Switzerland exists for tax purposes only.

The contracts authors entered into, beginning in 1983, identify Swiss 1 as the “Publisher”. Copyright pages, beginning in 1994, identify HQE publishing the book by arrangement with Swiss 2.

The 1990-2004 contracts have an “All Other Rights” clause.

“On all other rights exercised by Publisher or its Related Licensees fifty percent (50%) of the Net Amount Received by Publisher for the license of said rights by Publisher from a Related Licensee shall, in Publisher’s estimate, be equivalent to the amount reasonably obtainable by Publisher from an Unrelated Licensee for the license or sale of said rights.”

The “Other Rights” are defined as follows:

If Publisher licenses, sublicensees or sells to an Unrelated Licensee any of the following rights to the Work anywhere in the world, in any language, Author’s and Publisher’s share of net amount received by Publisher for said license, sublicense or sale shall be apportioned as follows…Any other rights to reproduce, adapt, publish or otherwise deal in any manner whatsoever now existing or that may hereafter come into existence  [Author's share] 50% [Publisher's Share] 50%.

In 2011, HQE sent a letter to its authors declaring that the ebook royalties would be paid pursuant to the AOR clause.  HQE told authors that the Net Amount received by Swiss 2 was 6-8% of cover price and thus authors would get 3-4% of the cover price.  The lawsuit asserts that because HQE is really the entity playing the role of Publisher by acquiring, editing, promoting, packaging, marketing, licensing and sub licensing the book that the split should be 50% of what HQE receives; not 50% of what Swiss 2 receives.

While not pled as a Piercing the Corporate Veil suit, that is essentially what it is.

What is Piercing the Corporate Veil?

This is a legal doctrine that allows the plaintiffs to tear aside Swiss 2′s corporate identity and put HQE in its place.  A good case to consider when evaluating this claim is the 2008 decision of NetJets Aviation, Inc. v. LHC Communications LLC, 537 F. 3d 168 (2nd Cir. 2008)  In NetJets, the Second Circuit (Circuit where NY resides) had to evaluate whether LHC was the alter ego for another entity.  NetJets is a company that offers essentially timeshares of private planes.  It entered into an agreement to provide access to a private plane with a company called LHC Communications.  LHC Communication severed the contract after a year and NetJets wanted LHC to pay up. LHC declared it had no money.  NetJets pursued Laurence S. Zimmerman personally, asserting that Zimmerman was LHC’s alter ego and thus responsible for its debts.

This is the standard for proving the alter ego claim set forth by NetJets and fairly close to what the Authors will have to prove against HQE and Swiss 1 and 2.  (All citations removed to make it easier to read)

To prevail under the alter-ego theory of piercing the veil, a plaintiff need not prove that there was actual fraud but must show a mingling of the operations of the entity and its owner plus an “overall element of injustice or unfairness.”

“[A]n alter ego analysis must start with an examination of factors which reveal how the corporation operates and the particular defendant’s relationship  to that operation. These factors include whether the corporation was adequately capitalized for the corporate undertaking; whether the corporation was solvent; whether dividends were paid, corporate records kept, officers and directors functioned properly, and other corporate formalities were observed; whether the dominant shareholder siphoned corporate funds; and whether, in general, the corporation simply functioned as a facade for the dominant shareholder.”

“[N]o single factor c[an] justify a decision to disregard the corporate entity, but … some combination of them [i]s required, and … an overall element of injustice or unfairness must always be present, as well.”

Simply phrased, the standard may be restated as: “whether [the two entities] operated as a single economic entity such that it would be inequitable for th[e] Court to uphold a legal distinction between them.”

Our Court has stated this as a two-pronged test focusing on (1) whether the entities in question operated as a single economic entity, and (2) whether there was an overall element of injustice or unfairness.  Finally, we note that the plaintiff need not prove that the corporation was created with fraud or unfairness in mind. It is sufficient to prove that it was so used.

NetJets was able to show that Zimmerman and LHC were essentially the same entity and that Zimmerman was using LHC to avoid debts.  The evidence (and this was in a summary judgment motion so all the evidence was read in a light most favorable to NetJets) showed that Zimmerman provided the capital to LHC in the amount of $20,100; that LHC invested millions of dollars provided by Zimmerman; that any additional capital needed by LHC to run was provided by Zimmerman and that Zimmerman took money out of LHC whenever he liked.  LHC’s only other officer besides Zimmerman was an employee of Zimmerman.  LHC’s office space was shared with Zimmerman’s other companies; many of the LHC employees worked for Zimmerman. Zimmerman controlled or dominated LHC.

The Harlequin lawsuit asserts that HQE dominated and controlled the Publishing aspect of the books.

Is this a legitimate claim?

Someone asked me this question on Twitter and I’m uncertain how to respond.  It’s not a frivolous claim.  It is a serious claim and a decent legal theory.  Whether Harlequin Authors will win is another question.  Piercing claims are notoriously difficult. I’ve only handled a couple of them and the winning claims largely rested on proving that the corporations shared the same board members, the same employees, did not keep regular minutes and intermingled assets.  I don’t see those allegations here. Instead, the allegations are that HQE did all the work of a Publisher and thus should be deemed the Publisher.  That’s not the traditional evidence of a piercing claim.  This is not to say that there aren’t cases out there like it, only that I am not familiar with them.

The money being asserted in damages is quite low. There are maybe 5,000 books in question and assuming those books have sold 100,000 copies in total (the Harlequin Treasury titles don’t seem to be generating much interest as far as I can tell) and assuming that the authors are owed about $1.00 per sale to a customer, the damages are fairly low.  The real cost factor here may be the attorneys’ fees.  Attorneys’ fees in class action suits are in the millions of dollars.  Oftentimes, when attorneys’ fees are part of an award, defendants will settle just to avoid the astronomical legal bill.   Authors likely want Harlequin to just sever the contracts and allow the authors to self publish them.

It’s hard to say what the outcome will be.

What’s Next

Harlequin’s answer will need to be filed within 21 days of the complaint being served. Given that the Harlequin entities are outside the U.S., I believe the federal rules allow 90 days to respond.

Two questions

1) Why didn’t the suit assert per Rosetta case that Swiss 1 and Swiss 1 didn’t have the rights to ebook publication?  This very issue is being litigated by Open Road and Jean Craighead George against HarperCollins.  The Rosetta case occurred back in 2000 and 2001.  Rosetta was sued by Random House for selling digital copies of books Random House felt was under contract.  Random House moved for an injunction to halt the sales but the court refused to grant it.   The Second Circuit upheld the denial of the injunction:

But the law of New York, which determines the scope of Random House’s contracts, has arguably adopted a restrictive view of the kinds of “new uses” to which an exclusive license may apply when the contracting parties do not expressly provide for coverage of such future forms. In any case, determining whether the licenses here in issue extend to ebooks depends on fact-finding regarding, inter alia, the “evolving” technical processes and uses of an ebook, Random House, 150 F.Supp.2d at 615 n. 5, and the reasonable expectations of the contracting parties “cognizant of the customs, practices, usages and terminology as generally understood in the ? trade or business” at the time of contracting. ? Without the benefit of the full record to be developed over the course of the litigation, we cannot say the district court abused its discretion in the preliminary way it resolved these mixed questions of law and fact.

2) Why didn’t the suit assert a fraud claim since piercing ordinarily isn’t allowed unless improper conduct occurs.  

Those are my monday morning quarterbacking thoughts.  I was told by one author that the Author lawyers were told to proceed with the strongest legal theory.  My practice was always include as many counts of wrongdoing as possible.  There are three cases, it is said.  The one the client brings to you.  The one you prep for trial and the one you actually try.  They are all a little different.

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