Four quick thoughts on the Harlequin e-books class action

To catch up people who haven't read the complaint: a group of authors are suing Harlequin for their business practices in the e-books space. Important note: I'm basing this on a review of the Complaint. Although it's not usually the case that plaintiffs get things grossly wrong in drafting these things, keep in mind that Harlequin hasn't answered any of these points and we're a long way from judgment (or settlement, which I think is way more likely). So Harlequin will probably not agree with the way I'm characterizing things below.

Weasel words out of the way, let's look at the Complaint.



The facts as alleged are pretty clear. There are two Harlequin companies involved and I'll use the names for them from the Complaint: Harlequin Enterprises and Harlequin Switzerland. Although Harlequin Enterprises performed all the functions of the publisher, authors sign their publishing contracts with Harlequin Switzerland. These contracts addressed publishing physical books, and in the 1990-2004 contract they also covered e-book rights at a 50/50 revenue share.

Harlequin Switzerland isn't the publisher of the e-books. That's Harlequin Enterprises. So Harlequin Enterprises needed a license from the owner of the rights to e-book publishing. But of course, the author didn't own those rights. That was Harlequin Switzerland. So Harlequin Enterprises cut a deal with Harlequin Switzerland to buy those rights. And Harlequin Enterprises offered Harlequin Switzerland a rate of 6-8%.

As the authors' lawyers set out in the Complaint, the math is clear.

• On a book with a cover price of $8.00, Harlequin Enterprises would probably make at least $4.00.
• If the authors were paid based on their royalty rate from the Harlequin Switzerland deal, then they should have made $2.00 per e-book (50% of $4.00). 
• But because of the inter-company licensing deal, the authors would make $0.24 to $0.36 per book (6% of $4.00 is $0.48, and 50% of $0.48 is $0.24; the same math on 8% of $4.00 gets to $0.36).

I'll spend more time talking about this in the coming days. I also think my panel at the Romance Writers of America 2012 annual convention next week just got a new subject. But here's my three quick thoughts after reviewing the Complaint:

1. In a recent post I talked about how companies in the same corporate family (technically: related companies) have to do their deals on what's called an arm's length basis. That means the money they pay each other has to be what they would pay a third party. This principle, which has been investigated by the courts to great lengths in the ongoing litigation around Superman, Siegel v. Warner Bros, is going to be very important in this litigation. I think it'll cause problems for Harlequin, but they may not be insurmountable.

The baseline principle is clear. Harlequin Switzerland showed what it thought would be a fair royalty structure for e-books by putting a figure for that in their own contract: 50%. So why should Harlequin Enterprises only pay 6-8% for those same rights? It certainly looks like a sweetheart deal cut inside the same corporate family.

But wait. These same authors signed deals with Harlequin saying that publishing their print books should bring royalties. What were the rates for those print books? Those rates aren't in evidence yet, but probably: 6-8%. So there's an argument that the authors have accepted 6-8% for a reasonable royalty rate.

And yet... the difficult thing for Harlequin is going to be explaining why, if Harlequin Switzerland could be the publisher for the paperback books, why couldn't it also be the publisher for the e-books? Harlequin is going to have a tough time explaining that one.


So: One point for the authors.

2. Harlequin isn't the only company facing this problem in the e-content era. If you buy music from iTunes, Apple says you're paying for a license and you don't own the file. That matters: most artists signed contracts with their labels saying that a sale of a track would result in one type of payment and a license of the track would be a different type.

For example, Eminem's label had a structure with 12-20% royalties for sale of an album and 50% royalties for licensing it. In the litigation, the court held that iTunes "sales" required the 50% royalty since they were actually licenses.

Why this matters here: it layers on my first point. Harlequin Switzerland had demonstrated that, at least at first glance, it thought the reasonable rate for licensing an e-book to be published was 50%. "Sales" of e-books are, upon investigation, actually licenses.

So that's another point for the authors.

3. Harlequin wouldn't let authors negotiate their deals: they were take-it-or-leave-it. The technical term for that is "contracts of adhesion". Although it's different from state to state in its details, there's a contract law principle that says contracts of adhesion have to be reasonable and can't contain crazy terms.

The Harlequin contracts contained a clause saying that the rights could be assigned within the Harlequin family at Harlequin's sole discretion. Harlequin is relying on this to say they were allowed to do what they did. Maybe so, but this principle of law would also hold that Harlequin would have to be reasonable in exercising its rights to do so. Otherwise they should have given people the chance to negotiate that clause away. They didn't and so that becomes another, albeit lesser, point for the authors.

4. The authors argue that Harlequin Switzerland was just a tax shelter and Harlequin Enterprises was really fulfilling all the obligations of a publisher. Example: Harlequin Enterprises was marked on the copyright pages of the book as "publisher". This is going to matter a lot. If two companies run themselves as a joint unit when it's convenient, they have to be treated as a joint unit when it's inconvenient.

So if you're keeping score, that's: authors 4, Harlequin 0. Like I said, Harlequin hasn't had a chance to present its side yet. But it's tough to see how they come out the other side of this smelling like roses.

More as things develop.


LINKS:
Link to RWA convention agenda: Know Your Rights: Opportunities for Your Books Beyond Publishing (CAREER)
http://www.rwa.org/cs/2012_workshops
Four last points to remember about net profits clauses: see point #1
http://legalminimum.blogspot.com/2012/07/four-last-things-to-remember-for-now.html