Harlequin plaintiffs bring new allegations, improve their case

[NOTE TO READERS: It's been a while since I've posted. Thanks for coming back.]

On November 2, 2012, the authors(*) in the Harlequin class action upped their game against Harlequin. If they're wrong, they will lose their class certification request. But if they win, they will find themselves making a point that will have repercussions far beyond just e-publishing and authors.



I've previously summarized the facts of this claim in a post to which I've linked below; if you're new to the topic I'd suggest you go read those, or any of the other summaries around the Web. In a nutshell, the authors signed contracts with a Harlequin entity in Switzerland, but the contracts were administered by the main Canadian Harlequin company and the authors contend this was just a tax strategy from Harlequin. But when it came time to publish e-books, Harlequin licensed the rights from the Swiss company (which I'll call HS) back to the main Canadian company Harlequin Enterprises (which I'll call HE). The publishing contracts with HS had a clause giving 50% royalties for things like e-books to the authors, but the license with HE gave HS only 6-8% of cover price, meaning the authors only got 3-4% (50% of 6-8%). They claim this was unlawful. Not surprisingly, Harlequin disagrees.

After Harlequin filed a motion to dismiss the lawsuit, the authors amended their claims. They didn't add any new causes of action, meaning they didn't find any new grounds to sue. But the new facts that they have added in support of the old claims aren't very good for Harlequin.

There are two significant differences between the old and new Complaint, one that looks big on paper and another that I think could be an even bigger deal.


The one that looks big on paper, and has gotten a lot of attention, is the inclusion of more allegations to back up the argument that HS is nothing more than a shell for HE. The result of this argument, if the authors win, is that HE will be considered to be the Publisher under the contracts. That would make the 50% royalty payable on the amounts received by HE. Imagine an e-book with a $5.00 cover price. Amazon takes 30% or $1.50, leaving $3.50 per copy. If the authors are successful, they would get $1.75. Up to now they've been getting about $0.12. So that's a big difference.

They are arguing a doctrine called "alter ego" to make this claim. Unfortunately Batman is not involved. The alter ego argument basically holds that where you have two companies but one is basically a shell that has no independent operation, it's only fair to treat them both as the same company so that they can't do inter-company contracts that operate to deprive you of money you're owed. In order to make that argument, the authors basically have to show that HE acted as though HS was under its control. And they make some pretty compelling claims to this effect, including:

• HE referred to HS as being one of its "offices"
• HE referred to HS's accounting department as being "our accounting department"
• HE told the authors that it was asking them to sign contracts with HS in order to rationalize its business procedures and wouldn't prejudice them or put them in a worse position contractually.
• HE handled all administrative tasks for HS, including contract drafting and administration. Although HS sent the royalty statements, HE handled all followup questions.
• When authors wanted to obtain reversion rights for their books, which would terminate the publishing contracts and allow the authors to resubmit them elsewhere, authors had these discussions with HE. If HE's staff approved of the decision, they would prepare the documents for HS to sign.

One thing to note. The authors don't have to show all of the above things to be true in order to get their class action. That's what the actual trial is for. Here, they just have to show that they have reasonable grounds to believe those things are true, and then argue that if they are true then there's an alter ego situation.

That last bit matters. The kinds of things the authors are describing, where there are two companies but one is a shell that executes certain documents for certain reasons but otherwise all of its work is done by employees of another company, that happens more often than you'd think. In fact, it is central to the tax planning strategies of many major companies: they incorporate a company in a tax-advantageous state like Nevada or Ireland and then they route transactions through it, but otherwise the corporate family all acts like one entity. I think the last bullet is going to be very significant: if HE is negotiating the termination of contracts executed by HS, then that may well mean HS can't act independently. That could be critical.

But to me, the bigger issue is the one that isn't really fleshed out in either the old or the new Complaint: that the 6-8% royalty itself isn't equitable. That is, the authors are contending that even if the court decides that the HE-HS contract gets to be upheld, that doesn't end the conversation. Instead, they would have the court determine whether the 6-8% rate in that contract was fair to the authors, on whose behalf HS was negotiating when it licensed those rights.

And that argument risks being very interesting. For two reasons.

First of all, there's the fact that, when Amazon itself invited authors to go into the e-book business, it offered a rate of 70% for the authors, and Apple and B&N aren't too far off. That's a lot higher than 6-8%. Harlequin will be hard pressed to explain why its own inter-company rate should be respected by a court in light of numbers like that.

But although I know there are other people who disagree with me on this, I think this argument is going to raise a bunch of issues that have already arisen in the music industry. And just as they worked to the artists' benefit there, they will have the same effect here. In a case called F.B.T. Productions, LLC. v. Aftermath Records, Eminem sued his record label for treating purchases through iTunes like sales of a physical good, when they were really just licenses under the terms that purchasers had accepted when they accepted the iTunes Terms of Use. Eminem won this lawsuit, gaining the right to receive 50% of sums received (his contractual right for a sublicense) and not 12-20% (his right for a sale).

Just as with iTunes downloads, so too with e-books. They aren't sold, they are licensed. Whether that's good for consumers or not, it certainly sets up a very direct parallel between the two situations.

Played right, I think this could be a big issue for the authors, because it demonstrates that there is absolutely no need for HS to have put HE in the middle of this transaction flow. If the "sale" of e-books is actually a license, then why couldn't HS have been the entity doing business with the e-book retailers and, under the agency model, the customers? Yes, it chose not to. As the authors themselves note in their amended Complaint, Harlequin is entitled to do its tax planning as it chooses. But if its tax planning results in the authors being prejudiced, Harlequin will have to demonstrate why its structure should be held up against them.

And this could be a very difficult thing for them to do.

(*) I've seen people refer to the authors as "Plaintiffs". I've slipped from time to time and done that myself. Technically they're not plaintiffs. To bring a class action, you first have to file a motion for authorization to file a class action, and if that's granted then you get to be the class plaintiff. Until then they are technically petitioners to a motion, not plaintiffs to a lawsuit. This may seem picky but of such things are fortunes made...

LINKS:
Plantiffs' Amended Complaint:
http://www.harlequinlawsuit.com/uploads/Plaintiff_s_First_Amended_Complaint_Against_Harlequin_11.5.12.pdf Legal Minimum post on class action:
http://legalminimum.blogspot.com/2012/07/four-quick-thoughts-on-harlequin-e.html
Legal Minimum post on Harlequin's motion to dismiss:
http://legalminimum.blogspot.com/2012/10/three-reasons-harlequin-shouldnt-get-to.html 
Blog posting on FBT Productions case:
http://westlawinsider.com/top-legal-news/eminem-lawsuit-finds-itunes-downloads-to-be-licenses/