Appeals Court: Book Publisher Must Face Self-Dealing Lawsuit

On Thursday, the 2nd Circuit Court of Appeals revived a self-dealing claim brought by a class of authors against Harlequin Enterprises, the world's largest publisher of romance novels.

The dispute can be traced back to a time before the advent of eBooks, when publishers locked up broad "all other rights" from its authors. In doing so, the publishers gained a foothold on somewhat unimagined content technologies of the future. Nevertheless, book publishers are like colleagues in the movie, television and music industries struggling to figure out how to rightfully divide royalties for digital files that might be cheaper to distribute. Often, studios and publishers have come to contractual interpretations and vertically-integrated corporate structures that are most advantageous to them.

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In this lawsuit, the authors pointed to their contracts that gave them 50 percent of the "net amount received" for the license or sale of a book. But they weren't getting anywhere close to 50 percent on income received from eBooks.

According to the complaint, Harlequin Enterprises set up Swiss subsidiaries in 1983 and 1994 "for tax purposes," advising the authors that the purpose of the change was to "rationalize business procedures." These subsidiaries became the "publisher" in the contractual relationship with the authors, even though the authors contend that they have no publishing functions like promoting the books. As for Harlequin Enterprises, it became defined in the publishing agreements as a "related licensee."

When Harlequin didn't pay 50 percent of eBook royalties to authors, but instead gave them half of the amount received by Harlequin from the Swiss subsidiary, the authors sued. They claimed it was a breach of contract that they were only getting roughly 3 or 4 percent of the cover price of the eBook.

In an opinion on Thursday, 2nd Circuit Judge Barrington Parker affirms the lower court's holding that the publishing agreement explicitly provides for the allocation of royalty payments to the Swiss company. "Substituting Harlequin Enterprises as the Publisher, as urged by the plaintiffs, would, in effect, require redrafting significant provisions of the contract while ignoring other express ones," writes the judge.

That said, the authors including Barbara Keiler, Mona Gay Thomas, and Linda Barrett nonetheless get a huge victory because the 2nd Circuit decides to reverse the opinion of the lower court, with regard to a claim that the licensing fees that Harlequin Enterprises paid to its subsidiaries are not equivalent to “the amount reasonably obtainable from an Unrelated Licensee.”

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According to the opinion, "Plaintiffs have provided a basis [for this claim], albeit 'upon information and belief,' that defendants engaged in self?dealing because the industry standard is considerably higher than the 6 to 8 percent of net receipts that Harlequin Enterprises remits to its subsidiary Harlequin Switzerland (i.e. at least 50 percent of net receipts)."

The ruling could be a confidence boost for others bringing vertical integration claims. For example, The Walking Dead creator Frank Darabont sued last December in a New York court with a claim that AMC has cheated its profit participants by licensing the show to itself and "creating an unconscionably low license fee formula that had no regard for what AMC or any other network would pay in an arms' length agreement for the right to broadcast such a comparable highly successful series."

The publishing suit deals with romance novels, not zombie TV shows, but as the case gets remanded, it invites some exploration into industry practices.

Twitter: @eriqgardner