Today's news of HarperCollins buying Harlequin for $455 million is overshadowed by a recently revived lawsuit. Earlier this week the 2nd Circuit Court of Appeals issued a ruling which breathed life back in to a 2 year old lawsuit.
Following more than a year of failed negotiations, a group of authors filed a class-action lawsuit against Harlequin in. The authors alleged that Harlequin's practice of designating one of Harlequin 's Swiss subsidiary as the publisher, who then licensed the rights back to the parent company, cheated the authors out of their ebook royalties.
Between 1990 and 2005 Harlequin offered a standard contract that included an "all other rights" clause which promised authors 50% net royalties. While that is not a bad deal on its face, the publisher also set up a deal to internally license the digital rights through that Swiss subsidiary for about 6% to 8% of the retail price of the ebooks. This enabled Harlequin to claim that its net receipts were far smaller than what the ebook retailers were actually remitting to Harlequin.
Even though it's clear that in this case the authors were being cheated, this kind of internal licensing agreement is not unusual in many industries, and that is part of the reason why Judge Harold Baer threw out this lawsuit. He issued a summary judgement in favor of Harlequin based on a narrow interpretation of contract law.
Earlier this week that summary judgement was overturned - in part. The 2nd Circuit Court of Appeals didn't overturn the contract or Harlequin's internal sleight-of-hand accounting, but the 3 judge panel reinstated the lawsuit on the basis that the license fee was too low.
The United States District Court for the Southern District of New York (Baer, J.) concluded that plaintiffs’ allegations failed to state claims and dismissed the amended complaint pursuant to Federal Rule of Civil Procedure 12(b)(6). See Keiler v. Harlequin Enters. Ltd., No. 12-5558, 2013 WL 1324093 (S.D.N.Y. Apr. 2, 2013). For the reasons set forth below, we hold that plaintiffs’ claims based on agency, assignment, and alter ego theories cannot serve to modify the terms of the Publishing Agreements and were properly dismissed. We also conclude that the amended complaint set forth sufficient facts to plead a breach of the Publishing Agreements on the theory that defendants calculated their e-book royalties based on an unreasonable license fee. Accordingly, we affirm the judgment in part, reverse it in part, and remand for further proceedings consistent with this Opinion.
In short, the appeals court is saying that the sweetheart deal Harlequin gave itself doesn't pass muster; had a similar deal been arranged externally the net would have been significantly higher than 6% to 8%.
With revenues of around $400 million a year, the potential financial liabilities runs into the tens of millions of dollars, and I'm sure that's not news that Harlequin's new owner, HarperCollins, wants to hear.
But never mind the financial side; the damages Harlequin did to their reputation is already affecting the bottom line. In a time when the ebook market is growing, when more romance ebooks are being bought than ever before, Harlequin's revenues dropped in 2012 and 2013. By failing to negotiate and then fighting this out in court, Harlequin gave authors a good reason to not sign new contracts and instead sign with a smaller publisher or go self-pub.
It's not clear whether HarperCollins or Torstar, Harlequin's previous owner, is liable for this lawsuit.