ARE ROYALTIES DUE ON SALE OF THE BUSINESS?

IVAN HOFFMAN, B.A., J.D.


        Here is the situation:  Author and publisher enter into an agreement for the publishing of  book in consideration of the payment to the author of royalties.  (This situation is not limited to these facts and can actually be any agreement whereby a party transfers its rights to a work in exchange for a royalty but for simplicity sake, I will limit this to the said author-publisher situation).   Subsequently, the publisher enters into an agreement for the exploitation of some of the rights in the book.  Subsequently still, the publisher sells its business to another publisher who takes over the publishing of the book in question.

        Issue: is the author (or other party as indicated above) entitled to a royalty on the licensing transaction or on the sale of the business?

        In Postlewaite v. McGraw-Hill, Inc., a case out of the Second Circuit in which the plaintiffs, the 2 authors, were not represented by an attorney on appeal, involved such a situation.

        The plaintiffs entered an agreement with McGraw-Hill to publish their work and the publisher did so under the publisher’s imprint, Topical Publishing Division.  Under the terms of the agreement, all rights of copyright were transferred to McGraw-Hill.  Thereafter, McGraw-Hill entered into an agreement with Augusta Software Design, Inc. whereby Augusta was to produce a CD-ROM that would include material from plaintiffs’ book, which CD-ROM was to be marketed by McGraw-Hill and McGraw-Hill would pay Augusta royalties based on the sales of the said CD-ROM.  McGraw-Hill retained all rights of copyright in and to the material from plaintiffs’ book that was included in the CD-ROM.  According to the Court, McGraw-Hill never did market or sell the said CD-ROM.

        In the words of the Court in the agreement provided in part:

Specifically, the publishing agreement provides that McGraw’s payment of royalties to plaintiff will constitute “full payment” as follows:

(1) Domestic and Foreign Sales. The total royalty to be paid to the Authors is 20 percent of the Publisher’s gross selling price . . . for each copy of the Work.

(2) Exercise of Right of Publisher. 20 percent of the Publisher’s gross receipts from its exercise of any rights to the Work . . . for which a royalty is not otherwise provided in this Section 7 shall be paid to the Authors.

(3) Sale of Other Rights by Publisher. 20 percent of the Publisher’s gross receipts from the sale, assignment, or licensing to others by the Publisher of any rights to the Work.

Publishing Agreement  7(a)(1-3). The publishing agreement also provides for assignment of the agreement itself:

Assignments. This Agreement may not be assigned by either the Authors or the Publisher without the prior written consent of the other party or parties, which shall not be unreasonably withheld.

        Thereafter, McGraw-Hill sold its said imprint to Thomson Legal Publishing, Inc. and the sale included all of McGraw-Hill’s rights in and to an extensive number of publishing agreements including but not limited to the publishing agreement with plaintiffs.  Plaintiffs consented to the said sale.  The sale also include a transfer of the publisher’s rights in the agreement with Augusta.

A Loss of Leverage

        It is rare indeed when an author can restrict the right of the publisher from transferring and assigning its rights under an agreement, for many reasons not the least of which is that the publisher does not want an author to be able to prevent a sale of its company or a substantial part of its assets but in this instance, as indicated above, such a provision existed in the publishing agreement.

        Had the authors exercised the leverage that such a provision provided prior to the sale, they might have sought compensation, they might have sought termination of the publishing agreement, they might have negotiated for a wide variety of other considerations but they consented to the sale without apparently doing any of that.

        Instead, after the said sale, plaintiffs filed an arbitration seeking royalties on the said sale but lost that claim because the panel concluded that the said sale was not a royalty event. Plaintiffs then appealed that award and lost on appeal as well.  Thus, instead of having leverage on their side, the plaintiffs went through the time, expense and uncertainty of a legal proceeding…and lost!

        The Court referred to a paragraph 13 of the publishing agreement which, the Court said, precluded any claims by plaintiffs on the sale but the Court did not quote the provisions of paragraph 13 saying:

Defendants [i.e. the publisher] argue, as the district court concluded below, that paragraph 13 of the publishing agreement, the assignment provision, forecloses the availability of royalties on the assignment of an entire agreement, such as the software agreement, because that assignment provision does not provide for royalties on the assignment of the publishing agreement itself.  We need not consider whether paragraph 13 precludes a royalty on the transfer of the software
agreement because we conclude that a royalty is unavailable for a more fundamental reason – the assignment of the software agreement to Thompson involved no assignment of rights in the Work. Thus, a royalty is not permitted even under paragraph 7.
        Plaintiffs then filed another litigation, the one that resulted in the appeal that this article discusses, based on the same sale to Thomson by McGraw but this time claiming that the transfer of the agreement with Augusta to Thomson was a royalty event entitling plaintiffs to royalties. More time, expense and uncertainty.  And plaintiffs lost again at the trial court level and lost again on this appeal.

        The Court stated:

In our view, under the software agreement McGraw purchased rights in a computer program created by Augusta that dealt with plaintiffs’ Work but did not establish any rights to the Work.  Thus, the transfer to Thomson of rights and obligations contained within the software agreement was not a transfer of “any right to the Work” authored by plaintiffs and was not a royalty-triggering event under the publishing agreement.  Under the publishing agreement, there is a critical distinction between McGraw’s assigning or transferring a right in the Work and McGraw’s assigning or transferring contracts that facilitate McGraw’s right to publish the Work in the style and manner it deems suitable, here in a digital medium, on CD-ROM. Since the language of the agreements makes clear that McGraw owes no royalties to plaintiffs arising out of the transfer of the software agreement, summary judgment for defendant was appropriate.
        The Court further stated:
Under the software agreement, Augusta was retained to create a program which contained plaintiffs’ Work in CD-ROM format. McGraw acquired the exclusive right to market the Program and promised to publish the Program in CD-ROM format and to provide Augusta with 10% of the proceeds from the sale of any copies of the Program. Pursuant to the software agreement – and the rights and duties created thereby – there was no implicit or explicit transfer of any right to the Work between McGraw and Augusta. Simply put, the software agreement is an outsourcing arrangement for the creation of a different format of the Work. It neither creates nor conveys any rights to the Work itself. The assignment of the software agreement to Thomson transferred the right to market a computer program on CD-ROM that contains the text of the Work, along with tax software and a user’s manual produced by Augusta. The rights in the Work, including the rights to publish and distribute the Work in CD-ROM form, remain tethered to the publishing agreement.
        The Court also said:
Plaintiffs’ interpretation of the software agreement would produce some startling royalty producing scenarios. Under plaintiffs’ view of the publishing agreement, the software agreement itself is a “right[] to the Work.” That view confuses the assignment or transfer of rights in the Work by McGraw with McGraw’s exercise of its rights to produce or print the Work, here in the digital medium. The software agreement clearly constitutes only the latter, providing that McGraw, not Augusta, would publish the CD-ROM. If this nexus between the agreements were interpreted to mandate a royalty in the production context, the authors would have a claim to royalties at two stages of the distribution chain – one at production and a second at the sale of copies of the Work.

This interpretation of the contract ignores not only common sense but also the objective, rational, and reasonable expectations of authors and publishers entering into arms-length agreements to publish works. The publishing agreement provides plaintiffs with an economically viable publisher for the Work with minimal risk and maximum return to them. From McGraw’s  perspective, it acquired the rights to a valuable piece of intellectual property that enjoys considerable recognition in the marketplace. Thus, the parties agreed that upon the sale of copies of the Work or upon the sale of rights to the Work, plaintiffs would receive a royalty. It strains credulity that the transfer of a right to a program that serves as a potential medium for distribution of the Work is the same as the sale of a right to the Work.

        The Court noted in a footnote to the above passage:
At oral argument, Postlewaite seemed to contend that a printing agreement for reproduction of the Work could give rise to royalties to plaintiffs as a transfer of rights in the Work. We reject that contention as contrary to the unambiguous language of the publishing agreement, which expressly provides that McGraw “shall publish the Work at its own expense at such time and in such style and manner . . . as it shall deem suitable . . . .” Publishing Agreement 5
        For related issues, read “Exit Strategies,” “Leverage in Contract and Other Negotiations,” and “Selling Your Publishing (or Other Intellectual Property) Company.”

Conclusion

        Although not in regard to the within case since apparently there was a specific provision but in general, any publishing agreement that does not specifically deal with issues related to the sale of the publisher’s business is leaving the publisher open to just these kinds of costs, expenses, potential damages and uncertainty.  A simple provision can save both sides these problems.

        Unfortunately, in the overwhelming number of instances of publishing agreements that I have seen, such provisions are almost never included.

        As I have said numerous times, it never matters…until it matters…and then it matters!

Copyright © 2005 Ivan Hoffman.  All Rights Reserved.

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This article is not legal advice and is not intended as legal advice.  This article is intended to provide only general, non-specific legal information.  This article is not intended to cover all the issues related to the topic discussed.  The specific facts that apply to your matter may make the outcome different than would be anticipated by you.  This article is based on United States law.  You should consult with an attorney familiar with the issues and the laws of your country.  This article does not create any attorney client relationship and is not a solicitation.

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