A client recently asked me to prepare a cease and desist letter to be sent to his former band members. He was less concerned about the physical assets of the band but more about the intangible assets – the intellectual property – of the band. He was so much into the creative process when the band was formed and never paid attention to the business and legal sides of things. The band only had a two-page partnership agreement with little or nothing protecting him but now he has to go through the painful process of breaking off with his former band members while scrambling to retain control of rights in his contributions to the band’s intellectual property.

The provisions contained in a recording contract with a solo artist will very much apply to the band but instead of having just one artist, there are multiple artists in such contract. Ordinarily, the relationship of the band and the recording label for the exploitation of the band’s mechanical right, or the publishing company for the exploitation of the publishing right, will be governed by the recording agreement and publishing agreement, respectively. Such agreements, depending on how sophisticated the record label or publishing company is, will most likely make provisions applying to the band break up. For example, the agreement may provide for the “key member” concept whereby the withdrawal from the band by the lead artist may lead to the band’s breakup and the end of the recording contract. This may not apply if the drummer or the pianist leaves the group. However, the internal structure of the band as to who gets what share of the royalties or what happens when the band actually breaks up, among others, are often left to the band to determine.

The most important thing to note is that even though the band might have gotten together solely for creative purposes, it is still a business in the eyes of the law. That’s why it’s a “show business”. If there is no proper structure as to the kind of entity formed, the law will infer a partnership even if that is not the intent of the band members. Section 202 (a) of the Revised Uniform Partnership Act (See Section 16101 (9) of the California Corporations Code) defines partnership as “an association of two or more persons to carry on as co-owners a business for profit…” But partnership may sometimes not be the appropriate entity for band members given the partners’ unlimited liability, whereby third parties can attach not just the partnership’s assets but the partners’ assets. Things are a bit different for “limited partnership” where there is one general partner and other limited partners. In this situation, the general partner has unlimited liability and oftentimes it is a corporation which provides limited liability to its shareholders, while the other partner’s liabilities are limited to the amount of their contributions. Since members of a band are natural persons, they will very likely be treated as a “general partnership”.

A better way of ensuring that members are protected against liability and ensuring that their assets are properly held in an entity is to form a corporation or limited liability company (“LLC”). A corporation and a LLC are formed upon filing the necessary document, usually an article of incorporation or organization with the secretary of state. The benefit of forming a corporation or LLC is the limited liability protection it affords its members as their liability is limited to the amount of their contributions to the entity. The other benefit that LLC has over a corporation applies to taxation. As a corporation, its income is taxed at the source and if it makes distribution or pays dividend to its shareholders, the latter also gets taxed thus creating a double taxation scenario. For LLC, there is a pass-through taxation whereby the members of the LLC are taxed on their income drawn from the LLC.

Why create an entity and structure the relationship of band members before a break up happens? Each of the entities discussed above has an agreement which guides the operation of the entity and the relationship of its members. For a partnership, there is a Partnership Agreement. For the corporation, there is a Bylaw and for the LLC, there is an Operating Agreement. Through this agreement, the members are able to determine how their assets and liabilities, operation of the band, its intellectual property rights covering the mechanical, publishing, synchronization, public performance, merchandising, the name, trade name and trademark and right of publicity of each band member will be exploited and how much percentage or interest in the company each member has. The agreement will also provide for the control of the band. Will it be a “majority control” or control by whoever started the band? Will the entity (i.e. the band) continue to exist after a member withdraws from it? Will this lead to dissolution? Can the remaining band members continue the business? How does the band buy out the withdrawing member? Will the buyout apply only to tangible assets? How does the band value those assets? What about the intangible assets like intellectual property? What will happen to the band’s name (which may be its most valuable asset)? Does the withdrawing band member continue to get royalties on licenses of the band’s assets before his/her withdrawal? Does s/he continue to get royalties on merchandising using the band’s name?

These and many issues are what the band members should consider before setting up the band. The band will need an entertainment attorney who understands the issues in the music business in setting up the entity and provides ways of handling them in the organization document. It is advisable that the band consult an attorney not because members anticipate a break up but to cater for it in case it happens.

The Hollywood Reporter reported recently that Tess Gerritsen, the author of the book, “Gravity”, upon which the movie of the same name starring Sandra Bullock and George Clooney and directed by Alfonso Cuaron is based, has just suffered another setback in her case against Warner Bros. You can see the article here. Gerritsen filed the action on April 29, 2014 against Katja Motion Picture Corporation (“Katja”), New Line Productions, Inc. (“New Line”) and Warner Bros Entertainment, Inc. (“WB”) (collectively, “Defendants”) alleging breach of contract and guaranty on the option/purchase agreement entered into in 1999 and that she is owed a portion of the profits from the movie comprising of bonus and profit participation. Gerritsen based her claims on two theories: (i) direct breach; and (ii) indirect or vicarious breach.

The court allowed the defendants’ motion to dismiss the plaintiff’s direct liability claim on the ground that Gerritsen has not shown any connection between WB and Katja/New Line since the former was not party to the agreement. The court held further that the guaranty claim, even though is based on the main contract, is a standalone claim that should be pled separately and since it did not form the original complaint, the plaintiff cannot add it to the amended complaint. The court concluded that the plaintiff has not shown any alternative theory to make WB liable under direct breach. The plaintiff claimed under the second theory of indirect breach that WB is liable (i) as successor-in-interest to Katja and New Line, (ii) as alter ego of Katja and New Line and asked the court to use third party reverse piercing of the corporate veil, and (iii) because Katja and New Line acted as agents of WB which the latter ratified when it took the benefit of the assignment agreement between Katja and Gerritsen and made the movie. Gerritsen based her claim on the consolidation of defendants’ businesses in 2008 shortly after the acquisition of New Line and WB by Time Warner. The court upheld the defendants’ motion to dismiss the plaintiff’s claim mainly on the ground that she has not shown enough evidence or facts to support her claim and that her assertions are conclusory. The court gave Gerritsen an opportunity to amend her complaint for this purpose.

Gerritsen wrote the book, “Gravity” and Katja, the then literary properties acquisition and development arm of New Line, acquired the movie right in the book. Katja developed the film based on the book with New Line and Artists Production Group (“APG”), which is the production affiliate of the management company Artists Management Group (“AMG”), whose clients include Alfonso Cuaron. The project went into development by attaching Cuaron who created the screenplay for the movie. Gerritsen claimed that she assisted with the screenplay by adding additional scenes. In 2009, Cuaron with his son working on the movie, allegedly granted all rights in the Cuaron Gravity Project to WB which produced and distributed the film.

It is not unusual in the development and production process of a movie to have different assignment of rights from a production company or studio to another. This oftentimes occurs in independent film productions where the producer, in sourcing development and production finance, has had to assign rights acquired through the literary right option/acquisition agreement to the finance company, a bigger production company or studio. While it is normally expected during negotiation of the finance, production and/or distribution deals that the assignment of the movie rights to a book from the producer to the finance company, studio or distributor does not absolve the producer from its obligation as it may still be secondarily liable, there is also the presumption of law that assignment to and acquisition of benefits of a contract by an assignee also come with its obligation. See sections 1589 and 3521 of the California Civil Code. These obligations may include without limitation payment of bonuses and profit participation, according credit, honoring the reserved and/or frozen rights and other obligations in the agreement. Many production finance and distribution agreements will address these obligations by either acknowledging them and making sure that they take priority over any investment return or payment of loan plus interest; or pass the obligation along to the assignee or licensee of the movie distribution rights in making sure that any bonuses and profit participation payments are made by the distributor to be recouped as distribution expenses. The fact that these issues may not have been clearly spelled out in the option/acquisition deal may be one of the problems affecting Gerritsen’s claims.

Let’s take a look at a typical “right to assign” clause in an option/acquisition agreement. Given the entertainment industry’s response to the case of Gardner v. Nike Inc., 279 F. 3d 774 (2002) in which the court held that unless expressly stated in the contract, the assignee cannot license or assign the right granted under the agreement, you will often find the following clause “right to assign” in option/acquisition agreements:

Right To Assign. Company shall be free to sell, assign, license, mortgage, encumber or otherwise transfer this Agreement and its rights hereunder, and/or to delegate any or all of its duties hereunder at any time and from time to time to any person or entity. Upon such assignment of this Agreement, Company shall be released and discharged of and from any and all of its duties, obligations and liabilities arising under this Agreement if such assignment is to: (i) a person or entity into which Company merges or is consolidated or (ii) a person or entity which acquires all or substantially all of Company’s business and assets or (iii) a person or entity which is controlled by, under common control with, or controls Company or (iv) any major or “mini-major” motion picture company, United States television network or affiliates of such entities or (v) a person or entity who supplies a substantial amount of Company’s motion picture financing or financing for any Production produced hereunder or (vi) other financially responsible party who assumes in writing the performance and obligations of Company hereunder to be performed from and after such assignment. Owner may not assign this Agreement or Owner’s rights hereunder, or delegate Owner’s duties under this Agreement in whole or in part.”

Although the above clause allows the assignee of movie rights to assign their right and be released and discharged from all obligations and liabilities arising under the agreement if such assignment is made to any of the entities listed in the clause, it does not address where such assignment is only an “asset sale” (thus excluding liability or obligation under the agreement) or any instance whereby the assignee, like in the Gravity case, can claim that even though there is a combination of the businesses between the original assignee of the movie right and the second assignee, there is no evidence to show that any obligation or liability flows from the original assignee to the second assignee. It is very likely that Gerritsen will be able to supply more evidence to show that in proving the chain of title of the movie either while getting financing or distribution through the in-house process of WB, there were some documentation or agreements that transfer the rights and obligations under the option/acquisition agreement from Katja/New Line to WB. There is no doubt that Katja was the development arm of New Line and most option/acquisition deals of New Line were done through Katja. It may also not be difficult to get documents through discovery to show that upon consolidation of New Line with WB, there were documentation and agreements flowing from New Line to WB even though WB got an assignment of the screenplay from Cuaron. Note that Cuaron’s screenplay is a derivative work of Territsen’s book, the subject of the option/acquisition deal.

Apart from the issue in the ‘Gravity’ case, there may be an instance where upon assignment of the option/purchase agreement, the producer/original assignee jets into sunset and is no longer involved in the production of the movie. It is therefore important that in that case, the author will want to make sure that s/he is a part of the film making process to ensure that the assignee’s now transferred obligations are honored. So, how does the author or any copyright owner in an option/acquisition deal anticipate these issues and address them during negotiation of the agreement? Firstly, the original assignee must be secondarily liable for its obligation under the contract in spite of the assignment to the third party. Such clause will likely be drafted as follows:

Assignment: Purchaser shall have the right to assign any or all of its rights under this Agreement to any person, and upon such assignment Purchaser shall have no further obligations to Owner hereunder; provided that Purchaser shall remain secondarily liable for all of its obligations.” [underline mine].

The other option (perhaps a supplementary one) is for the author or copyright owner to state in the agreement that all assignment of right by the original assignee shall be invalid except the author’s consent is obtained and that such assignment shall have the effect of an assignment of rights as well as the obligations and liabilities of the original assignee under the contract, provided however that the original assignee shall remain secondarily liable for all of its obligations. The aim of this option is to ensure that the author is involved in the film making process in order to ensure that all obligations due to him or her are honored. Such assignment must anticipate all kinds of assignment including direct or indirect one which may be inferred from consolidation or merger and acquisition. This clause may be drafted as follows:

Assignment (or Right to Assign): Company shall have the right to assign any or all of its rights under this Agreement to any person provided that Author’s consent is first had and obtained. Any such assignment shall have the effect of an assignment of rights as well as the obligations and liabilities of the Company hereunder; provided, however, that the Company shall remain secondarily liable for all of its obligations and liabilities under this Agreement.”

While we await how this plays out in court as Gerritsen makes another attempt in her case, rights owner should carefully consider and have their attorneys review the “right to assign” clauses in their option/acquisition deals to avoid a similar situation in the future.