Participants in entertainment projects that are ensnared in litigation face potential personal liability under a variety of statutes and common law
By David J. Myers
David J. Myers specializes in business and entertainment litigation. He was defense counsel prior to trial in Kidron v. Movie Acquisition Corporation.
Irving Berlin's legendary anthem still says it best: there's no business like show business. Few if any other industries offer the glamour, fame, and fortune, or comparable opportunities for creativity and individuality. Along with the benefits, however, come a number of vagaries.
Multimillion-dollar transactions are routinely conducted based on deal memos that lack sufficient documentation or even signatures, a practice that inexorably leads to considerable uncertainty about the determination of rights. Ideas are pirated. Accounting practices often defy comprehension, with profit participations in even the most successful projects somehow being circumvented.
No matter what type of conflict emerges, aggrieved parties often seek alternate, deep pocket sources of recovery, perhaps in response to a party's potential or actual financial instability, or maybe as a form of leverage to encourage an adversary to throw in the towel. For deal participants, the potential to become embroiled in litigation, even for those seemingly without fault, is significant. Concluding that the risks are remote, the exposure minimal, or that a brewing controversy is someone else's problem, could not be more wrong.
The danger of liability may seem less significant in contract claims, or when settlement appears likely, or in claims against financially viable parties. However, a participant's potential exposure should never be discounted if tort remedies also are available-and they usually are. Settlements frequently are less likely than they may first appear and can fall through for seemingly unimportant differences. As for financial viability, joint tortfeasors will find that collectibility is no guarantee against someday having their own opportunity to explain to a jury why they should not be punished.
Remedies for claims of wrongdoing in the entertainment industry usually are available under collective bargaining agreements, federal copyright law, the Lanham Act, and other federal statutes. Plaintiffs' counsel, however, often seek to forego federal claims in favor of state law claims.
The choice to avoid federal jurisdiction is based on the perceived benefits of California state law over federal law, including the likelihood of arguing a claim before a jury because summary judgment motions are more difficult to obtain in California courts than in federal courts. Also, juries in California state courts consist of 12 members (versus 6 in federal court), and agreement among only 9 jurors will support a verdict (versus the requirement of unanimity in federal court). Perhaps most significantly, punitive damages are perceived to be potentially greater in value than the statutory remedies available under federal law. Beyond the issue of preferred jurisdiction, however, the likelihood is great that California law will govern the scope of available relief in an entertainment dispute, even if a claim is brought in a federal court or another state's court, given the amount of entertainment business that is (and arguably could be) subject to California law.
There are numerous sources of potential exposure under California law for participants involved in entertainment projects that are mired in claims of misconduct:
Until a recent series of decisions by California's appellate courts, transaction participants-such as financiers, producers, distributors, and even talent-could only speculate about the consequences of their involvement in any project that could possibly face future claims of wrongdoing, such as assertions that the project was based on stolen or fraudulently acquired rights. By establishing several limitations that, if applicable, can shelter a participant from liability for the misconduct of others, courts now can offer some guidance and comfort.
- A participant is jointly and severally responsible for the liabilities of a partnership or joint venture.1
- A participant may be jointly and severally liable under contract law, statute, or equity based on principles of agency, trust, guaranty, indemnity, or alter ego.2
- Any person or entity that comes into possession of wrongfully acquired property may be required, as a constructive trustee, to return the property to its rightful owner, regardless of culpability.3 A participant thus could be required to disgorge the very assets acquired by the participation.
- An entire investment can be lost or tied up in litigation if the project is frustrated by an injunction.4
- A participant also could face tort damages, both directly and vicariously as a "coconspirator" or "aider-abettor."5 Even if innocent of wrongdoing, a participant may risk potentially devastating litigation by being included in a project that is confronted with a claim of misconduct.
Applying the new protections successfully, however, may be an uncertain enterprise in itself. Nevertheless, potential participants in entertainment projects have new, albeit limited, tools to measure the predictability of the risk of signing on to a project-and potential claimants can use the same tools to avoid insupportable lawsuits, potential sanctions, and malicious prosecution claims.
The Conspiracy Risk
No case better illustrates the potential problems confronting participants in a project clouded by accusations than Kidron v. Movie Acquisition Corporation.6 The published portion of the decision affirmed a judgment of nonsuit in favor of one participant, but the unpublished portions of the decision reversed judgments in excess of $50 million against various parties involved in the production and distribution of a television series. These parties were held liable merely because they participated in the series after receiving notice of the plaintiff's claims of wrongdoing against the series producer.
The case involved a dispute between a television producer and the producer's joint venture partner, the purported creator of the concept for the series, who alleged that the producer fraudulently acquired the rights to his concept. When the dispute could not be resolved, all the primary participants in the series-the financiers, distributors, broadcasters, production executives, and the writer-were sued along with the producer as coconspirators in the producer's alleged fraud and breaches of fiduciary duty, even though the participants either were already under contract or were allowed to participate in the series without the claimant's objection.
After extensive litigation (in which, luckily for individual defendants, the producer provided a defense), the participants who were contractually committed to the series before receiving notice of the claims obtained summary judgment or voluntary dismissal before trial. However, all the postnotice participants were forced to endure a lengthy trial and, in many cases, they sustained adverse judgments.
Fortunately for future potential defendants, the Kidron court set forth several strict requirements for claims that depend upon proof of a conspiracy. First, the court clarified that no conspiratorial agreement-in other words, no agreement to injure-can exist without the requisite intent both to commit an act and to injure. Therefore, the court held that proof of intentional participation in wrongdoing, without proof of participation with the intent to injure the claimant, was legally insufficient to implicate the participants.
Second, for plaintiffs to establish the required conspiratorial agreement, the court required proof that the defendants had actual knowledge of wrongdoing-as opposed to knowledge of a claim of wrongdoing-before the completion of the underlying tort, which the court held occurred at the time of the acquisition of rights. Absent such evidence, the court refused to impose a duty of inquiry upon potential participants, who do not have the responsibility or means to investigate or police relationships between third parties.
Third, in barring the plaintiffs' attempt to implicate the participants in the producer's alleged breaches of fiduciary duty, the Kidron court relied on Applied Equipment Corporation v. Litton Saudi-Arabia, Ltd.7 and held that, as a matter of law, a cause of action could not be stated against a nonfiduciary for conspiracy to breach a fiduciary duty.
Not withstanding these limitations on liability, reliance on Kidron should be guarded for a host of reasons. Intent, for example, is generally a question of fact, and questions of fact are generally resolved by trials. Also, a seemingly completed tort may actually be a continuing tort, and thus a conspiracy could exist based on later-acquired knowledge. Moreover, the distinction between a "claim" of wrongdoing and "evidence" of wrongdoing can be less than clear, which could lead to a finding that the knowledge of certain facts is sufficient to impart actual knowledge of wrongdoing. In addition, another court could impute knowledge of wrongdoing to a participant who turns a blind eye to circumstances that impart constructive notice or are sufficiently suspicious to create a duty of inquiry.
Kidron also fails to reach issues such as the dangerous possibility that constructive or inquiry knowledge may be sufficient to support liability if the participant's conduct is independently actionable based on that knowledge. The relationships between the parties also may be sufficient to create an independent duty between a claimant and a third-party participant that could lead, in turn, to a direct right of action against a participant. Even more troubling, the seemingly resolved question of whether a nonfiduciary can be implicated in a breach of trust has recently been reopened.8
The Direct Liability Risk
A subsequent case, Recorded Picture [Productions] Company, Ltd. v. Nelson Entertainment, Inc.,9 underscores the concerns that remain after Kidron. In Nelson, a movie producer sued a subdistributor, among others, for conversion of 20 percent of the revenues generated by the subdistributor. The subdistributor had retained the money pursuant to its contract with the master distributor-a contract that provided for a 50/50 revenue split. The producer claimed that the subdistribution agreement was subject to the 70/30 split contained in the master distribution agreement, and that the subdistributor had constructive or inquiry notice of the 70/30 split. The master agreement was referenced in a recorded UCC-1 filing, but the 70/30 split was not. An added complication existed: the master distributor was bankrupt. The producer thus had no other recourse than to pursue the subdistributor but, conversely, a decision in the producer's favor would leave the subdistributor uncompensated. Nevertheless, the court refused to allow the conversion claim against the subdistributor based on the subdistributor's lack of actual or constructive notice not only of the terms of the master agreement but also of anything suspicious that would invoke a duty of inquiry.
Although the producer in Nelson was unable to demonstrate knowledge on the part of participants of sufficient facts to establish actual or constructive notice of the producer's rights, under the Nelson ruling, constructive or inquiry notice of wrongdoing may be sufficient to support liability if the challenged conduct is independently actionable based on such knowledge. A participant in a claimed wrongful enterprise thus may incur tort liability based on constructive or inquiry notice when, for example, a claimed defect in title (not subject to federal copyright law) is brought to a participant's attention, and the participant fails to verify the chain of title or continues to exploit the asset without regard to the claim. Although the participant may be insulated from conspiracy liability, the participant's own conduct may constitute actionable conversion if the participant knew or should have known of the defect and nonetheless continued to exploit the property.
Counsel should note that the question of the sufficiency of circumstances to create a duty of inquiry is itself a factual question. Therefore, although the Nelson court did not find sufficiently suspicious circumstances to justify inquiry into the master distribution agreement, a court could impute knowledge of the contents of a document that is referenced in a recorded document, or other reasonably ascertainable facts.10
Last year's decision in City of Atascadero v. Merrill Lynch, et al.11 further highlights the risks that remain after Kidron. In Merrill Lynch, a number of municipalities that had entrusted funds to the now infamous Orange County investment pool-and then refused to participate in a contingent bankruptcy court settlement-sought to recover approximately $400 million in losses against the county's investment adviser. Their claim was based on alleged misrepresentations contained in investment materials prepared by the adviser, along with breaches of fiduciary duty in the handling of the trust's assets.
Merrill Lynch successfully challenged the complaint on the grounds that the municipalities, as trust beneficiaries, lacked standing to assert the alleged wrongs, and that the exclusive remedy belonged to the county, as trustee and real party in interest. However, relying on longstanding trust principles, the court of appeal reversed the judgment, holding that the municipalities, as equitable interest holders, had a direct right of action against Merrill Lynch based on the company's active participation in the making of the alleged misrepresentations, "independent of any duties owed by Merrill Lynch to the trust."12
The court also held that the municipalities could pursue claims against Merrill Lynch as a coconspirator and aider-abettor in the county's breaches of fiduciary duty, and in so doing rejected Litton's and Kidron's absolute prohibition of a cause of action for conspiracy by a nonfiduciary in a breach of trust. Instead, relying on Pierce v. Lyman13 and Doctors' Company v. Superior Court,14 the Merrill Lynch court held that an action may be maintained against nonfiduciaries that actively participate in a fiduciary's breach of trust "for the purpose of advancing their own interests or economic advantage."15
Moreover, applying trust principles, the court held that liability may be imposed on nonfiduciary participants in a breach of trust if they knew or should have known that they were assisting the breach of trust-i.e., if they had actual or constructive knowledge. 16 As a result, Kidron's protections appear, at minimum, to be limited to nontrust situations, and thus potential participants would appear to have a duty of inquiry with regard to the handling of trust assets. Under Merrill Lynch, breach of trust claims must be investigated, and care must be exercised not to participate in potential breaches of trust to the extent the participation is for personal benefit.
However, in cases that do not involve breach of trust claims or participation in an alleged breach of trust, Kidron would still appear to be good law and thus its protections remain. Presumably, outside of the trust context, liability will depend upon proof of 1) actual knowledge of wrongdoing, and 2) the sufficiency of the known facts to constitute the required knowledge.
The Aider-Abettor Risk
Like conspiracy, an aider-abettor claim is a means to impose vicarious liability upon a third party for participation in a wrongful enterprise. Unlike civil conspiracy, aider-abettor liability does not require proof of an agreement to injure and is based on conduct occurring after the completion of the underlying wrong.17
Aider-abettor liability thus could be imposed on a participant in a wrongful enterprise that could not be implicated in a conspiracy because of the timing of the participation or the unavailability of proof of an agreement to injure. Saunders v. Superior Court, a 1994 case, offers the most recent articulation of the aider-abettor test: a participant is liable as an aider-abettor if the participant gives 1) substantial assistance or encouragement to actions known to constitute a breach of duty, or 2) substantial assistance to another in accomplishing a tortious result when the participant's own conduct, separately considered, constitutes a breach of duty to the third person.18
Under Saunders, aider-abettor liability may be broader than conspiracy liability to the extent that participation in furtherance of a breach of duty that is not owed by a participant can support liability, even though a claim for conspiracy to breach another's fiduciary duty is not allowed. Such a distinction has been rejected by the bankruptcy court overseeing claims arising from the Orange County bankruptcy,19 but in light of the Merrill Lynch decision, that conclusion is now subject to dispute regarding its applicability to breach of trust claims. Similarly, while there is no apparent basis to conclude that a lesser degree of knowledge is required to support an aider-abettor claim as opposed to a conspiracy claim, Merrill Lynch suggests-again, at least with regard to breach of trust claims-that both conspiracy and aider-abettor claims may be subject to proof of actual or constructive knowledge of wrongdoing.
In the absence of a claim of participation in a breach of trust, however, aider-abettor liability would still appear to be contingent upon proof of knowledge of wrongdoing and would only apply upon resolution of the same questions applicable to conspiracy regarding the sufficiency of the known facts to impart the required actual knowledge.
A prominent entertainment attorney once remarked that the best deals he ever made were often the deals that he never made. Differentiating the worthwhile deals from the unduly risky deals is important-and so are the steps that can be taken to protect a client's interests if a decision is made to proceed with a project notwithstanding the existence of a claim of wrongdoing. Being forewarned and forearmed is well worth the expense.
1 Corp. Code §15004.
2 Civ. Code §2339 (agency), Prob. Code §§18000 et seq. (trust), Civ. Code §§2787-2856 (guaranty), Civ. Code §§2772-84.5 and Code Civ. Proc. §§875-83 (indemnity), Assoc. Vendors, Inc. v. Oakland Meat Co., 210 Cal. App. 2d 825 (1962) (alter ego).
3 Civ. Code §§2223-24.
4 Civ. Code §526. A project could similarly be frustrated by bankruptcy. A bankruptcy court could order return of compensation that is determined to be a preference, thus potentially depriving or significantly impairing the benefits of participation in a project. 11 U.S.C. §547.
5 See text, infra.
6 Kidron v. Movie Acquisition Corp., 40 Cal. App. 4th 1571 (1995).
7 Applied Equipment Corp. v. Litton Saudi-Arabia, Ltd., 7 Cal. 4th 503, 508 (1994).
8 See City of Atascadero v. Merrill Lynch, et al., 68 Cal. App. 4th 445, 80 Cal. Rptr. 2d 329, 1998 Cal. App. LEXIS 1014, 98 C.D.O.S. 8971, 98 Daily Journal D.A.R. 12529 (1st Dist. 1998), modified and reh'g denied, 99 Daily Journal D.A.R. 231 (Cal. App. 1st Dist. 1999).
9 Recorded Picture [Productions] Company, Ltd. v. Nelson Entertainment, Inc., 53 Cal. App. 4th 350, 365-67 (1997).
10 Triple A Management Co. v. Frisone, 81 Cal. Rptr. 2d 669, 1999 Cal. App. LEXIS 55, 99 C.D.O.S. 721, 99 Daily Journal D.A.R. 857 (Cal. App. 1st Dist. 1999). See also Bank One Texas v. Pollack, 24 Cal. App. 4th 973, 981-82 (1994).
11 Merrill Lynch, 68 Cal. App. 4th 445, modified and reh'g denied, 99 Daily Journal D.A.R. 231.
13 Pierce v. Lyman, 1 Cal. App. 4th 1093, 1104-06 (1991).
14 Doctors' Co. v. Superior Court, 49 Cal. 3d 39, 46-47 (1989).
15 Merrill Lynch, 68 Cal. App. 4th 445, modified and reh'g denied, 99 Daily Journal D.A.R. 231.
17 Janken v. GM Hughes Electronics, 46 Cal. App. 4th 55, 78 (1996).
18 Saunders v. Superior Court, 27 Cal. App. 4th 832, 846 (1994).
19 In re County of Orange, 203 B.R. 983, 997-1000 (C.D. Cal. 1996).