At last I’ve had a chance to go through the various documents that have piled up this summer in the lawsuit by the Tolkien Trust against New Line Cinema. I first summarized the suit on February 18 and followed that up on April 21. Here I’ll try to lay out the highlights of what has happened since then, month by month. Earlier this year I was hopeful that we would see a settlement in the case this summer, but that was obviously overly optimistic.

I don’t want to interpret these documents or make a case for either side as being in the right. I simply offer some thoughts that I hope will be useful to fans in following what is going on.

The term “Demurrer” gets used a lot. It’s basically a traditional term for a motion to dismiss for failure to state a claim adequately. That is, even if the information given in the complaint is true, there’s a legal defect in the way the plaintiff’s pleading has been stated.

May

On May 14, New Line’s filed its Demurrer in response to the Tolkien Trust’s initial February 11 Complaint. That Complaint’s main claims were that New Line had breached its contract with the Trust and had defrauded it. The Trust requested that a punitive measure be taken, with the court affirming the Trust’s right to terminate New Line’s rights to produce and distribute any further films based on Tolkien’s work

A breach of contract might be inadvertent or arise from a disagreement on the terms of the contract, whereas fraud would involve doing something dishonest with an intention to deceive. Fraud would open the defendant to being liable for greater damages. New Line claims that the Plaintiffs have not established a basis for a fraud charge, even though all the information in the complaint may be true. The studio requests that that portion of the Complaint, along with the request for the punitive measures, should be dismissed. Although New Line asks for the fraud charges to be dismissed, it doesn’t oppose the breach of contract charges (though it may well deny having breached the contract).

The original Complaint also claimed that New Line had a fiduciary duty to protect the Tolkien Estate’s money. (A fiduciary duty goes beyond ordinary duty, e.g., a bank has a greater duty to manage your money well than a business partner would.) New Line claims that it did not have such a heightened duty.

Finally, New Line also argues that demands for punitive damages should simultaneously be dropped from the Complaint, since they are based entirely on the fraud claims, not the breach of contract ones. The punitive damages included the right for the Tolkien Estate potentially to rescind New Line’s right to make The Hobbit into a film.

On May 22, each side in the case filed a Case Management Statement. These are required and deal with such issues as the anticipated schedule for the case, e.g., how long the trial is likely to take. That length is given in both statements as 15-20 days.

The sides must declare whether they are willing to participate in alternative dispute resolution. Both parties did express a willingness to engage in mediation. A Mandatory Settlement Conference is currently set for October 9, 2009. The judge or her representative might take part in this, but it’s optional. Of course, the sides may meet for negotiations at any earlier time they might agree on.

The statements also estimate how long each side anticipates the discovery phase (that is, the gathering of evidence) will take. New Line estimates it can complete discovery around September of 2009. The Plaintiffs give December 31, 2008 as the end date. This isn’t surprising, since the Plaintiffs knew all this was coming, and they gathered much of their evidence in order to lodge the complaint. More importantly, the Plaintiffs stand to gain something, so they would presumably wish the case to be resolved quickly. New Line has a lot of material to go through, and typically a defendant wants to put off that resolution, especially if it involves payment.

June

On June 6 a Case Management Conference was held. We don’t know much about what went on there, though a trial date of October 19, 2009 was set. That date is scheduled in accord with the length of time New Line needs for discovery. The court might be put off if one or both of the sides requests it. If the parties agree on a settlement between now and then, the trial will not take place.

On June 11, the “Tolkien Plaintiffs” filed an Opposition to New Line’s Demurrer, with the publishers in the case filing a parallel Opposition. The contents are the Plaintiffs’ arguments for the judge not to sustain the Demurrer.

(On June 14, Douglas C. Kane, a California lawyer and regular contributor to TheOneRing.net, posted a lengthy summary of the case to that point and has followed up on the message boards as each major new development has occurred.)

New Line responded on June 17 by filing a Memorandum supporting the Demurrer. This fell into two sections. First, “Plaintiffs’ Cause of Action for Breach of Fiduciary Duty Fails Because Plaintiffs Allege No Special Relationship Arising from an Enduring Relation.” That is, the original contracts are nearly 40 years old, and yet New Line has held the production and distribution rights for only about ten; hence it has no “Special Relationship” with the Plaintiffs that would imply a fiduciary duty to them.

Second, “Plaintiffs Allege No Fraud Distinct from Any Contractual Breach, and Allege No Detrimental Reliance.”

These were pretty much the same arguments made in the original Demurrer.

Lawyers for the two sides met with the judge in the case, the Hon. Ann I. Jones, on June 24. She sustained New Line’s Demurrer. A document filed on August 4, “Declaration of Eric P. Tuttle in Support of Demurrer to First Amended Complaint,” contains a transcript of this meeting. One complication in this case is that it is taking place in California, and yet the contracts are governed by the laws of the state of New York. The reason for this is that United Artists, the studio that originally bought the adaptation rights from J. R. R. Tolkien and his publisher George Allen & Unwin, had its corporate headquarters in New York City. Some of the discussion during the June 24 meeting involves how New York law would apply in the case

The judge agrees with New Line that the Plaintiffs have not established their allegation of fraud. She says to the Plaintiffs lawyers, “Basically what you are complaining about is their impermissible or improper calculations on the participation agreement. Without more, that’s a breach of contract” (p. 15) A little later she lays out that point more fully to Bonnie Eskenazi, one of the Plaintiffs’ lawyers:

The Court: So they do three things wrong. They underreport the revenues, they overreport the costs, and they assign charges to the film that weren’t in fact properly charged?

Ms. Eskenazi: Essentially, that’s correct. So, for example—

The Court: That is not embezzlement separate and distinct from breach of contract. That is that you and they disagree as to what they are entitled to take. There is absolutely nothing in that paragraph that suggests that they invented numbers, they charged their laundry, they—I mean, if that’s what you think they did, you need to say it.

To establish a case for fraud based on excessive charging of expenses to the Trilogy’s budget would require specific allegations of such charges. The judge gives the Plaintiffs 20 days to file a revised complaint.

(Kane’s June 29 discussion of these developments is here.)

July

Exactly 20 days later, on July 14, The Plaintiffs file a First Amended Complaint, still alleging fraud in addition to breach of contract and offering more specific claims and information concerning items allegedly fraudulent charged by New Line against the Trilogy’s budget. (Announcing this news on TORN, Kane predicted that New Line would file another Demurrer and opined that there was a 50/50 chance that the judge would sustain it as well.)

The new Complaint does not back down on any of the original allegations, but simply adds more information to sustain them. The Plaintiffs still request punitive damages from New Line if the Trust wins the lawsuit.

On July 22, an order gave New Line an extension of the deadline for responding to the new Complaint. On July 23, a summary of the case listed a Status Conference as scheduled for December 8, 2008.

August

August 4 saw a batch of documents filed by New Line, starting with its Demurrer to the First Amended Complaint. Again the main argument is that the new support provided for a fraud accusation is inadequate. The date set for the meeting at which the judge will decide whether to sustain this Demurrer is September 22—which, as many have noted, happens to be Bilbo and Frodo’s mutual birthday.

Both sides may take the next month to do some discovery while waiting for the meeting. It is possible that the material that comes out of the discovery would lead New Line to request summary judgment. That is, there might be no mystery or disagreement about who did what when, but only whether those actions breached the law. That decision would lie with a judge, not a jury, and her decision could be made without the case going to court.

Another document, a “Request for Judicial Notice in support of Demurrer & Declarations of Eric P. Tuttle and Angela Clare in Support thereof,” contains two exhibits, A and B: the two original July 8, 1969 contracts that sold the production and distribution rights of The Hobbit and The Lord of the Rings to United Artists. These documents have never been available to the public before, so this filing was a major development for those of us interested in this particular case and in the more general history of the film rights to Tolkien’s novels.

Why do the contracts show up in this particular document? The introductory portion states, “Where plaintiffs reference and rely upon a contract in their complaint without attaching it, a defendant is entitled on demurrer to present the court with the complete document.” The “Request for Judicial Notice” simply asks that the court consider the actual language of the contracts. New Line is not at this point offering its own interpretation of that language.

Some Comments on the Contracts

I’m not a lawyer, but I do know something about how the film industry works. I’ll try to clarify the contracts as I understand them.

There are two contracts because it was decided back into the late 1960s that George Allen & Unwin would sell the rights for The Hobbit and The Two Towers to United Artists, and that the Sassoon Trustee and Executor Corporation would sell the rights for The Fellowship of the Ring and The Return of the King. It’s not clear why this was done. The two contracts are similar, often word-for-word the same for several paragraphs on end.

The 1969 deal was unusual in a number of ways. First, as Rachel Abramowitz points out in an informative piece published in the Los Angeles Times on July 2, it is atypical for an author to receive a percentage of the income from films adapted from his or her writings. That Tolkien could receive a 7.5% share of gross receipts (minus costs) was exceptional. On the other hand, the deal had one peculiarity that worked against the author and later his estate: it signed away the film rights in perpetuity. Ordinarily film rights would be sold for a limited number of years and would ordinarily eventually revert to the previous owner if no film project emerged within a certain time period. Perpetual rights have meant that the owners could sell them to other companies. As the rights changed hands over the years, from U.A. to Saul Zaentz to Miramax to New Line, the provisions of the original contract were binding on each new owner.

One of the consequences of the rights being sold permanently has been that the film industry has, not surprisingly, changed over the decades since the contracts were formulated. The authors of the contracts were careful to try and anticipate changes by using the sort of broad, inclusive language that is common in such texts. Still, I suspect that some of the complexities of the current lawsuit come from differing views of the contracts by each side, based on new practices in the film industry.

I’ll be commenting specifically on the George Allen & Unwin (GAU) contract, though referring occasionally to the second, “Sassoon” contract. The “Seller” referred to the in former is GAU, the Purchaser is United Artists, though as I’ve just said, the term now in effect applies to New Line. The Writer, of course, is Tolkien.

1. Sequels and Adaptations. Given that Peter Jackson’s team has decided to make a bridging “Film 2” that takes place between the action of The Hobbit and The Lord of the Rings, it’s interesting to note that the contract explicitly gives the Purchaser considerable scope for doing so. This is a fairly long clause, but I’ll give most of it, because it’s clearly important for the current situation:

The sole and exclusive right in connection with the making, exhibition and exploitation of said motion picture photoplays to translate into all languages, to freely adapt, change, transpose, revise, rearrange, add to and subtract from the Work or any part thereof and the title, theme, plot, sequences, incidents and characterizations thereof, to make interpolations in and substitutions for any part of [sic] parts thereof, to make sequels to and new versions or adaptations of the Work or of the theme thereof or any incidents, characters, character names, scenes, sequences or characterizations therein contained in conjunction with any other work or works, and to separately or cumulatively do any or all of the foregoing, to such extent as the Purchaser, in its sold discretion may deem expedient in the exercise of any of the rights, licenses or privileges herein conveyed and to interpolate in said motion picture photoplays music compositions, gags, lyrics and music of all kinds, to set to music any verse, lyric, prose or part or parts of the Work and any characters thereof. (p. 4)

The clause goes on to give the Purchaser the rights to copyright and exploit all this new material in its own name.

Of course, none of this implies that Tolkien or his heirs would approve of all these changes or sequels, but nevertheless the Purchaser gained the rights to create them

2. Licensed tie-in products. In the 1960s, the licensed action toys, clothes, games, and so on were not nearly such a major source of income for the studios as they are now. Franchise ancillaries really became a big deal through home video and through George Lucas’ brilliant exploitation of the licensed products for Star Wars in 1977.

Even so, the GAU contract deals with such ancillaries and turns over considerable rights concerning them to the Purchaser:

The right to use and exploit and to license others to use and exploit all commercial tie-ups of any sort or nature arising out of or connected with said motion picture photoplays and/or the title or titles thereof and/or the characters thereof and/or their names and their characteristics provided, however, that Purchaser shall have no right to use Author’s name in such commercial tie-ups nor shall any indication be made in such commercial tie-ups that Author endorses any commercial product. (p. 9)

This clause reserves the right for the Seller to create such tie-in products in relation to the published books. GAU and the various companies that have evolved from it have continued to make such products, notably the calendars that appear each year.

I don’t know but I would guess that this clause is what allowed Saul Zaentz to claim the extensive number of Middle-earth trademarks that he still controls. Presumably those rights were not passed along in the contract that transferred the film-production rights to Miramax. Hence all the references to Zaentz and his Tolkien Enterprises stamped or printed on every licensed product generated by the films.

Substantial portions of the contracts are devoted to the ancillary products. They specify that 9% of New Line’s gross receipts from those products will go to the Sellers. I won’t go into detail on this point, since the information would not mean much unless we knew the terms of New Line’s deals with its various licensees. To cut to the chase, the Plaintiffs contend that New Line has not reported its full income on the ancillaries, especially the DVDs.

3. Up-front payments. Flat sums were to be paid up front (though spread out over about four years). For TTT, the total is $83,333.33. For the U.S. rights for FOTR and ROTK, $88,333.33 and for the rest of the world, $78,333.33. These add up to $250,000. That seems a low sum, though adjusted for inflation, the modern equivalent is about $1.5 million. This money would be paid regardless of whether a film adaptation was commenced. Another clause specifies that if a sequel (e.g., “Film 2”) is made, a flat fee of $20,833.33 will be paid “at or prior to the commencement of principal photography.” I can’t find a reference to adjusting for inflation in the contract, so presumably these original sums is still valid.

For years Tolkien scholars and fans have assumed that these up-front fees were all that Tolkien and his publisher received for the film rights. Even adjusted for inflation, the sums are small for such a valuable property. But Tolkien’s team was not as naive as many have assumed. The contract also contained that provision for 7.5% of gross receipts, minus expenses, to be paid as well. That percentage also applied to any potential sequel (see number 4, below).

Schedule B of the contract states that if The Hobbit is made into a separate film, a fee of $125,000 must “be paid within ten (10) days after the commencement of principal photography.” The 7.5% of gross receipts figure would apply to that film as well.

4. Adaptation rights to Tolkien sequels. Much has been made of the fact that any material that might go into “Film 2” would have to be derived directly from material in The Hobbit and LOTR. New Line does not own the rights to any other books or stories by Tolkien.

Naturally some of these other works are quite relevant. The posthumously published Unfinished Tales includes material on Gandalf, Saruman, and the Black Riders during roughly the period when Gandalf was imprisoned on Orthanc’s roof. “The Quest of Erebor,” in effect a short story that Tolkien was forced to cut from the appendices to LOTR for length reasons (and first published in its entirety in the second edition of Douglas Anderson’s The Annotated Hobbit), shows Gandalf recounting his dealings with the dwarves who figure so prominently in The Hobbit and his decision to send Bilbo along with them on their expedition to kill Smaug. Some of that material could make a nice pre-credits prologue for The Hobbit.

One clause in the GAU contract has some bearing on this issue, though it might never have any practical effect. It commits the publisher to offer the first option to purchase adaptation rights on any sequel:

The Seller reserves the right to authorize and license others to write and publish sequels (as that term is hereinafter defined) subject to the terms and conditions contained in this paragraph 14. The term “sequel” shall be construed to mean a play, novel, short story, novella, or other literary work, written or published subsequent to the date of this agreement, containing any character or characters who have been portrayed in the Work, and in which sequel they are portrayed or participate in similar or different incidents, situations, settings and events to or from those in the Work. Seller agrees that it will not sell, license or otherwise dispose of any of the right to such sequel as have been granted to the Purchaser hereunder with respect to the Work, unless Seller shall have given to the Purchaser the option, on forty-five (45) days prior written notice, to acquire such rights upon the terms and conditions (which shall be set forth at length in such notice) of any bona fide offer received by the Seller for such rights.

This clause seems somewhat unclear, since it doesn’t specific whether the “others” whom the publisher might authorize and license to write sequels include Tolkien himself. And do posthumously published, incomplete works count as sequels?

Even if the answers were yes and yes, such a provision presumably would be irrelevant unless the Tolkien Estate were to seek to sell the film adaptation rights to the Unfinished Tales or “The Quest of Erebor” or any other texts by Tolkien relating to The Hobbit or The Lord of the Rings. Presumably if they did, the contract might require them to give New Line the first opportunity to purchase those rights. Conceivably, if a settlement can be reached in the current lawsuit, the Estate might wish to sell such rights to New Line.

5. 7.5% of what? As a result of earlier documents in the case, we had already known that the Tolkien Estate claims 7.5% of New Line’s gross receipts minus an “artificial payment level.” That means that New Line would be allowed to deduct certain expenses from its income before starting to pay a percentage to the Estate. We’ve also known that the artificial payment level equals 2.6 times the budget of the Trilogy.

I should pause here to specify here that the box-office figures we hear in the news media are not the same as the studio’s gross receipts. They refer to the total amount that people pay to see films. Some of that money stays with the theater owner. Part of it is kept by the distributor. (In this case New Line itself distributed the Trilogy in North America but not elsewhere.) Broadly speaking, after those other shares are taken out, the studio gets the rest. It pays its expenses, and anything left is profit.

Even today, 2.6 times the budget of a film is a reasonable figure to adopt as the break-even point for the studio after all expenses are covered–especially given that advertising has risen considerably in proportion to most films’ production budgets. If we assume that the budget for the Trilogy was around $330 million (not counting advertising), 2.6 times that would be $858 million.

Thus when the Plaintiffs’ complaint points out that the Trilogy has grossed perhaps $6 billion worldwide in theaters and on DVDs, they are not claiming that they are entitled to 7.5% of that sum. They are emphasizing how much the Trilogy has brought in overall in order to suggest that New Line must have made a profit on the three films, enough so that they would owe the Tolkien Estate a considerable amount of money.

The Plaintiffs allege that New Line has not made a proper accounting of income to them, as is required by the contract. According to the Estate, although New Line had reported to them the figures on FOTR, it was not given comparable information for the second and third films of the Trilogy. That situation may have changed. In the July 2 Abramowitz article linked above, the author says

All of New Line’s litigation has been assumed by its corporate owner, Warner Bros., which is making pains to at least sound more conciliatory. A spokesman gave us the following statement: “The Tolkien estate is currently auditing New Line’s books and records for the ‘Lord of the Rings’ films and we are working closely with the estate’s accountant and lawyers to facilitate and expedite this process. While we respectfully disagree with some of the estate’s positions, we are hopeful that the dispute can be amicably resolved once the audit has been completed.

I haven’t heard anything about whether that audit is still proceeding or when it might be finished. I would think that any possible settlement that the sides might make would not happen until the Plaintiffs have seen the figures that they claim were being withheld. The First Amended Complaint states that although they have used the figure $150 million, “Plaintiffs will seek leave to amend this Complaint to set forth the full amount of such damages when ascertained.”

The breach of contract alleged by the Plaintiffs in both versions of their Complaint would arise mainly through the juggling and withholding of figures about the Trilogy’s income and expenses.

In relations to the fraud claims, the Plaintiffs mention such items as New Line paying millions of dollars to AOL, also part of the Time Warner group, to improve its bottom line, and writing the money off as expenses for the Trilogy. They claim that New Line wrote off a million dollars for a “completion bond” that in fact was never paid for. The amended Complaint states,

Plaintiffs are informed and believe and thereon allege that New Line built office buildings and production facilities in New Zealand and charged the cost of those new buildings and facilities as a production expense to the Films. Plaintiffs are further informed and believe and thereon allege that these offices and production facilities are an asset of New Line which are being used for other and further productions. Yet, New Line falsely claims the cost of building these facilities as a cost of producing the Films.

We won’t know until September 22 or shortly thereafter whether the court will again sustain New Line’s second Demurrer and dismiss the fraud charges. If that happens, these claims may never be followed up or resolved.

Even if it can be established to the satisfaction of both sides how much money New Line took in, questions about what expenses could be deducted beyond the artificial payment level might remain. Here I think the changes in the industry since the original 1969 contracts would make it especially difficult to interpret money the 7.5% portion covers. In 1969, United Artists was a company. In the intervening decades, the Hollywood studios have all become part of large conglomerates. New Line is part of Time Warner. In the 1960s it was fairly rare for participants in a film to get a substantial percentage of “first dollar” income. Now it’s pretty common, and such participation was complicated in the case of the Trilogy.

In the introduction the First Amended Complaint, the Plaintiffs state:

New Line has included, as a cost of producing the Films, the share of profits it has paid to its own predecessors in interest, Zaentz and Miramax. Amazingly, New Line contends that the amount of profits earned by its predecessors should be accounted in the same way as the salary paid to the film’s editor or gaffer. This accounting trick has (not surprisingly) helped to inflate the cost of each Film by over $100 million dollars per film.

My guess is that New Line would claim that the 5% paid out each to Saul Zaentz and Miramax were the deferred cost of obtaining the rights to produce and distribute the Trilogy. But one certainly can’t be sure, since the terms of the contracts between New Line and the two companies have not been made public. The nature of those percentages is presumably spelled out there, and perhaps those contracts will also become exhibits in the course of the legal proceedings. (The $12 million that New Line paid Miramax in 1998 when it took over the production was to reimburse Miramax for expenses it had incurred during its pre-production of the two planned films; in exchange New Line received the designs, technical developments, and other items that had thus far been created, mostly by Weta Ltd. Those $12 million would then become part of the Trilogy’s overall budget.)

Other people involved with the production received percentages, including Peter Jackson and, rumor has it, at least one of the actors. Those sums might also be payment for work on the films, but again, we do not know the terms of their contracts.

6. What’s the 2.5% thing about? New Line is claiming that while it would owe 7.5% on FOTR and ROTK, it owes only 2.5% on TTT. This claim arises from the breaking of the original contract into two. The GAU contract specifies that TTT should bring in 2.5% of gross receipts to the Estate, and the Sassoon contract lists 5% as the fee for the other two films. The Tolkien Trust complaint takes the position that the figures in the contract were meant to be taken in combination, 7.5%. The figure 7.5% appears elsewhere in the contract and is also given in the section on The Hobbit (first page of Schedule B).

Complications

One aspect of all this that intrigues me is how the method of financing the Trilogy will factor into the dispute. As I explain in The Frodo Franchise (Chapters 1 and 9), New Line obtained much of the film’s budget from pre-selling foreign distribution rights to companies in various countries. Apparently somewhere around 65 to 70% of the total budget was raised in this way. That meant that New Line did not receive a share of those companies’ receipts on the Trilogy until the film passed a certain ceiling. After that point, the studio started earning a portion. How will that system affect what is counted as the Trilogy’s total budget? How will it influence the income on which the Plaintiffs’ share will ultimately be calculated? In 1969, the financing of a big-budget film in that way–basically as an independent film rather than a studo picture–would be rare, if it was done at all. I’ll be very interested to find out (if the case ever comes to court) how these issues are ultimately treated.

What happens next?

The September 22 meeting will decide whether New Line’s Demurrer to the terms of the First Amended Complaint will be sustained. If it is, the Plaintiffs could revise their Complaint again and submit it. If they chose not to, then the case would proceed as a breach of contract matter. We would then enter the “discovery” phase. Neither side would face any short-term deadline but would have the time to gather evidence that would bolster their respective cases. There would likely be a long period during which very little news would come out about the case (except perhaps rumors). An exception would be if the Plaintiffs want information that New Line won’t provide, in which case they could file a motion for the court to compel New Line to hand it over. If that happens, it might give clues as to what sorts of evidence the sides are looking for during the discovery process.

It’s worth noting that during the discovery process, one side or the other or both might find evidence that makes an out-of-court settlement more desirable to them. I suspect that wouldn’t happen until after the September 22 ruling, where a lot is at stake. If indeed the Plaintiffs are still auditing New Line’s financial records for the Trilogy, the completion of that audit might also be a spur for a settlement.

(Note: As in previous entries on this subject, I’ve had information and explanations from James Peterson, of Godrey & Kahn here in Madison.)