Texas Business Dispute Blog

Tuesday, December 29, 2015

Royalty Dispute Over Steamy Sex Books and Lust For Oil Pipeline Battle: Shades of Gray On Display in Recent Texas Partnership Litigation

By:  Ladd Hirsch (Dallas)

Has it become riskier for private company business owners in Texas to conduct business when they enter into preliminary agreements with third parties?  Two high profile Texas jury verdicts in the past two years have made this a more frequent question.  In both cases (1) a Fort Worth lawsuit tried earlier this year seeking royalties resulting from the “Shades of Gray”book series and (2) an oil pipeline dispute tried in Dallas in 2014, the juries found that common law partnerships existed between the parties even though they had never signed written partnership agreements.  Despite the angst these decisions created (largely from outside Texas), on closer examination of the verdicts, both now on appeal, Texas business owners can take precautionary measures to avoid successful claims based on an unwritten “partnerships by conduct.”

“Shades of Gray”– Royalty Battle in Fort Worth (2015)

The Fort Worth case presented competing claims to the ownership of royalties from the “Fifty Shades of Gray” book series.  The drama pitted a former Texas schoolteacher against an Australian native in which the plaintiff claimed royalties based on rights allegedly arising under a Texas partnership. The suit claims that the partners were Jennifer Pedroza, from Arlington, Texas, and Amanda Hayward, of Australia, who met online through a fan fiction website.  They became friends and started their own website, the Writer’s Coffee Shop, where writers could upload their stories and participate in online discussions about their work.

In May 2011, The Writer’s Coffee Shop landed the pot of gold –“Shades of Gray” – the rights to Erika Leonard’s work, who previously wrote “Twilight” fan fiction, and was now using the E.L. James pseudonym. In September 2011, the Writer’s Coffee Shop published “Fifty Shades of Gray” as an e-book and a print-on-demand novel.  “Fifty Shades”quickly went viral and the Writer’s Coffee Shop sold about 250,000 of the e-books and hit the NY Times best seller list.  Random House won the bidding war for the rights to the series in March 2012, and agreed to pay E.L. James and the Writer’s Coffee Shop a hefty advance along with future royalties. 

The partnership battle arose when Hayward took action to terminate Pedroza under a service agreement and denied the existence of any partnership.  In the lawsuit that Pedroza filed against Hayward in Tarrant County, her lawyer, Mike Farris (a six-time novelist himself), asked the Court to declare that a partnership existed, that Hayward’s actions in forming new companies in Australia had not dissolved or converted the parties’ original partnership.  Pedroza alleged also that Hayward had violated her fiduciary duties as a partner, breached statutory partnership duties and engaged in fraud.  Before trial, Pedroza secured a temporary injunction to stop Hayward from enforcing a service agreement and to prevent her from transferring or using the amounts paid by Random House.

The crux of the issue during the trial in February 2015 was whether a partnership arose between Pedroza and Hayward under common law. Pedroza’s attorney argued that Texas law does not require a signed partnership agreement and authorizes a partnership to be formed by the parties’ conduct.  As set forth below, there is a five factor test for determining partnership based on the Texas Business Organizations Code (“TBOC”) and common law.  TBOC, 152.052(a)

  • Two or more individuals express an intent to be partners in a business,
  • These individuals actively participate in the control of that business,
  • They agree to share in the profits and losses of the business,
  • They agree to contribute money or property to the business, and
  • They agree to share control over operation of the business.

During the five-day trial, Farris peppered the jury with evidence of examples of Hayward referring to Pedroza as “one of the partners” or “founders” of The Writer’s Coffee Shop.  Further evidence of the alleged partnership included Pedroza’s actions in filing a partnership tax return and securing an Employer Identification Number.  The jury returned its verdict shortly before the release of the “Fifty Shades of Grey” movie and held that that The Writer’s Coffee Shop was a partnership, that Pedroza was a 25 percent partner, and that she was therefore entitled to recover 25 percent of the partnership’s profits, along with her legal fees.

The parties are now contesting the value of a 25% stake in the Writer’s Workshop based on royalties from the movie and book. The Judge has not yet signed a final judgment, but after forensic accountants for both of the parties indicated that Pedroza’s 25% interest was worth the approximate amount of $10.7 million, the Judge ordered the Defendants to deposit at least $10 million into the court’s registry.  Hayward’s appellate counsel, David Keltner, represented that his client, Hayward, didn’t have $10 million in cash. Farris then shared his concerns with the court that Hayward has spent the royalties she received “for her own personal benefit.”

Oil Pipeline Claims–Partnership Dispute in Dallas (2014)

On March 3, 2014, a year before the jury in the “Shades of Gray”case reached its verdict in Fort Worth, a Dallas jury also found (by a 10-2 vote) that a partnership by conduct existed and awarded Energy Transfer Partners, L.P. (“Energy”) a total of $319 million in damages.  As in “Shades of Gray” case, no signed partnership agreement existed.  Energy’s lawyers at Lynn Tillotson Pinker and Cox argued, however, that Energy had entered into a binding partnership with the Defendant, Enterprise Products Partners, L.P. (“Enterprise”), to develop a pipeline to carry crude oil from Cushing, Oklahoma to the Gulf of Mexico.  The jury agreed and awarded damages to Energy finding that Enterprise, represented by Beck Redden and Sayles Werbner,had breached its fiduciary duty of loyalty by leaving the project to build the pipeline with a Canadian company called Enbridge.

Apart from the large amount at stake, what makes the jury’s decision in the pipeline case stand out is the disclaimers included in the documents signed by the parties. The jury found that a partnership existed despite a letter of intent signed by Energy and Enterprise at the outset of their business relationship, which stated that they did not intend to become partners until other specified events took place.  Specifically, the parties’ letter agreement stated that neither it “nor the JV Term Sheet create any binding or enforceable obligations ... between the Parties.”  The parties’ letter agreement also provided that no binding obligations would arise between them “unless and until” the parties had “received their respective board approvals and definitive agreements memorializing the terms and conditions of the Transaction have been negotiated, executed and delivered by both of the Parties.”

The trial court denied Enterprise’s legal motions to dismiss the case before, during and after trial based on the parties’ written agreements.  The question the court submitted for the jury to decide at trial was whether a partnership had arisen between the parties based on the evidence of the five factor test from the TBOC listed above. Importantly, the court’s charge to the jury also instructed that not all five of these factors had to be present for a partnership to exist and stated: “No single fact may be stated as a complete and final test of partnership.”

During trial, Energy’s counsel, Mike Lynn, urged the jurors to assess the relationship between the parties as they would a common law marriage in deciding whether a partnership existed.  Lynn and his team presented evidence during trial showing that Enterprise referred to Energy repeatedly as a joint venture partner.  Lynn also reminded the jurors that if it walks like a duck, it is a duck, and he showed the jury a duck that was pictured with a sign stating, “I am not a partner.”  The jury decided that a partnership did exist, and that Enterprise had breached its fiduciary duties as a partner when it left the partnership and joined forces with Enbridge to build the pipeline that Energy had planned to develop with Enterprise.

Lessons Learned – Avoiding an Unintentional Partnership

The partnership by conduct verdicts created significant negative press about the perils of conducting business in Texas.  The Texas Lawyer reported that the firms of Sidley and Austin and DLA Piper both issued client advisories warning that the use of standard terms disclaiming partnerships in letters of intent would not be sufficient.   Texas Lawyer also reported that counsel for Enbridge, with Sullivan and Cromwell,stated that the pipeline verdict “raises troubling questions about the value of written contracts in supposedly business-friendly Texas.”See Texas Lawyer, How Texas oil company won $319 million “common law’ partnership” verdict, Alison Frankel March 7, 2014.

The concerns expressed following the jury verdicts in “Fifty Shades” and the pipeline case may be premature as both cases are now on appeal.  Yet, the warnings set forth above are well-taken.  Even before the results on appeal are known, business owners will want to consider steps they can take to avoid forming “unintentional partnerships” when they enter into contracts and business relationships with other companies. 

  1. Written Disclaimers:These cases confirm that statements disclaiming the intent to form a partnership are just one factor the jury will consider in deciding whether the parties intended to form a partnership. Intent is a critical issue, however, and owners should include specific, detailed and clear disclaimer statements in the formation documents to preclude a partnership from being formed until the specified conditions are met. Each situation is different and dependent on specific facts, but a generic form of a disclaimer provision is set forth below.

    Sample Disclaimer Provision

    1. The parties agree and acknowledge that this agreement does not create a partnership.The parties further agree and confirm that no partnership will be created between them until all of the following conditions are met:

       

      1. The Board of Directors or the Managing Members of each of the Parties approves in a formal written resolution the Party’s decision and authorization to enter into a partnership agreement;

         

      2. An authorized representative of each of the Parties signs a formal written partnership agreement; and

         

      3. The Parties’ partnership agreement is formally presented to and registered with the Texas Secretary of State.

         

  2. Public Statements:The most compelling evidence of partnership in these cases appears to be the parties’ public statements in which they repeatedly refer to each other as partners. The lesson here is straightforward. Business owners need to refrain from referring to the parties with whom they are doing business as “partners” in their public statements, as well as in written materials, including emails.Use of the “p” word (for partner) in public statements will help to open the door to the “walk like a duck” argument successfully presented by Energy’s counsel at trial.

     

  3. Arbitration Provisions: Arbitrations do not provide a safe harbor against litigation risk.Yet, business owners may prefer for a panel of lawyers in arbitration to decide whether a partnership existed rather than to submit this question to a jury that lacks business experience.For this reason, business owners may want to discuss with their counsel including a mandatory arbitration provision in their business agreements with third parties, particularly when this provision provides for a “fast track” resolution of any claim to a partnership.

     

  4. Definitive Partnership Date:The formation documents should set forth a date certain by which the partnership will be formed or any potential partnership will be automatically terminated unless there is a signed, written extension.The owner’s goal is to prevent a “partnership by ambush” as argued by Enterprise’s counsel on appeal. This provision requires the parties to sign a written extension of their joint venture or other business arrangement or it will definitively preclude a partnership from being formed between them.

     

  5. Negative Covenants:In addition to disclaiming the existence of a partnership, the formation documents should include what are known as negative covenants.In this regard, the documents should set forththe following express representations:(i) the parties will not bring any legal action contending that a partnership exists between them, (ii) the parties waive all claims to the existence of a partnership and (iii) the parties will pay the legal fees and costs incurred by the other party if a party does assert any legal claim that a partnership exists between them.

Conclusion

Businesses should not unwillingly be made partners with third parties.  Texas law has long recognized, however, that parties can become partners if they act in a manner that reflects their desire to be treated as partners.  As a result, Texas business owners should exercise caution when they form business relationships with other companies.  Specifically, business owners need to carefully document their relationship with third parties and then strive to make sure that both their words and actions reflect that no partnership exists until they are in full agreement.


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