Last month gave us three noteworthy post-trial decisions in three different cases from three different states, all centering on disputes among business co-owners over the ownership and exploitation of the businesses’s core intellectual property. While each case stems from a unique set of facts, they all have in common failures to allocate IP ownership by means of clear contractual undertakings ex ante and/or failures to exercise due diligence at inception or during the life of the business.
The first highlighted case hails from New York, involving an extremely high stakes financial dispute between family members comprising the minority and controlling shareholders of the famous Palm restaurants located throughout the United States and elsewhere. The second case comes from Delaware, in which the court ordered dissolution of a limited liability company where the 50% member who licensed to the LLC the patented technology on which rested its entire business plan, as it turned out, did not own the rights. In the third case, from Arkansas, the judge dismissed a one-third LLC member’s claims for copyright infringement and dissolution after finding that he was equitably estopped from enforcing his copyrights in the company’s principal software products.
Derivative Suit Over Palm Restaurant IP Yields $120 Million Award
The original Palm Restaurant was founded in Manhattan in 1926 by Pio Bozzi and John Ganzi, who ran it with their wives. Today, despite the ubiquity of Palm-branded restaurants throughout the U.S. and worldwide, the original corporation formed by Pio and John, now owned by third-generation family members, does not operate a single restaurant. Rather, its sole asset consists of the enormously valuable Palm IP consisting of a series of trademarks and service marks, and design elements including its menu and distinctive restaurant décor, all of which is licensed to independent Palm restaurant operators as well as Palm restaurants owned in whole or with other investors by two family members, Bruce Bozzi and Walter Ganzi, who also happen to own 80% of the original Palm corporation that owns the IP, which I’ll called Palm IP Corp.
Therein lies the seeds of a blockbuster shareholder derivative suit brought in 2012 by the other 20% shareholders of Palm IP Corp., accusing Bruce and Walter of breaching fiduciary duty as the controlling owners of Palm IP Corp. by licensing the IP to Palm restaurants they own and, through their separate management company, to Palm restaurants they don’t own, at a tiny fraction of the IP’s value as compared to industry standards. Specifically, for over 40 years, Bruce and Walter on Palm IP Corp.’s behalf charged a flat annual $6,000 license fee to each of the new Palm restaurants they owned (which, between 2006 and 2017, in the aggregate grossed $1.5 billion), and a flat $12,000 fee to their separate management company which in turn charged exponentially higher, market rate license fees to independent Palm-branded restaurants.
In a post-trial decision authored by Manhattan Commercial Division Justice Andrea Masley in Ganzi v Ganzi, 2018 NY Slip Op 32961(U) [Sup Ct NY County Nov. 13, 2018], the court found that, by 1982 when they were so advised by their trademark counsel, the defendants were aware that the $6,000 license fee was fast becoming unreasonable; that the plaintiffs were unaware of the unfair license and sub-license agreements being made by the defendants; that corporate formalities ceased being followed when defendants took over Palm IP Corp.; that the defendants “treated [Palm IP Corp.] as their own without any regard to other shareholders”; and that defendants’ self-dealing “is a textbook example of fiduciary misconduct.”
Justice Masley’s opinion also discussed and rejected each of the defendants’ claimed defenses to liability based on the statute of limitations, laches, acquiescence, ratification, and equitable estoppel.
On the question of remedies, Justice Masley agreed with the plaintiffs’ damages experts to use a 5% weighted average royalty rate, comparable to rates charged by other restaurant brands and consistent with defendants’ own presentations to bankers and public filings. Based on the plaintiffs’ experts’ evaluations, the court awarded Palm IP Corp. over $70 million in damages. With prejudgment interest going back to 2006 plus some millions in damages on other claims, reportedly the total damage award comes to approximately $120 million.
That, my friends, is a lot of surf and turf.
Update May 7, 2020: The Appellate Division, First Department, today issued its decision upholding the damages award.
Court Dissolves LLC Created to Commercialize Patented Technology Held Under Infringing License Given by 50% Member
After a one-day trial with only two live witnesses, 11 exhibits and a record described by Vice Chancellor Laster as “mercifully sparse,” the Delaware Court of Chancery in Decco U.S. Post-Harvest, Inc. v Mirtech, Inc., C.A. No. 2018-0100-JTL [Del Ch Nov. 28, 2018], ruled that the subject LLC in a successful dissolution case brought by a 50% member no longer had a viable business because the patented technology upon which its sole business purpose relied, and which had been contributed under license by the other 50% member, was not within the other member’s ability to license because it had already granted all rights in the technology to a third party.
Essentiv LLC was formed in 2016 as a joint venture by plaintiff Decco and defendant MirTech to commercialize products based on a gas known as 1-MCP used to delay the ripening of fruit and other produce. MirTech, which represented that it owned the patented rights in certain inventions using 1-MCP, granted the LLC a license to use the patented rights.
Six years previous, however, MirTech and a company called AgroFresh had entered into an agreement calling for joint ownership of “any and all inventions conceived or reduced to practice jointly by the Parties”. A year later MirTech ceded sole ownership of all such rights to AgroFresh, including a series of inventions known as the RipeLock Patents. MirTech informed Decco that it had partnered with AgroFresh to produce RipeLock but, remarkably, Decco did not ask to see any of MirTech’s agreements with AgroFresh.
Soon after Essentiv went to market with its first 1-MCP product, it (along with MirTech and Decco) was greeted with an infringement suit by AgroFresh as owner of the patented RipeLock technology Essentiv used for its own product called TruPick. In 2017, the court ruled in favor of AgroFresh, after which Essentiv agreed to stop all commercial activity related to TruPick. In a subsequent Consent Judgment, MirTech agreed to entry of judgment against it on 20 different counts of wrongdoing, including willful infringement, fraud, and misappropriation of trade secrets.
Decco filed suit to dissolve Essentiv after MirTech spurned its proposal to dissolve voluntarily based on the company’s loss of its sole technology. MirTech’s principal filed a counterclaim (the word “chutzpah” comes to mind) seeking payment of his salary under a consulting agreement, which VC Laster dismissed before proceeding to trial on Decco’s dissolution claim.
In the space of just a few pages, the court found that the Consent Judgment “prevents the Company from continuing to sell TruPick”; that the company “has no plans to develop any other products”; and that “there is no viable 1-MCP Business” and “no viable Non-1-MCP Business.” It therefore followed, the court held, that “it is not reasonably practicable for the Company to carry on its business” and that dissolution is required under Delaware LLC Act § 18-802.
Court Denies LLC Dissolution Claim Arising From Copyright Dispute with Minority Member
Only four months ago, I wrote about an Arkansas federal court’s decision denying dueling summary judgment motions in the Oliver v Johanson case involving what I called an existential crisis triggered by a dispute between members of an LLC over the ownership of the firm’s principal software product. A trial was needed, the court held, to resolve factual disputes concerning whether the software created by the plaintiff one-third member of the LLC, and copyrighted in his name, was a work made for hire and/or was derivative of earlier software copyrighted by the company.
A bench trial followed, and last month the court issued its opinion finding that the plaintiff created the company’s original versions of its software programs as an independent contractor; that the works were not made for hire; and therefore the copyrights in the programs vested in him. The court then found that the company’s current software product was a derivative work jointly owned by the plaintiff and another programmer.
Sounds like lights out for the company, right? Wrong. The court went on to find that the company held an “irrevocable implied nonexclusive license to continue using the software.” The court based its finding on evidence that, from the onset of his affiliation with the company, the plaintiff “intended that his work would be used, copied, and distributed” by the company, including inserting copyright notices in favor of the company into the code.
The court further held that the plaintiff was equitably estopped from bringing a copyright infringement action against the company based on the duration of the company’s use of the software with plaintiff’s full knowledge and participation and even encouragement when he announced his resignation. On the other hand, the court did enjoin the plaintiff from disseminating software unless he first removes or is able to license from the majority members certain trade secret methodology incorporated in the software developed by the plaintiff.
Lastly, the court denied the plaintiff’s claim for judicial dissolution of the LLC, finding that the defendants “now understand” that the plaintiff remained a one-third member “despite his resignation” and “testified under oath that they are willing to continue to work with” the plaintiff on the company’s success, and because the company’s financial statements “indicate that it has largely been a profitable and successful venture.”
The court then offered some words of advice:
As has hopefully become clear by now, the only way that the parties are likely to experience success with their software or business operations going forward is if they resume making decisions like they used to: together.
Anyone care to wager?