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Daily News, Pop Law, Small Business

Rockin’ Out: Learning From Big Business Mistakes

Rock Band 2, Winshall v. Viacom

There was a fun lawsuit that cropped up a little while ago, Winshall v. Viacom International, Inc. The suit was brought by 150 former investors in Harmonix Music Systems, the creators of Rock Band and contributors to Guitar Hero.

In 2007 Viacom International saw just how amazingly profitable Rock Bank could be. It was competing very well with Guitar Hero, and it was the first to market with a full band’s worth of controllers, including a microphone.

The world was looking up for Viacom. They had a hugely popular product to sell, and it was going to rake in the dough.

However, somewhere in the depths of the company, someone forgot how to read a balance sheet and that led to some pretty bad lawyering from either an AMLaw firm or Viacom’s in-house legal team.

As it turns out, the “instruments,” despite being somewhat cheap feeling pieces of plastic (which are easily smashable if your band has tried and failed to beat Ball Room Blitz on expert for the seven thousandth time) are quite costly to make. What this meant for Viacom is that despite the multiple sequels and band sponsored iterations which added up to over a billion dollars in sales, was that the game, and therefore Harmonix, was not profitable for Viacom, which, of course, was an issue.

When Viacom moved to acquire Harmonix, they did so through the use of an incentive laden contract.

These contracts are very visible, and much simpler, in sports.

In business incentive contracts are common, but they seem to never have a formula that is as simple as, “if the player hits 30 home runs he earns an extra $500,000 for the season.”

In the acquisition, the contract had a provision providing for a base purchase price, and then “bonus” payments based upon international and domestic sales. The problem is that how the incentives are calculated, even when based upon sales, seems to have been left open for debate because no one seems to have come up with a definition for what “sales” means. For example, they could be calculated to be based upon gross or net sales for example or net profit or some other variable.

Now, it seems like Viacom’s legal team decided to allow for a flexible definition of “sales” because it would have allowed for a little bit of wiggle room in the event of a dispute. However, it was to their disadvantage because the more open the definition of “sales” is, the more literally it can and will be construed, and Harmonix’s shareholders were intent on being as literal as possible.

The upshot of that is even though Viacom was losing money on the deal, they still had to pay, and when they made the first payment it was a good one. $150 million to be exact. But then they realized how bad the deal actually was, and decided that they didn’t want to do that anymore and was left attempting an “efficient breach” of contract… which ultimately backfired. They Viacom made an attempt to get their money back… which also backfired.

These moves backfired because they were predicated upon the aforementioned definition of “sales.” Viacom believed that they could argue that “sales” meant whatever was left after costs and simply not pay in 2008, despite already setting an estimated value for the bonus payment.

That’s where Walter Winshall came in. Understandably, he and his fellow investors were a bit miffed when Viacom decided that it did not want to pay what was going to be close to $200 million. So, Winshall led a group of investors into a lawsuit and a subsequent arbitration where he won the investors $383 million based on Viacom’s refusal to pay, and caused Harmonix to be sold to a hedge fund for $50.

All told, though, this case is a fantastic example of the type of diligence required to be a good lawyer and to successfully make a deal. The major failing here was the inability to define the word, “sales” and the failure to consider just what the result of that would be. While it is a bit of a case of the rich getting richer, the Harmonix investors took advantage of a bit of bad lawyering on Viacom’s behalf and are rightly being compensated for the deal they made.

So, those of you running a small business, you may not need a lawyer to consummate every business transaction or to look at every contract. But, if you choose to go it alone, always take the time to make sure all you dot every “i” and cross every “t,” and make sure someone else can understand what the deal is from a simple description. It may take a little haggling and negotiation, but in the end everyone will be better for it, and you can say that you don’t make the same mistakes as Viacom.

About E.C.

Corporate and regulatory attorney. Also experienced in advocacy for the mentally disabled and minor litigation matters. Not currently practicing, but maintaining the blog to keep my research and writing skills sharp. Splitting time between Connecticut and Massachusetts.


One thought on “Rockin’ Out: Learning From Big Business Mistakes

  1. Wow- epic fail. Not sure, but it seems like “sales” is one of those things should be clearly defined.

    Posted by Alia Murphy | December 28, 2011, 2:06 pm

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