Inside the Taco Bell Case

Alfaro spent the next year soliciting ideas from the plaintiffs, as well as their licensing agent, Arlene Scanlan, on how Psycho Chihuahua could be adapted for use by Taco Bell. The plaintiffs not only provided Taco Bell with licensed merchandise, but with commercial ideas and storyboards. By early 1997, the plaintiffs had presented Taco Bell with the core concept of the Taco Bell Chihuahua – a live-action Chihuahua with an attitude that would ignore any distraction and overcome any obstacle to get to Taco Bell food. It was a toned-down, live version of their Psycho Chihuahua character adapted for use by Taco Bell. The plaintiffs proposed that the character be used in TV commercials, as well as on licensed merchandise and premiums.

In November 1996, Scanlan proposed terms for Taco Bell to license the Psycho Chihuahua character. The proposal was based on a similar spokescharacter deal that 7-Up did with another relatively unknown character called Fido Dido. Under the proposal, Taco Bell would pay the plaintiffs a royalty for any use of their character. For use in TV advertisements, Taco Bell would pay the plaintiffs a percentage of Taco Bell's media expenditures on commercials using the character. Although Taco Bell did not accept or reject the proposal, it continued working with the plaintiffs.

By July 1997, Taco Bell had stopped communicating with Shields, Rinks and Scanlan. At about the same time, Taco Bell released a regional one-off commercial featuring a live-action, male Chihuahua with an attitude passing up a female Chihuahua to get to Taco Bell food. This was a specific idea that the plaintiffs had presented to Alfaro. Consumer reaction was so strong that Taco Bell decided to make the Chihuahua character the focus of its national campaign beginning in December 1997. Between July 1997 and August 2000, Taco Bell ran at least 50 commercials featuring the “Taco Bell Chihuahua,” and Taco Bell's advertising agency won numerous awards for the success of the commercials. Taco Bell spent over $500 million on media time for commercials featuring the Chihuahua.

Filing the Complaint

In January 1998, the plaintiffs sued Taco Bell in U.S. District Court for the Western District of Michigan. The complaint alleged breach of an implied-in-fact contract, unfair competition, misappropriation of ideas and conversion. In response to the lawsuit, Taco Bell claimed that its new advertising agency, TBWA Chiat/Day, came up with the idea for the Taco Bell Chihuahua independent of the plaintiffs in the spring of 1997. Specifically, it claimed that Chiat/Day's creative directors came up with the idea when they were sitting at a Mexican grill in Venice, CA, on a Sunday afternoon and saw a Chihuahua without an owner walking down the street looking like it was on a mission.

In June 1999, the court dismissed the plaintiffs' lawsuit, holding that the federal Copyright Act preempted their claims. The court also held that all of the plaintiffs' claims required proof that their ideas were novel, and that the plaintiffs could not show novelty as a matter of law. Wrench LLC v. Taco Bell Corp., 51 F. Supp. 2d 840 (W.D. Mich. 1999). In July 2001, the U.S. Circuit Court of Appeals for the Sixth Circuit reversed, holding that the plaintiffs' claims were not preempted because proof of an implied-in-fact contract contains the “extra element” of a promise to pay. Wrench LLC v. Taco Bell Corp., 256 F.3d 446 (6th Cir. 2001). Further, the appeals court ruled that, under Michigan law, novelty is not necessary to prove an implied-in-fact contract based on the use of ideas.

Two weeks before trial began in May 2003, the court dismissed the plaintiffs' tort claims, holding that, under Michigan law, those claims did not arise from the breach of a duty that was separate and distinct from the breach of contract. The plaintiffs had argued that their tort claims were separate and distinct because they were property-based claims that did not involve the breach of a duty. The court also clarified that the plaintiffs were entitled to recover the reasonable value of the ideas presented to Taco Bell under the implied-in-fact contract.

Limits on Damages Theories

The court, however, precluded the plaintiffs from presenting several of their damages theories to the jury. First, the court ruled that, because the plaintiffs no longer had tort claims, they could not present evidence regarding the profits that Taco Bell gained as a result of the Chihuahua campaign. The court held that such evidence was not relevant in determining the reasonable value of the plaintiffs' ideas. Similarly, the court precluded the plaintiffs' advertising and damages experts from testifying about the significant increase in Taco Bell's brand equity attributable to the Chihuahua campaign. The court did, however, permit limited evidence of the popular success of the Chihuahua campaign as background information.

Second, Taco Bell asked the court to preclude the plaintiffs from presenting expert testimony regarding customary royalty rates in the character licensing industry. The court ruled, however, that the jury could use a particular rate if the evidence showed it was customary or, if there was no customary rate, the jury could determine the reasonable value of the plaintiffs' ideas “based upon any other competent evidence in the record.” The court thus permitted the plaintiffs' licensing experts to testify about the reasonable value of the plaintiffs' ideas based on their experience in the industry.

Third, the court held that the plaintiffs could not present evidence regarding the residual value of the Chihuahua character based on the opinion of the plaintiffs' experts that it was highly probable Taco Bell would use the Chihuahua again in the future because of the success and popularity of the campaign. The court, though, did observe that the plaintiffs could bring a new claim for damages if Taco Bell was found liable and used the Chihuahua again.

At trial, the plaintiffs presented evidence concerning the ideas they had provided to Ed Alfaro at his request over the course of a year. The plaintiffs also presented evidence that Alfaro presented the plaintiffs' character to numerous people in upper management at Taco Bell, including the president of the company and its chief marketing officer, as well as many others in Taco Bell's marketing department. These people had regular contact with Chiat/Day and participated in the ultimate decision to use a Chihuahua in Taco Bell's marketing campaign.

Aside from its “independent creation” defense, Taco Bell's primary argument at trial was that there was no agreement as to the subject matter of the parties' alleged implied-in-fact contract. Taco Bell claimed that it was not clear whether the subject of the contract was the “identifiable” Psycho Chihuahua character Ed Alfaro saw at the licensing show, or amorphous ideas about using a Chihuahua in Taco Bell ads. The plaintiffs, on the other hand, argued that the subject matter of the contract was never in doubt. It was the ideas, concepts, and images based on the Psycho Chihuahua character as adapted for Taco Bell at its request.

As for damages, the plaintiffs argued at trial that the Scanlan proposal presented to Taco Bell in November 1996 represented the reasonable value of the plaintiffs' ideas, even though Taco Bell never accepted it. The parties agreed that the proposal, when applied to Taco Bell's media expenditures and the licensed merchandise and premiums sold, would yield $30.1 million in royalties. Scanlan testified that she based her proposal on the deal that 7-Up did with Fido Dido. In fact, Taco Bell mentioned Fido Dido to Scanlan as an example of how a character could be used in advertising, licensing and promotions, not knowing that she was familiar with the deal. The plaintiffs also presented evidence of other more famous licensed characters, such as Snoopy, Garfield and the Pink Panther, that were used as spokescharacters for a particular brand and received substantially higher royalties on media expenditures than the plaintiffs had proposed for their Psycho Chihuahua character.

Multi-Pronged Defense Attack

Taco Bell responded with a multi-pronged attack on the plaintiffs' damages claim. It argued that an unknown character like Psycho Chihuahua could not possibly be worth $30.1 million and that the licensed characters mentioned by the plaintiffs were not analogous because they were all substantially more famous. Therefore, Taco Bell claimed, the royalty percentages were much too high. Taco Bell's licensing and advertising experts testified that they were not familiar with licensed characters receiving a royalty on a company's media expenditures – rather, such characters typically get paid only for licensed merchandise and premiums. Taco Bell also argued that the plaintiffs' ideas were not novel – that they were just an amalgam of tried and true advertising and marketing techniques, and therefore had little or no value to Taco Bell. Finally, Taco Bell's advertising expert testified that celebrities who act as spokespeople typically earn between $200,000 and $2 million.

Taco Bell presented the jury with several different alternatives to the plaintiffs' $30.1 million figure. First, Taco Bell presented a range between $175,000 and $250,000 based on a fee for service for the creation of a graphic design or logo. Second, it presented a range between $700,000 and $3.6 million for a royalty on premiums. Third, the company presented a range of $1.2 million to $4.2 million for a flat fee for advertising use.

Based on the $30.1 million jury verdict, the jury apparently believed that Scanlan's proposal represented the reasonable value of the plaintiffs' ideas. Because the plaintiffs argued that they were entitled to damages under the Scanlan proposal, Taco Bell attempted to force the plaintiffs to prove an agreement as to the terms of a licensing deal agreement. To establish the existence of an implied-in-fact contract, the law simply requires proof that both parties understood that if a defendant used a plaintiff's ideas, it would have to pay for that use.

Manifest Unreasonableness Test Rejected

The court had rejected a jury instruction offered by the plaintiffs that would have provided the jury yet another method of adopting the Scanlan proposal as the method of damages. The plaintiffs' proposed instruction would have instructed the jury that, if the plaintiffs established that Taco Bell breached the parties' implied-in-fact contract by using the plaintiffs' ideas without compensation, the plaintiffs would be entitled to hold Taco Bell to the offer they made unless Taco Bell could prove the offer was manifestly unreasonable. See Restatement (Second) of Contracts Sec. 69; 4 Nimmer on Copyright Sec. 16.05[D], at 16-42 n.30. The policy behind this rule is reflected in the following hypothetical posed in the seminal idea case, Desny v. Wilder, 299 P.2d 257 (Cal. 1956): “A buyer who goes into a shop and asks and is given (told) the price of an article, cannot take it and say 'I decline to pay the price you ask, but will take it at its fair value.' He will be liable, if the seller elects to hold him so liable, not simply as a converter for the fair value of the property, but as a buyer for the stated price.”

While contract-based idea claims are typically limited to the reasonable value of a plaintiff's ideas, property-based idea claims, such as misappropriation and conversion, usually allow for damages measured by the gain to the defendant from the use of the plaintiff's ideas. In many cases, the gain to the defendant may coincide with the reasonable value of the plaintiff's ideas. In some cases, however, the gain to the defendant may deviate substantially from the reasonable value of the ideas under a contract theory.

Moreover, there is a myriad of ways to determine the benefit that a defendant has derived from another's ideas. In the Wrench case, the parties and their damages experts were substantially at odds regarding how to measure this benefit, and this would have been a significant bone of contention at trial had the court permitted such evidence. The plaintiffs' damages expert, for example, had performed a regression analysis correlating advertising awareness to Taco Bell's sales and determined that Taco Bell gained over $80 million by using the plaintiffs' ideas. Taco Bell's damages expert concluded that Taco Bell's benefit from the Chihuahua campaign was negligible.

Finally, in assessing potential damages, it is vital to determine whether a defendant adopted a plaintiff's ideas wholesale, or whether the ideas used were simply a small part of a larger idea. For example, in Wrench, the plaintiffs set out to prove that Taco Bell's entire marketing campaign featuring a Chihuahua was based on a character that they had provided to Taco Bell. If, instead, the plaintiffs had simply attempted to show that they came up with a few of the advertising executions, but not the overarching creative platform, their potential damages may have been reduced.

Competition in all aspects of the entertainment world – from television to movies, to the record industry, to the Internet, to the video game industry – has grown quite fierce over the past decade. The stakes are higher than ever. So is the demand for successful, breakthrough ideas. Consequently, cases alleging the theft of creative ideas are becoming more and more common. A recent case in which this writer served as plaintiffs' co-counsel demonstrates how substantial damages can be in lawsuits over ideas.

In June, after a three-week trial, a federal jury in Grand Rapids, MI, awarded plaintiffs Joseph Shields, Thomas Rinks and their company, Wrench LLC, $30.1 million against Taco Bell for breach of an implied-in-fact contract. Wrench LLC v. Taco Bell Corp., 1:98 CV 45. (Taco Bell is expected to appeal the case.) The plaintiffs claimed that Taco Bell used their ideas for a live-action Chihuahua with a feisty attitude and an obsession with Taco Bell food in a TV advertising campaign for 2.5 years without payment.

The plaintiffs came up with the idea for a character called Psycho Chihuahua in 1995. They licensed the character for such merchandise as t-shirts, posters and school supplies. In June 1996, Ed Alfaro, who was in charge of Taco Bell's licensing program, saw Psycho Chihuahua at the Licensing Expo in New York City.

Alfaro spent the next year soliciting ideas from the plaintiffs, as well as their licensing agent, Arlene Scanlan, on how Psycho Chihuahua could be adapted for use by Taco Bell. The plaintiffs not only provided Taco Bell with licensed merchandise, but with commercial ideas and storyboards. By early 1997, the plaintiffs had presented Taco Bell with the core concept of the Taco Bell Chihuahua – a live-action Chihuahua with an attitude that would ignore any distraction and overcome any obstacle to get to Taco Bell food. It was a toned-down, live version of their Psycho Chihuahua character adapted for use by Taco Bell. The plaintiffs proposed that the character be used in TV commercials, as well as on licensed merchandise and premiums.

In November 1996, Scanlan proposed terms for Taco Bell to license the Psycho Chihuahua character. The proposal was based on a similar spokescharacter deal that 7-Up did with another relatively unknown character called Fido Dido. Under the proposal, Taco Bell would pay the plaintiffs a royalty for any use of their character. For use in TV advertisements, Taco Bell would pay the plaintiffs a percentage of Taco Bell's media expenditures on commercials using the character. Although Taco Bell did not accept or reject the proposal, it continued working with the plaintiffs.

By July 1997, Taco Bell had stopped communicating with Shields, Rinks and Scanlan. At about the same time, Taco Bell released a regional one-off commercial featuring a live-action, male Chihuahua with an attitude passing up a female Chihuahua to get to Taco Bell food. This was a specific idea that the plaintiffs had presented to Alfaro. Consumer reaction was so strong that Taco Bell decided to make the Chihuahua character the focus of its national campaign beginning in December 1997. Between July 1997 and August 2000, Taco Bell ran at least 50 commercials featuring the “Taco Bell Chihuahua,” and Taco Bell's advertising agency won numerous awards for the success of the commercials. Taco Bell spent over $500 million on media time for commercials featuring the Chihuahua.

Filing the Complaint

In January 1998, the plaintiffs sued Taco Bell in U.S. District Court for the Western District of Michigan. The complaint alleged breach of an implied-in-fact contract, unfair competition, misappropriation of ideas and conversion. In response to the lawsuit, Taco Bell claimed that its new advertising agency, TBWA Chiat/Day, came up with the idea for the Taco Bell Chihuahua independent of the plaintiffs in the spring of 1997. Specifically, it claimed that Chiat/Day's creative directors came up with the idea when they were sitting at a Mexican grill in Venice, CA, on a Sunday afternoon and saw a Chihuahua without an owner walking down the street looking like it was on a mission.

In June 1999, the court dismissed the plaintiffs' lawsuit, holding that the federal Copyright Act preempted their claims. The court also held that all of the plaintiffs' claims required proof that their ideas were novel, and that the plaintiffs could not show novelty as a matter of law. Wrench LLC v. Taco Bell Corp. , 51 F. Supp. 2d 840 (W.D. Mich. 1999). In July 2001, the U.S. Circuit Court of Appeals for the Sixth Circuit reversed, holding that the plaintiffs' claims were not preempted because proof of an implied-in-fact contract contains the “extra element” of a promise to pay. Wrench LLC v. Taco Bell Corp. , 256 F.3d 446 (6th Cir. 2001). Further, the appeals court ruled that, under Michigan law, novelty is not necessary to prove an implied-in-fact contract based on the use of ideas.

Two weeks before trial began in May 2003, the court dismissed the plaintiffs' tort claims, holding that, under Michigan law, those claims did not arise from the breach of a duty that was separate and distinct from the breach of contract. The plaintiffs had argued that their tort claims were separate and distinct because they were property-based claims that did not involve the breach of a duty. The court also clarified that the plaintiffs were entitled to recover the reasonable value of the ideas presented to Taco Bell under the implied-in-fact contract.

Limits on Damages Theories

The court, however, precluded the plaintiffs from presenting several of their damages theories to the jury. First, the court ruled that, because the plaintiffs no longer had tort claims, they could not present evidence regarding the profits that Taco Bell gained as a result of the Chihuahua campaign. The court held that such evidence was not relevant in determining the reasonable value of the plaintiffs' ideas. Similarly, the court precluded the plaintiffs' advertising and damages experts from testifying about the significant increase in Taco Bell's brand equity attributable to the Chihuahua campaign. The court did, however, permit limited evidence of the popular success of the Chihuahua campaign as background information.

Second, Taco Bell asked the court to preclude the plaintiffs from presenting expert testimony regarding customary royalty rates in the character licensing industry. The court ruled, however, that the jury could use a particular rate if the evidence showed it was customary or, if there was no customary rate, the jury could determine the reasonable value of the plaintiffs' ideas “based upon any other competent evidence in the record.” The court thus permitted the plaintiffs' licensing experts to testify about the reasonable value of the plaintiffs' ideas based on their experience in the industry.

Third, the court held that the plaintiffs could not present evidence regarding the residual value of the Chihuahua character based on the opinion of the plaintiffs' experts that it was highly probable Taco Bell would use the Chihuahua again in the future because of the success and popularity of the campaign. The court, though, did observe that the plaintiffs could bring a new claim for damages if Taco Bell was found liable and used the Chihuahua again.

At trial, the plaintiffs presented evidence concerning the ideas they had provided to Ed Alfaro at his request over the course of a year. The plaintiffs also presented evidence that Alfaro presented the plaintiffs' character to numerous people in upper management at Taco Bell, including the president of the company and its chief marketing officer, as well as many others in Taco Bell's marketing department. These people had regular contact with Chiat/Day and participated in the ultimate decision to use a Chihuahua in Taco Bell's marketing campaign.

Aside from its “independent creation” defense, Taco Bell's primary argument at trial was that there was no agreement as to the subject matter of the parties' alleged implied-in-fact contract. Taco Bell claimed that it was not clear whether the subject of the contract was the “identifiable” Psycho Chihuahua character Ed Alfaro saw at the licensing show, or amorphous ideas about using a Chihuahua in Taco Bell ads. The plaintiffs, on the other hand, argued that the subject matter of the contract was never in doubt. It was the ideas, concepts, and images based on the Psycho Chihuahua character as adapted for Taco Bell at its request.

As for damages, the plaintiffs argued at trial that the Scanlan proposal presented to Taco Bell in November 1996 represented the reasonable value of the plaintiffs' ideas, even though Taco Bell never accepted it. The parties agreed that the proposal, when applied to Taco Bell's media expenditures and the licensed merchandise and premiums sold, would yield $30.1 million in royalties. Scanlan testified that she based her proposal on the deal that 7-Up did with Fido Dido. In fact, Taco Bell mentioned Fido Dido to Scanlan as an example of how a character could be used in advertising, licensing and promotions, not knowing that she was familiar with the deal. The plaintiffs also presented evidence of other more famous licensed characters, such as Snoopy, Garfield and the Pink Panther, that were used as spokescharacters for a particular brand and received substantially higher royalties on media expenditures than the plaintiffs had proposed for their Psycho Chihuahua character.

Multi-Pronged Defense Attack

Taco Bell responded with a multi-pronged attack on the plaintiffs' damages claim. It argued that an unknown character like Psycho Chihuahua could not possibly be worth $30.1 million and that the licensed characters mentioned by the plaintiffs were not analogous because they were all substantially more famous. Therefore, Taco Bell claimed, the royalty percentages were much too high. Taco Bell's licensing and advertising experts testified that they were not familiar with licensed characters receiving a royalty on a company's media expenditures – rather, such characters typically get paid only for licensed merchandise and premiums. Taco Bell also argued that the plaintiffs' ideas were not novel – that they were just an amalgam of tried and true advertising and marketing techniques, and therefore had little or no value to Taco Bell. Finally, Taco Bell's advertising expert testified that celebrities who act as spokespeople typically earn between $200,000 and $2 million.

Taco Bell presented the jury with several different alternatives to the plaintiffs' $30.1 million figure. First, Taco Bell presented a range between $175,000 and $250,000 based on a fee for service for the creation of a graphic design or logo. Second, it presented a range between $700,000 and $3.6 million for a royalty on premiums. Third, the company presented a range of $1.2 million to $4.2 million for a flat fee for advertising use.

Based on the $30.1 million jury verdict, the jury apparently believed that Scanlan's proposal represented the reasonable value of the plaintiffs' ideas. Because the plaintiffs argued that they were entitled to damages under the Scanlan proposal, Taco Bell attempted to force the plaintiffs to prove an agreement as to the terms of a licensing deal agreement. To establish the existence of an implied-in-fact contract, the law simply requires proof that both parties understood that if a defendant used a plaintiff's ideas, it would have to pay for that use.

Manifest Unreasonableness Test Rejected

The court had rejected a jury instruction offered by the plaintiffs that would have provided the jury yet another method of adopting the Scanlan proposal as the method of damages. The plaintiffs' proposed instruction would have instructed the jury that, if the plaintiffs established that Taco Bell breached the parties' implied-in-fact contract by using the plaintiffs' ideas without compensation, the plaintiffs would be entitled to hold Taco Bell to the offer they made unless Taco Bell could prove the offer was manifestly unreasonable. See Restatement (Second) of Contracts Sec. 69; 4 Nimmer on Copyright Sec. 16.05[D], at 16-42 n.30. The policy behind this rule is reflected in the following hypothetical posed in the seminal idea case, Desny v. Wilder, 299 P.2d 257 (Cal. 1956): “A buyer who goes into a shop and asks and is given (told) the price of an article, cannot take it and say 'I decline to pay the price you ask, but will take it at its fair value.' He will be liable, if the seller elects to hold him so liable, not simply as a converter for the fair value of the property, but as a buyer for the stated price.”

While contract-based idea claims are typically limited to the reasonable value of a plaintiff's ideas, property-based idea claims, such as misappropriation and conversion, usually allow for damages measured by the gain to the defendant from the use of the plaintiff's ideas. In many cases, the gain to the defendant may coincide with the reasonable value of the plaintiff's ideas. In some cases, however, the gain to the defendant may deviate substantially from the reasonable value of the ideas under a contract theory.

Moreover, there is a myriad of ways to determine the benefit that a defendant has derived from another's ideas. In the Wrench case, the parties and their damages experts were substantially at odds regarding how to measure this benefit, and this would have been a significant bone of contention at trial had the court permitted such evidence. The plaintiffs' damages expert, for example, had performed a regression analysis correlating advertising awareness to Taco Bell's sales and determined that Taco Bell gained over $80 million by using the plaintiffs' ideas. Taco Bell's damages expert concluded that Taco Bell's benefit from the Chihuahua campaign was negligible.

Finally, in assessing potential damages, it is vital to determine whether a defendant adopted a plaintiff's ideas wholesale, or whether the ideas used were simply a small part of a larger idea. For example, in Wrench, the plaintiffs set out to prove that Taco Bell's entire marketing campaign featuring a Chihuahua was based on a character that they had provided to Taco Bell. If, instead, the plaintiffs had simply attempted to show that they came up with a few of the advertising executions, but not the overarching creative platform, their potential damages may have been reduced.