Relativity, Netflix Battle Involves Interplay Between Bankruptcy and Streaming License

The notices of assignment at issue originally provided “outside dates” of June 17 and June 30 for the films Masterminds and Disappointment Room. Payment of the license fee was to coincide with the date on which Netflix began distributing and streaming the film to subscribers. Consistent with industry custom, '5.6 of the agreement required Netflix to “promptly upon the request of Relativity, enter into all agreements reasonably requested by Relativity ' which extends or is willing to extend credit to Relativity against License Fees payable to Relativity hereunder.” The notices of assignment also included an arbitration clause.

In its objection to confirmation of Relativity's plan and assumption of the licensing agreement, Net flix argued that Relativity could not demonstrate adequate assurance of future performance because it challenged Relativity's ability to release the films on schedule (Relativity had cancelled and rescheduled the release dates multiple times in 2015), and whether it could release the films to the minimum number of theater screens simultaneously. Netflix's own witness confirmed that its license fee is calculated based upon domestic box office revenue for each film and that a material requirement of the agreement is that “the films provided must be first run, theatrically released films.” Noteworthy is the fact that Netflix's objection failed to argue that it was contractually entitled to stream the films prior to their theatrical release.

The bankruptcy court overruled Netflix's assumption objection, the plan was confirmed in February 2016 and became effective in April. Netflix appealed the confirmation order but later voluntarily dismissed its appeal.

During the confirmation process, Relativity and its secured lender informed the bankruptcy court and parties in interest (including Netflix) that they had agreed to the postponement of the films' release dates to later this year. Notwithstanding the prior knowledge of the release date extensions, Netflix later refused to sign amendments that would extend the fee payment and release dates. As a result, Relativity sought an order from the court compelling Netflix to sign the extension date amendments. In response, Netflix contended that it had the right to distribute and stream the films even though the films had yet to be released in theaters. Also before the court was whether this dispute was one that had to be arbitrated, and whether under Stern v. Marshall, 131 S.Ct. 2594 (2011), the court had constitutional authority to issue a final ruling on the debtors' motion.

According to the bankruptcy court, it could not have been any clearer at the confirmation hearing that the planned distribution sequence (theater releases of the films followed later by Netflix distribution) was key to the plan as it would impact both the debtor's financing arrangements and recoveries projected for unsecured creditors. Moreover, the bankruptcy court recalled that Net flix's position throughout the confirmation hearing was that theatrical release of the movies was a material requirement under the agreement and necessary to qualify the movies for distribution, and that the debtors' forecasted benefits under the agreement were key to the debtors' survival and plan feasibility.

The bankruptcy court therefore found Netflix's refusal to sign the date extension amendments (based on its new position that Netflix had the right to distribute the movies prior to theatrical release) to be irreconcilable with its assertions made during confirmation. The court further noted that as a practical matter, if Netflix is not barred from distributing the movies before they go to the box office, theatrical release after Netflix streaming would never happen and Relativity would receive no license fee, all of which Netflix knew perfectly well.

Bankruptcy Judge Wiles denied Netflix's request to have the matter sent to arbitration. The judge reasoned that the issue of whether res judicata and judicial estoppel bar Netflix from arguing its current position necessarily boils down to what was previously concluded at confirmation and why ' issues that should be determined by the presiding court, not an arbitrator. Further, enforcement of the plan terms against Netflix affect the entire confirmation process and impact all creditors, none of which are party to any arbitration agreement. In addition, Judge Wiles found no arbitration clause in the license agreement (just in the assignment notice) and thus, the issue of whether Netflix is required under '5.6 of the agreement to sign the date extension amendments was not a dispute subject to arbitration.

Noting Netflix's testimony at the confirmation hearing, Judge Wiles then ruled that under the doctrines of res judicata and judicial estoppel, Netflix was barred from asserting that it has distribution rights based on the original assignment notices and likewise enjoined Netflix from streaming the movies at any time earlier than the time specified in the license agreement (i.e., prior to theatrical release). The bankruptcy court's injunction against Netflix was buttressed by the court's belief that Netflix's new contract interpretation lacked good faith and was asserted as leverage to terminate the contract.

Judge Wiles next assessed Relativity's request, made pursuant to Bankruptcy Code '1142(b), for the court to compel Netflix to sign the extension date amendments as required under '5.6 of the agreement. Section 1142(b) provides, in relevant part, that “the court may direct any necessary party to ' perform any act ' that is necessary for the consummation of the plan.” The bankruptcy judge found that, as a matter of custom and under the contract, Relativity and its lender are entitled to new assignment notices that would incorporate reasonable new outside dates. However, the court reasoned that '1142(b) does not go so far as to authorize the court to impose upon Netflix the new outside dates proposed by Relativity. Instead, Judge Wiles strongly signaled to Relativity that it may seek ' in another judicial forum ' to compel Netflix's execution of amended assignment notices with new outside dates.'It is easy to assume that Relativity will take the court's advice in this regard.

Judge Wiles likewise denied Netflix's Stern claim because there was no precedent preventing the bankruptcy court from enforcing its own prior plan confirmation order or making a final ruling as to res judicata and judicial estoppel matters in the context of the confirmation process.

Conclusion

The Relativity decision highlights the need in a bankruptcy proceeding to be mindful of the potential impact an asserted position at one hearing may have later in the case, even if it involves different circumstances. Among other examples of this conundrum include whether the secured creditor takes the position at the outset of the case as to whether or not it is fully secured.

In this case, Netflix has filed a notice of appeal with the U.S. District Court for the Southern District of New York. It will be interesting to see how things play out on the appeal.

Francis J. Lawall is a partner in the Philadelphia law office of Pepper Hamilton and concentrates his practice in national bankruptcy and reorganization matters. He routinely lectures to various creditor groups concerning general bankruptcy issues, including preferences, reclamation, the role of creditors committees and related issues. Lesley S. Welwarth is an associate in the firm's Detroit office, where she concentrates her practice in national bankruptcy and reorganization matters. This article also appeared in The Legal Intelligencer, the Philadelphia-based ALM sibling of Entertainment Law & Finance.