Netflix's gambit to throw a wrench into the comeback of Relativity Media could be costly. On Thursday, U.S. Bankruptcy Judge Michael Wiles heard arguments on whether the streaming company should pay more than $1.2 million in legal fees to the film studio and its leader, Ryan Kavanaugh. The judge took the matter under submission but appears to be leaning toward ordering a fee reimbursement. And the tab could grow.
Back in May, after the bankruptcy judge had approved Relativity's reorganization plan, Netflix insisted it had the contractual right to stream the Zach Galifianakis comedy Masterminds and the Kate Beckinsale horror film The Disappointments Room the following month.
That represented a problem for Relativity because both of those films weren't coming out in theaters until later in the year. The studio had worked out an agreement with its creditors and reduced $630 million in debt on expectations of a theatrical release and then, and only then, downstream distribution. Netflix's move, likely aimed at escaping tens of millions in future licensing payments, was "putting at risk the successful reorganization," Relativity's lawyers told the judge at the time.
On May 27, Wiles rejected Netflix's contention that the dispute should be arbitrated and offered a harsh opinion about Netflix's "bad faith." Wiles ruled that Netflix had an obligation to resolve contractual issues before the confirmation and that Netflix's arguments were "irreconcilable" from its past position that Relativity's films had to be theatrically released under its license agreement to qualify as quality material that its users would want to see.
Netflix appealed the judgment, but on Tuesday, a U.S. District Court judge affirmed Wiles' finding and determined his court had jurisdiction over the matter.
Meanwhile, as the "prevailing party" in litigation, Relativity brought a motion for its attorneys' fees per the contract between the two companies. In response, Netflix argued that fee-shifting wasn't appropriate under bankruptcy code, that Kavanaugh wasn't really a prevailing party and that the lawyers on the opposing side - some of whom were making more than $1,200 per hour - were asking for too much.
"Netflix thus claims it is not obligated to reimburse at 'Caddilac Escalade' rates under the License Agreement, without regard to the context of this litigation and the Chapter 11 proceedings as a whole," stated a Relativity response brief. "As Netflix would have it, it has to reimburse only for the 'Honda Civic' level of lawyering."
Relativity's lawyer, Richard Wynne at Jones Day, said at today's hearing that Netflix's challenge was an "extremely important case to the company" and that attorneys had to work quickly with not much preparation. He said Relativity isn't simply trying to "stick it to Netflix" but added, "They took a flyer on trying to destroy the company."
Kavanaugh's own attorney commented that for this "$40 billion cap company" - referring to Netflix - "there was only upside" in attempting to sink Relativity. He thought that should be a factor in the judge's decision to award fees as the contract between the companies contemplated.
Wiles, who has repeatedly commended the debtors' lawyers for doing a fine job, appeared to be on Relativity's side. "The truth of the matter is the vehicle you need depends on where you are trying to get," Wiles said. "This case required high expertise."
Wynne told the judge the studio also intends to seek additional fees for the appeal. Relativity's attorney joked, "I'm sure if we get to the Supreme Court, we'll be talking about a Chevy Truck."
UPDATE 9/22: It's not over. With the clock ticking, Netflix has filed a notice that it will be appealing the bankruptcy judge's refusal to let it immediately stream Masterminds and The Disappointments Room to the 2nd Circuit Court of Appeals.
The appeal will give the federal appellate circuit an opportunity to weigh the boundary between bankruptcy matters and arbitration clauses in contracts.
Netflix states in its notice that the "order of the District Court refusing to compel arbitration, and otherwise affirming the order of the Bankruptcy Court, incorrectly holds that the dispute is a 'core' matter," which the streaming company argues is in contradiction with legal precedent.