As with most breakups, it looks like this one might get ugly.

Industry gaming site Gamasutra posted an exclusive story this morning alleging that former shareholders, including founders Alex Rigopulos and Eran Egozy, filed a lawsuit last week against their soon-to-be ex parent company Viacom, accusing them of manipulation in having to avoid paying out performance-based bonuses. The suit is asking to “recover damages arising from Viacom’s manipulation of these earn-out payments by diverting opportunities from Harmonix for its own benefit in breach of the implied covenant of good faith and fair dealing that inheres in Viacom’s contract with Harmonix.”

As background, Viacom acquired Harmonix in September 2006 for an initial sum of $175 million, plus the potential for much more in performance-based earn-outs. According to the suit, the earn-out formula would be 3.5 times any gross profit in excess of $32 million earned in 2007, and $45 million earned in 2008, with no cap. The first Rock Band title sold 382,000 copies in its first month on the market, and surpassed $1 billion in sales in North America through March 2009, according to statistics released by Viacom and its MTV division. Viacom distributed $150 million in anticipation of earn-out payments for 2007, for which it set aside over $200 million, according to its SEC filings, however Viacom never paid any money for the 2008 earn-out. Then early this year, Viacom stated in its financials that “we believe that we are entitled to a refund of a substantial portion of amounts previously paid,” without publicly disclosing its methodology.

Because the bonus agreement had no cap, the resulting bonus payment would have been significant, and the suit alleges that Viacom sought ways to reduce payments to Harmonix’s shareholders, including a mid-earnout negotiation of the distribution agreement with EA, the distributor of the franchise. The suit alleges that Viacom “decided to forego the opportunity to reduce EA’s distribution fees during 2008 (or in any other way enhance Harmonix’s net income or Gross Profit for 2008), and instead demanded benefits for itself (rather than Harmonix) in exchange for allowing EA to continue distributing Rock Band.” In other words, Viacom received benefits directly from EA instead of reducing Harmonix’s distribution costs, and therefore higher earn-out bonuses. The complaint alleges: “Although a reduced 2008 EA distribution fee would have increased Harmonix’s gross profit and operating profits in 2008, Viacom realized that every $1.00 of distribution fees that Harmonix saved during 2008 would require Viacom to pay an additional $3.50 of earn-outs to the [ex-shareholders].” Benefits to Harmonix from EA included commitments by EA to buy millions of dollars in ads from Viacom subsidiary MTV Networks and other Viacom outlets, a reduction in Rock Band franchise distribution fees beginning in 2009 (after Harmonix’s earn-out period), and “acceleration of 2009 payments to 2008.”

There is also an escrow account containing $13 million that Viacom has not released to Harmonix based on “claims for indemnification” around lawsuits (mostly patent infringement cases) that have been settled.

Gamasutra claims that the suit is being addressed in arbitration and that a “resolution accountant” is examining the situation. Now that this has gone public, I would expect to hear Viacom’s story sometime soon, that is unless they “don’t comment on pending litigation.”

[Gamasutra via Kotaku via @redion1992]

16 Responses to “Harmonix Filing Suit Against Viacom, Alleges Profit Manipulation”