Musical Chairs

When Napster board members turned down a deal by Bertelsmann AG to acquire the music swapping service's assets, it was the last straw for Napster General Counsel Jonathan Schwartz and other company officials. Schwartz, along with CEO Konrad Hilbers, founder Shawn Fanning and two other executives, resigned from the company Tuesday -- setting off another round of speculation on when Napster would fold.

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When board members of Redwood City, Calif.-based Napster turned down a deal for German media conglomerate Bertelsmann AG to acquire the struggling music swapping service’s assets, it was the last straw for Napster General Counsel Jonathan Schwartz and other company officials. Schwartz, along with Napster CEO Konrad Hilbers, founder Shawn Fanning and two other executives, resigned from the company Tuesday — setting off another round of media speculation on when Napster would fold. “There is a clear path before the board in which Napster would stay intact, all of its employees would keep their jobs and new money would be pumped in,” Schwartz said in his resignation letter. “It is the path we should be on. Since the board has decided to take the company in another direction I plan to resign today along with Konrad.” The resignations capped a weeklong effort by Hilbers, Schwartz and a team of outside attorneys to hammer out a deal after Bertelsmann pulled its initial proposal off the table to acquire Napster’s assets. Having lost Bertelsmann’s backing — the company has poured $85 million into Napster and was to serve as the deep pockets in settling ongoing litigation — it’s uncertain whether Napster is going to attempt to restructure or liquidate. The fate of copyright infringement litigation against Napster by the record labels and music publishers is thus uncertain. While pending litigation is automatically stayed when a bankruptcy proceeding is filed, plaintiffs can petition the bankruptcy court to lift the stay. The latest turmoil at Napster began earlier this month when Bertelsmann offered to pay $16.5 million for Napster’s assets. Those close to the deal said it fell through over the issue of whether Bertelsmann would make sure that board members Hank Barry and John Hummer, of Hummer Winblad Venture Partners in San Francisco, were protected from future litigation by the record labels. Barry had served as interim CEO of Napster until Hilbers took over in July, at which time Barry — a former lawyer of Palo Alto, Calif. firms Cooley Godward and Wilson Sonsini Goodrich & Rosati — returned to Hummer Winblad. Schwartz and Napster CFO Lyn Jensen worked with a team of about 10 attorneys from Jones, Day, Reavis & Pogue — including partners Daniel Mitz in the firm’s Menlo Park, Calif., office and Richard Cieri in the Cleveland office — to come up with a final deal for Bertelsmann’s acquisition of Napster. Christopher Mayer, the head of Davis Polk & Wardwell’s corporate group in New York, led the team representing Bertelsmann. Under the new offer, Bertelsmann would have put up another $5 million to help Napster pay its creditors and additional money to pay employees. “This deal would have allowed the company to keep its assets, including its employees, together in the long term,” Hilbers said in his resignation letter. Individuals close to Napster said Barry gave the company’s 70 employees the option Tuesday of leaving with two weeks severance pay or taking a week of unpaid vacation and then waiting to see what happens with the company. Barry and Hummer could not be reached for comment Wednesday. In a statement Napster said: “We deeply regret that we have not yet been able to find a funding solution that would allow Napster to launch a service to benefit artists and consumers alike. We will be looking at additional steps in the coming week to further reduce expenses.” The implosion at Napster occurred as Chancellor William Chandler III, of the Delaware Court of Chancery, dismissed a suit against Barry and Hummer by John Fanning, the uncle of founder Shawn Fanning. Fanning had sought to remove the two from Napster’s board of directors. Meanwhile, Napster has a little breathing room to deal with copyright infringement litigation by the recording industry. Napster and the record labels and music publishers agreed to suspend litigation for two weeks. Chief Judge Marilyn Hall Patel, of the Northern District of California, previously stayed the dispute when the record labels and Napster asked for a 30-day reprieve to try to work out a settlement. They scrambled to reach a deal after Patel said she was going to let Napster look into whether the labels had violated antitrust rules in licensing rights to their music. The parties weren’t able to work out their differences, and the battle resumed. Last week, the music publishers, who had reached a tentative settlement with Napster in September, resubmitted a motion for summary judgment on Napster’s liability for infringement. A hearing on the motion is set for July 8. Napster had agreed to pay songwriters and music publishers $26 million to settle their suit plus $10 million against future licensing royalties, but plaintiffs say the settlement stalled. “Napster had not lived up to the preliminary terms to settle the suit,” said Carey Ramos, a partner at Paul, Weiss, Rifkind, Wharton & Garrison in New York who represents the music publishers. “We had been patient giving them time to make deals to get licenses from the record labels and they had not done so.” As to what impact the resignation of Napster officials and loss of Bertelsmann support will have on the litigation, attorneys say it’s too soon to tell. “We would have to look at the proceeding they file, the creditors and where we stand in line as a creditor,” said Jeffrey Knowles, a partner at Coblentz, Patch, Duffy & Bass in San Francisco. “Maybe they’ll disappear and there’ll be no point pursuing a judgment but we don’t have enough information to know yet whether it makes sense to pursue a judgment.”

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