Business Law Update

February 2009

Ninth Circuit Rules Against Taco Bell for Indemnification in Chihuahua Lawsuit

In June 1996, Ed Alfaro, a licensing manager at Taco Bell, attended a trade show in New York where he first discovered and became interested in a cartoon depiction of a Chihuahua dog character being marketed by its creators, Thomas Rinks and Joseph Shields, owners of the marketing company Wrench LLC ("Wrench"). Thereafter, Wrench provided Taco Bell with goods bearing the Chihuahua's image, and the Chihuahua character marketing idea was pitched internally at Taco Bell, and to the company's advertising agency, Bozell Worldwide. In November 1996, at the request of Taco Bell, Wrench's licensing agent submitted a proposal of financial terms for the use of the Chihuahua, which Taco Bell did not accept, although discussions about Taco Bell's possible use of the Chihuahua character continued.

In March 1997, Taco Bell changed advertising agencies from Bozell to TBWA. Taco Bell commissioned TBWA to create a new advertising campaign for 1998. Between February and April 1997, Alfaro continued to work with Wrench to develop possibilities for Taco Bell's use of the Chihuahua character. In May 1997, TBWA presented approximately 30 advertising ideas to Taco Bell's marketing executives for its new campaign, including one involving a male Chihuahua dog. After favorable test advertising results, Taco Bell's marketing executives chose the Chihuahua character as the center of its new advertising campaign starting in January 1998, and began using a Chihuahua character to advertise its business. Wrench then initiated litigation in Federal District Court in Western Michigan alleging that Taco Bell breached an implied contract (there was no written agreement) by using the Chihuahua dog in its advertising campaign from 1997 to 2000 without paying Wrench and without their permission. See Wrench LLC v. Taco Bell Corp., 51 F. Supp. 2d 840 (W.D. Mich. 1999).

In its defense to the lawsuit, Taco Bell unsuccessfully alleged that there was no contract because the company's licensing manager who originally accepted the idea of the character from Wrench had no authority to bind the company, and that the character was independently created by its ad agency, TBWA. In June 2003, a jury awarded $30.1 million to Wrench ($42 million after tacking on pre- and post-judgment interest), finding that Taco Bell had breached an implied contract to compensate Wrench in the event it used Wrench's Chihuahua idea (copyright claims were originally alleged, but were disposed of prior to trial).

Taco Bell then filed a lawsuit against TBWA requesting full indemnification from TBWA for its liability to Wrench, suing for breach of contract, and seeking declaratory relief. Both parties moved for summary judgment. The district court denied Taco Bell's motion and granted TBWA's cross-motion for summary judgment.

Taco Bell appealed the district court's summary judgment in favor of its former advertising agency, relying heavily on an indemnification provision in the parties Agency Agreement (effective April 1, 1997). On January 23, 2009, the Ninth Circuit upheld the district court's grant of motion for summary judgment for TBWA. The Ninth Circuit's findings are summarized as follows:

  1. Based on a reading of the jury instructions in Wrench, the jury's verdict did not prove TBWA's fault, and TBWA was therefore not obligated to indemnify Taco Bell;
  2. the undisputed facts did not support a finding of fault or negligence on the part of TBWA, since TBWA was not a party to the implied contract between Taco Bell and Wrench and was unaware of its existence;
  3. the district court properly determined that TBWA was not obligated to indemnify Taco Bell under the indemnification provision of the parties' Agency Agreement, based on an exception in the indemnity provision which excluded claims resulting from Taco Bell's fault;
  4. TBWA could not be held at fault under the Agency Agreement, because it expressly required and allowed TBWA to rely on the approval of Taco Bell for all content;
  5. Taco Bell approved of the Chihuahua advertisements and commercials for airing, despite the existence of its implied contractual commitment to Wrench;
  6. Taco Bell's argument that TBWA failed to meet an obligation under the Agency Agreement by failing to conduct copyright and trademark searches was meritless not only because TBWA had no express obligation to do so under the Agency Agreement, but also because the Wrench liability included neither copyright nor trademark damages;
  7. the entire judgment was based on Taco Bell's breach of an implied contract to pay Wrench for use of the Chihuahua character;
  8. TBWA should not be collaterally estopped from denying that it was at fault and that its fault caused the liability to Wrench, because the elements of collateral estoppel under Michigan law were not met due to the Wrench jury instruction's failure to support TBWA's fault; and
  9. California Civil Code section 2778(6), governing the interpretation of a contract of indemnity, did not apply here, since TBWA was not an indemnitor under the undisputed facts, and because no fault or negligence of TBWA caused the duty to indemnify to arise.

Based on these findings, the Ninth Circuit held that the district court properly concluded there was evidence only of Taco Bell's fault in its liability to Wrench, and, as a result, no indemnification obligation from TBWA to Taco Bell arose.