Defining Moments in Agency History | The Bankruptcy that Changed Agency Media Relations Forever and the Demise of Sole Liability

Read this new article series on the history of advertising agencies from Marsha Appel, SVP Research Services, marsha@4as.org. Don’t miss other Defining Moments in Agency History. Let us know what you think!

 

Lennen & Newell was ranked as the 13th largest advertising agency in the U.S. in 1970. Its sudden bankruptcy in February 1972 was the worst agency financial disaster the advertising world had ever experienced. The fallout from that event led to the overturning of the almost century-old and time honored policy of agency sole liability for payment to media, and caused a disruption in the entire client-agency-media ecosystem. In order to grasp the magnitude of this event, it is necessary to understand the origins and workings of the sole liability concept.

Sole Liability and its Origins

Advertising agencies started out as agents selling space on a commission basis for newspapers. By the late 19th century, agencies operated as principals, buying media space and time and reselling it to advertisers, keeping what eventually became 15% of the gross as their compensation. The advertiser would pay the agency for the media space they ordered and had no further financial obligations; the agency took care of all the subsequent financial details in creating and placing ads. The agencies were solely liable for payment to the media for all contracted space, even if a client didn’t pay the agency. That’s how the principle of sole liability became the cornerstone of the fiscal relationship between advertisers, agencies, and the media for almost a century.

While the policy of sole liability had worked reasonably well for a long time, there were some cracks in the system by the middle of the 20th century. Television, with its unprecedented enormous volume of multi-million dollar transactions funneling through the system, left broadcasters understandably nervous at the higher risks associated with agency nonpayment. Throughout the 1960s, the controversy had been simmering. While agencies continued to use media insertion orders forms containing a sole liability clause, the major TV networks began removing that clause from their contracts. They insisted that the agency is an “agent for a disclosed principal (the advertiser),” rather than an independent entity, and this leaves ultimate liability at the doorstep of the client. The media wanted the ability to go after the client if they weren’t paid by the agency. Despite this impasse, business went on as before, with contracts rarely signed and verbal commitments allowing sole liability to remain the de facto policy…until the Lennen & Newell disaster brought everything to a head.

The Lennen & Newell Bankruptcy and its Aftermath

The Lennen & Newell story was one of too much control in the hands of one person, with no oversight by others at the agency. In short, owner and CEO Adolph Toigo expanded too fast, took on too much debt, and then mismanaged the agency’s funds. Because he kept financial problems close to the vest, the ensuing disaster was a surprise to most.

There had been some warning signs. The TV networks knew there was a “slow pay” problem, whereby Lennen & Newell was using client money to keep the agency afloat and delaying payment of its media bills, but the media continued to extend credit to the agency. It is worth noting that Lennen & Newell was a member of the American Association of Advertising Agencies. One criterion for 4A’s membership has always been the demonstration of financial stability, so media tended to do less aggressive credit checking of 4A’s members, assuming they were ‘good for the money’.

In February 1972, the agency declared bankruptcy, closed its doors, and upended the relationship between agencies and media permanently.

Left hanging by the demise of Lennen & Newell were blue chip clients and major media. There was $3 million in unpaid media bills due, mostly to the TV networks, with no agency funds remaining to pay them. Under sole liability, the clients were not liable, but in the absence of a signed contract, CBS sued Lennen & Newell client Stokely-Van Camp to recoup $428 thousand. Stokely-Van Camp had paid Lennen & Newell in full, and its attorneys claimed they should not have to pay twice.

While the lawsuit snaked through the courts throughout most of the 1970s, the controversy raged. The 4A’s issued a number of press releases and bulletins to its members in support of sole liability. 4A’s President John Crichton claimed that media needn’t freak out over the risks of agency nonpayment by pointing out that media losses involving 4A’s agencies were incredibly small: only nine 4A’s members went through bankruptcy in the preceding 20 years, with an estimated total loss to media of approximately $1.5 million, about 1/500th of one percent of the $80 billion in sales during that period. Without sole liability, media would have to check the credit of perhaps 14,000 individual advertisers vs. 2,000 agencies, and they wouldn’t have agencies speeding along the collection process.

The media associations weren’t buying it. They pushed back hard, demanding ‘joint and several’ liability, where they would have the right to go after either the agency or advertiser or both for payment, regardless of whether or not the agency had been paid. They claimed they were not privy to, and should not be involved in client-agency financial transactions, and shouldn’t have to ascertain if a client had paid its agency. Sounds almost reasonable, but if media looked directly to clients for payment, that could cut agencies out of the financial equation, eliminate one of the major services they performed for clients, and put their primary source of income at risk. For their part, most clients did not want to take on the complex media ordering/tracking/payment system handled by their agencies and they certainly didn’t like the prospect of double jeopardy–the risk of having to pay twice.

Finally, in late 1977, the courts ruled in favor of Stokely Van-Camp. The court upheld Stokely’s defense because they deemed the principle of sole liability to have been in force, by tradition if not contractually. In addition, CBS had failed to tell Stokely about Lennen & Newell’s financial woes and slow payment practices, yet it had continued to extend credit to the agency. CBS also had not informed the advertiser that they would hold it liable.

Sequential Liability

This did not put the matter to rest, and the sole liability issue simmered for another decade. By 1990, the 4A’s decided it was time to rethink sole liability. As one member of its Fiscal Control Committee put it, “Perhaps we are fighting to maintain a beachhead already eroded away.” In 1991, the 4A’s issued a statement endorsing the concept of sequential liability. Simply put, the agency would be liable for media payments if the agency had been paid by the advertiser. Prior to that event, the advertiser would be liable. This was designed to retain the agency’s position in handling the complex financial transactions with media on their clients’ behalf, and to be fair to clients, who could not be put in a position to pay twice.

The media associations denounced the 4A’s statement vociferously. The Association of National Advertisers did not adopt an official position on the subject, but ANA President DeWitt Helm said “It doesn’t really make any difference to us whom we pay as long as we get what we pay for and we only pay once.”

The arguing continued in speeches and in the press for a few more years, and then it trailed off with no clear resolution. For the most part, the agencies and media agreed to disagree. A case can be made that sequential liability has become standard trade practice, due its inclusion in agency forms, and the fact that no other single practice has superseded it to become widely used.

As complicated and nuanced as the issue of sole/sequential/dual/joint/several liability for payment to media was at the time, the question always really boiled down to: When the media isn’t paid, who is liable? In retrospect, it seems very simple and almost quaint in comparison with the intricacies inherent in the current digital ecosystem debate.