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Former Rhythm & Hues Directors, Officers Sued for ‘Recklessly and Blatantly’ Violating Duties

Lawsuit alleges that risky transactions by founders including John Hughes helped drive the Oscar-winning visual effects and animation company into bankruptcy

Multiple former officers and directors at Rhythm & Hues, the visual effects and animation company behind “Life of Pi,” are being sued for making reckless business decisions and questionable investment and real estate transactions.

The complaint that was filed on Friday at a bankruptcy court in Los Angeles included John Hughes, Pauline Ts’o, Keith Goldfarb, Lee Berger, Prashant Buyyala, Raymond Feeney and David Weinberg as defendants, along with CCC Diagnostics LLC, Rhythm & Hues Sdn. Bhd and 2100 Grand LLC.

It alleges that the reason why Rhythm & Hues filed for Chapter 11 bankruptcy in February 2014 — 11 days before winning its third Academy Award for Best Visual Effects for “Pi” — was because “Hughes, Ts’o and Goldfarb breached their duties of loyalty, due care, and good faith by directing R&H to engage in risky transactions with entities they or their family members owned or controlled.”

Alleged transactions included: Transfers of millions of dollars to a biotech start-up company founded by Hughes’ father-in-law in return for unsecured notes that were eventually sold to Hughes for one dollar; a transfer of software rights critical to R&H’s business to a company owned by Hughes, Ts’o and Goldfarb for no consideration whatsoever; and a real estate transaction in which the trio received millions of dollars from R&H to invest in a property with potential upside to them while R&H bore all the downside risk.

The lawsuit also claims that Hughes, Ts’o and Goldfarb “pillaged R&H with little concern about the consequences.” The company, which was founded in 1987, “could ill afford these costly, self-interested transactions,” causing it to limit customer base so it was beholden to only three studios and submit reckless bids that resulted in detrimental studio contracts, as well as underutilizing hundreds of employees and sacrificing valuable tax refunds.

Other company officers and directors, “if not actively involved in the wrongful acts, were completely derelict in their duties by failing to halt these primary actors from engaging in acts that clearly constituted breaches of their fiduciary duties.”

As a result, “R&H deteriorated rapidly and could not remain a financially viable entity,” claims the lawsuit.

Before its demise, R&H had worked on hit movies such as “Django Unchained,” “The Hunger Games” and “The Lord of the Rings,” and won Academy Awards for “Babe,” “The Golden Compass” and “Life of Pi.”

Rhythm & Hues was one of the world’s leading producers of visual effects and computer-generated animation for the entertainment industry and went on to become the largest VFX and CG studio in Los Angeles (and among the top eight VFX and CG studios globally) with more than 700 employees at its headquarters in El Segundo, California, and over 600 employees oversees in Canada, India, Malaysia and Taiwan. Three of R&H’s largest customers were Warner Bros., Twentieth Century Fox and Universal Studios, according to the legal filing.

On March 29, an affiliate of Prana Studios won the bidding of Rhythm & Hues in a bankruptcy auction, with the sale “valued at about $30 million.”

The company’s financial troubles began in 2007, according to the lawsuit, after it had added hundreds of employees to its U.S. operations without planning or foresight, causing the total to almost double from 375 to 700. “R&H, in turn, was crushed by the weight of excessive labor costs and accompanying benefit programs.”

By 2012, “after years of financial distress, R&H’s situation was dire, and its efforts to seek financing to salvage the company were too late,” the company “suffered losses of $22.5 million,” forcing it to seek bankruptcy protection in early 2013.

One of the major charges is that starting in 2007, “the Primary D&Os [directors and officers] began funneling R&H’s precious cash resources to CCCD, a start-up biotechnology company founded by Dr. Paul Ts’o, the father of Ts’o and the father-in-law of Hughes. CCCD had no revenues. Its business was wholly unrelated to R&H’s business, and the two companies had absolutely no corporate synergies.” Hughes allegedly transferred millions of dollars into CCCD without board approval or adequate protection.

Despite major financial problems, the company heads adamantly refused to reduce excessive costs by cutting staff and superfluous costs. “R&H had hundreds of idle staff members who continued to collect salaries and benefits during R&H’s financial crisis,” states the suit. Hughes has since acknowledged in an interview that they were aware that they needed to “cut people’s salaries or to lay off a significant number of people or to work people overtime without paying them for overtime by restructuring their contracts” and the directors and officers drove R&H “into bankruptcy and ‘destroyed’ the company by failing to take such action,” claims the lawsuit.

As TheWrap previously reported, the failure of Rhythm & Hues — which led to hundreds of employees being laid off — galvanized visual effects workers, leading to a protest outside last year’s Oscars that drew 500 people, and scores of articles and blog posts about the dire state of the business.

Pamela Chelin contributed to this report

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