Penney CEO knew Martha Stewart deal stepped on Macy's toes

J.C. Penney Co Inc chief Ron Johnson knew before doing a deal with Martha Stewart that it would create a conflict with rival Macy's Inc, which already had a relationship with her.

Johnson testified in New York state court on Friday in proceedings brought by Macy's against his company and Martha Stewart Living Omnimedia Inc over their proposed deal.

The chief executive wrung his hands as a lawyer for Macy's grilled him over an email he wrote to a board member saying Martha Stewart would have to "break" her agreement with Macy's if he was going to "pull off" a deal with her.

Macy's sued Martha Stewart Living and J.C. Penney after the they announced plans in December 2011 to launch Martha Stewart boutiques in about 700 J.C. Penney department stores. The boutiques are part of Johnson's strategy to re-invent the 102-year-old retailer, which released dismal holiday shopping season results on Thursday.

Macy's claims that, by signing a deal with J.C. Penney, MSLO breached its contract to sell products in certain categories such as cookware, bedding and bath items, exclusively at Macy's.

A non-jury trial is underway before Justice Jeffrey Oing in New York state court in Manhattan.

Johnson testified he got the idea for putting Martha Stewart in J.C. Penney stores when he read in the spring of 2011 that her company had hired the Blackstone Group to evaluate opportunities. He believed Martha Stewart's influence on home goods was greater than the influence of any designer on the apparel industry.

Theodore Grossman, representing Macy's, asked Johnson about an Aug. 14, 2011, email he sent to J.C. Penney board member Steven Roth, whose Vornado Realty is Penney's second-largest shareholder. Roth had said in an earlier email that Martha Stewart's exclusive deal with Macy's would be a "major impediment."

"Martha could be the foundation of a reinvented home," Johnson wrote in the email. "Macy's deal is key. We need to find a way to break the renewal right."

Johnson said that "break" did not exactly mean breaking the contract.

"I knew there would have to be an amendment ... for us to do what we wanted," Johnson told the court. "The word 'break' meant there would have to be a change ... for us to carry the products" in certain categories.

Johnson also used the word "break" in an Aug. 17, 2011, email to a Penney executive.

"I need to propose a deal so she can go to Terry L at Macy's and break their agreement," he wrote, referring to Macy's CEO Terry Lundgren. "That is the only issue in the way of success at this point."

Johnson said he learned of another way around the Macy's deal on Sept. 20, 2011, when Stewart and an MSLO executive told him the company's outside counsel concluded the Macy's contract allowed them to create a store within J.C. Penney.

"That's great news," Johnson recalled saying.

Under the contract with Macy's, Martha Stewart Living can sell product categories that are now exclusive to Macy's if MSLO opens its own stores. Macy's says the proposed boutiques at J.C. Penney are not the same as standalone stores.

Asked by Penney's lawyer, Mark Epstein, if he would have allowed MSLO to breach its contract with Macy's if that were the only way to move forward, he said: "Absolutely not."

Terry Lundgren, the chief executive of Macy's, testified in the trial on Monday that when Martha Stewart told him the night before the public announcement that she was starting an alliance with his rival, he hung up the telephone and has not spoken to her since.

Martha Stewart is Macy's No. 1 brand of home goods, Lundgren testified. Sales increased 8 percent last year, twice that of Macy's as a whole, Lundgren said.

Martha Stewart is expected to take the stand on Tuesday.

The testimony capped off a tough week for Johnson and J.C. Penney. After Penney shares plunged 17 percent on Thursday, analysts forecast Johnson will have until back-to-school season in August to show he has put the retailer on the right road.

The cases are Macy's Inc v. Martha Stewart Living Omnimedia Inc, 650297/2012, and Macy's Inc v. J.C. Penney Corp, 652861/2012, New York State Supreme Court, New York County.