J.C. Penney emails suggest CEO pushed Martha Stewart to break deal with Macy's

Martha Stewart, left, and Ron Johnson appear on Jan. 25, 2012, in New York Astrid Stawiarz/Getty Images/J.C. Penney

NEW YORK It's been a tough week to be Ron Johnson.

J.C. Penney's (JCP) CEO was in the hot seat again on Friday in New York State Supreme Court after facing investors this week over a dismal quarterly earnings performance.

This time he was being scrutinized by Macy's (M) lawyers for a stack of emails that he wrote that they claim show he repeatedly pushed home diva Martha Stewart to try to break an exclusive deal with his rival so Penney could be the sole department store distributor of the domestic diva's goods.

"I need to propose a deal so she can go to Terry Lundgren at Macy's and break the agreement," according to one email Johnson wrote to an executive at Penney in August 2011.

Lundgren is CEO of Macy's.

Penney ended up signing a pact in December 2011 with Martha Stewart Living Omnimedia to open shops at most of its stores in spring 2013. But one month later, Macy's renewed its long-standing exclusive deal to sell some of Martha Stewart's products such as cookware and bedding. And then immediately sued Martha Stewart Living and Penney.

The trial, which began Feb. 20, focuses on whether Macy's has the exclusive right to sell some of Martha Stewart branded products such as cookware, bedding and bath items.

Macy's is seeking to block Penney from opening Martha Stewart mini shops in its stores. The shops are part of Johnson's big plan to reinvent the shopping experience at the beleaguered chain. The stakes are high for all three companies but particularly for Penney.

Penney's shares have now lost nearly 60 percent of their value since early last year when Johnson revealed his plan to scale back most sales in favor of everyday low prices. The stock drop is the latest indictment that Johnson's turnaround is failing Wall Street as much as on Main Street. Johnson is counting on the shops, particularly Martha Stewart's, to bring back shoppers who have fled to rivals like Macy's.

Johnson, who is expected to be questioned by Penney attorneys later Friday, acknowledged that getting a deal with Martha Stewart was critical and acknowledged that he knew the deal was exclusive with Macy's but stopped short in saying he wanted to break the exclusive. "I knew there had to be an amendment" to a deal between Macy's and Martha Stewart.

Johnson's appearance comes four days after Lundgren testified in court that the company had built the Martha Stewart brand to be the biggest name in home items since it began to start carrying the products in 2007.

Martha Stewart, who founded Martha Stewart Living, is expected to testify Tuesday.

Johnson's testimony marks a culmination of a legal battle between the three companies that started shortly after the Penney-Martha Stewart deal was announced in December 2011.

Macy's renewed its 2006 pact with Martha Stewart Living in January 2012 but then immediately sued the company, saying it breached a long-standing contract when it penned the 10-year deal with Penney. Penney also invested $38.5 million in a nearly 17 percent stake in Martha Stewart Living. In a separate lawsuit, Macy's sued Penney, claiming it had no regard for the Macy's contract and that Johnson had set out to steal the business that it had worked hard to develop.

Macy's also contends that Johnson "knowingly and purposely demanded and received confidential information" from Martha Stewart about the contract and crafted a deal that was more lucrative than the terms of the Macy's agreement.

The two suits were consolidated for the bench trial. Supreme State Court Judge Jeffrey Oing is presiding over the trial, which is expected to last three weeks.

Penney is aiming at what it believes is a loophole in the agreement between Macy's and Martha Stewart. It's a provision that allows Martha Stewart to sell goods in categories like bedding in Martha Stewart Living's own stores.

According to Martha Stewart, because the Macy's agreement doesn't say the goods under dispute can be sold "only in "stand-alone" stores, the mini shops within J.C. Penney stores do not fall under the exclusive agreement.

Macy's Inc., based in Cincinnati, disagrees. Lundgren argued that a typical definition of a store is that it has a parking lot, is part of a mall or has a sidewalk in front.

Macy's claims substantial damages and said the maneuver by Penney "threatens to inflict incalculable further harm on Macy's." The company claims that "billions of dollars of sales are involved."

But according to a memo filed by Penney, Macy's rights to Martha Stewart aren't nearly as sweeping as it suggests. Under Macy's interpretation of the contract, Martha Stewart Living is "little more than an in-house designer for Macy's," according to Penney.

Last summer, Macy's won a preliminary injunction against Martha Stewart Living that would prevent it from selling housewares and other exclusive products at Penney. Judge Oing granted Penney permission to open Martha Stewart shops, as long as the items under the exclusive contract with Macy's are not sold in them.

Penney plans to open shops featuring designs from Martha Stewart on May 1, but spokeswoman Daphne Avila said that the products like bedding that Macy's has deemed exclusive have been stripped of the Stewart name and instead feature the label "JCP Everyday." Window treatments and paper products like stationery, which are not included in the exclusive arrangement with Macy's, will bear Martha Stewart's name.

But Macy's is also trying to stop Martha Stewart from providing designs to J.C. Penney - whether or not it gets rid of the Martha Stewart name.

The stakes are high for all three companies, but particularly for Penney.

Investors were bracing for a bad fourth-quarter report from Penney, but the staggering losses and revenue drops were far worse than feared.

Penney reported on Wednesday after the markets closed that its quarterly loss widened to $552 million, or $2.51 per share. Revenue fell 24.8 percent to $12.98 billion.

Results for the full year were even more jaw-dropping. For the fiscal year, Penney lost $985 million, or $4.49 per share.

Macy's, one of the best performing department stores, turned in a solid fourth quarter. Lundgren says home items a key business. Having another major department store sell Martha Stewart towels, pots and other merchandise could hurt its sales in that area.

For its part, Martha Stewart Living is trying to fatten merchandise revenue as it struggles to offset declines in its broadcast and publishing business, a segment that accounts for more than 60 percent of its business.

The stakes also are high for the personalities involved in the suit. Lundgren said that he hasn't spoken with the lifestyle guru since Dec. 6, 2011, when she called him to inform him that she signed a deal with Penney. The next day, Martha Stewart announced the deal to the public. Lundgren testified Monday that he was so shocked when Stewart told him that she had signed a deal, he hung up on her.

"I was completely shocked and blown away," he testified. "It was so far from anything I could imagine."

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