(FORTUNE Magazine) – Nobody loves Winnie the Pooh more than Shirley Slesinger Lasswell. The 79-year-old widow wears Pooh pajamas, Pooh watches, and Pooh polo shirts. A Pooh waves at other drivers from the rear window of her Mercedes as she is chauffeured around Beverly Hills. But these days, some of her most treasured Pooh merchandise languishes in boxes in her lawyer's office. It breaks Shirley's heart. "I never wanted Winnie the Pooh to go through anything like this," she says. "It's just not right."

Pooh would no doubt scratch his fluff-stuffed head in disbelief at what's going on. Shirley and her daughter, Pati, are embroiled in an epic legal battle with the Walt Disney Co. over the merchandising rights to the world's most beloved bear. Shirley's former husband, Stephen Slesinger, acquired the merchandising rights to Winnie the Pooh in 1930 from his creator, A.A. Milne. After Slesinger died, Shirley granted the rights to Walt Disney himself. Now Shirley's company, Stephen Slesinger Inc., accuses Disney of cheating it out of royalties for nearly two decades. Her lawyers want Stephen Slesinger Inc.'s contract with Disney voided so they can shop Pooh around to competing entertainment companies.

Disney vigorously disputes the allegations. The company paints Shirley and Pati as freeloaders whom Disney has made fabulously wealthy through its shrewd marketing of Pooh. Instead of being grateful, argues Disney, Shirley and her daughter have attempted to stretch the terms of a yellowing contract to bag royalties on all sorts of things, even home videos, which were beyond anybody's imagination in 1930.

Billions of dollars are at stake in the lawsuit, which is scheduled to go to trial in March. Pooh videos, teddy bears, and other merchandise generate $1 billion in annual revenues for Disney--the same amount as Mickey Mouse, Minnie Mouse, Donald Duck, Goofy, and Pluto combined. Disney has disclosed to the Securities and Exchange Commission that it may be liable for "as much as several hundred million dollars" if it loses the case. Shirley and Pati's attorneys say the number may be closer to $4 billion. One thing is sure: This is the last thing Disney needs at a time when its stock is ailing, its CEO, Michael Eisner, is under fire, its theme park attendance is down, and its most recent animated feature, Treasure Planet, just resulted in a $74 million pretax loss.

Both sides have hired celebrity lawyers to battle over Pooh. Disney's is Daniel Petrocelli, who handled a successful civil suit against O.J. Simpson on behalf of Ron Goldman's family. Bert Fields represents Stephen Slesinger Inc. He is best known for handling former Disney chairman Jeffrey Katzenberg's suit against the Magic Kingdom for unpaid wages. Before the suit was settled, Fields eviscerated Eisner on the witness stand. He is eager to get him back on the stand in the Pooh case.

There will be plenty for Fields and Petrocelli to wrangle about. Judge Ernest Hiroshige has already sanctioned Disney for destroying some 40 boxes of documents that Pati and Shirley's lawyers say may have held crucial evidence. Disney says it did nothing wrong.

Millions of dollars have already been spent on the Pooh case, which is the longest-running lawsuit in Los Angeles Superior Court. There are reams of documents on file. They tell a fascinating story of how Winnie the Pooh morphed from a storybook character to perhaps the world's best-known children's plaything. It's not the sort of tale one finds in A.A. Milne's books. For while Pooh has made generations of youngsters smile, he has made everybody close to him--from A.A. Milne to the adversaries in Slesinger v. Disney--miserable.

"He was a nice, quiet English man," Shirley says. "His wife was effervescent. She'd talk. She was a delight. But he was very sweet."

It's a brilliant morning in November, and Shirley sits at a table just off the patio of Pati's Beverly Hills home reminiscing about meeting A.A. Milne in London in the late 1940s. Shirley connected more with Milne's bubbly wife, Daphne, than with the writer himself. That's understandable. Shirley was a former showgirl from Detroit who had appeared in the hit Broadway musical Hellzapoppin' before her marriage in 1948 to Slesinger, a literary agent who was 22 years her senior.

Milne, on the other hand, was a world-weary intellectual. The writer, who died in 1956, was known wherever he went as the man who breathed life into Winnie the Pooh. But success as a children's writer had made him bitter. As a young man Milne was an up-and-coming playwright in London. On a whim he wrote a poem about his 2-year-old son, Christopher Robin, entitled "Vespers," with the now famous closing lines: "Hush! Whisper who dares! Christopher Robin is saying his prayers." He told his wife she could keep the money if she sold the poem to a magazine.

Daphne promptly sold "Vespers" to Vanity Fair, where it was published in 1923. Other magazines clamored for Milne to write more children's poems. The most popular were his whimsical verses about Christopher Robin and his teddy bear, who appeared early on as Edward Bear and was soon dubbed Winnie the Pooh. In 1924 the poems were collected in a book called When We Were Very Young. It sold so well that Milne bought a farmhouse on the edge of Ashdown Forest. The forest became the setting for Winnie the Pooh, a book of stories about the unforgettable bear who lived for honey and lazy afternoons doing "Nothing" in the Hundred Acre Wood with Christopher Robin and Piglet. Winnie the Pooh was published in October 1926. In the U.S. alone, it sold 150,000 copies before the end of the year.

Milne could see where Pooh was going--and wanted to stop him. He published a second collection of tales in 1928 entitled The House at Pooh Corner, but tried to kill off Pooh at the end of the book. In the haunting final scene, Christopher Robin tries to explain to an uncomprehending Pooh that he's growing up and will soon have to bid farewell to his playmate from his nursery days.

'Pooh?'

'Yes, Christopher Robin?'

'I'm not going to do Nothing any more.'

'Never again?'

'Well, not so much. They don't let you.'

Pooh wasn't so easily done away with. Milne wrote novels, antiwar essays, and more plays. But the public cared only about Pooh. That, Milne wrote in his autobiography, bothered him to no end: "As a discerning critic pointed out: The hero of my latest play, God help it, was 'just Christopher Robin grown up.' So that even when I stop writing about children, I still insist on writing about people who were children once. What an obsession with me children have become!"

Pooh also dragged his reluctant creator into the entertainment business, where he didn't show much smarts. In 1930, Slesinger, whose clients included Western writer Zane Grey, traveled to London and offered Milne a $1,000 advance for the merchandising rights to Pooh in the U.S. and Canada. Milne happily accepted. Two years later, for no additional charge, he granted Slesinger the rights for any performance of Pooh on radio, television, or any "other mechanical instrument" or similar "devices" created in the future. Milne would get two-thirds of whatever royalties Slesinger collected from broadcasting rights; the agent would keep the rest.

The deal must have seemed fairly inconsequential at the time. The market for merchandise of branded characters barely existed. What did Milne have to lose? Quite a bit, as it turned out. In 1937, Walt Disney, America's most famed animator, came calling. Fresh from his triumph with Snow White and the Seven Dwarfs, Disney wanted to make Winnie the Pooh a movie star. Milne may have been crotchety, but he loved Disney cartoons. The news of Disney's interest arrived the day after he and his family saw Snow White. "We all loved it and said, 'If only ...' 'What fun it would be IF--' " Milne gushed in a letter.

Alas, Pooh would have to wait for his Hollywood debut. One sticking point was Milne's merchandising agreement with Slesinger. Walt Disney was an early apostle of synergy. He wasn't interested in simply making Pooh cartoons; he saw that the movies could also drive sales of Pooh merchandise. His brother, Roy, was apoplectic when he discovered that Slesinger controlled the Pooh merchandising rights. "If we were to attempt to do anything with Winnie the Pooh," he fumed in a memo, "Slesinger is in a beautiful spot to either hold us up for an outrageous price or sit back and reap the rewards of our work and investment."

Slesinger had every intention of doing the latter. He insisted on a fifty-fifty split of Pooh merchandising income with Disney. He was furious when Disney refused his terms.

It wasn't until 1961 that Disney finally won the right to make Pooh movies and toys. By then, Milne and Slesinger were dead. Walt Disney negotiated the merchandising contract with Shirley. It stated that Shirley's company would get 4% of Disney's worldwide revenue from a seemingly endless list of Pooh items, including puppets, wallpaper, puzzles, phonograph records, and food. Daphne Milne would get 2.5%. Disney would pocket the rest. In February 1966, Disney released Winnie the Pooh and the Honey Tree, its first movie set in the Hundred Acre Wood.

The British thought the 25-minute cartoon trivialized Milne's masterpiece. Americans were charmed. A sequel, Winnie the Pooh and the Blustery Day, immediately went into production. But before he fully realized the rewards of his 30-year pursuit of Pooh, Walt Disney died on Dec. 15, 1966.

Today Disney executives act as if Pooh is as much a Disney character as Mickey himself. There's something to their sense of ownership. After all, the Pooh known throughout the world isn't the gentle stuffed bear that wanders through Milne's book; it's the merry cartoon character featured in the movies Disney continued to produce after its founder's death.

Disney's Petrocelli refuses to entertain the notion that Shirley and Pati might have a right to feel similarly attached to Pooh. "They didn't create Winnie the Pooh," he says. "They didn't write a word. They didn't draw a picture. [Slesinger] was just a promoter trying to exploit the property in merchandise transactions."

Shirley feels her relationship with Pooh is much deeper. After her first husband died in 1953 (she later married Fred Lasswell, the cartoonist who drew the Barney Google comic strip), she inherited Slesinger's rights to Pooh. She spent most of her time trying to license him to coloring-book publishers, children's clothiers, and stuffed-animal makers. Her office on Park Avenue in Manhattan had its own Pooh Corner inhabited by life-sized embodiments of Milne's creations. "I like best just to sit here alone and think of all the wonderful things that we can do," she once sighed to a reporter. "The world of Pooh is still a magic world for me."

For Shirley, handing Pooh over to Disney was like giving a child up for adoption. She couldn't let go. For a while Disney indulged Shirley when she made suggestions about how the company should develop Pooh. It was a heavenly experience for Pooh's biggest fan. "In the very beginning, if I didn't like something, I'd say, This is really not right," she says. "Quality control is what it was. They gave that to me, and [the products] turned out to be beautiful."

By the late '70s, the relationship began to sour. Shirley's daughter, Pati, born in 1952, became involved in Stephen Slesinger Inc. Shirley still had the breezy air of a showgirl, but Pati was quick to take offense. She became obsessed with the contract her mother had signed with Disney. The more she took part in negotiations with Disney, the more contentious things became.

In 1980 she and her mother confronted Disney executives with a suitcase full of Pooh stuffed animals, toys, and brochures for Pooh promotions that weren't included on their royalty statements. Vince Jefferds, head of Disney's merchandising division, was furious. He warned that he would pull all Pooh products from Disney's theme parks if they hounded him further. He even threatened to get Christopher Robin Milne to terminate the 1930 contract with A.A. Milne, as permitted under a recently passed U.S. copyright act. "I'm going to go to England and get Milne to cut you off," Pati recalls Jefferds saying. "Fine," said Pati. "We'll see you in England."

Pati and her mother hurried to London and met with Christopher Milne and trustees of the Milne estate. The real Christopher Robin wasn't interested in reclaiming the merchandising royalties. Like his father, he was deeply conflicted about Pooh Bear. He rued the day he was immortalized as Pooh's flesh-and-blood sidekick. When he went off to boarding school, the other students teased him mercilessly. The only reason he eventually accepted royalties from the Pooh books after his father and mother's deaths was that his only child, Clare, was born with cerebral palsy. She would need to be looked after when he and his wife, Lesley, passed away. (Christopher Milne died in 1996.)

However, Milne was also contemptuous of Disney for commercializing his teddy bear. He was only too happy to help these two odd women from America. "I don't see how they can do this," Pati recalls him saying when she told him of Disney's threat. "It doesn't make sense."

The trustees of the Milne estate were also interested when Pati and Shirley told them of their plight over tea at London's Dorchester hotel. If Stephen Slesinger Inc. was being shortchanged, it stood to reason that the estate might be as well. There might be consequences for beneficiaries designated by A.A. Milne in his will, including his alma mater, Westminster School, and his favorite watering hole, the Garrick Club in London. (The estate declined to discuss the Pooh case.)

In 1983, Disney paid $1.1 million to Stephen Slesinger Inc. and the Milne estate to settle the royalty dispute. The three parties also agreed to a new contract. Stephen Slesinger Inc.'s percentage of the Pooh royalties fell from 4% to roughly 2%. However, Shirley and Pati say they went along because they believed Disney would start treating them more fairly.

Peace was short-lived. Once again, Pooh had other plans. In the '80s, U.S. consumer spending on home video grew from $369 million to $8.3 billion, according to Adams Media Research. Pooh videos soared to the top of Billboard's "kid videos'' list.

Everybody made a grab for the royalties. Disney said it didn't owe anybody anything. The company claimed that the videos were included in the motion-picture rights that it was granted by Daphne Milne in 1961. There was only one problem with Disney's argument: It had paid Stephen Slesinger Inc. video royalties after signing the 1983 contract. Then it stopped. The company now says the payments were mistakes. Pati and Shirley insisted that Stephen Slesinger's original contract with A.A. Milne gave them the rights to a percentage of the revenues. "What was [Slesinger] talking about but the future of home entertainment?" Pati says. "He wanted to make sure that was covered."

So Disney tried to divide and conquer. It settled for an undisclosed sum with the Milne trustees, who had no stomach for a fight. When Pati and her mother tried to press their case, they say, Disney lawyers told them in no uncertain terms: Sue us.

If you've read Winnie the Pooh, you may recall the "rather sad and boggy" place where the self-pitying donkey Eeyore resides. There must be times when Disney's lawyers feel that is where they have arrived after fighting for 11 years with Stephen Slesinger Inc. in Los Angeles Superior Court.

Disney's Petrocelli says Shirley and Pati and their lawyers have skillfully manipulated the legal system, keeping alive a frivolous lawsuit that should have been dismissed years ago. "It's a perfect example of a simple and straightforward case getting bollixed up by lawyers who are trying to invent and conjure up claims where no claim really exists," he says.

Characterizing Shirley and Pati as brilliant legal strategists is a stretch, however. The two actually believed that their dispute with Disney would be resolved quickly. They felt certain that all Judge Ernest Hiroshige had to do was throw open the Magic Kingdom's financial records and it would be clear they had been cheated. "We were very naive," Pati admits.

Here's what happened instead. Disney urged the judge to seal the court records. Then, according to Bert Fields, the Magic Kingdom "stonewalled discovery from beginning to end." Disney says it had no choice because the other side was on a fishing expedition and kept making voluminous document requests. "They kept striking out looking for unpaid royalties," says Petrocelli. "Before long they were asking to examine everything."

Things became so contentious that a second judge was appointed to referee the discovery process. That only further delayed a resolution. When Disney didn't like a decision by the referee, it asked Hiroshige to reverse it. Opposing attorneys did the same.

As the case crawled forward, Disney got the upper hand. In 1997 a court-appointed accounting firm found that the company owed Stephen Slesinger Inc. only $60,508 in unpaid royalties. Shirley and Pati were furious.

Then who should come to their rescue but Winnie the Pooh. In the '90s, Disney aggressively expanded the number of its retail stores. Pooh items flew off the shelves. From 1991 to 2000, Stephen Slesinger Inc.'s annual Pooh royalties climbed from $334,731 to $12.4 million. It's no mystery where that money has gone. When Shirley and Pati filed their lawsuit, they were represented by lawyers on a contingency basis. Once they were millionaires, they hired Bert Fields, whose personal fee is $850 an hour.

Disney began to lose ground. In 2001, Judge Hiroshige granted a motion by the Los Angeles Times to unseal the court records. He dismissed the court-appointed accounting firm for producing an audit that he called "one sided" and "inaccurate." He recently granted Fields' request to submit written deposition questions about Winnie the Pooh to Eisner himself.

The biggest blow came when the judge sanctioned Disney for destroying the files of the late Vince Jefferds, the Disney executive who signed the 1983 agreement. Early in the lawsuit Pati made a surprising claim: She said Jefferds had told her that Stephen Slesinger Inc. would be entitled to video royalties no matter what the contract said. Pati eventually produced two pages of notes that she claimed to have hastily typed up after a private meeting with Jefferds at the Beverly Hills Hotel. "He said, Videos and all these new things are covered, and to shut up about it," Pati wrote. "He said, When I get back from China, I'll have millions of kids eating with Pooh chopsticks. Well, they are not listed in your contract. It's just not necessary to start listing and adding every new product that comes out on the market. We'll never get done with this."

In Pati's notes, Jefferds also concedes that Disney would have to pay Stephen Slesinger Inc. royalties not just on licensing fees but on the gross sales of Pooh products. In the lawsuit, Stephen Slesinger Inc. has accused Disney of fraudulently depriving it of this money.

Petrocelli vehemently disputes the authenticity of the memo. He says Pati dreamed up Jefferds's statements after the former executive died in 1992 of a rare blood disorder. "Mr. Jefferds was alive for the first year of this case," he scoffs. "The critical allegations and accusations that are now being made against him were not made at the time that he was alive. They knew he was ill. After he dies, they amend their complaint, and they allege fraud against him."

Yet Disney behaved rather strangely for a company that insisted its former executive had said nothing incriminating. It said it couldn't find letters Shirley insisted she had exchanged with Jefferds. Then out of the blue in 1999, Disney volunteered that it had destroyed some 40 boxes of Jefferds's files three years after the lawsuit had started.

Disney says no skullduggery was involved. "These were boxes filled with obsolete papers having nothing to do with the case," Petrocelli says. Judge Hiroshige wasn't impressed. He sanctioned Disney, saying that there was evidence suggesting it had "willfully" destroyed Jefferds's files. As part of the punishment, when the case goes before a jury the judge will prohibit Disney from disputing what Pati says Vince Jefferds told her. An appellate court recently refused Disney's request to overturn part of the sanctions.

Bert Fields says the decision may cost Disney billions of dollars. He estimates that if Pati and Shirley win on all counts, Disney could owe more than $1 billion in royalties on gross sales of items like Pooh teddy bears since 1983. He says Disney could owe at least another $1 billion if a jury finds that it must pay royalties on disputed items like videotapes and the use of Pooh in promotions like McDonald's Happy Meals, which his clients are also demanding. "Now that's without punitive damages," Fields cautions. "We have a lot of evidence that I think will call for it. It could be another $500 million easily. It could be double compensatory damages if the jury really gets sore at Disney."

Disney blithely insists that the sanctions will eventually be reversed and the case will be dismissed. But it is clearly worried about losing the merchandising rights to Pooh. The best indication is the federal lawsuit the company filed in November seeking to terminate Stephen Slesinger Inc.'s rights under U.S. copyright law in 2004. In a surprising twist, the company maintains it has a willing participant from the Milne clan this time. Its co-plaintiff in the lawsuit is A.A. Milne's only surviving blood relative, Christopher Milne's daughter, Clare, whom you'll recall was born with cerebral palsy.

The lawsuit asks the court to allow Clare Milne to take back the merchandising rights that her grandfather granted Stephen Slesinger 72 years ago. According to Disney, she would then sell the company these rights for an undisclosed sum. Why is Clare Milne coming forward at such convenient time for Disney? That's hard to say. Her mother, Lesley Milne, recently told the Sunday Telegraph that her daughter is in a nursing home and didn't quite grasp how much her Pooh rights were worth. "She's rather vague about that sort of thing," Lesley Milne told the British paper. "She doesn't know the difference between 1,000[pounds] and 1 million[pounds]. That's rather nice, don't you think?" Clare Milne's British lawyer, Michael Joseph Coyne, declined to discuss the case. Disney attorneys would only say that Clare Milne and her attorney, not Disney, initiated the effort to strip Stephen Slesinger Inc. of its Pooh merchandising rights.

Disney's legal action may backfire. Fields says it will just make it easier to convince a jury that Shirley and Pati should be able to shop Pooh around Hollywood. "By issuing this public statement that they are not going to pay any royalties [beginning in 2004], Disney has now repudiated the contract," Fields claims. Disney, of course, strongly disagrees.

No matter what happens, Shirley and Pati won't go to the poorhouse. They have collected more than $60 million in Pooh royalties since 1983. Pati resides in a plush house with a swimming pool and a Jacuzzi high in Beverly Hills. These days her mother can often be found there too. On a recent morning, two servants attended to their needs while they told their story to Fortune.

They spent much of their time lamenting how their feud with Disney has cast a pall over their lives. "The money at the end of the day isn't rewarding," Pati says. "The question is, How did we get ourselves into this?"

"Water!" she calls out. A servant fills her glass.

"We don't want this to continue," Shirley says. "[Pati has] had too much. She's exhausted. She's worked so terribly hard. If she was your daughter you'd feel the same way. Enough is enough. But they [Disney] don't say, 'Enough.' "

What are Pati and Shirley really after? Essentially, visitation rights to Pooh. "I wish--this is impossible--but I wish it could be the way it seemed like it was going to be when we signed the '83 agreement," Pati says. "If we saw a Pooh that didn't look right, we would tell them, and when they did a good job, we would write them and tell them or call them up on the phone and say that's wonderful or ..."

"That's what I used to do," Shirley says wistfully.

Pati is full of ideas for Pooh. "There's a wealth of literature that hasn't been touched by Disney," she says, her eyes growing wide. "What about Kanga? She's a single mother. With a little Roo? Isn't that a good theme? Why not develop that? There's a million things they could be doing. There's a lot of richness there that they haven't, they are not tapping into, in my opinion. This could be such a good positive relationship. Because we love Pooh. I grew up with it."

"It's really been my whole life," Shirley sighs.

That's the Pooh paradox. He delights children. The grownups who have tried to control him have gotten rich. But it has cost them something precious.

Lunch is served. Shirley and Pati retire to a dining room decorated with large painting depicting early Renaissance scenes. As they dine on bagels and cream cheese, they complain about their legal bills, their taxes, and, of course, Disney.

In the corner, a Pooh bear reclines in silence. What does he make of all this? It's impossible to say. Shirley and Pati have done everything they could to hold on to him. The truth is, Pooh left them a long time ago.

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