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Film investments have a bad
reputation, and deservedly so. There are instances where financiers
have been cheated and lost their entire investment. Consequently, some
investors simply refuse to consider film-related investments. This is
unfortunate because an intelligent investment in a motion picture can
earn substantial returns. While film investments are risky, the
potential return from a hit can be enormous. No only can the film earn
revenue from box office receipts, but there are many ancillary sources
of income. These sources include revenue from television, home video,
merchandising, music publishing, soundtrack albums, sequels and
remakes.
As
an attorney who represents investors, as well as filmmakers, I have
learned that there are ways to reduce the risk of film investments.
Here is a checklist to guide investors.
DUE
DILIGENCE: Thoroughly investigate the reputation and track
record of any producer or distributor you contemplate doing business
with. No contract can adequately protect you against a scoundrel. Speak
to filmmakers and investors who have done business with a candidate.
Check court records to see if the company has been sued.
FULL
DISCLOSURE: Federal and State security laws are designed to
protect investors. Offerings to the public generally require prior
registration with the SEC or a state agency. Usually private placements
are limited to persons with whom the offeror has a pre-existing
relationship. Even if registration is not required, the anti-fraud
provisions of the security laws require that the offeror make full
disclosure of all facts that a reasonably prudent investor would need
to know in deciding whether to invest. The information disclosed should
include a detailed recitation of all the risks involved in developing,
producing and marketing a movie. Avoid any offering that appears to
violate this requirement by making less than full and truthful
disclosure. Carefully read the prospectus, and consult your own
financial and legal advisors before making a decision to invest.
TRACK
RECORD: Do
not back a filmmaker or production team that does not possess the
proven skill needed to make a professional-looking movie. Avoid
first-time filmmakers. You are safer backing filmmakers whose have
completed at least one short or a feature-length work. Partner with
people of integrity who bring the skills, expertise and resources to
the endeavor that you lack. For instance, if you don't have the
knowledge necessary to evaluate a script, bring aboard someone who has
that expertise, or hire a script doctor.
IDENTIFY
THE POTENTIAL MARKET FOR THE FILM: There is a
very limited market, and modest potential revenue, to be earned from
short films, documentaries, black and white films, and foreign language
pictures. Distributors and exhibitors are prejudiced against motion
pictures shot on videotape. They prefer films shot on 35 mm stock,
although quality films shot on 16 mm or Super 16 mm stock can obtain
distribution. The top festivals do not exhibit motion pictures on
videotape.
Certain
themes, topics and genres can be difficult to sell. Religiously-themed
pictures can easily offend audiences. Cerebral comedies can be
difficult to export because their humor may not translate well. Films
with a great deal of violence may be shunned by European television which
is a prime market for independents. Films with explicit sex may not
pass censorship boards in certain countries.
Independent
films without name actors are difficult to sell. Of course, name
recognition varies around the world. The star of an American television
series may be a big name in the United State but unknown abroad. On the
other hand, some actors have large following aboard, yet are relatively
unknown in the United States. There are several publications that can
be consulted to determine the commercial appeal of actors. The Ulmer
Guide (julmer@primenet.com) surveys financiers, sales agents and other
industry insiders. Also, the Hollywood Reporter (213) 525-2087
publishes its "Star Power" guide.
DON'T
BACK DIRECTORS WHO ARE ONLY CONCERNED WITH THEIR OWN VISION: The
director of the film is the key person who will determine whether the
final product is marketable. If a filmmaker shows no concern about
making a movie with audience appeal, you can expect a film whose
exhibition will be limited to the family and friends of the filmmaker.
This is not to say that the only films you should invest in are
low-brow fare like "Dumb and Dumber." A well-made
"art" film like "Elizabeth," can win awards and
make a handsome return on investment. Filmmakers should give some
thought beforehand as to the nature of the film's intended audience. I
once watched a wonderful "Lassie" type film spiced with
four-letter words uttered by one character. I explained to the
filmmaker that his film would never sell in the family market because
of the vulgar language, and it was too soft a story to appeal to teens
and adults.
CONGRUENCE
OF INTERESTS: It is best to invest in an endeavor where
everyone shares the same risks and rewards. A filmmaker who takes a
large fee from the production budget may financially prosper from a
picture that returns nothing to the investors. It is better to back a
filmmaker willing to work for a modest wage and share in the success of
the endeavor through deferments or profit participation. An investor can
take some comfort investing in a motion picture on the same terms as a
producer or distributor where all parties recoup at the same time.
Beware of investing in a project where other parties benefit when you
lose.
UNDERSTAND
THE PARAMETERS OF A FAIR DEAL: Usually, investors are
entitled to recoup all of their investment from first revenues before
payment of deferments or profits. Many times investors are allowed to
recoup 110% or more of their investment in order to compensate them for
loss of interest and inflation. Profits are declared after payment of
debts, investor recoupment and payment of deferments. Profits are
generally split 50/50 between the producer(s) and the investors. Thus,
investors who provide 100% of the financing are entitled to 50% of the
profits. From the producer's half of net profits are paid any
third-party profit participants (e.g. the writer, director and stars).
OBTAIN
ALL PROMISES IN WRITING: Don't ever accept oral assurances
from a producer or distributor. If they promise to spend $50,000 on
advertising, get it in writing. If there is not enough time to draft a
long-form contract, ask for a letter reiterating the promises. Retain
copies of all correspondence, contracts and any promotional literature.
If a filmmaker makes fraudulent statements in order to induce you to
invest, you will have a much stronger case if his statements are in
writing.
Avoid
filmmakers who make handshake deals. Such individuals may neglect to
obtain the necessary contracts needed to fully secure ownership to
their motion picture. In order to have a complete chain of title to a
film, one needs to secure written contracts with many parties including
actors, writers and music rights owners. Filmmakers who fail to pay
attention to such legal niceties lack the professionalism needed to
succeed.
SECURE
AN ARBITRATION CLAUSE: Provide that any contractual
disputes be subject to binding arbitration, rather than litigation,
with the prevailing party entitled to reimbursement of legal fees and
costs. Arbitration is usually a quicker, more informal, and less
expensive method of resolving disputes than litigation. The parties and
the arbitrator typically gather in a meeting room. Each side is given
an opportunity to present documents and witnesses. The rules of
evidence do not apply. Parties may be represented by counsel, or they
may choose to represent themselves. Usually disputes are resolved
within a matter of months.
Investors
should also have their filmmakers demand an arbitration clause when
contracting with distributors. The filmmaker is invariably the
financially weaker party -- often the filmmaker cannot afford to retain
an attorney and pay court costs in order to bring a suit. If the
filmmaker doesn't a have a viable means of protecting his interests, he
may be forced to watch from the sidelines as a distributor ignores the
terms of a distribution agreement and pockets revenue from the film. An
arbitration clause levels the playing field.
Binding
arbitration awards are difficult to overturn. The grounds for vacating
an award are limited to such instances as when an award is procured by
corruption or fraud, or if the arbitrator lacked jurisdiction. A party
cannot reverse an arbitration award simply because he does not like the
outcome.
The
arbitration clause may provide that the award is final, binding and
non-appealable. Otherwise, trial costs may be avoided only to incur
large legal bills on appeal. The parties should specify the venue for
any arbitration. The parties may agree on the number of arbitrators and
their qualifications. It is common for the parties to have disputes
resolved by a single arbitrator who is an entertainment attorney.
Most
entertainment industry arbitrations are conducted under the auspices of
either the American Arbitration Association (AAA), or IFTA, a trade
organization representing the interests of international distributors.
The AAA has a well-defined system of procedural rules and maintains
numerous offices across the nation and in many foreign countries. IFTA
is the entity which organizes the American Film Market (AFM). IFTA
arbitrations usually occur in Los Angeles, but they can be held during
an international film market or in a foreign city. All of the
IFTA arbitrators are experienced entertainment attorneys.
Under
IFTA rules, if a filmmaker wins an award, and the distributor refuses
to comply with its terms, the filmmaker can have that distributor
barred from participation in future AFM's. This remedy is particularly
useful if the distributor's assets are abroad and difficult to reach
under the authority of U.S. law. The threat of being barred from AFM
may convince a distributor to obey an arbitration award. Some
disreputable individuals, however, have sought to avoid awards against
them by abandoning their distribution company -- often a shell
corporation -- and then establishing a new enterprise. Conducting their
business under a new name, they exploit another wave of filmmakers,
fully expecting to abandon the new company when the law catches up with
them.
To
preclude such behavior, IFTA has created a personal binder that can be
enforced against distribution executives. If an executive signs this
binder, and his company fails to comply with an arbitration award, the
executive can be barred from future AFM's.
INTEREST
ON LATE PAYMENTS: Remove any incentive for a producer
or distributor to hold onto your money. Generally, courts do not award
pre-judgment interest to a prevailing party, unless there is a
provision in the contract providing for such interest. Thus, if you
become embroiled in a dispute with a distributor who is unlawfully
holding onto $100,000 owed you, and after four years of litigation you
win the case, the court will award you $100,000 in damages without
interest. During those four years the distributor could invest your
money and reap the profits. Under such circumstances the distributor
has an incentive to delay payment.
COMPLETION
BOND: A
completion bond is issued by a completion guarantor which is an
insurance company that insures the production against budget overruns.
Before issuing the policy, the completion bond company will closely
review the production personnel, script and budget and assess whether
they think this team of individuals can bring in this script within the
shooting schedule and budget proposed. The completion bond company
usually is quite diligent in its review because if the film goes over
budget, the bond company is financially responsible. Having a
completion bond should give investors some comfort. They know that if
the budget is inadequate to complete the film, the investors will not
confront the dilemma of either putting up more money or owning an
unfinished film.
TAKE
AN ACTIVE ROLE: As a shareholder in a corporation,
or limited partner in a partnership, an investor has very limited
control over the management of the enterprise. In the past, investors
who wanted limited liability, had to be willing to pay the price of
accepting limited control. With a Limited Liability Company (L.L.C.),
however, an investor can be one of the managers of the enterprise yet
maintain limited liability. Thus, the investor can have a vote on
critical decisions such as approval of the script, cast, budget, and
distribution agreements. By being actively involved in the production,
an investor will be better able to monitor the performance of the
filmmaker and discover problems while there is time to remedy them.
MAKE
SURE FUNDS ARE SPENT ON PRODUCTION: During
fundraising, it is common for the filmmaker to set up an escrow account
to hold investor funds. The money stays in the escrow account until the
filmmaker raises the minimum necessary to produce the film. If the
filmmaker cannot raise sufficient money, the funds in escrow are
returned to the investors. By depositing money in an escrow account,
investors are protected because they know none of their capital will be
spent unless and until all the money needed to produce the film has
been raised.
After
funds are disbursed for production, there should be a system of checks
and balances to ensure that all monies are properly spent and accounted
for. A budget and cash flow schedule should be approved beforehand.
Production funds should be placed in a separate segregated account and
not commingled with the filmmaker's personal funds. All checks
withdrawing funds from the account should be signed by two individuals.
Investors may want to insist that one of the signatories is a trusted
person selected by the investors.
OBTAIN
AN EXPERIENCED ADVISOR: Retain an entertainment attorney or
experienced producer's rep to advise you and review all documents. Make
sure the filmmaker has adequate representation as well. Filmmakers may
be very capable in the arena of production, and yet be unsophisticated
in business matters. Film makers can be badly taken advantage of if
they attempt to negotiate a distribution deal without assistance. Since
the investor generally shares in the revenue paid to the filmmaker, if
the filmmaker gets taken, the investor suffers as well.
A
skilled attorney or producer rep who represents many filmmakers may
have added clout in negotiations. Such a person is aware of what
distributors pay for films, and the concessions they are willing to
make. By virtue of the attorney's or rep's relationships with festival
directors and acquisition executives, attention can be drawn to a film
that might otherwise get lost in the shuffle.
RETAIN
YOUR MASTERS: The production company should retain possession
of all master elements. Original film negatives, video masters, sound
masters, artwork, still photos and slides should not be delivered
directly to a distributor. Instead, the distributor should be given a
lab access letter which enables it to order copies of the motion
picture so the distributor can fulfill orders.
There
are numerous reasons why a producer should retain possession of master
elements:
1)
Masters may be irreplaceable. If lost or damaged, the producer will
incur a substantial expense to replace them, if they can be replaced.
2)
In the event of a dispute, it is best for the producer to control the
materials. If the distributor has defaulted, for instance, the film
maker may have a right to terminate the agreement and seek a new
distributor. The film maker will need access to his materials, however,
in order to make delivery to a new distributor.
3)
If your initial distributor has become bankrupt, you do not want to
have to go to court to extricate your materials from bankruptcy
proceedings.
4)
You may need to give several distributors access to your materials.
Typically, independent filmmakers enter into multiple distribution
deals. Often, one deal is concluded with an international distributor
(a.k.a. foreign sales agent) to distribute the film outside North
America, and one or more deals may be made with a domestic distributor
for distribution in the United States and Canada. The best solution,
when dealing with multiple distributors is to place your materials in a
professional laboratory. Each distributor is then granted a lab access
letter enabling each to order copies.
5)
You can discourage cheating by keeping masters in a laboratory and
having the lab report to you how many copies have been duplicated.
Suppose that at the end of one year, the lab reports to you that ten
film prints have been made. You review your producer reports and see
eight sales reported. This is a red flag alerting you that sales may
have been made that were not reported. Most filmmakers would not know
if their film had been licensed in Malaysia. Distributors do not
order copies of films without an order in hand. Typically, they receive
full payment for the film before they manufacture a duplicate and ship
it.
One
way to monitor which countries have licensed a film, is to place the
music on the soundtrack with a music publisher (which could be a
publishing company the producer establishes), and make sure the
publisher has entered into an agreement with ASCAP, BMI or one of the
other music collection agencies. These agencies collect public
performance royalties when the film is exhibited on television in the
United States, and in theaters and television abroad. If the music is
registered with such an agency, and royalties from Thailand are
remitted, this alerts you that a sale to Thailand has been made.
In
selecting a laboratory to deposit your materials, choose one that
charges competitive rates and has experience duplicating films for
international distribution. Buyers in certain countries, such as
Germany, are notoriously finicky and often reject films on the grounds
of poor technical quality. It is also a good idea to select a lab that
is not the lab ordinarily used by the distributor. A lab in the habit
of fulfilling orders for a distributor who is a regular client may not
bother checking to see if the distributor has authority to order
copies. Moreover, such a lab might inadvertently release the master to
the distributor. The filmmaker should always deliver the master
directly to the laboratory after the laboratory and distributor have
signed a lab access letter. If you deliver your materials to the
distributor, and the distributor places them with a lab, the laboratory
may treat the distributor as the owner of the film.
The
lab access letter should include language permitting the film maker to
receive copies of all invoices or report disclosing the nature and
amount of duplication performed. Some film makers insist that the
laboratory ship all copies directly to the territory buyers.
The
distributor will probably insist that the lab access letter be
irrevocable for the term of the distribution deal. The distributor will
want to retain access to the materials in order to fulfill any orders
arising from its licenses.
OBTAIN
AND REGISTER SECURITY INTERESTS: A security
interest gives the secured party rights in designated collateral. A
bank, for instance, has a security interest in the form of a mortgage
when it disburses a home loan. If the house is sold, the bank loan must
be repaid from the proceeds. In the movie and television industry, film
lenders may want to secure their financial interests by obtaining a
security interest in certain collateral, such as the film negative and
master materials.
Likewise,
investors may want to make sure the filmmakers they back protect their
rights by having distributors grant the filmmaker a security interest.
The collateral here is the proceeds derived from exploitation of the
film. By having a security interest, the filmmaker will have superior
rights to unsecured creditors. If a distributor goes bankrupt, its
assets will be auctioned off to pay the distributor's creditors. One of
the distributor's assets may be the right to distribute your film, and
any revenue generated from this right. If the filmmaker has a security
interest, then proceeds derived from it will be paid to the filmmaker
first, as a secured creditor, before payment is made to the
distributor's unsecured creditors (e.g., the office supply store).
It
is important not only to have a written security agreement, but also to
record it. The distribution agreement should have a clause granting the
filmmaker a security interest. A separate long and short form security
agreement is also signed by the parties, as well as a UCC-1 form which
is signed and recorded with the Secretary of State where the collateral
or distributor is located. The security interest should also be
recorded with the Copyright Office at the Library of Congress in
Washington, D.C. If you are not knowledgeable about security interests,
it is advisable to retain an attorney to assist you.
DON'T
INVEST MORE THAN YOU CAN AFFORD TO LOSE: Investing
in a film is a highly risky endeavor. Investors should never invest
more than they can afford to lose. The complete loss of your investment
should not appreciably affect your standard of living.
1.
See section 1268.2, California Code of Civil Procedure.
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