PROTECTING FILM INVESTORS (A brilliant article by Mr. Litwak © Mark Litwak. All Rights Reserved)

PROTECTING FILM INVESTORS (A brilliant article by Mr. Litwak © Mark Litwak. All Rights Reserved)

BY: MARK LITWAK

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. Not 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.

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Sources & Credit: Entertainment Law Resources - Mark Litwak © 2013, Mark Litwak. All Rights Reserved