Cash-Flow Insurance Is No Guarantee For Financing of Film Productions

Putting together a film financing package can often be risky. Artisan Entertainment learned that after it thought it had entered into an essentially risk-free financing deal to produce eight films. But after its cash-flow insurer refused to accept some of the films, Artisan found itself on the losing end of a lawsuit that offers insights into just how complex and tricky film financing can be.

The financing deal began when film-industry player Peter Hoffman proposed that Artisan obtain short-term loans that Chase Manhattan Bank would “take out” (ie, provide permanent financing for) for a total of $163 million if each produced film met the definition of a “Qualifying Picture.” The take outs would be backed by cash-flow insurance from a third-party insurer for which Artisan would pay a premium of 10%-15% of the insured sum. The cash-flow insurer would then pay Chase for any film revenues shortfall.

“Qualifying Picture” was defined in the cash-flow insurance master policy issued by Royal & Sun Insurance Alliance as:

“any Picture which meets the following criteria: (a) has a maximum Total Negative Cost of $40 million and a minimum Total Negative Cost of $8 million; provided, however, that the minimum Total Negative Cost may be less than $8 million if the sum of such Picture's Total Negative Cost plus its Print and Advertising Costs is at least $13 million and provided, further, that a signed commitment from the Sponsor [Artisan] in its capacity as distributor stating that it has in place sufficient print and advertising commitments to meet this test is submitted along with the Qualifying Picture Declaration; (b) is subject to the Distribution Agreement; (c) was produced for theatrical release; (d) is released theatrically in the United States at least 30 months before the Maturity Date; (e) for which the Borrower is the initial United States copyright owner; (f) has been produced by the Sponsor or on behalf of the Sponsor, has not yet been released at the time of its acquisition by the Borrower and for which the Borrower will own substantially all worldwide distribution rights for not less than twenty years; (g) is a live action theatrical feature film filmed primarily in English; (h) filmed primarily in color; (i) rated by the MPAA (or any equivalent rating system if the MPAA rating system is generally abandoned), but is not rated 'X', 'NC-17' or any equivalent or more restrictive rating (or if the MPAA rating system is modified or abandoned would have been so rated by the MPAA); (j) has not been exhibited in any medium anywhere in the United States prior to its United States theatrical release, except for limited test marketings, previews, free, charities or academy award screenings or exhibitions; (k) is not an animated film, a depiction of a concert of any sort, a depiction of a performance of a play or musical performed on stage, or a documentary; (l) is available for and is scheduled for initial United States theatrical distribution in 35mm or 70mm film or is otherwise suitable for first class theatrical distribution and has a running time of at least 80 minutes, but no more than 150 minutes. Notwithstanding the foregoing, each of 'Stir of Echoes' and 'The Ninth Gate' shall be considered a Qualifying Picture notwithstanding the fact that with regard to 'Stir of Echoes,' the criteria set forth in (f) above are not met and with regard to 'The Ninth Gate,' the criteria set forth in (e) and (f) above are not met.”

Artisan liked having objective criteria and that Chase Manhattan would take film revenues and the insurance as the exclusive form of repayment. Chase Manhattan liked that Artisan would be responsible for repayment if the films weren't properly delivered. Still, Royal & Sun added a “Decisions Clause” to its master policy that stated that the insurer “hereby agrees (with the consent of the other insurers) that upon receipt by [Royal & Sun] of a satisfactory risk management report including a completed Questionnaire and a completed Declaration fully signed by the other parties thereto indicating that the Film Production complies as a Film Project within the terms of this Policy and has been approved by ICE Media Limited [Royal & Sun's risk manager], [Royal & Sun] will accept, execute and return the Declaration under the terms and conditions of this Policy.”

As stipulated in the qualifying picture clause, Royal & Sun accepted the first two films, “Stir of Echoes” and “The Ninth Gate,” that Artisan delivered but rejected the next three. That led to Artisan having to provide Chase Manhattan with secondary collateral. Artisan also filed suit in Los Angeles Superior Court alleging promissory fraud by Peter Hoffman and Royal & Sun, and breach of contract by Royal & Sun. In its complaint, Artisan alleged that Royal & Sun knew that it planned to leave the cash-flow insurance business. The trial court granted summary judgment to the defendants on the promissory fraud claim on the ground that, among other things, Artisan's counsel knew of the revised decisions clause. The trial court also ruled that a triable issue of fact existed as to whether Artisan was a third-party beneficiary to the master policy. Artisan later settled with Royal & Sun.

In an unpublished opinion, the Court of Appeal of California, Second Appellate District, Division Seven, upheld summary judgment for Hoffman on the fraud claim. Artisan Entertainment Inc. v. Royal & Sun Alliance, B167560. The court of appeal noted that “we find that whether Hoffman's statements constituted a misrepresentation turns on the language of the Decisions Clause. Artisan argues Hoffman misrepresented that the Decisions Clause granted no discretion to Royal & Sun, and assured Artisan that Royal & Sun would issue insurance if the films delivered were Qualifying Pictures and the risk manager approved them. The evidence establishes that the Decisions Clause provides for issuance of insurance if the film is a Qualifying Picture and Royal & Sun receives a satisfactory risk management report. … Furthermore, as Artisan recognizes, Royal & Sun flatly rejected the subsequent films on 'technical' grounds without much explanation other than claiming the risk management reports, which were satisfactory to the risk manager, were unsatisfactory to Royal & Sun. This conduct may have constituted a breach. However, there is no evidence in the record that Hoffman knew Royal & Sun intended to exit the cash flow insurance market or that it did not intend to honor the Master Policy after the first two films in the slate.”

The court of appeal concluded, “Lastly, the fact that previous transactions [by Royal & Sun] contained 'automatic' acceptance of risk language for those films meeting the necessary box office criteria and Artisan did not know of this language which was previously acceptable does not convert Hoffman's statements to misrepresentations. … The fact that other insurers were exiting the cash flow insurance market does not mean, at the time the [financing structure] was entered into, that Royal & Sun had no intention of performing or that Hoffman knew this.”

This ruling places on the production company the burden of knowing the nuances of the insurance provisions on which it would rely. The film financing market often changes and the court's ruling also gives counsel that those seeking insurance backup must educate themselves to the strengths and weaknesses of the current and future insurance market. In this case, the restrictions in the decisions clause were strong enough to defeat a reliance on market changes, despite the specificity of the qualifying picture criteria.

Putting together a film financing package can often be risky. Artisan Entertainment learned that after it thought it had entered into an essentially risk-free financing deal to produce eight films. But after its cash-flow insurer refused to accept some of the films, Artisan found itself on the losing end of a lawsuit that offers insights into just how complex and tricky film financing can be.

The financing deal began when film-industry player Peter Hoffman proposed that Artisan obtain short-term loans that Chase Manhattan Bank would “take out” (ie, provide permanent financing for) for a total of $163 million if each produced film met the definition of a “Qualifying Picture.” The take outs would be backed by cash-flow insurance from a third-party insurer for which Artisan would pay a premium of 10%-15% of the insured sum. The cash-flow insurer would then pay Chase for any film revenues shortfall.

“Qualifying Picture” was defined in the cash-flow insurance master policy issued by Royal & Sun Insurance Alliance as:

“any Picture which meets the following criteria: (a) has a maximum Total Negative Cost of $40 million and a minimum Total Negative Cost of $8 million; provided, however, that the minimum Total Negative Cost may be less than $8 million if the sum of such Picture's Total Negative Cost plus its Print and Advertising Costs is at least $13 million and provided, further, that a signed commitment from the Sponsor [Artisan] in its capacity as distributor stating that it has in place sufficient print and advertising commitments to meet this test is submitted along with the Qualifying Picture Declaration; (b) is subject to the Distribution Agreement; (c) was produced for theatrical release; (d) is released theatrically in the United States at least 30 months before the Maturity Date; (e) for which the Borrower is the initial United States copyright owner; (f) has been produced by the Sponsor or on behalf of the Sponsor, has not yet been released at the time of its acquisition by the Borrower and for which the Borrower will own substantially all worldwide distribution rights for not less than twenty years; (g) is a live action theatrical feature film filmed primarily in English; (h) filmed primarily in color; (i) rated by the MPAA (or any equivalent rating system if the MPAA rating system is generally abandoned), but is not rated 'X', 'NC-17' or any equivalent or more restrictive rating (or if the MPAA rating system is modified or abandoned would have been so rated by the MPAA); (j) has not been exhibited in any medium anywhere in the United States prior to its United States theatrical release, except for limited test marketings, previews, free, charities or academy award screenings or exhibitions; (k) is not an animated film, a depiction of a concert of any sort, a depiction of a performance of a play or musical performed on stage, or a documentary; (l) is available for and is scheduled for initial United States theatrical distribution in 35mm or 70mm film or is otherwise suitable for first class theatrical distribution and has a running time of at least 80 minutes, but no more than 150 minutes. Notwithstanding the foregoing, each of 'Stir of Echoes' and 'The Ninth Gate' shall be considered a Qualifying Picture notwithstanding the fact that with regard to 'Stir of Echoes,' the criteria set forth in (f) above are not met and with regard to 'The Ninth Gate,' the criteria set forth in (e) and (f) above are not met.”

Artisan liked having objective criteria and that Chase Manhattan would take film revenues and the insurance as the exclusive form of repayment. Chase Manhattan liked that Artisan would be responsible for repayment if the films weren't properly delivered. Still, Royal & Sun added a “Decisions Clause” to its master policy that stated that the insurer “hereby agrees (with the consent of the other insurers) that upon receipt by [Royal & Sun] of a satisfactory risk management report including a completed Questionnaire and a completed Declaration fully signed by the other parties thereto indicating that the Film Production complies as a Film Project within the terms of this Policy and has been approved by ICE Media Limited [Royal & Sun's risk manager], [Royal & Sun] will accept, execute and return the Declaration under the terms and conditions of this Policy.”

As stipulated in the qualifying picture clause, Royal & Sun accepted the first two films, “Stir of Echoes” and “The Ninth Gate,” that Artisan delivered but rejected the next three. That led to Artisan having to provide Chase Manhattan with secondary collateral. Artisan also filed suit in Los Angeles Superior Court alleging promissory fraud by Peter Hoffman and Royal & Sun, and breach of contract by Royal & Sun. In its complaint, Artisan alleged that Royal & Sun knew that it planned to leave the cash-flow insurance business. The trial court granted summary judgment to the defendants on the promissory fraud claim on the ground that, among other things, Artisan's counsel knew of the revised decisions clause. The trial court also ruled that a triable issue of fact existed as to whether Artisan was a third-party beneficiary to the master policy. Artisan later settled with Royal & Sun.

In an unpublished opinion, the Court of Appeal of California, Second Appellate District, Division Seven, upheld summary judgment for Hoffman on the fraud claim. Artisan Entertainment Inc. v. Royal & Sun Alliance, B167560. The court of appeal noted that “we find that whether Hoffman's statements constituted a misrepresentation turns on the language of the Decisions Clause. Artisan argues Hoffman misrepresented that the Decisions Clause granted no discretion to Royal & Sun, and assured Artisan that Royal & Sun would issue insurance if the films delivered were Qualifying Pictures and the risk manager approved them. The evidence establishes that the Decisions Clause provides for issuance of insurance if the film is a Qualifying Picture and Royal & Sun receives a satisfactory risk management report. … Furthermore, as Artisan recognizes, Royal & Sun flatly rejected the subsequent films on 'technical' grounds without much explanation other than claiming the risk management reports, which were satisfactory to the risk manager, were unsatisfactory to Royal & Sun. This conduct may have constituted a breach. However, there is no evidence in the record that Hoffman knew Royal & Sun intended to exit the cash flow insurance market or that it did not intend to honor the Master Policy after the first two films in the slate.”

The court of appeal concluded, “Lastly, the fact that previous transactions [by Royal & Sun] contained 'automatic' acceptance of risk language for those films meeting the necessary box office criteria and Artisan did not know of this language which was previously acceptable does not convert Hoffman's statements to misrepresentations. … The fact that other insurers were exiting the cash flow insurance market does not mean, at the time the [financing structure] was entered into, that Royal & Sun had no intention of performing or that Hoffman knew this.”

This ruling places on the production company the burden of knowing the nuances of the insurance provisions on which it would rely. The film financing market often changes and the court's ruling also gives counsel that those seeking insurance backup must educate themselves to the strengths and weaknesses of the current and future insurance market. In this case, the restrictions in the decisions clause were strong enough to defeat a reliance on market changes, despite the specificity of the qualifying picture criteria.