A Primer on Protecting Investments In Motion-Picture Productions

If not for the infusion of private capital, many independent films ' generally films produced outside the traditional studio system ' would probably never have been made. That's because banks are unlikely to loan money for such an uncertain and risky venture ' the success of which is greatly dependent on the fickle nature of audiences. But most independent film investors are either unaware of, or pay little attention to, the realities of the theatrical film market. Given the limited potential for widespread independent film success and other inherent investment risks, an entertainment attorney must be diligent and proactive to fully protect a client's film investment.

Structure of the Production Entity

The agreements for production financing are as varied as the underlying films. The terms and conditions that may be imposed upon the production company by the financing source also vary greatly. Traditional film-studio agreements subject a filmmaker to a number of approvals and controls, unless the party is very experienced and has an established relationship with the studio. When drafting an agreement for an investment in an independent film, an attorney should attempt to enact a similar level of approvals and controls for the benefit of his or her client.

One method commonly used in film-financing projects is the formation of a joint venture. In this form, two or more individuals or entities may contribute various elements to the production, some of which may be monetary and others non-monetary (such as a script, directing, acting or production services). This flexibility of contributions allows for the possibility of significant investor involvement in the filmmaking process. A joint venture is treated legally as a partnership and usually reflects the value of the respective contributions of the individual joint venturers. While this form may have tax or other benefits to the individual joint venturers, a joint venture could potentially leave a client individually liable for the debts of the enterprise if the production is ultimately unsuccessful. Therefore, this form is a risky enterprise and should only used by experienced and knowledgeable parties and/or by individuals intending to be active rather than passive investors in the film production.

Alternatively, a limited partnership can provide a greater level of protection for a client and therefore should be considered. A limited partnership combines one or more general partners with one or more limited partners in a relationship in which the general partners operate the partnership's business and are thereby subject to their general liability, while the limited partners act solely as investors with their liability limited to the amount of their investment or contribution. The filmmaker or production company will likely negotiate an arrangement under which it will act as the general partner and make all decisions relevant to the production. The business structure must comply with the various limited partnership requirements of its state of formation, which may be somewhat burdensome. However, a limited partnership is somewhat flexible and may be considered when there are a small number of “qualified” investors or a large number of participants who do not all meet the requirements to be considered qualified investors. (Qualified investors include, among others: Any natural person whose individual net worth, or joint net worth with that person's spouse, at the time of the purchase exceeds $1 million; any natural person with an individual income in the 2 prior years and an estimated income in the current year in excess of $200,000 or joint income with spouse of $300,000; or any director, executive officer or general partner of the issuer of the securities being offered or sold, or any director, executive officer or partner of a general partner of the issuer.) Depending on the size of the investment and the number of investors, a limited partnership arrangement must comply with any applicable state blue sky laws or federal securities laws. (However, raising from under $1 million to $5 million from less than 35 investors will generally fall within the Regulation D exception to federal reporting requirements.) While there may be various advantages to this choice of form, one particular disadvantage in a limited partnership is that the investor cannot participate in the production or management of the partnership without the possibility of loosing the limited liability treatment for any partnership debts. Given the various requirements of a limited partnership, a practitioner should only consider this form if the investor has a significant level of confidence in the filmmaker.

There is also an investor-financing agreement that may be a useful alternative to a limited partnership when investors are small in number and financially knowledgeable. Because this structure is commonly used to memorialize a financing agreement with a small number of financially adroit investors, it does not fall under the registration requirements. This type of agreement dispenses with the elaborate limited-partnership format, but will not provide the same limitation of liability for investors. However, this form of agreement can greatly benefit a client by allowing the investor more leeway to individually negotiate provisions, which may, among other things, provide for a producer credit, indemnification or preferential payment terms relating to the manner and amount of the return over and above the initial investor contribution. This type of agreement may be of particular interest to an investor because limited-liability partnerships generally do not allow for the same type of flexibility. However, given its less formalized disclosure and generally non-existent registration requirements, this investor-financing agreement should only be used in connection with experienced investors.

Limited-liability companies, yet another option, have become one of the most popular independent film-financing vehicles recently because they can be readily used for a small number of investors and allow for member participation in the production without risking loss of the limited-liability treatment. Structuring a film-production project as an investment in a limited-liability company can allow the investor the opportunity to have a role in all aspects of the film from the script to the choice of actors. As a manager of the limited-liability company, the investor can negotiate and/or review all relevant contracts and agreements to ensure that the investor's interests are being represented. Acceptance of this investor-oversight power can be extremely useful if the investor has some level of experience in the film industry or generally in the nature and scope of business transactions. Moreover, limited-liability companies are pass-through entities for tax purposes, which allows for any profits or losses to be reported on the investors individual tax returns.

Elements of the Deal

Once the form of the production structure has been determined, an attorney should draft an agreement that details the rights and obligations of the various parties. As stated above, one of the best ways to protect an investment and ensure the profitability of a film is to structure the deal to allow for the investor's involvement in the production process. Among other benefits is that the investor can ensure that monies invested in the production are not being commingled and are properly being spent and accounted for. Additionally, an investor's counsel should insist that the agreement requires that, prior to the bank releasing any of the contributed funds, each payment must be approved by the investor or investor's representative. While an element of oversight may be beneficial to an investor, a practitioner may face a certain amount of resistance from a filmmaker who may see an investor as merely an unqualified neophyte, or worse, a potential production hindrance.

Requiring that all relevant parties equally share in the risks as well as the rewards of the film may also be beneficial to the investor client. A filmmaker who only profits when a film is successful will be more motivated to work to insure a profitable return on investment than will a filmmaker who receives a large upfront fee for the production regardless of its results. Therefore, an investor's attorney should consider provisions under which a filmmaker is paid little or no upfront fees, instead receiving a percentage of the profits, if any, on the “back end.” Likewise, because without a completed project an investor is highly unlikely to obtain a return on investment, the agreement should also provide that a completion bond for the project will be obtained. A completion bond provides the investor with assurances that an independent third-party bonding company has thoroughly reviewed the elements of the production and agrees to guarantee that, in the event of any budgetary overruns, the bonding company will be financially responsible for the film's completion.

Any investment in a film production must also contain provisions ensuring that the underlying rights and materials are being fully protected so they can be exploited in a profitable manner. Therefore, the agreement should demand that the filmmaker, or some neutral entity determined by the investor, retain all original or “master” materials and all rights thereto, and that these materials shall be properly secured and stored. The best solution for safety and storage of master materials is to place them in the possession and care of a professional laboratory. Access to the materials should be contractually limited to the production team with specifically authorized distributors only able to obtain copies as needed. By requiring that these materials be secured, an attorney will provide the investor with protection that a distributor or another party is not making unauthorized copies or otherwise wrongfully infringing on the production's rights in the film and materials. Additionally, this required protection may avoid accidental destruction of the master materials, which may be very expensive to recreate ' if they can be duplicated at all. This being said, even contracted laboratories have been known to lose films or deliver master materials to the wrong parties. An attorney would therefore be wise to require that the laboratory have specific written instructions and procedures limiting access to the materials.

Additionally, in order to fully protect ownership interests in a film ' and because various statutes and common law may provide ownership interests or rights to individuals involved in a film production ' there should be written agreements and releases executed by all parties who make creative contributions to the project (such as the actors, writer or composer), stipulating that the contributions are works for hire in which all ownership rights vest in or are assigned to the production vehicle. A practitioner must also ensure that the filmmaker obtains and properly registers a security interest and a UCC-1 form from any party ultimately distributing the film. These security agreements should be filed where the collateral is located as well as in the U.S Copyright Office. This will provide the filmmaker with a superior interest in any proceeds a distributor may derive from the film in the event that the distributor becomes bankrupt before making payment.

While Hollywood accounting tricks are the stuff of legend, there is a generally followed formula that a practitioner should be aware of when negotiating a film-investment agreement. Investors generally receive a return of their initial investment and, in some instances, if properly negotiated, an additional premium from the gross revenues of the film. Thereafter, a film's profitability is determined following payment of all expenses, deferments and investor returns. Of the remaining monies, investors traditionally receive 50% of the profits with the remaining 50% going to the producer. Any other profit participants such as the actors, writer or director are generally paid from the producer's share of the profits. Negotiating a similar payment system will potentially ensure that an investor receives a return on an initial investment, even on a moderately successful venture. Finally, a practitioner should also require that any of the above profit payments be made in a timely manner. In order to dissuade a production partner from delaying any payments, a provision that provides for interest or penalties should also always be considered.

Sample Provisions in Film-Investor Agreements

Business and Purpose of the Limited Liability Company. The business of the Company shall be: i) to develop, produce and exploit a feature-length theatrical motion picture project presently entitled (“name of production”) (the “Picture”) based on a screenplay of the same name by (“name of author”); ii) to perform and conduct any other activity necessary or incidental to the foregoing in furtherance of the objects of the business of the Company. The Company shall own any and all allied and/or ancillary rights in and to the Picture. The Members may agree to expand the scope of the Company's business to include other projects and business activities, provided, however, the Company shall not conduct any business which may or will cause the Company to lose its limited liability nature.

Limited Partnership Allocation of New Profits, Losses, Gains, Deductions and Tax Credits. All net profits, net losses, deductions, gains and tax credits to the Partnership shall be allocated 99% to the Limited Partners and 1% to the General Partner until full recoupment of the Limited Partners' investment is made. After said recoupment, the General Partner's interest shall equal 50% of the net profits, net losses, deductions, gains and tax credits from Partnership operations and the limited Partners will share in the remaining 50% of such items.

Indemnification by Production Company in Investor Financing Agreement. Production Company shall, at its own expense, indemnify, save and hold harmless Investor and its successors, licensees, assigns, agents, representatives and affiliates from and against any and all claims, demands, causes of actions, obligations, liability, loss, damage, cost and expenses (including reasonable attorney fees), incurred or sustained by reason of or arising out of any breach or alleged breach of any of the warranties, representations or agreements herein made by Production Company, or from any reliance upon any such warranties, representations or agreements. If any person or entity shall make any claim or institute any suit or proceeding alleging any facts, which, if true, would constitute a breach by Production Company, of any warranty, representation or agreement herein made, Production Company shall give prompt written notice of same to Investor and Production Company shall undertake at its own cost and expense the defense thereof and shall supply competent and experienced counsel to defend any such suit or proceeding. Investor may also engage its own counsel in connection with any such suit or proceeding (and Production Company shall reimburse Investor for the cost thereof).

If not for the infusion of private capital, many independent films ' generally films produced outside the traditional studio system ' would probably never have been made. That's because banks are unlikely to loan money for such an uncertain and risky venture ' the success of which is greatly dependent on the fickle nature of audiences. But most independent film investors are either unaware of, or pay little attention to, the realities of the theatrical film market. Given the limited potential for widespread independent film success and other inherent investment risks, an entertainment attorney must be diligent and proactive to fully protect a client's film investment.

Structure of the Production Entity

The agreements for production financing are as varied as the underlying films. The terms and conditions that may be imposed upon the production company by the financing source also vary greatly. Traditional film-studio agreements subject a filmmaker to a number of approvals and controls, unless the party is very experienced and has an established relationship with the studio. When drafting an agreement for an investment in an independent film, an attorney should attempt to enact a similar level of approvals and controls for the benefit of his or her client.

One method commonly used in film-financing projects is the formation of a joint venture. In this form, two or more individuals or entities may contribute various elements to the production, some of which may be monetary and others non-monetary (such as a script, directing, acting or production services). This flexibility of contributions allows for the possibility of significant investor involvement in the filmmaking process. A joint venture is treated legally as a partnership and usually reflects the value of the respective contributions of the individual joint venturers. While this form may have tax or other benefits to the individual joint venturers, a joint venture could potentially leave a client individually liable for the debts of the enterprise if the production is ultimately unsuccessful. Therefore, this form is a risky enterprise and should only used by experienced and knowledgeable parties and/or by individuals intending to be active rather than passive investors in the film production.

Alternatively, a limited partnership can provide a greater level of protection for a client and therefore should be considered. A limited partnership combines one or more general partners with one or more limited partners in a relationship in which the general partners operate the partnership's business and are thereby subject to their general liability, while the limited partners act solely as investors with their liability limited to the amount of their investment or contribution. The filmmaker or production company will likely negotiate an arrangement under which it will act as the general partner and make all decisions relevant to the production. The business structure must comply with the various limited partnership requirements of its state of formation, which may be somewhat burdensome. However, a limited partnership is somewhat flexible and may be considered when there are a small number of “qualified” investors or a large number of participants who do not all meet the requirements to be considered qualified investors. (Qualified investors include, among others: Any natural person whose individual net worth, or joint net worth with that person's spouse, at the time of the purchase exceeds $1 million; any natural person with an individual income in the 2 prior years and an estimated income in the current year in excess of $200,000 or joint income with spouse of $300,000; or any director, executive officer or general partner of the issuer of the securities being offered or sold, or any director, executive officer or partner of a general partner of the issuer.) Depending on the size of the investment and the number of investors, a limited partnership arrangement must comply with any applicable state blue sky laws or federal securities laws. (However, raising from under $1 million to $5 million from less than 35 investors will generally fall within the Regulation D exception to federal reporting requirements.) While there may be various advantages to this choice of form, one particular disadvantage in a limited partnership is that the investor cannot participate in the production or management of the partnership without the possibility of loosing the limited liability treatment for any partnership debts. Given the various requirements of a limited partnership, a practitioner should only consider this form if the investor has a significant level of confidence in the filmmaker.

There is also an investor-financing agreement that may be a useful alternative to a limited partnership when investors are small in number and financially knowledgeable. Because this structure is commonly used to memorialize a financing agreement with a small number of financially adroit investors, it does not fall under the registration requirements. This type of agreement dispenses with the elaborate limited-partnership format, but will not provide the same limitation of liability for investors. However, this form of agreement can greatly benefit a client by allowing the investor more leeway to individually negotiate provisions, which may, among other things, provide for a producer credit, indemnification or preferential payment terms relating to the manner and amount of the return over and above the initial investor contribution. This type of agreement may be of particular interest to an investor because limited-liability partnerships generally do not allow for the same type of flexibility. However, given its less formalized disclosure and generally non-existent registration requirements, this investor-financing agreement should only be used in connection with experienced investors.

Limited-liability companies, yet another option, have become one of the most popular independent film-financing vehicles recently because they can be readily used for a small number of investors and allow for member participation in the production without risking loss of the limited-liability treatment. Structuring a film-production project as an investment in a limited-liability company can allow the investor the opportunity to have a role in all aspects of the film from the script to the choice of actors. As a manager of the limited-liability company, the investor can negotiate and/or review all relevant contracts and agreements to ensure that the investor's interests are being represented. Acceptance of this investor-oversight power can be extremely useful if the investor has some level of experience in the film industry or generally in the nature and scope of business transactions. Moreover, limited-liability companies are pass-through entities for tax purposes, which allows for any profits or losses to be reported on the investors individual tax returns.

Elements of the Deal

Once the form of the production structure has been determined, an attorney should draft an agreement that details the rights and obligations of the various parties. As stated above, one of the best ways to protect an investment and ensure the profitability of a film is to structure the deal to allow for the investor's involvement in the production process. Among other benefits is that the investor can ensure that monies invested in the production are not being commingled and are properly being spent and accounted for. Additionally, an investor's counsel should insist that the agreement requires that, prior to the bank releasing any of the contributed funds, each payment must be approved by the investor or investor's representative. While an element of oversight may be beneficial to an investor, a practitioner may face a certain amount of resistance from a filmmaker who may see an investor as merely an unqualified neophyte, or worse, a potential production hindrance.

Requiring that all relevant parties equally share in the risks as well as the rewards of the film may also be beneficial to the investor client. A filmmaker who only profits when a film is successful will be more motivated to work to insure a profitable return on investment than will a filmmaker who receives a large upfront fee for the production regardless of its results. Therefore, an investor's attorney should consider provisions under which a filmmaker is paid little or no upfront fees, instead receiving a percentage of the profits, if any, on the “back end.” Likewise, because without a completed project an investor is highly unlikely to obtain a return on investment, the agreement should also provide that a completion bond for the project will be obtained. A completion bond provides the investor with assurances that an independent third-party bonding company has thoroughly reviewed the elements of the production and agrees to guarantee that, in the event of any budgetary overruns, the bonding company will be financially responsible for the film's completion.

Any investment in a film production must also contain provisions ensuring that the underlying rights and materials are being fully protected so they can be exploited in a profitable manner. Therefore, the agreement should demand that the filmmaker, or some neutral entity determined by the investor, retain all original or “master” materials and all rights thereto, and that these materials shall be properly secured and stored. The best solution for safety and storage of master materials is to place them in the possession and care of a professional laboratory. Access to the materials should be contractually limited to the production team with specifically authorized distributors only able to obtain copies as needed. By requiring that these materials be secured, an attorney will provide the investor with protection that a distributor or another party is not making unauthorized copies or otherwise wrongfully infringing on the production's rights in the film and materials. Additionally, this required protection may avoid accidental destruction of the master materials, which may be very expensive to recreate ' if they can be duplicated at all. This being said, even contracted laboratories have been known to lose films or deliver master materials to the wrong parties. An attorney would therefore be wise to require that the laboratory have specific written instructions and procedures limiting access to the materials.

Additionally, in order to fully protect ownership interests in a film ' and because various statutes and common law may provide ownership interests or rights to individuals involved in a film production ' there should be written agreements and releases executed by all parties who make creative contributions to the project (such as the actors, writer or composer), stipulating that the contributions are works for hire in which all ownership rights vest in or are assigned to the production vehicle. A practitioner must also ensure that the filmmaker obtains and properly registers a security interest and a UCC-1 form from any party ultimately distributing the film. These security agreements should be filed where the collateral is located as well as in the U.S Copyright Office. This will provide the filmmaker with a superior interest in any proceeds a distributor may derive from the film in the event that the distributor becomes bankrupt before making payment.

While Hollywood accounting tricks are the stuff of legend, there is a generally followed formula that a practitioner should be aware of when negotiating a film-investment agreement. Investors generally receive a return of their initial investment and, in some instances, if properly negotiated, an additional premium from the gross revenues of the film. Thereafter, a film's profitability is determined following payment of all expenses, deferments and investor returns. Of the remaining monies, investors traditionally receive 50% of the profits with the remaining 50% going to the producer. Any other profit participants such as the actors, writer or director are generally paid from the producer's share of the profits. Negotiating a similar payment system will potentially ensure that an investor receives a return on an initial investment, even on a moderately successful venture. Finally, a practitioner should also require that any of the above profit payments be made in a timely manner. In order to dissuade a production partner from delaying any payments, a provision that provides for interest or penalties should also always be considered.

Sample Provisions in Film-Investor Agreements

Business and Purpose of the Limited Liability Company. The business of the Company shall be: i) to develop, produce and exploit a feature-length theatrical motion picture project presently entitled (“name of production”) (the “Picture”) based on a screenplay of the same name by (“name of author”); ii) to perform and conduct any other activity necessary or incidental to the foregoing in furtherance of the objects of the business of the Company. The Company shall own any and all allied and/or ancillary rights in and to the Picture. The Members may agree to expand the scope of the Company's business to include other projects and business activities, provided, however, the Company shall not conduct any business which may or will cause the Company to lose its limited liability nature.

Limited Partnership Allocation of New Profits, Losses, Gains, Deductions and Tax Credits. All net profits, net losses, deductions, gains and tax credits to the Partnership shall be allocated 99% to the Limited Partners and 1% to the General Partner until full recoupment of the Limited Partners' investment is made. After said recoupment, the General Partner's interest shall equal 50% of the net profits, net losses, deductions, gains and tax credits from Partnership operations and the limited Partners will share in the remaining 50% of such items.

Indemnification by Production Company in Investor Financing Agreement. Production Company shall, at its own expense, indemnify, save and hold harmless Investor and its successors, licensees, assigns, agents, representatives and affiliates from and against any and all claims, demands, causes of actions, obligations, liability, loss, damage, cost and expenses (including reasonable attorney fees), incurred or sustained by reason of or arising out of any breach or alleged breach of any of the warranties, representations or agreements herein made by Production Company, or from any reliance upon any such warranties, representations or agreements. If any person or entity shall make any claim or institute any suit or proceeding alleging any facts, which, if true, would constitute a breach by Production Company, of any warranty, representation or agreement herein made, Production Company shall give prompt written notice of same to Investor and Production Company shall undertake at its own cost and expense the defense thereof and shall supply competent and experienced counsel to defend any such suit or proceeding. Investor may also engage its own counsel in connection with any such suit or proceeding (and Production Company shall reimburse Investor for the cost thereof).