Drafting Film Production Compensation Clauses In Light of State Tax Credit Requirements

Entertainment industry contracts often cover a variety of issues: services to be performed, rights granted, representations and warranties, travel and expense arrangements and compensation (both fixed and contingent), among other matters. In many cases, the compensation provisions are in one or two subparagraphs. To simplify drafting and to use “plain English,” the compensation provisions often contain introductory, governing language along the lines of: “In full and complete consideration for entering into and performing all of the terms hereof.” However, is such a “plain English” approach always a “best practice”?

Not necessarily. Drafters of contracts for a film project must consider the agreements in the larger context of other considerations relevant to the project. If state production tax incentives are part of the financing plan, an attorney for the producers needs to review the current requirements of the applicable tax incentive program before drafting agreements with creative contributors: What types of production expenditures qualify for the credit? Are there caps on particular expenses? Does the company applying for the credit need to be organized in the jurisdiction offering the credit or is authority to do business sufficient? What are the requirements of the state with respect to the selection of an auditor who will submit a cost report to obtain the credit, and does the state supply a list of pre-approved auditors for cost report submissions? Will using a pre-approved auditor expedite receiving the credit? (This consideration is important if the finance plan involves banking the expected credit with a due date for repayment of the loan.)

The Memphis Example

A 2016 New York appeals court decision demonstrated the value of taking a contextual approach. In the case, a producer applied for the New York production tax credit for costs incurred in filming the Broadway play Memphis. The New York State credit is available for “qualified” production costs, which mean costs “attributable to the use of tangible personal property or to the performance of services within the State.” The credit is not available for payments for rights or for certain above-the-line costs such as screenplays, directors, principal cast and producers.

When the producer submitted his cost report to the Governor's Office of Film and Television Development, the office awarded less than the amount of credit that the producer had claimed. The producer appealed the decision and an administrative law judge, after reviewing contracts submitted by the producer, affirmed the decision by the film and television office in a recommended order dated Dec. 31, 2013. The producer then appealed to the N.Y. Appellate Division, First Department.

The appellate court upheld the administrative determination that the producer was not entitled to a New York State production tax incentive credit for amounts paid to a number of people in filming a live stage production of Memphis. In re Broadway Worldwide Inc. v. New York State Department of Economic Development, 139 A.D.3d 508 (N.Y. App. Div. 2016).

To find out what went wrong, we obtained copies of the relevant contracts (financial terms redacted) under a Freedom of Information Act request.

The problem for the producer applying for the credit was that the language in the contracts did not clearly distinguish between payments for services and payments for rights. In some of the contracts (such as with the unions), payments were characterized as a “royalty,” thus suggesting rights, as opposed to a supplemental payment for services performed that would have required some incremental services for the filming, not just incremental payments for the services for the live stage production, in order to qualify for the film incentive payment from the state. In certain contracts, there was a paragraph providing for just such incremental services in connection with the film production, but the paragraph providing for compensation stated that the total compensation was “for the rights granted,” and the producer failed to submit support that the incremental film production services had actually been performed.

The administrative law judge, therefore, held that none of the payments qualified for the New York State credit for services because the contracts did not distinguish between the payments for rights and payments for services — and further did not distinguish between payments for services in putting on the live stage play and supplemental work required for the filming.

The New York office administering the film incentive credits has indicated that this distinction is not a problem in the standard film services agreements, which may contain a paragraph granting rights to name, image and likeness, or a work-for-hire paragraph stating the copyright in the product of services is owned by the producer. Those rights provisions are, in effect, incidental to the services to be performed for the film. In an agreement where the producer intends to apply for the New York credit, the language governing compensation should state that it is for services to be rendered, rather than the more general governing language such as “in consideration for entering into and performing obligations hereunder.” Alternatively, there should be separate compensation for services and other compensation for the balance of obligations. (Although such separate compensation terms may result in a smaller credit, it is better than receiving no credit for any of the amounts payable under the agreement.)

Furthermore, when a contract provides for filming a live stage production involving payments to people who worked on the live stage production and who will be performing additional or incremental services due to the filming of the live stage production, both the contract and the final cost report should spell out payments for these additional services separately. And if there are royalty payments, such as to the unions governing the employees working on the stage production, those costs should not be included when a producer is putting together the finance plan for filming. Otherwise, as far as the state is concerned, the payments for filming may appear to be payments for the rights and/or services performed for the live stage production, rather than for film-related services.

Conclusion

The lesson for producers and their lawyers, therefore, is to watch your language: If a contract covers rights (e.g., an option on a literary property or writing or directing services, none of which qualify for the New York tax credit) and services (e.g., director of photography or editing services), there may be a variety of reasons to provide for separate compensation for each. Among the possible contextual considerations are: 1) withholding tax questions, where, for example, withholding tax rates for rights royalties may vary from withholding tax rates applicable to services, particularly if the services are being performed outside the United States; 2) union pension, health and welfare payments that may have a cap on the amount of such compensation subject to pension, health and welfare contributions; and 3) eligibility for the New York State production tax credit incentive.

***** Thomas D. Selz is a founder of the New York City law firm Frankfurt Kurnit Klein & Selz PC (www.fkks.com). His entertainment practice includes advising on film, TV, live stage productions, publishing and sound recordings. Bernard C. Topper Jr., counsel at Frankfurt Kurnit who specializes in tax, including tax matters affecting the entertainment industry, helped in the preparation of this article.