Minimum Guarantees. Almost all film licenses require the licensee to pay a fixed amount on or before delivery (referred to as the “minimum guarantee”).
Amount: Simply for want of a better gauge, most advances are calculated as a fixed percentage of the estimated budget for the film. The fact that advances are a function of the budget, and are not based on the inherent worth of a film, leads to absurd results, including a tendency for producers to inflate a budget or pad it with producer fees or payments to affiliates, as well as a reckless disregard for the amount of the budget in the first place. Another oddity of this approach is that the amount of the advance is generally not adjusted up for cost overruns (referred to as budget overages) or down when a film is produced for less than the budget. This latter fact has burned many licensees, who agreed to pay a fixed percentage of a stated estimated budget, when in fact the film was produced for far less.
Timing: Whenever a license is entered into prior to completion of a film, the timing of any advance payment is critical. Often, between 10% and 20% of the advance is paid as a deposit upon execution of the license. This is risky from the licensee’s point of view, because the licensee typically has no security for repayment of the deposit, such as a security interest in the film, and licensees are typically not beneficiaries of the completion bond. Thus, if the film is never produced, they may lose their deposit.
The most contentious issue for most licenses is defining the event that triggers payment of the balance of the advance. Typically, payment is made upon “delivery” of the film to the licensee, and the battle is over what constitutes “delivery.” Licensors (and particularly their banks and the completion guarantor) want delivery defined as the mere sending of a notice to the licensee that the film materials are ready and available for duplication once the licensee has paid the advance. On the other hand, licensees typically want the right not only to inspect the physical material, but also to screen the film in advance. Also, licensees want payment of the advance to be subject to such conditions as confirmation that the film conforms to the script and the accuracy of all representations and warranties made relating to the film (such as good title, no infringement, no liens, budget, cast, director, etc.).
Industry practice has resulted in a lopsided victory in favor of licensors and their banks on this issue because even if the license itself provides protections for the licensee, banks typically will not fund production of a film unless the licensee signs a notice of assignment and distributor’s acceptance that waives all defenses to payment and creates direct liability from the licensee to the bank. A sample of such a notice is included as Form C in the Appendix. If the licensee does not sign this notice, the bank does not loan the funds, and the film does not get made. Thus, the licensee is in a Catch-22 situation. Under customary industry practice, the most that the licensee can hope for is the right to inspect and accept the technical quality of the physical material. Any disputes as to this limited issue are typically subject to expedited binding arbitration. The only other typical conditions are that the film must be based upon the script and that the key cast includes certain actors named as “essential elements.” Thus, the licensee is typically required to pay the advance even if all the licensor’s other representations and warranties are inaccurate.
Security and Letters of Credit: Often, the licensor (or its bank) insists that payment of the advance be secured in some manner. This security can take several forms, including a large initial deposit that is subject to forfeiture, a guarantee from a third party, or a letter of credit.
A letter of credit is a direct contractual commitment requiring the distributor’s bank (referred to as the “issuing bank”) to pay the licensor or its bank (referred to as the “beneficiary”) the amount of the advance upon delivery. As a condition precedent to issuing the letter of credit, the issuing bank will always require the distributor to agree to reimburse the issuing bank for any payment the issuing bank makes under the letter of credit, and this reimbursement obligation is usually secured by a deposit of cash by the distributor with the issuing bank. Thus, distributors often loathe letters of credit, because they view them as equivalent to the current payment of cash. (However, if they are smart, they will prefer them to paying a deposit before delivery.) On the other hand, licensors and their banks love letters of credit, because it guarantees them payment upon delivery, as most issuing banks honor their letters of credit, and if they don’t, it is easier to sue and collect from a bank than from a distributor.
The mechanics of a letter of credit work as follows: All the parties agree in advance to the exact wording of the letter of credit and, critically, the documents required to be presented to trigger payment under the letter of credit, referred to as the “draw-down documents.” The draw-down documents are the key to the letter of credit: At one extreme, if the draw-down documents require presentation of a notice of acceptance signed by the distributor, then the letter of credit becomes worthless because the distributor can hold up payment by not signing. At the other extreme, if the draw-down document is simply a notice of delivery from the beneficiary, the distributor risks having to make payment without the opportunity to inspect the delivery materials. In most cases, the resolution is to permit the distributor to inspect the delivery materials for technical quality only, and the draw-down documents are either (a) a notice of acceptance signed by the distributor or (b) an arbitrator’s award that delivery has occurred. The distributor should also insist that the draw-down documents include all the documentary delivery items for which the exact form of the documents can be fixed in advance. In all cases, however, the letter of credit must be payable upon presentation of pre-agreed documents; there can be no requirement that the bank confirm the existence of facts outside the written documents. For example, a letter of credit could never state that payment will be made when the bank confirms that delivery has occurred, as banks simply don’t do this. The banks want only to compare the signed draw-down documents to the pre-agreed forms in order to make payment.
But what does the distributor do if the beneficiary fraudulently signs, or forges a signature on, the draw-down documents and presents them? For example, if the only draw-down document is a notice of delivery, what if the beneficiary signs and presents the notice while the film is still in production? The answer to this dilemma is that there is always at least a three-business-day delay between presentation of the draw-down documents and payment by the issuing bank, and this waiting period can be extended by contract. During this waiting period, the issuing bank typically notifies the distributor of presentation of the draw-down documents (the distributor should require this notification in its contract with the issuing bank), and the distributor can run to court and seek an injunction blocking payment if the distributor has a valid complaint. In general, the only valid complaint is for outright fraud by the beneficiary; courts will not block payment under a letter of credit because of a mere good-faith dispute.
Letters of credit are of two basic types: “standby” and “payment.” Under a “standby” letter of credit, the distributor is expected to pay the advance directly, and the issuing bank stands by to make the payment if the distributor defaults. Thus, one of the draw-down documents under a standby letter of credit is always a document from the beneficiary stating that the distributor has defaulted. This means that the licensor can trigger any available remedies against the licensee (such as terminating the license), and then get paid in full under the letter of credit. Under a “payment” letter of credit, the distributor is not expected to pay the advance, which will be paid in all cases by the issuing bank under the letter of credit. One problem with a standby letter of credit is that if the distributor pays the advance directly and thereafter declares bankruptcy within 90 days of paying the advance, there is a risk that the beneficiary will be forced by the bankruptcy court to repay the advance. The beneficiary can avoid this risk of repayment if payment is made directly under a payment letter of credit. This risk can also be avoided by requiring a standby letter of credit to remain outstanding for an additional 90 days if the advance is paid directly by the distributor.
Withholding Taxes: Many countries require the licensee to withhold taxes on any license payments, including advances. Licensors typically deal with this problem with a “gross-up” clause, which means that the licensee is required to pay the distributor an additional amount sufficient to cover all withholding taxes, so the licensor receives the same net payment. These provisions can be quite unfair to licensees, particularly if the licensor obtains the benefit of a tax credit in its home country for the withholding taxes. To solve this problem, it is common for both parties to use an intermediary in a country that has favorable treaties to eliminate withholding, and to run the license back-to-back through the intermediary.
Controls and Approvals
Licensee: A frequently contentious issue is the level of controls or approvals that the licensee will have over production of the film. Even if the licensee is given control or approval rights in the distribution agreement, in most cases the notice of assignment and distributor’s acceptance will make the licensee’s exclusive remedy for any breach of its theoretical control or approval rights merely an action at law for damages, as opposed to the right to withhold payment of the advance. Thus, as a practical matter, licensees typically have no real control or approval rights over production.
Licensor: Licensors are often wildly zealous in attempting to impose various controls and approvals over exploitation by licensees. For example, licensors may seek control or approval over (a) sublicensing, (b) packaging with other films, or (c) pricing. These restrictions are generally imposed out of the licensor’s motivation to protect its right to overages, but licensees typically (and properly) object to these types of approvals and controls, as they can effectively hamstring the licensees’ exploitation of the film. While they may be properly imposed on a sales agent, they are wholly inappropriate when a licensee has paid a significant advance.
Representations and Warranties
Typically, the licensor makes extensive representations and warranties to the licensee with respect to various matters relating to the film. For example, there are typically several representations relating to the validity of the grant of rights, including good title, no liens, no claims, and no infringement on the rights of third parties. There are usually representations that the film will be based on a particular script, that it will be made for a certain budget, and that it will include certain named individuals as the key actors or director. Foreign licensees often request a guarantee that the film will receive a U.S. theatrical release by a major studio, but it is typically impossible for a licensor to guarantee this, particularly a specified minimum number of theaters or a minimum prints and advertising expenditure.
The problem with all the representations and warranties is that even if the license states that their accuracy is a condition precedent to payment of the advance, they are all overridden by the standard notice of assignment and distributor’s acceptance requested by the licensor’s bank. Thus, the licensee will only be left with a claim for monetary damages against the licensor—often a single-purpose production -company.
Chain of Title: One way for the licensee to protect its grant of rights is to carefully check the film’s chain of title, including the chain of title leading from any underlying book and the screenplay. The licensee should also undertake a search of the public records available through the U.S. Copyright Office, a UCC search for state security filings, and a litigation check to search for any voluntary or involuntary liens against the rights, and a general search of news articles, which can provide invaluable clues to potential problems. Even the most thorough search, however, will not reveal all potential problems, as it will not disclose outright plagiarism under a new title or undisclosed and unrecorded grants of rights. To protect against these types of problems, it is common to obtain (or be named as an additional insured under) an errors and omissions (E&O) insurance policy, which generally insures against the risk that a film infringes on the rights of third parties.
Practical Protections: A licensee can protect its position by implementing several practical protections. First, it should seek to avoid making any deposits or other payments prior to delivery of the film. Not only is it difficult to obtain a refund if the film is not made for any reason, but many licensees have been snared by the age-old problem of “in for a penny, in for a pound” and find themselves throwing more and more money at a lousy film that has gone over budget. A licensee should also seek to obtain some controls or approvals over production, as well as several conditions precedent to payment of an advance. These protections will, however, be swept aside if the licensee signs the standard notice of assignment and distributor’s acceptance to the licensor’s bank.
A licensee should, of course, seek to obtain the most expansive definition possible of the term, territory, language, and media granted. The licensee should resist any clause permitting the licensor to terminate the license upon an actual or alleged breach by the licensee; in fact, the licensee should insist on an express clause stating that the license may not be terminated in such event to avoid any risk on this issue. The licensee should also obtain representations and warranties from the licensor regarding the film, although these representations and warranties are only as good as the financial solvency of the licensor.
To strengthen its rights, and to avoid any risk of losing its rights in the event of a subsequent bankruptcy of the licensor, the license should be drafted as a “purchase” or “acquisition” of rights, as opposed to a “license,” and the licensee should make every effort to avoid being appointed as merely a sales agent. Similarly, licensees prefer to receive all money from exploiting the film directly, as opposed to having money paid to an escrow or collection account to secure the payment of overages to the licensor.
Modifications: Licensees generally want the unfettered discretion to edit or modify a film, including adding a logo or “presented by” credit for the licensee. Licensors are generally reluctant to permit the right to edit, and they may not be able to grant this right in any event if they have granted third parties, such as the director, discretion over any editing of the film. In addition, in some countries, such as France, droit morale rights (moral rights) of “artists” (including the director and screenwriter) may prohibit editing a film. The courts have held that the default rule is that the licensee does not have the right to edit if the contract is silent on the point, so it behooves licensees to deal with this issue expressly. In most cases, the end result is that the licensee has the right to edit the film only when required for purposes of censorship approval or to meet time restrictions of particular media, such as airline and television exploitation.
Licensors can undertake several steps to maximize their protections in the event of a default or bankruptcy by the licensee. One obvious approach is to limit the term, territory, language, or media granted to the licensee or, better yet, to appoint the licensee as the sales agent of the licensor, as opposed to granting any rights to the licensee. An alternative approach is to grant rights, but to provide an express termination right in the event of a breach by the licensee. The safest course is to record any termination right in the U.S. Copyright Office, either by recording the long-form license itself or a short-form summary that incorporates the termination right.
The licensor can also use any of the normal means to secure payment of any advance, such as a letter of credit or a guarantee from a third party. The licensor will want to trigger payment of the advance by simply mailing notice of availability of the physical material and will want to eliminate any licensee approvals required to pay the advance. If substantial overages are anticipated, the licensor may want to protect its right to such overages by having the right to approve sublicenses or requiring sublicensees to make payments to an escrow account.
Governing Law, Jurisdiction, and Remedies
In most cases, the license will be expressly governed by the laws of a particular country or state. These clauses apply only for interpretation of the license and do not confer jurisdiction for litigation. Many lawyers have a knee-jerk reaction to impose exclusive jurisdiction in their home territory over any disputes, but this is an unwise approach if the other party has no assets in that jurisdiction; in most cases, it is better to provide for non-exclusive jurisdiction and venue in a particular location, leaving open the possibility of suing the other party wherever their assets are located, to avoid the time, expense, and delay of having to re-enter a judgment in the other jurisdiction.
A related question is what type of remedies will be available in the event of a breach by the other party. Typically, both parties want the right to obtain equitable relief, such as an injunction, against the other, while vociferously objecting to a similar remedy against themselves. Under most licenses, after payment of the advance by the licensee, the licensor’s remedies are limited to an action at law for damages in the event of any subsequent breach by the licensee.