Understanding contract accounting practices for films

February 19, 2014
posted by sheric

Recently, I was introduced to a podcast series on the business of film from the folks over at Craft Truck. While perusing the episodes, I found one covering the creative accounting practices of studios and distributors and thought I would share some of the material here. You may be surprised at what is lurking in your distribution contracts regarding royalties and how payments are reported to you, probably unpleasantly surprised. Steven Sills, co author of Movie Money: Understanding Hollywood’s (Creative) Accounting Practices, reminds us repeatedly in his interview, “Get as much money up front as you can.”

Sills also explains that even though he is a CPA, his work in the industry has nothing to do with the generally accepted accounting principles (GAAP) found in financial statements prepared for companies in other industries. In film, accounting is done according to the language of the contract that was signed and the ones drawing up the contracts are the studios and distributors. Obviously, they are drafting contracts that benefit themselves and their only requirement after the contract is signed is to report to the participant in exactly the way the contract says. Sills simply ensures that reporting and payments are being made in accordance with the signed contract. If you are about  to sign a contract that you expect to see revenues from, you better understand exactly what you are signing!

contract accounting practices for film

If I am a producer about to finalize my distribution contract from a distributor, what are the 2 or 3 things I should do to help insure I am treated fairly as a profit participant?

SS: “Everyone has different reasons for engaging in contracts. If you are a successful producer, you may be looking to make money. If you are a new producer, you may simply be looking for credits for your resume. A lot has to do with what you want to accomplish, but let’s assume you want to get your fair share.

First, get a very good entertainment lawyer and have that lawyer negotiate on your behalf. It is going to cost you money upfront, but it could save you a fortune on the backend. Next, get as much money upfront as you possibly can because you don’t control how you will be reported to in the future. The distributor controls that whole process, how they record information, how they report information, how they interpret the contract. The more money you can get upfront, the better off you will be financially. Then, keep an eye on what happens in the reporting. Review your statements, get good consultation on reading the statements to see if anything inaccurate jumps out. Your lawyer may want to consult with an auditor before any contract is signed to see if any changes could be made that could benefit you in the future.

Certain things can be negotiated if you have good representation. When we sit down for an audit, first we read the contract and see if it differs from what we would normally see from that studio. If the lawyer was able to get certain provisions changed, chances are the studio will screw it up because they are huge multinational corporations who have certain ways of doing things, accounting systems that do the same thing over and over. If you change the language in your contract, chances are it won’t be changed in their system. This is why we audit.”

Do you find there is a habitual practice to misinterpret the contract on the part of studios or distributors? What is the state of practice when it comes to contract accounting?

SS: “Studios and distributors write the contracts to be beneficial for themselves. They interpret things for their own best interests. Unless a participant has a lot of leverage, he has very little ability to negotiate significant changes within those contracts. People in business expect that if you are writing an agreement, you will write it in such a way that it will benefit you. These agreements are written with a certain end result in mind. That result is to give a reasonable amount of money to the profit participant, but also to cover the studio’s or distributor’s own costs and that includes the whole business. However, to a profit participant who believes they are a contributor to the success of a movie, they want their fair share of that success.

There is a very famous litigation out there about the Buchwald case. It has to do with the movie Coming to America, the Eddie Murphy film. In that case, there is testimony from a former studio executive that shed a light on how this process works. He said the reason we [studios] do the practices we do is because the winners have to pay for the losers. For every successful film we make, we have 9 unsuccessful ones and we have to cover the cost of those unsuccessful movies. If we give away all the profits for the successful ones, then we lose money on the unsuccessful ones so we need everyone to participate in that. Well, a profit participant doesn’t feel that way. If they contributed to the successful movie, they want their share of that success and that’s where the tension is. So in your contract, you will need to determine if you are involved in the business of the studio, or whether you are a participant only in the profit of the film in which you were an actor/writer/director/producer.”

Do you see a major shift in where money is coming from in terms of revenues and how that impacts contract terms?

SS: “There’s definitely a major shift. The DVD market is diminishing very rapidly and the VOD market is increasing, but not at the same rate as the decline in DVD sales so there is a definite decline in overall revenue and that has to do with how people get their content.

But to understand this, it requires a little history. Go back to the early 1980s when the home video business first started. It started with the Sony Betamax machine in Japan.

The Sony equipment allowed Japanese businessmen and women to record onto tape TV shows during the day and watch a tape of the programs at night. And then a company called Magnetic Video worked with Sony to market that machine in the United States. At the same time, Magnetic Video negotiated a deal with 20th Century Fox to license their films and put them on tapes and sell them in boxes to consumers, the VHS tape. It was the beginning of the home video industry.

In negotiating with Fox, all parties figured out how much they should get out of this product. They figured that the cost to revenue ratio back in the early 80s was about 60%; 60 cents of every dollar went to buy the tape, design and make the case, market the VHS copy, market the machine just to get this product out to the public. So the 40% that was left over was split. Magnetic got 20% royalty for creating the concept and Fox got a 20% royalty for licensing their films. So that is where the 20% royalty rate comes from and persists to this day. It was the basis for this entire home video industry.

Now the cost to revenue ratio for DVDs is more like 25-30% range for cost, but making a 65% profit, but still only paying a 20% revenue share to the profit participant. That takes us into the VOD realm, which will soon become the dominant source of revenue for distribution. Most studios have decided to classify VOD as home video revenue subject to the 20% royalty even though they don’t have the same cost structure involved as in DVD. In a digital file, there is no cost to manufacture a disc and ship it anywhere, no packaging to make, marketing costs are reduced because much is done by the entity that is selling the product, but they still only pay 20% royalty to the profit participant. Why they are keeping royalties the same? Their response is they need more profits to offset the losses they incur from the decline in DVD sales. They need to maintain their profit margins.

Let’s say the distributor charged the consumer $10 for a download copy of a movie, one the consumer can keep, not just rent. Let’s say the download came from iTunes, so they keep 30% of the transaction or $3 and pass $7 back to the distributor. The distributor will report 20% of that $7 on your statement. That’s $1.40 and if you get a 10% profit participation, you get $.14.

Certain types of downloads will only receive a 20% royalty on the revenues received. When negotiating your deal, you need to find out how they treat downloads; as home video purchases subject to the 20% royalty or as rentals because those are more like the licensing fees received from broadcast deals.

We’re dealing with an oligopoly here. 90% of the films are being distributed by a handful of major distributors and they set the terms. If you don’t like their deal, they will tell you to go down the street, but often you will find the exact same terms everywhere else. You have to hope to get your movie made, it becomes a huge success and you will get something out of it.”

 

To listen to the whole podcast, jump on over to the Craft Truck site HERE  I will be recording a podcast for their Business of Film show next week. I’ll post the link to it here when it is available.

Sheri Candler
 

It’s critical that one’s contract contain language that covers a wide range of contingencies and possibilities in a rapidly changing and unpredictable landscape. Plan for changing revenue models, companies to go out of business, and rights classes/categories to shift and have your contract drafted accordingly. There is nothing you cannot protect yourself from in a contract, as long as you are reasonable, and an honest distributor will expect you to cover yourself.

Did you know that The Film Collaborative has a social networking platform for filmmakers called The Film Collaborators? Visit the site to set up your free account.

Sales Agents and Contracts-What to Watch Out For

October 7, 2009
posted by sheric

handshakeThis is an excerpt from a great blog I have been reading by John Rodsett, also known as Mr. Film Biz. It is reprinted here with his permission, but I encourage you to check out what he has to say on his site.

 

 

I always think it sad when a producer finishes his film, signs on a sales agent and then waits for months and hears nothing. What is worse is they get no money from any sales during this time. To help mitigate this dilemma, a producer must use some common sense and be on guard for an agent who does not fit with his needs or hopes.

How does one select a good sales agent?

Well this is not easy. Start by finding out who are the sales agents. Do this by obtaining copy of the Hollywood Distribution Directory, published by the Hollywood reporter. This directory is a fine source of information. Select a few and check them out. Look at the type of films they represent; how long have they been in business; if they attend film markets; if they provide references; ask friends in the film biz if they know of them, use due diligence!

Producer & sales agent agreement – points to watch.

Finalizing an agreement with a sales agent can go on and on, but I think these points will assist you.

 Term of the contract

A producer needs to ensure the agent has enough time to sell, but if he is not doing a great job, you need to be able to terminate the agreement. One way is to agree to a short term deal, maybe one year with option of additional year. Another way to try and ensure performance by the agent is to state that if the sales agent does not approach a certain amount of within a period of time, the producer can terminate. This area can be contentious, so be prepared to negotiate.

Potential revenue

A producer should ask the agent to provide a list of potential revenues for the major territories. This usually covers all rights for the individual countries such as Germany, UK, Japan etc. Such a list can be very revealing, as it will show the producer, probably for the first time, the potential revenue he may get for the film he has spent two years of his life to make and, also, whether his investors will ever get their money back. Please note these estimates by territory provided are only estimates and many factors go into such a list including, budget, actors, genre, etc.

What is beneficial about this list given to you by your potential agent is that the producer can state that territories cannot be sold beneath a set price without producer agreement. This prevents an agent selling your film below a value you wish to obtain – of course that has its own downside in that you need to negotiate that with the agent and the might feel inhibited during the sales process at a market. So there is good and bad in this area.

Arbitration

Make sure you have in any agreement with an agent for a binding arbitration clause that in event of a dispute no law courts are used to settle the matter, but an arbitration tribunal will make a decision that is binding on all parties. Cheaper and quicker that law courts.

Access to film/digital masters

Never, never, never, NEVER allow the agent access to your film negative or digital masters. You provide to the agent only the masters specified in the licensing agreements for sales with buyers. However, I must warn you, the agent has ways around that control, but that is a completely different discussion……..

Documentation/Accounting

The producer MUST get full and documented accounting of all costs and revenue from the agent. Quarterly for the first year, then half yearly from then on. Also, get signed and fully executed copies of all licensing agreements with buyers on sales made for your film.

Wrapping it up…

A contract between a producer and sales agent is an important and complex document and if not fully examined can cause the producer real heart ache over a long period of time. So try and do it right up front and pay for a good entertainment lawyer to help you!!!