How to legally avoid an evil net profits definition in a motion picture contract.

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Hey cats.

Welcome back. Today’s discussion is about “net profits” as they exist in the world of independent film. Depending on the terms of your contract, net profits can become your best friend in life, or your worst enemy that torments you for years.

For purposes of our hypothetical discussion, let’s assume you graduated with a film degree from UCLA. Cool. Then a month later, you accomplished the film school equivalent of winning the lottery. Two producers hired you to direct an independent feature right out of the gate.

You read the script, and it was kooky — a sci-fi sports war flick about Benito Mussolini traveling through time to try to lead the Detroit Lions into the NFL playoffs, set to the backdrop of an American president trying to build a giant underwater wall across the South China Sea.

You decide to take the gig if you can rewrite the script and they pay you DGA scale. Because you have value, and standards. So, you meet in a Century City hotel and you tell the producers how you feel. “The project seems cool, but the story is unrealistic,” you explain. Then you hand them 10 pages of notes and your cast ideas. Two hours of nodding later, the producers agree to change the Detroit Lions to the Cleveland Browns. Everything else will remain the same, and they will tell you who the lead actor will be. Their friend.

You sign the deal.

You’re not in the DGA yet, and it’s a relatively small $5m film, so you don’t get much money in the contract, no box office bonuses or anything like that. You didn’t even have the time or money to hire an entertainment lawyer to review the contract, but you don’t care. It’s your first feature, you got your foot in the door. And besides–they gave you ten percent (10%) of the net profits, which they increased from 5% after you asked. Rock-n-roll!

So you pack your bags and go to Toronto or wherever they got the tax credits to work, and you wake up early a lot and shoot weird scenes of an Italian dictator peering through a fence as the Cleveland Browns practice. Production stops and the force majeure provision in your contract kicks in when the President of the United States accidentally declares war on Canada on Twitter, and you don’t get paid for a few weeks.

Somehow, someway, you and your actors not only get the movie done–but you knock it out of the park. Post-production become a celebration of cinematic excellence. Then you win a festival, sales agents jump up and down and buy the producers stupid-expensive bottles of Perrier in Cannes. Next comes a new poster and a distributor who drinks the movie cool aid. Everyone and their brother puts money into P&A, and your weird little movie goes out into the wild world and makes a big splash. Lots and lots of press. Lots and lots of money. People go nuts

Woah. Grab the fucking champagne….

1 year later…

Your movie is still famous, random nerds everywhere can quote pages of dialogue. Then suddenly, Variety reports the film made more money than Norway.

Holy crap. All of your friends call and congratulate you.

But, where are you?

Well, first and foremost, you’ve already been paid your fee.

It was a pittance, true. But legally speaking, you were paid an agreed-upon sum for agreed-upon services. You’re not in the guild, you have no union to back you up. Barring exceptionally crazy circumstances or fraud, trying to invent some sort of lawsuit that your fixed compensation was too low because the movie made money will result in laughter, and you never getting to direct again. Maybe you can retroactively win some money on some sort of hybrid minimum wage claim or something, but at the end of the day, that could be nothing more than a creative way to murder your directing career.

But wait, you have 10% net profits.

Which is  the reason you signed the deal. This is GENIUS. It has to be. You have not seen any money yet, but the producers of the film just bought new homes in Malibu. The lead actor just got a new Ferrari, started adopting kids from ten different countries.

Then suddenly, your net profits statement arrives.

And it does not say “zero.” It says less than zero. Negative three hundred thousand dollars. Your account is in the red, you are nowhere near your first dollar of net profits.

What the fuck is going on? How is this even possible?

IMPORTANT CONCEPT – NET PROFITS

My friends, please understand one thing.

There are 101 different ways to name and/or define contingent compensation on a movie. In your contract, it may be called “net profits” or “adjusted gross profits” or “gross profits” or “profits” or “distributable cash” or any number of other words. The key thing to understand here is that in a film production contract, the financial definitions only mean what the contract says they mean.

Ponder this – a good film attorney can draft a contract that will give you .01% net profits, and the contract will make you insanely rich if the film hits big. On the other hand, an attorney can also draft a contract that will give you 25% so-called ‘gross’ profits, but ensure you will never see a dime, even if the film makes $100 million at the box office.

The point is not to suggest renegade contract drafting, but rather that you can not know what ANY contingent compensation numbers mean in a contract until and unless someone takes a good look at your contract. Don’t get fooled by smoke and mirrors. There is no standard or universal definition of net profits when it comes to a motion picture. There are some basic principles that most producers uphold in terms of the financial structure of a film, but there is no guarantee that the definitions in your contract do not differ wildly from expectations.

The ONLY way to know what the “net profits” means in your contract, is to read the definition. If you do not read that definition, you have no idea what that 10% means. Zero. Nor will your lawyer, producer, or astrologer.

Furthermore, the definition of net profits in a contract can be a short as one sentence, or 10 pages or more, depending on the studio. There may also be multiple levels and definitions. If you are on a film with Spielberg, the definition of contingent compensation in your contract will probably differ from Steven’s definition. Point of fact, everyone on any given movie may have a different definition of contingent compensation in their contract, especially if it is a studio film.

Accordingly, it is possible in the kooky hypothetical scenario described above, your movie could bring in $250 million across the world, and you could have no money in your pocket. And have to pay your own way to the premiere.

And then the film wins an Oscar. And you still will have no money.

You will have another opportunity to direct, yes. But what about the revenue from this movie, which might be the most valuable project of your entire life?

Forget it. It’s over.

HOW TO AVOID THE NIGHTMARE NET PROFITS SCENARIO

First and foremost, if you are going to direct a feature, you must have a lawyer review your contract, or the nightmare scenario regarding contingent compensation is a possibility. Period at the end of the sentence.

Now, let’s look past the lawyer-answer for a second. Generally speaking, here are a few big-picture issues for you to look out for in your contract, in terms of your net profits.

This is general information to help you in the initial stages of looking at your contract, not legal advice, nor a substitute for good counsel. But this will get you started.

A.  THE PROFIT DEFINITION – MOST FAVORED NATIONS.

As stated above, you have no idea what your 10% net profits means unless you read the definition. If the film is big enough and/or counsel it is crazy enough, your profit definition could be pages of legalese, all cross-referenced throughout the contract, leaving your profit definition about as easy to decipher as unlocking an iPhone with psychic powers.

What do you do?

Well, as stated above, you can hire counsel and wade into the morass of negotiating net profit contract definitions.  And/or — you can use a trick of the trade called a “most-favored-nations reference, or “MFN” for short.

Most-favored-nations is a term of art from the days of people trading spices around the world on big ships, fighting pirates and all that. Basically, for film industry purposes, this term of art serves to tie your net profits definition (or anything else) to that of another party on the movie. And if you’re smart, that party is one of the VIPs.

There are many ways to word this, but here is a basic example of this concept in a contract provision:

….  the Producer shall pay to the you TWO POINT FIVE PERCENT (2.5%) of the “Net Profits” of the Picture. Statements of account and the associated Net Profits, if any, shall be paid at the same time and calculated and defined in the same manner as for the lead producer of the Picture. 

See what just happened?  

There are 100 different ways to word it, but suffice it to say, this provision just tied your definition of “net profits” to the lead producer. Who is going to have the best profit definition on the film, because he or she came up with it.

So, instead of fighting over your net profit definition, jump on the bus with the producer and/or director and/or lead actor.  When they make their first dollar, so will you. Genius, no? You can also add language that ensures there will be no more favorable contingent compensation on the film, regardless of what that term is called in the contract.

B.      STATEMENTS.

Beyond your net profits definition, you need a provision in your contract that addresses the financial statements that you will receive concerning said net profits. Because if you do not have this provision, you are at the mercy of the producer, as to when and you ever get any type of written “anything” concerning your net profits and/or lack thereof.

There are many ways to word this, but here is a basic example of this concept in a contract provision:

Within ninety (90) days after the last days of March and September of each year, the Producer will prepare and furnish semi-annual statements to the Contractor hereunder, and each Statement shall be accompanied by payment of all royalties due thereby. Notwithstanding the foregoing, no Statement shall be furnished to the Contractor following any semi-annual period in which no royalties are due to the Contractor thereunder.

C.    Audit Rights.

OK, cats, here is a mission critical concept when it comes to contingent compensation.  Pay attention.

If you don’t have audit rights in your contract, you will have no legal right to look at the producer’s financial records concerning your net profits.  The only way to do so is through a lawsuit if the producer will not cooperate.

There are many ways to word this, but here is a basic example of this concept in a contact provision:

Accounting records relating to Net Profits shall be available for audit on thirty (30) days notice, at reasonable times during business hours at the Producer’s principal place of business, to a duly authorized person or firm acting on behalf of the Performer. Said audit rights shall not be exercised more than once in any twelve (12) month period, and only with respect to new activity reflected in statements received by the Performer within one (1) year prior to the commencement of the audit. 

D.  PAYING FOR THE AUDIT.

And finally, if you audit someone who is supposed to be paying you royalties or net profits, and the books are “way off” when you audit them, you should not have to pay for the audit (which can be crazy expensive).

There are many ways to word this, but here is a basic example of this concept in a contract provision:

If an audit reveals that the Producer underreported any item bearing upon the computation of amounts payable to the Contractor by five percent (5%) or more, the Producer shall, in addition to re-calculating and making payment of the amounts due based on the actual and true items, pay the Contractor’s actual out-of-pocket audit costs.

CONCLUSION

Thanks for checking out this article.

Above all, I hope it opened your eyes to the fact that you can not know anything about your net profits, whatever term is used, unless and until you see the profit definition.  Tying your definition to that of other VIPs on the film is one way to mitigate the risk.

For more information about film finance, check out my article – A Simple Guide to Financing an Independent Film with Private Equity.

I enjoy helping filmmakers make movies, and help them make money from their talents. If you need counsel, give me shout.

Thanks for reading!

Lee Rudnicki, Esq.

http://www.drumlaw80.com

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