INDEPENDENT FEATURE-FILM

       DISCOUNTABLE-CONTRACT FINANCE:

          Documentational Mechanics of Negative-Pickup

            and Presale Financing Arrangements

                  Jeffery C. Foy, J.D.*

                  Copr. 1993 Jeffery C. Foy

            TABLE OF CONTENTS

Introduction          5

I. Fundamentals of Negative-pickup and Presale Financing 7

A. Negative-Pickup and Presale Terminology

B. Letters of Credit

C. The Financing Arena

1. Producers

2. Licensees

3. Lenders

4. Completion Guarantors

D. Obtaining Discountable Contracts: The Producer's Package

II. The Licensing Contracts and Central Legal Concepts 19

A. Defining Picture, Production, and Product; Delivery

B. Conditions Precedent

C. Rights Licensed

D. Consideration

E. Chain of Title Contingency

F. Assignment of Rights

G. Approvals and Consultation Rights

H. Security Interests

I.   Default and Takeover

III. Assignments

A. Definition

B. Requisites to Valid Assignments

C. Governing Law

D. The Obligor's Notice, Acknowledgement and Acceptance

  of the Collateral Assignment

IV. Security Interests    29

A. Requirements of Attachment and the Security Agreement

B. Collateral Classification and Means of Perfection

C. Collateral Descriptions and Perfection Issues

1. Copyright

2. Tangible Film and Other Materials

3. Accounts and Other Contractual Rights

4. Other Intellectual Property

5. Tangible Personal Property

6. UCC Terms

V. The Lender's Perspective 48

A. The Single-Purpose Corporation

B. Lender Risks

C. The Completion Guarantor

D. Ensuring Cash Flow: Assignment of Rights and Letters of Credit

E.  Discounting

1. Loan Costs

2. The Reserve Account

F. Conditions Precedent

VI. Completion Guaranties 60

A. The Guaranty

1. The Production Price

2. Conditions Precedent

3. The Undertaking

4. Exclusions

5. The Lender's Role

6. Recoupment

B. The Producer's Completion Agreement

1. Producer's Representations

2. Conditions Precedent

3. Production Changes and Enhancement

4. Ownership of Rights

5. Union and Guild Considerations

6. Progress and Financial Stability

7. Services Agreements

8. Monitoring and Auditing Rights

9. Insurance

10. Takeover

11. Power of Attorney

12. The Production Account Takeover Letter

13. The Laboratory Pledgeholder Agreement

14. Recoupment and Indemnification

VII. The Interparty Agreement 75

A. The Primacy of the Interparty Agreement

B. Approvals

C. Licensing Agreement

D. Completion Guaranty

E. Mandatory-Delivery and the Duty to Pay the Minimum Guaranty

F. Assignment of Receipts and Application of Funds Received

G. Priority of Security Interests and Collateral Execution

H. Interparty Liabilities: Problems Relating to Assignment and Third-Party Beneficiary Claims

I.   Insurance Proceeds

J.  Arbitration

K. Miscellaneous Rights and Obligations

VIII. Letters of Credit   89

A. Commercial Letters of Credit

B. Standby Letters of Credit

IX. Conclusion 99

* Jeffery C. Foy is an attorney residing in Los Angeles. He is a graduate of the University of Texas film-production school and holds a J.D. from the University of Texas School of Law. This article is the product of numerous interviews of professionals involved in financing feature-films, and analysis of the contracts and other documents used by studios and production companies, lenders, completion guarantors, and other parties. Mr. Foy has designed a comprehensive course on the topic, and has lectured on discountable-contract finance several times at UCLA's Extension program.

                 INTRODUCTION

In the world of film finance outside the domain of direct-studio financing the independent producer[1] has available to him or her numerous means of securing production funds. One method, a form of interim financing,[2] or project financing,[3] involves the discounting of special licensing contracts and, in some instances, the use of letters of credit. Various industry sources suggest that approximately one-third of all major studio-distributor releases, and over two-hundred feature-length motion pictures released annually, are financed by means of the transactional design described in this article. Clearly, what the author terms discountable-contract finance, is a prevalent and firmly entrenched method of financing feature films. The licensing contracts, known as negative-pickups and presales, and letters of credit essentially serve as security for loans made to fund production of single- and multi-pictures projects. As the loan is generally nonrecourse, the producer has no direct obligation to repay the loan from any assets other than the licensing contracts and other specified collateral.

Since the lender looks primarily to the cash flow from the licensing contracts in order to repay the loan, the enforceability of those contracts is of chief concern. In order to ensure that the licensees' obligations to make payment become absolute in a timely fashion, the lender requires various credit-enhancement measures, or risk-reduction mechanisms, including a completion guaranty, production insurance, and letters of credit. In addition to these protective measures, the dual legal constructs of assignments and security interests are used by the lender and other parties to protect their interests in the transaction. In a given project, in order to ensure that the film is produced, the loan repaid, and all parties to the transaction receive their expected benefits, a number of contracts and instruments are negotiated and drafted. This article provides a study of the transaction scheme, focusing on the contracts and legal mechanisms that lay the framework for the system.

The author will assume the following factual scenario throughout the article for the sake of brevity and in order to impart some concision to what would otherwise quickly become an unwieldy topic: an individual producer, possibly a controlling shareholder or owner of an independent production company, who has obtained a negative-pickup contract and/or presale contracts, seeks a loan to fund the production of his or her feature-film. While this model is probably the most conventional use of discountable-contract finance, it is not the only use, and the reader is advised to consider that many variations on the transactional design are possible. In addition to funding production of theatrically-released motion pictures, licensing contracts similar to the ones here discussed are used to make production loans for made-for-television movies, direct-to-video productions, and for pictures produced pursuant to multi-picture deals. Such multi-picture deals may exist between theatrical-, homevideo-, and syndication-distributors, on the one hand, and independent individual-producers or production companies, on the other.

The reader is therefor cautioned to remember that, while the author will refer to the producer as an individual, the party that has granted the licenses in the contracts may in fact be a large, incorporated production-company. Further, the reader may, from experience, also be aware of other dissimilarities or variations in the financing model described herein. Throughout this transactional guide, the reader should therefor consider that the documents discussed here naturally will vary in terms of character and function with the particular application of the design. Further, the reader is cautioned that even within the particular application used here as a model, many deviations from the exemplar contracts described in the following pages are possible. The purpose of this guide is to provide an exploratory journey through the documentational infrastructure of the conventional model. While it is intended to be comprehensive in terms of documentation and legal concepts of the model application, it does not aspire to be encyclopaedic of all uses of interim finance in relation to film projects.

Part I of this article introduces the licensing contracts and surveys the arena in which this financing takes place. Additionally, Part I describes the means by which producers obtain these valuable negative-pickup and presale contracts. The next part contains a description of the licensing contracts, which form the foundation of the transaction system, and introduces a number of fundamental legal concepts and devices that are indigenous to discountable-contract finance. Part III provides an examination of the law of assignments as it relates to interim production-financing, and Part IV focuses on the secured-transaction aspect of this form of film finance, providing guidelines for drafting and perfecting effectual security interests. In part V the author assumes the lender's perspective in the transaction scheme. That part identifies the special risks posed to lenders in discountable-contract finance, explains the means by which those risks are reduced or eliminated, and demonstrates the process of discounting. Part VI exposes the contractual apparatus of the documents embodying the completion guaranty, a vital piece of the financing system supplied by special surety-companies unique to the film industry. In part VII there is a detailed discussion of the provisions that form the paramount document in the contract mix, the interparty agreement. This contract disposes of any inconsistencies arising from the several agreements, and stipulates representations, obligations, and other commitments relating to the interplay of the contract assortment. Part VIII illustrates the function of letters of credit in this unique form of film finance, and the article closes with some general observations about the mechanics of discountable-contract finance.

X. FUNDAMENTALS OF NEGATIVE-PICKUP AND PRESALE FINANCING

The licensing contracts and letters of credits are supplied to the producer by one or more of the many theatrical distributors and distribution agents (foreign and domestic), television networks, homevideo distributors, and companies involved in exploiting the ancillary rights to motion pictures. All of these discountable documents contain an obligation to pay a specific sum of money, or minimum guaranty, upon the occurrence of a certain event--usually the producer's delivery of the completed film to the licensee[4]--or some fixed time after theatrical release. The independent producer presents the contracts to a lender that engages in this form of finance. The lender first makes an assessment of the risks of the transaction and begins providing for the installation of risk-reduction mechanisms. Chief among these mechanisms is the entry into the transaction of the completion guarantor, which guarantees the lender that the producer's obligations under the licensing contracts will be satisfied, or in the alternative, that the loan will be repaid. In some instances the lender will require the use of a letter of credit as a payment vehicle or as a secondary source of repayment. After providing for additional contingencies in an agreement to which guarantor, lender, producer, and licensee(s) are all parties, the interparty agreement, and executing numerous other instruments, the lender creates a production account, into which loan funds are deposited. The lender makes production funds available to the producer in accordance with a cash flow schedule derived from the film's budget and production schedule.[5]

Once the film is completed and delivered to the licensees, the licensees make payment directly to the lender pursuant to an instrument of assignment executed by the producer in favor of the lender. Where a letter of credit is used as a payment vehicle, the particular licensee's bank honors the credit (i.e., makes payment) to the lender upon presentation of pre-specified documentation. After the lender is fully repaid outstanding principal, interest, and fees, the lender is generally "taken out" of the transaction; i.e., the lender has no financial interest in the subsequent exploitation of the film and the revenues derived therefrom. In contrast, the licensees always have a continuing financial interest in the various revenue streams generated by the commercial exploitation of the film and ancillary rights. The producer, too, is often at least a nominal participant in the film profits.[6]

The licensing contracts in negative-pickup and presale financing arrangements are thus more complex than the relatively simple licensing contracts (termed acquisition/distribution agreements[7]) used by distributors in "picking up" a completed film for theatrical release or other commercial exploitation. In addition to providing for the terms relating to commercial exploitation, negative-pickup and presale contracts must attend to eventualities that may arise before completion of the film and repayment of the loan, including the default or breach of one or more of the parties. Also, these contracts must define or specify the characteristics and components of the finished product (e.g., cast, screenplay, technical requirements and materials, etc.) and typically, provide the licensee with certain rights of approval and consultation with regard to the actual production of the film.

A. Negative-Pickup and Presale Terminology. The contracts used in this form of finance are known as negative-pickup agreements, pickup agreements, and presale agreements. Although many industry professionals use the term negative-pickup or pickup to refer to a variety of contracts,[8] in the context of discountable-contract financing the term is properly used to denote a contract that meets the following definition: an agreement for domestic theatrical-distribution (and often other media and territories) made by a distribution or production company (theatrical, homevideo or cable network) entered into prior to completion of the film, that requires the licensee to pay a specific sum of money on delivery (or over the course of production) of the completed film and other required delivery items.

A variation on the paradigmatic negative-pickup agreement, defined above, is an agreement identical in form except that it licenses all rights in multiple foreign-territories. These agreements are provided by international-distribution companies, and are termed by the author foreign negative-pickups. An additional earmark of negative-pickups (particularly the paradigm model) is a minimum guaranty large enough to cover the film's entire budget. Negative-pickups are often the sole contract obtained by the producer and relied upon by the lender. This attribute and the license of domestic-theatrical distribution rights or of multi-territory rights are the distinguishing characteristics of negative-pickup agreements as compared to presale agreements.

Presale agreements are functionally identical to negative-pickups since these agreements also are entered into prior to production and contain a minimum guaranty, which allows the producer to use the contract as "collateral"[9] for production financing. Although other industry figures use the term presale broadly to encompass the term "negative-pickup,"[10] it will be used here to refer to agreements identical to negative-pickups but with the following difference: presales license neither domestic theatrical-distribution rights nor rights in multiple territories. In the author's terminology presales transfer foreign theatrical distribution, homevideo distribution, cable broadcast rights, and other ancillary rights (including publishing, soundtrack, nontheatrical, and merchandising). It follows that presale agreements do not license a cluster of rights in multi-territories, but merely some or all rights in a foreign country, or merely domestic homevideo, cable or other ancillary rights. Due to the economics of the film industry, presale agreements do not, with rare exceptions, contain minimum guaranties large enough to cover the entire budget of a feature-length, 35 millimeter, color film with "A" talent. Negative-pickups, then, are simply "presales" of domestic distribution and/or multi-territory rights, with guaranties (usually) large enough to be discounted for the full budget amount. As will be shown, the terminology is important only insofar as it may facilitate the following discussion of current industry practices. From the lender's and guarantor's perspectives, presales and negative-pickups are merely two names for the discountable contracts that form the basis for the financing system.

B. Letters of Credit. The third form of legal paper used to facilitate discountable-contract financing is the letter of credit. Letters of credit (or "LCs") are non-negotiable, non-contractual instruments governed by Article Five of the Uniform Commercial Code (the "UCC") and the Uniform Commercial Practices[11] ("UCP") and are issued by banks on behalf of a borrower for the benefit of some third party. In the discountable-contract film-finance context one type of letter of credit, the standby credit, is issued by a licensee's bank and contains the bank's promise to pay the minimum guaranty in the event the licensee does not. Essentially, the standby credit functions as a surety agreement since it embodies the bank's independent obligation to make payment on behalf of the borrower if, as, and when necessary. Another type of letter of credit, the commercial letter of credit, is used as a payment conduit in many negative-pickup and presale deals, particularly where foreign distributors are involved. The commercial letter of credit assures the lender that it will receive payment under the contract in question simultaneously with delivery of the completed film. This form of credit contains a promise made by the licensee's bank that it will make payment upon receipt of evidence that delivery has been made. Broadly stated, a letter of credit thus functions as an inducement to a party (such as a lender) to enter into an agreement or transaction with another (such as loaning production funds to a producer) by eliminating the risk that the other will fail to meet his or her end of the bargain (i.e., repay the loan). These unique instruments are examined and discussed in detail in Part VIII infra.

C. The Financing Arena

1. Producers. The term producer is used throughout to refer to the individual or business entity primarily responsible for: securing acquisition rights in the screenplay and/or underlying elements; developing and packaging the project; obtaining production financing; and for executing licensing agreements pertaining to commercial exploitation of the film. Such individuals may be independents with little or no track record seeking to produce their first film, or may be producers who have an existing relationship with one or more studio-distributors or independent production/distribution companies. Most established independent-producers are affiliated with, or are principal partners or owners of one or more of the several-hundred independent motion-picture production companies.

2. Licensees

a. Domestic Theatrical Distributors and Production Companies. All of the major studio-distributors regularly enter negative-pickup deals in which they purchase domestic theatrical rights (and usually all other rights worldwide).[12] In addition to the majors are the large independent production/distribution companies and non-distributor production companies,[13] most of which regularly enter into negative-pickup contracts with outside independent producers.

b. International Distributors and Sales Agents. There are many domesticly-based international distributors engaged in financing the production of feature films.[14] In addition, there are foreign-based distributors that distribute internationally.[15] As explained in connection with foreign negative-pickups, these companies often purchase all rights to exploit a film internationally (in several territories or worldwide) prior to production and agree to pay a minimum guaranty on delivery. Distinct from the international-distribution arrangement is the employment of a sales agent, although many international-distributors are in the sales-agency business as well. Although not technically licensees,[16] the numerous foreign and domestic sales-agent companies are involved in licensing distributors (usually local-foreign end-users) with film rights and delivering minimum guaranty contracts--presales--to their producer clients.

c. Homevideo Distributors. Every major studio-distributor has a subsidiary division (or an affiliated company) that distributes homevideo, both domestically and abroad in some instances, some of which are involved in discountable-contract financing.[17] In addition, in the U.S. there are at least one-hundred and sixty-five homevideo distributors not affiliated with the studios, only a handful of which are involved in production. Today, homevideo presales are not as prevalent as in the 1980s when producers were often able to enter negative-pickups and retain homevideo, TV, and other ancillary rights. Such fractional-rights deals have given way to split-rights deals, negative-pickups that license only domestic rights, leaving the producer with all foreign territories.

d. Television Licensees. Although in years past it was possible to obtain discountable contracts from the major networks (ABC, CBS, and NBC), neither of these, nor the Fox network, are involved in production-financing of independent feature-films. Syndication companies and television production were also, some years ago, a viable source for obtaining presale agreements, but are no longer. However, a new source of negative-pickup/presale financing appears to be evolving in the pay-television sector. Basic cable networks and premium channel companies are increasingly involving themselves in production-financing.[18]

e. Local-foreign Licensees. Producers may choose to bypass sales agents and international distributors and instead seek to obtain presale contracts directly from local-foreign distributors and other licensees. All of the eight major-territories[19] have their own domestic distributors, which actively seek American product to distribute in their own countries. This category of licensee includes the sub-licensees of the international distributors and sales agents, described above. Local-foreign presale contracts are perhaps the chief commodity at the film markets.[20]

f. Other Licensees. As set out more fully below, lenders generally will loan against any contract that provides for a quantifiable and time-specific payment. In rare instances, a producer may obtain an agreement, prior to production, by a record company, merchandising company (such as a toy manufacturer), or a publisher[21] to pay a sum of money at a certain point in the future. Provided that the lender trusts the creditworthiness of the particular licensee (or licensee's bank), it will discount the contract and furnish the producer with immediately-available production funds.

3. Lenders. Discountable-contract entertainment lenders include banks and specialized nonbank-lenders. Many domestic banks will not discount foreign paper. However, the majority of the nonbank-lenders readily lend against foreign receivables since they specialize in knowing the credit-risks of the various foreign licensees and in protecting themselves against such risks.[22]

4. Completion Guarantors. Completion guarantors, or completion bond companies, are specialized entertainment-industry companies that issue guaranty agreements to lenders. These companies are staffed by persons with extensive production experience and by lawyers and bankers well-versed in the language of film finance and distribution contracts and methods of entertainment lending.[23]

D. Obtaining Discountable Contracts: The Producer's Package. In order to persuade a distributor or other potential licensee to enter into a negative-pickup or presale deal, the producer assembles a package for the review of potential licensees. The package usually contains a completed script, budget, and letters of intent executed by the key above the line personnel.[24] Letters of intent are agreements by a party whose services are sought stating that that party intends to provide certain services in connection with the production and that he or she agrees to negotiate and execute an agreement that sets out certain basic terms. While often not legally enforceable,[25] letters of intent are useful to the producer seeking financing since they evidence a sincere interest by the artist or performer in the production. As an alternative, the producer may include an option clause in a services contract with his or her talent, in which the artist (director, actor, etc.) agrees to perform within a specified period of time in consideration for receipt of a specified sum of money, payable on signing. Agreements from certain established actors, directors, or writers can be extremely valuable to a producer, since the attachment of certain talent may ensure the producer's success in negotiating valuable deals and obtaining one or more discountable contracts. These commitments are sometimes termed bankable elements, since they sharply increase a producer's chances in signing a negative-pickup or presale.

In the usual negative-pickup deal, an independent producer, such as an individual who owns a small- or medium-sized production company, sets up a meeting with a production executive at a production/distribution company and "pitches" his or her project. If the production executive is favorably impressed, a decision regarding the method of production/financing and distribution of the film will be made. Where the producer is in need of financing the studio or production company may have three choices. First, it may purchase the producer's rights in the film and produce the film in-house, funding the production with its own credit and assets, with the producer attached as hired talent. Second, the studio or production company may enter into a production-financing/distribution agreement with the producer, under which the studio provides production funds directly to the producer. The third option is for the studio/production company to negotiate a negative-pickup deal with the producer. The reasons behind the studio/production company's decision in a given case is a function of a number of variables, including labor law considerations, tax incentives, and financial health of the company. Additionally, since projects financed via negative-pickup and presale agreements are not deemed in-house productions, the producer may not be subject to the guild compensation requirements. Thus, a studio's or distributor's "purchase" of a film via a negative-pickup may be substantially less expensive than producing the film in-house.

In some cases, a studio or production company will take a concept developed in-house by a studio executive or studio-affiliated producer, and make a negative-pickup deal with an independent production company to produce the film. This is referred to as an artificial pickup, by some studio executives. Another variation on the negative-pickup deal occurs between the independent production companies that do not own distribution operations and the major studio- or independent-distributors with whom they have multipicture deals. The mechanics of these deals are virtually identical to negative-pickups with producers who are individuals or who are principals in small- or medium-sized production companies. One distinction is simply that the former situation involves a preexisting relationship between producer and distributor, reflected by the multipicture deal. Another distinction is that these deals are sometimes entered into between large independent production companies (e.g., Carolco or Morgan Creek), rather than an individual, and licensees. Thus, the producer-signatory to the licensing contract is not an individual--or an individual who is the principal shareholder or owner of a production company and the producer in fact--but is a large corporation.

Perhaps the most important occasions for players involved in discountable-contract financing, particularly with regard to local-foreign licensees and international distributors, are the film markets and festivals. The annual film markets and festivals, such as the American Film Market, the Cannes Film Festival, and MIFED are the chief events which bring buyers and sellers of feature-films together. During these markets, independent producers and their agents have the opportunity to mix and mingle with foreign distributors and attempt to pre-sell rights in their unrealized projects. Of course, presale contracts and foreign negative-pickups are also negotiated directly with the end-users at other times and in other locations than the markets and festivals.

XI. THE LICENSING CONTRACTS AND CENTRAL LEGAL CONCEPTS

In order to present a coherent explanation of the documentational mechanics of discountable-contract financing, it is best to begin with the contracts that form the foundation for the entire financing design--the licensing contracts. Many of the legal constructs and provisions contained in the negative-pickup and presale agreements are also contained in the other central documents, viz., the completion guaranty contracts, interparty agreement, and credit and security agreement. An analysis of the licensing agreements provides a useful springboard for developing an understanding of the dynamics of the transaction system. What follows is an overview of the salient provisions contained in those contracts.

A. Defining Picture, Production, and Product; Delivery. Discountable contracts initially describe the product which the distributor or other licensee is agreeing to purchase in terms of the picture's elements. Typical elements include the director, producer, principal cast members, and screenplay. Elements that are absolutely required by the licensee are termed essential elements. Numerous other specifications regarding technical quality, length, MPAA rating, and content are also set out in the agreement. The licensee also obtains certain representations from the producer regarding the logistics of the physical production of the film, and other representations designed to ensure that production proceeds in a timely manner without predicament.

Among these requirements, often contained in a separate schedule, are commencement of principal photography by a set date, the producer's use of the production schedule previously approved by the licensee, and the use of agreed-upon shooting locations. Additionally, the production specifications will include representations by the producer that the licensee will have access and opportunity to examine the progress of the production by viewing "dailies," and by examining the producer's weekly cost reports and accounting records (to be kept in accordance with GAAP[26]). While responsibility for ensuring that the producer completes the picture in accordance with the picture specifications rests on the shoulders of the completion guarantor, many licensees nevertheless include these physical-production assurances. The last set of specifications relating to the producer's obligations are those enumerating the physical materials to be delivered to the licensee, often contained in a separate delivery schedule.

Delivery schedules often define delivery as either actual physical delivery of the materials, or as the making available of such materials via a laboratory access letter or similar instrument.[27] Most delivery schedules are lengthy, technical lists designating the required negatives, prints, soundtrack items, video masters, TV version elements, trailer elements, production photographs and other promotional items, production-related documents, and other materials. All discountable contracts indicate the delivery due date, and most state that time is of the essence[28] as regards delivery.

B. Conditions Precedent. A condition precedent is a fact which must occur before a duty of immediate performance of a promise arises.[29] Conditions precedent, sometimes termed contingencies, are contained within most of the principal documents--the licensing contracts, the credit and security agreement, and the completion guaranty documents. Most conditions precedent stipulate the producer's (or other party's) submission of contracts and other documents (to the licensee, lender, etc.) that evidence facts or contain representations relating to elimination of the various risks.

The documentation required under most discountable contracts primarily concerns issues relating to the licensee's ability to profit from its distribution or other exploitation of the picture. One such contingency is the producer's providing the licensee with satisfactory proof that he or she has clear title to the rights in the film.[30] Another common condition precedent is the producer's delivery of the executed completion guaranty documents (although the lender will require a guaranty in any event). Similarly, some negative-pickup contracts also state that the agreement is contingent upon all financing necessary for the production being in place--a requirement also imposed by the lender.[31] Negative-pickup agreements and presale contracts may further condition their effectuation on proof that all essential elements[32] have been secured. The conditions precedent peculiar to the credit and security agreement and the completion-guaranty contracts are discussed in subparts IV and V infra.

C. Rights Licensed.[33] All film licensing contracts use three license parameters to describe the rights licensed: media; territory; and term. Traditionally, the major studio-distributors have preferred (and in some cases insisted) on all rights arising to and from a picture, in all territories. However, as mentioned above, this practice has been replaced somewhat with the advent of fractional- and split-rights deals. Apart from film projects driven by major studio-distributor negative-pickups, are those projects revolving around international-distribution deals, local-foreign presales, and less conventional arrangements, such as cable TV, homevideo, merchandising, and soundtrack presales and negative-pickups. The rights granted in each of these will, of course, depend on the use(s) the particular licensee is capable of exploiting.

D. Consideration. The consideration agreed upon for the license(s) varies with the media, territory, the term licensed, and the business practices of the licensee. In typical negative-pickup and presale contracts (including foreign negative-pickups), the most important item of compensation for financing purposes is the sum of money paid upon delivery of the picture--the minimum guaranty, also referred to as the pickup price, or purchase price, or in some cases, advance. A second item of compensation is a percentage participation in the film's net profits or net proceeds, as defined in great detail usually in a separate exhibit. The pickup price is recoupable out of the share of net profits paid to the producer in the event such payments are made. Thus the pickup price is sometimes termed a recoupable advance.

The second item of compensation is a subject of considerable debate and controversy. Much has been written about the value of profit participations.[34] Net profit participations, a term unrelated to generally accepted accounting principles and arduously defined in a separate exhibit (to the licensing contract) that may run fifty-pages in length,[35] often range from 5-15%. Gross participations are commanded only by very powerful producers, directors, and actors, and are simply a percentage of some defined level of the distributor's gross receipts (or gross film rentals) from the exhibitors.

E. Chain of Title Contingency. The licensee's obligations under the negative-pickup or presale agreement are conditioned upon the producer's delivery of documentation evidencing clear chain of title in the picture's underlying material.[36] Chain of title as it relates to motion-picture licensing contracts refers to the successive conveyances of the rights to produce and exploit a motion picture based upon or incorporating the subject properties. The underlying properties may be literary, dramatic, or musical material. The documents that evidence chain of title include certificates of authorship, options, acquisition agreements, assignments, title search reports and opinions, copyright reports and opinions, WGA registration records, and music synchronization- and performance-rights licenses. Clearing chain of title is part of the process known as rights clearance.[37]

F. Assignment of Rights. An assignment is a transfer of intangible rights under a contract, or of intangible rights in a legal claim, to the transferee.[38] In order to ensure that the minimum guaranties are paid directly to the lender, the lender requires the producer to assign his or her rights to such payments to the lender. In addition, the lender requires the assignment of the producer's rights to receive all other payments due under the licensing contracts (such as profit participations, royalties, etc.) until the loan has been repaid.[39] This use of assignment, known as collateral assignment, overlaps with the law regarding security interests and is therefor governed by several UCC provisions in addition to the common law of assignments.[40] In addition to the contractual rights to receive payments under the licensing contracts, the guarantor, lender, and (some) licensees insist that all agreements for services and goods relating to the production be "freely assignable." This assignment facilitates the substitution of another party to complete production in the event of the producer's default and the exercise of takeover by another party.[41] The final category of rights that are assigned in the discountable-contract financing system are those rights which are also licensed under the negative-pickup and presale contracts, i.e., the exploitation rights (copyright, trademark and other).[42]

G. Approvals and Consultation Rights. Negative-pickup and presale agreements grant the licensee certain rights of approval over, or consultation regarding the selection of, various production elements. The elements typically include: completion guarantor; financing source; locations; grants of merchandising rights; the hiring of principal production personnel--director, executive producer(s), associate and/or line producers, principal cast, composer, production manager, location auditor--and all services contracts for such personnel; the production budget (including insurance costs, guaranteed deferments, and production legal fees); the production schedule; the production cash flow schedule; the screenplay; chain of title; credits; insurance; laboratory; participations; and key crew personnel. Negotiations between the producer and the licensee concerning which approvals are to be granted to the licensee often are extensive, particularly with respect to the more creative elements. As discussed more fully below[43], the lender and guarantor will seek to vest approval rights in the licensee in order to prevent the licensee from claiming that the producer did not deliver the product, from a creative standpoint, that he or she promised. Of course, the producer's ability to limit the licensee's approval rights is a function of his or her industry track record and bargaining power.

H. Security Interests. Negative-pickup and presale agreements customarily grant the licensee a security interest in all rights in and to the picture. The licensee is one of at least three parties that may take security interests in the picture and concomitant rights of exploitation. The licensing contract states that upon delivery of the picture the licensee's security interest is made to terminate, and the licensee agrees to execute the documents necessary to evidence the termination. The creation, effect and utility of security interests are discussed in detail in the next part.

I. Default and Takeover Provisions. Under many commercial contracts, each party is contractually accorded certain rights or remedies in the event another commits an act or omission rendering it in default, as defined by the contract. Default provisions are standard in all licensing contracts, credit and security agreements, and completion guaranties. Of special interest, however, is a remedy unique[44] to licensees and to completion guarantors involved in film-financing, the so-called right of takeover.

Takeover describes the cluster of rights that arise in favor of a licensee or (more commonly) a completion guarantor, upon the producer's default. Essentially, once the producer has defaulted, the licensee or guarantor is entitled to complete the picture unrestrained and unchecked by the producer. The events that constitute a default for purposes of the takeover remedy include the failure of the producer to adhere to the budget or schedule, and other actions that jeopardize the delivery of the completed film materials by the due date. Takeover is a drastic remedy that, in practice, rarely occurs. It is discussed in more detail at V.B.10. infra.

XII. ASSIGNMENTS

As indicated above, three types of rights may be assigned in interim production-financing arrangements: the right to receive contractual payments; the right to receive goods or services; and the right to commercially exploit the picture. The former, collateral assignment, merits special attention due to its centrality to the transaction. Before discussing collateral assignments, however, an introduction to the law relating to the power to make an effective assignment is helpful.

A. Definition. The Restatement of Contracts (Second) defines assignment of a right as "a manifestation of the assignor's intention to transfer it by virtue of which the assignor's right to performance by the obligor is extinguished in whole or in part and the assignee acquires a right to such performance."[45] Assignments therefor have the effect of extinguishing the right of the assignor in addition to recreating the right in the assignee. In some jurisdictions the assignor is said to retain a beneficial interest in the assigned rights, described as a power of defeasance,[46] while the assignee is said to hold an "entire but defeasible present interest in the subject matter of the assignment so long as the obligation secured remains unsatisfied."[47] Assignments are distinguished from liens in that assignments effect an unconditional ownership interest in the propery of the assignment, whereas liens merely create a conditional right against the the owner of the property and do not divest the owner with the right to convey the property.[48]

B. Requisites to Valid Assignments. Assignments generally must satisfy the essential requisites of contracts, including mutual assent and consideration.[49] Under the law in most states, contractual rights may be effectively assigned so long as the assignment is not validly precluded by contract and does not fall within certain other exceptions not applicable here.[50] Many contracts contain a standard clause prohibiting assignment of the contract, reflecting a common reluctance to be being forced into a contract with another party who may be unacceptable from a legal or business standpoint. However, under the Restatement, provisions that prohibit the assignment of the contract are effective only to bar the delegation of duties owed by the assignor.[51] Further, unless "a different intention is manifested," a provision prohibiting assignment of rights under a contract is not effective as an invalidation of the assignment.[52] The UCC is consistent with both of these rules.[53] Notwithstanding these rules holding that assignment prohibitions or nullity clauses are ineffective to invalidate assignments, most guaranties, credit and security agreements, and licensing contracts stipulate that the various contracts must contain no such clauses.

The assignment language may be contained within a paragraph of the licensing agreement or other contract, or instead may consist of a separate document titled instrument of irrevocable assignment.[54] Regardless of where the assignment is contained, it is not effective until the assignor has delivered the document that contains it to the assignee with the intent to make a present transfer, and until the assignee has accepted the delivery.[55] Finally, as explained below, the obligor's notice of, and consent to the assignment are not necessary to make the assignment effective,[56] but giving notice to the obligor provides the assignee with rights and protection otherwise not available.

C. Governing Law. Generally, the issue of the validity of an assignment is governed by the law of the place where the assignment is executed, subject to the rule that the law of the jurisdiction with the more essential or greater number of contacts to the transaction is controlling.[57] However, in determining the validity of the assignment as against the obligor or other third parties to the assignment, the law of the place where the obligor is domiciled is controlling on the issues of giving notice, the recording of the assignment, and taking possession of the assigned property.[58] Therefor, counsel for the assignee should research the law of the obligor's domicile in order to ascertain any further or special rules relating to the assignment.

D. The Obligor's Notice, Acknowledgement and Acceptance of the Collateral Assignment. While the common law of assignments does not require that the debtor receive notice of the assignment in order to render it effective (unless statutorily-mandated), notice serves to impose upon the obligor the duty to make payment to the assignee.[59] That is, until the obligor has received notice of the assignment, the obligor may lawfully, and without exposing itself to liability to the assignee, make payment (or performance) to the assignor. UCC § 9-318(3) is consistent with this rule.[60] The consent or acceptance of the obligor is not required under either the common law or under the UCC.[61]

In order to effectuate the notice rule with regard to the collateral assignment, the assignee (lender or guarantor) delivers to each licensee an instrument, usually signed by the producer and assignee, that gives notice of the assignment and of other facts. The instrument states that the producer has assigned to the lender (or guarantor) the right to receive an amount of money equalling the amount of the loan[62] (or in the case of the guarantor, the amount of the guarantor's completion funds expenditures). The assignment notice may contain a clause stating that the producer agrees to indemnify the licensee against liability or cost arising from the licensee's compliance with the assignment. The notice instrument also may contain a representation by the licensee that it has no knowledge of any prior claims to the assigned rights, and an agreement to notify the lender upon discovering such claims. An additional function of the notice instrument is to secure the obligor's representation that it will not assert against the assignee any claims, defenses, or offsets[63] that the obligor may have against the assignor or other party. UCC § 9-206 expressly makes such waiver agreements enforceable where the assignee takes the assignment for value, in good faith, and without notice of any such claims or defenses to performance by the obligor.[64]

Despite the fact that the obligor's consent to the assignment is unnecessary for its validity, many assignees require that the obligor give its consent to the assignment.[65] In addition, most notice instruments require that the obligor acknowledge and accept the representations and notifications contained therein. In many cases, obtaining this acknowledgment and acceptance is difficult due to many foreign licensees' lack of familiarity with Anglo-American law. Delays resulting from the timely acceptance of a foreign distributor have held up many productions, since the lender may, in such cases, not be willing to execute the loan agreement until it has received this important documentation. Because the notice instrument also serves the functions of acknowledgment and acceptance, the instrument is variously titled notice and acknowledgment of assignment, acceptance and acknowledgment by licensee, or simply notice of assignment.

XIII. SECURITY INTERESTS

Security interests are legal mechanisms governed by Article Nine of the UCC,[66] which facilitate lending, sales, and other transactions where collateral is required. Article Nine provides rules for the creation of security interests--an event called attachment, the prioritizing of such interests among competing claimants to the same collateral--the so-called priority rules and the process known as perfection, and rules regarding lawful means of executing on the collateral and satisfying the indebtedness. The discountable-contract finance drafter is concerned primarily with the former two matters, attachment, and priority and perfection issues.

The requirements of a valid Article Nine security interest are: (1) the existence of a security agreement with the debtor (the party granting the security interest); (2) the reduction of the necessary parts of that agreement to writing,[67] or the creditor's (the secured party) consensual taking of possession of the collateral; (3) the debtor's having rights in the collateral; and (4) the creditor's giving value.[68] Once these requirements are satisfied, the security interest come into existence, and is said to attach. Attachment has two general consequences. First, upon the debtor's default in the transaction, the secured party may lawfully seize and/or dispose of the collateral in satisfaction of the debt, without the necessity of seeking a judicial lien or other governmental remedy.[69] Second, the secured party may enforce the security interest against third parties who lay claim to the collateral. The secured party may sell the collateral and apply the proceeds to the outstanding debt before the unsecured third parties may validly assert any claim to the collateral or its proceeds, with some exceptions.[70] It is the process of perfection that provides the secured party with maximum protection against claims of third parties, including bankruptcy trustees. However, before seeking to perfect the interest, in order to ascertain whether this protection is available, the creditor must determine that there are no existing claims to the collateral. This procedure of discovering competing claims and the means of perfection are explored infra at subparts III.B. and III.C. Since the process of attachment must occur before or contemporaneously with perfection, it is discussed next.

A. Requirements of Attachment and the Security Agreement. The security agreement referred to in § 9-203 is usually, if not always, reduced to writing in large commercial transactions, rather than relying on possession alone. The latter two requirements of § 9-203, the debtor's having rights in the collateral, and the secured party's giving value, merit some discussion, since attachment "occurs as soon as all of the events specified in subsection (1) [of § 9-203] have taken place...."[71] Since the security agreement is usually contained within one of the principal contracts--the negative-pickup or presale agreements, credit and security agreement, or completion guaranty contracts--assuming the other attachment requirements are satisfied, attachment occurs simultaneously with execution of the principal contract containing the security agreement. This fact is relevant to the issue of value given by the secured party.

Section 1-201(44) of the UCC defines the meaning of value: "A person gives 'value' for rights if he acquires them (a) in return for a binding commitment to extend credit or for the extension of immediately available credit ...; or (d) generally, in return for any consideration sufficient to support a simple contract."[72] In the case of the credit and security agreement, the value definition of subsection 1-201(44)(a) applies since the credit and security agreement contains a binding promise to make a loan.[73] With respect to the guaranty and to the licensing contracts, the security agreement is given in return for the binding obligations contained within those contracts, viz., to guaranty the production, and to pay for the film upon delivery. A security agreement in one of the principal contracts likely will be construed as granted in return for the binding obligations of the other party in the contract, even if not explicitly stated. Of course, the security agreement may be a separate document executed independently of the principal agreement; in such cases, the drafter should not omit a recitation of value given in exchange for the security interest.

Since much of the collateral is non-existent at execution of the principal agreements,[74] the attachment prerequisite of the debtor's having rights in the collateral appears to pose an obstacle. However, sections 9-204(1) and 9-108 sanction the granting of security interests in such after-acquired collateral.[75] This issue is discussed further in connection with the problematic items of collateral described below. First, however, the process and consequences of classifying the collateral and perfecting the security interest are explained.

B. Collateral Classification and Means of Perfection. As stated above, perfection is the means by which a secured party may obtain the highest degree of protection as against competing claimants to the same collateral. Much of Article Nine is concerned with rules of priority, i.e., rules determining which party prevails in situations where there are two or more parties asserting a claim to the same collateral. Competing claims may arise under a variety of circumstances, including a debtor's fraudulent conveyance of two or more conflicting interests in the same collateral, or under circumstances where an interest (or lien) arises by operation of law or by judicial action and stands in opposition to the secured creditor's interest.[76]

Article Nine provides three ways of perfecting security interests, the availability of which depends upon the classification of the collateral. Essentially, collateral classified as accounts and general intangibles may be perfected only by filing a document known as a financing statement.[77] Accounts refers to rights to payment and to rights arising from contracts generally,[78] and thus include the producer's right to receive the minimum guaranties and other compensation due under the licensing agreements. General intangibles refers to rights other than goods, accounts, negotiable instruments, documents of title, and money, and therefor includes such rights as copyright, trademark, and other intellectual property rights.[79]

Accounts and general intangibles must be distinguished from instruments, a UCC term referring to negotiable instruments (such as promissory notes and drafts), certificated securities, and certain other writings evidencing a right to payment.[80] The distinction is important because security interests in instruments, as well as letters of credit and money, are perfectible only by taking possession, the second method of perfection.[81] The third method of perfection, automatic perfection, is available only for certain types of transactions, none of which are clearly applicable to discountable-contract finance.[82] Of the above mentioned classes of collateral, only goods and negotiable documents of title may be perfected by either possession or filing a financing statement. The classification of collateral is important not only as to what means of perfection are available, but also with respect to where the financing statement must be filed, in states where filing is proper.[83] The UCC provides three alternative subsections providing for the place of filing, all of which indicate that the proper place to file a security interest in the relevant collateral is the office of the Secretary of State.[84]

Before extending credit or giving value based on the security interest, the secured party will determine whether there are any other perfected security interests in the same collateral, in order to ensure first priority. This determination requires a search of the recordation system(s) in-place in the appropriate jurisdictions. These systems contain public records of UCC financing statement filings, judicial liens, and other encumbrances in collateral. The secured party researches the filing systems in the appropriate jurisdictions prior to taking the security interest in order to ensure that there are no existing security interests or other conflicting interests in the collateral.

The question of which filing systems must be searched and in which jurisdictions the interest must be perfected are answered by § 9-103.[85] Regarding documents, instruments and ordinary goods, § 9-103(1)(b) provides that, "perfection and the effect of perfection...are governed by the law of the jurisdiction where the collateral is when the last event occurs on which is based the assertion that the security interest is perfected...."[86] If perfection of the same collateral were never required more than once, counsel for the secured party would only have to research the filing system and comply with the Code requirements in one jurisdiction in order to obtain (and maintain) a first-priority security interest. However, subsection (d) of § 9-103(1) makes clear that where the documents, instruments, or ordinary goods are removed from the state in which the security interest was perfected, and brought into another jurisdiction, the secured party may be required to perfect the interest in the new jurisdiction as well.[87] Essentially, the secured party has a four-month grace period during which perfection in the new jurisdiction is not required, with some exceptions.[88] Since the only usual items of collateral that fall within § 9-103(1) are the physical film materials and production equipment and other personal property, the additional filing requirement and the four-month rule are normally relevant only as to those objects.[89]

Section 9-103 also provides rules regarding filings for security interests covering accounts and general intangibles. Subsection (b) of § 9-103 states the debtor-location rule: "the law of the jurisdiction in which the debtor is located governs the perfection and the effect of perfection...of the security interest."[90] In addition, there is a four-month rule that applies to changes in the debtor's location, which may be interpreted and applied in the same way as the § 9-103(1)(d) rule.[91] Given that the purpose of perfecting the interest in additional jurisdictions (or in any jurisdiction) is to provide public notice to the inhabitants of those jurisdictions, section 9-103, then, tells not only where the interest must be perfected, but also suggests that the secured party should check to see that there are no competing interests in the same collateral in those other jurisdictions.

In the event that a conflicting interest arises after attachment, the priority rules of Part 3 of Article Nine are controlling. Section 9-312(5) states the general priority-rules for purposes relevant to this discussion.[92] Subject to the proper choice-of-law regarding perfection dictated by § 9-103, described above, priority between conflicting security interests in the same collateral is determined by application of two rules.[93] First, "conflicting security interests rank according to priority in time of filing or perfection," whichever is earlier, provided that the interest remains continuously perfected.[94] Second, as between unperfected security interests, the first to attach has priority.[95] An additional qualification to the general priority-rules is contained within § 9-316.[96] Section 9-316 permits parties having conflicting security interests, or parties contemplating taking such interests, to agree to a specific order of priority.[97] Since § 9-103 provides the rules as to where the security interest must be perfected and provides choice-of-law rules as to perfection generally, § 9-103 in conjunction with § 9-312 furnish the secured party's counsel with the jurisdictions in which to search filing systems to discover competing claims.[98]

C. Collateral Descriptions and Perfection Issues. Of the section 9-203(1)(a) requirements for attachment, the one dealt with most meticulously is the requirement of describing the collateral. While some security agreement paragraphs simply contain a blanket security interest,[99] most contain lengthy non-exclusive descriptions of the various items and categories of collateral. Due to the number and diversity of the proprietary rights in feature-films, properly describing the collateral is a hazardous and excruciating exercise for the uninitiated. What follows is a list of those collateral items, designed to guide counsel for lender, guarantor, or licensee in effectively creating a comprehensive security interest in a feature-film.

1. Copyright. As personal property not falling within the exclusionary list of § 9-106, copyright is a general intangible.[100] The document that creates the security interest in copyright is often termed Mortgage of Copyright, where a separate document is used.[101] The security interest should comply with the requirements of both the UCC and the U.S. Copyright Act due to legal ambiguities regarding the application of those statutes.[102] In order to discuss security interests in copyright, it is necessary to briefly examine the exclusive rights that arise in the copyright owner. Those rights are:

 To reproduce the work (i.e., to make copies in the form of prints, videocassettes, videodiscs, audio-cassettes, etc.);

To prepare derivative works (i.e., to produce a feature-film based on the work, and to make sequels, prequels, remakes, TV series based upon the film, dramatic works, and merchandise based on or arising from the film, etc.);

To distribute copies of the work (e.g., in the form of theatrical prints, videocassettes, etc.);

To perform the work (i.e., to exhibit the film theatrically, over television, or otherwise, and to playback the soundtrack over broadcast media or otherwise); and

To display the work publicly (e.g., with regard to motion pictures, to display still photos comprising part of the picture or otherwise related to the production).[103]

The different elements of a feature-film which may constitute a "work" for the purposes of copyright are: the underlying literary property, if the screenplay is not original; the screenplay; the feature-film itself; the music composition; the recorded music itself; and the soundtrack.[104] The granting language should specify: whether or not the rights are exclusive or non-exclusive; the term of the license; and the territory. The most expositive and comprehensive collateral descriptions articulate the numerous copyright interests under four or five classifications, each of which is discussed below.

Picture. The secured party will, of course, take a security interest in the copyright to the completed motion picture itself, alternatively denominated picture or photoplay.[105] With regard to the means of distribution and the performance right, many security agreements contain all-encompassing language, such as "theatrically, non-theatrically, on videocassette, cartridge, or disc, on all media, or by all other devices having as their function the performance or exhibition of the picture, by all electromagnetic, electronic, mechanical, or acoustic means, presently known or hereafter created." The broadcast right should explicitly include radio and all forms of television, including free, cable, pay-per-view, and all other modes of transmission for home viewing.

Literary material. The second category of copyright often included in collateral descriptions relates to the literary material underlying the picture. All of the written material upon which the picture is based, in whole or in part, should be included. This will include all the borrower's rights in the underlying material (such as a novel, short story, etc.) and in the screenplay and its various drafts, versions, and rewrites. Descriptions often include story, theme, title, characters, trademarks, and servicemarks. Additional literary items may include treatments, outlines, synopses, etc.

Music. The collateral description should include the rights to record, re-record, produce, reproduce, perform, and synchronize all music and musical compositions created for or used in the film, and other rights to exploit the music, including the soundtrack recording and music publishing rights.

Ancillary Rights in Derivative Works. Conceptually distinct from the right to produce the film--a derivative work of the screenplay, underlying literary material, and music--are the rights to make derivative works based on the completed film itself. Among these rights are the right to produce and exploit remakes, sequels, prequels, and television series based upon or derived from the film and the characters contained therein. In addition are the rights to license the novelization and other literary publishing rights to the picture and the not insubstantial rights to license merchandise and to enter into commercial tie-ins.[106]

Other copyright. Most collateral descriptions grant the secured party a blanket copyright security interest. A sample clause might read "all statutory and common law copyrights, foreign and domestic, and the rights of renewal and extension of such copyrights, in the picture, literary materials, and music." Additionally, the secured party should include the right to sue for legal infringement of the copyrights.

Perfection of Copyright Collateral. Since copyright is classified as a general intangible, security interests in copyright must be perfected by filing a financing statement. As indicated above, the filing location is governed by UCC § 9-103(3), and counsel for the secured party should research the filing systems in the jurisdictions indicated by the debtor-location rule in that subsection.[107] However, since the U.S. Copyright Act also provides for a system of filing records of copyright transfer, the secured party must research the records of the Copyright Office as well. In this regard, counsel must examine the copyright and title research reports to determine whether there are any conflicting transfers of rights in the underlying material and screenplay.[108] These reports will reveal not only whether conflicting transfers have been recorded, but also whether the borrower in fact owns the rights purported to be transferred, and whether the underlying property has been registered with the U.S. Copyright Office. Registration is important since priority under the U.S. Copyright Act requires that the transfer be recorded with the U.S. Copyright Office.[109] Once counsel determines that an effective security interest has been created and that there are no conflicting interests, the next step is to perfect the interest.

Under the U.S. Copyright Act, after registering the copyright to the underlying material and screenplay (if not already registered), counsel must record the creation of the security interest by filing a copy of the document that creates the interest with the U.S. Copyright Office. The filing must occur within thirty-days of the execution of the creation of the security interest, or within sixty-days if a foreign transaction is involved in order to assure priority over a conflicting later transfer recorded within the statutory period.[110] Where there appears some potential for conflict, the secured party should wait until the expiration of the sixty-day period in order to guarantee its first priority before disbursing the loan funds.[111]

2. Tangible film and other materials. Since an interest in copyright is distinct from any proprietary interest in the tangible forms containing the subject of copyright, the collateral description should include the tangible elements of the motion picture. Those elements include: all exposed film (whether negative or reversal, developed and undeveloped); all pre-print materials or intermediates such as color intermediate master positives, color reversal intermediates, color separation negatives, interpositives, internegatives, duplicate negatives or reversals; all answer prints and release prints; and soundtracks and other audio recordings of any kind. Since these items of collateral are classified as goods, both filing and possession are permissible means of perfection. And unlike the other goods (such as production equipment, wardrobe, sets, props, etc.) discussed infra at subpart IV.C.5., the film materials are kept in the possession of a third-party to the secured transaction, the film processing laboratory. This allows the secured party to claim possession for purposes of perfection,[112] via a laboratory pledgeholder agreement.

The laboratory pledgeholder agreement[113] is an agreement among the lender, the guarantor, the producer, and the laboratory (and in some cases, one or more of the licensees[114]), that serves two important functions relating to security interests. First, the agreement provides that the laboratory holds the materials as a pledgeholder, for the benefit of the secured parties. This establishes possession for purposes of perfection as against parties claiming an interest in the materials through the producer.[115] Secondly, the laboratory pledgeholder agreement usually provides that the laboratory waives any liens arising under statutory or common law.[116] Regarding perfection by filing, UCC § 9-103(1) provides the proper jurisdictions in which to ensure that there are no competing claims, and in which filing must occur.

3. Accounts and other contractual rights. The third class of items in the collateral description that should be specified are the rights to payment under all commercial exploitation contracts--the minimum guaranties, profit participations, royalties, and other compensation, if any.[117] The contractual rights assigned should include not only those under the initial discountable-contracts, but all other distribution contracts subsequently executed, and all other revenue-producing contracts, such as merchandising, publishing, soundtrack, and nontheatrical deals. In addition to these agreements, the collateral description should include all rights under all agreements relating to the performance of services, and the sale or rental of equipment, space, or facilities for purposes of the production. Some descriptions specify service agreements for producers, directors, cast, writers, special effects technicians, and camera personnel. Common agreements for space and equipment include studio rental agreements, animation and special effects facilities, and sound and film laboratory contracts. A third form of contract in which the secured party may take a security interest is the production insurance policy.[118] Like the copyright collateral, filing is necessary in order to perfect the interest,[119] and the proper jurisdictions in which to search the filing systems and in which to file are indicated by UCC § 9-103(3).[120]

4. Other Intellectual Property. In addition to the general-intangible copyright are the other intellectual-property general-intangibles. The description should therefor include all rights arising under the law relating to trademark, service mark, and unfair competition. Additionally, some descriptions include language relating to patent law to provide for the possibility that in the course of the production a patentable invention or process (such as a special effects technique, or piece of production equipment) is created. As with copyright and accounts, the necessary filing locations and jurisdictional research are governed by UCC § 9-103(3).[121]

5. Tangible Personal Property. The secured party should include in the description all of the equipment and goods used in the production, such as wardrobe, sets, camera and lighting equipment, props, etc. Since this item falls within the meaning of goods, the interest may be perfected by filing in the UCC § 9-103(1) jurisdictions.[122]

6. UCC Terms. In addition to the above, many collateral descriptions also include a list of the collateral categories set out in the UCC. For example, "all accounts, chattel paper, documents, goods, including inventory and equipment, and intangibles, arising from the production or commercial exploitation of the picture."

The producer grants a security interest in all of the above collateral not only to the lender, but also to the guarantor, and in some cases to one or more of the licensees. The reader should recognize that the task of counsel for the secured party extends far beyond merely drafting a description of the collateral adequate for purposes of attachment and the creation of an enforceable security agreement. In addition to the drafting exercise, which requires an understanding of the bundle of proprietary rights in motion pictures, counsel must ensure that the security interest is effective to withstand the claims of potential competitors for the same collateral, should the producer default. To that end, counsel must determine where to search in order to discover such competitors. The lender's counsel will then secure a first-priority security interest in the collateral by filing financing statements and providing for possession of the film materials held in pledge by the laboratory. As explained infra at subpart VII.G., the guarantor will take a security interest subordinate only to the lender's interest, and the guarantor's counsel will likewise perfect its second-priority interest. Upon delivery and extinguishment of the guarantor's liability and repayment of the loan, the secured parties execute termination statements pursuant to § 9-404 which evidence the release of the collateral, and which are filed within the jurisdictions where the collateral is perfected.[123]

XIV. THE LENDER'S PERSPECTIVE

Once the independent producer has obtained the discountable contracts, he or she presents them, along with any letters of credit, to a lender that specializes in this form of interim finance. In addition to regular commercial banks that engage in financing film projects, there are a few specialized non-bank lenders[124] that discount negative-pickup and presale contracts. Many domestic commercial banks will not discount foreign paper as they do not have the expertise and/or the contacts necessary to accurately estimate the creditworthiness of foreign licensees and their banks. In contrast, and as noted above, most nonbank-lenders lend against foreign receivables.

A. The Single-Purpose Corporation. Generally, lenders will require the producer to form a single-purpose corporation,[125] before executing the loan agreement. The single-purpose corporation functions to isolate: the borrower's assets--the production assets, including all contracts, equipment, exposed film, etc.; and the borrower's one liability--the production loan.

By isolating all of the assets that relate to the production under the ownership of the single-purpose corporation, the lender avoids a number of potential legal dangers. First, the lender can require that all property and contracts relating to the production be owned by, or executed on behalf of, the single-purpose corporation. Once effected, the lender can simply take a blanket security interest in "all assets now owned or acquired by the borrower in the future."[126] Second, the lender can protect the value of its security interest by requiring that the borrower not jeopardize the value of that interest. Specifically, the lender may then require that all property owned by the single-purpose corporation, including all contractual rights, be owned free of any interest, lien, or encumbrance, other than those explicitly permitted by the lender.[127] Further, the lender may then contractually require that the borrower not grant any interest that is superior or equal to the lender's in any item of collateral, except as expressly permitted by the lender.

B. Lender Risks. The lender, whether a bank or non-bank lender, assesses the risks of the transaction and begins providing for the installation of risk-reduction mechanisms. Among the risks that the lender (and other parties) will seek to minimize or dispose of include:

1. Completion and Delivery Risk. As discussed above, in order to ensure that the film is completed and delivered in accordance with the specifications contained in the license contract(s), the lender requires a completion guaranty. The guaranty serves as a contractual assurance by a third entity that the picture will be completed in accordance with such specifications under the license contract(s).

2. Title and Copyright Infringement/Business Tort Claims/Privacy and Defamation Tort Claims. The lender, guarantor, and licensees may all insist that the producer obtain errors and omissions ("E&O") insurance covering these claims. E&O insurance protects the licensees, producer, and other parties involved in the production (including the guarantor and lender) from potential claims based on various copyright infringement, business tort, defamation, privacy, and related causes of action.

3. Production Risk. In order to dispose of the risks associated with the physical production of the film, the lender and the guarantor require the producer to obtain a production insurance package.[128] Such packages cover numerous production related items, including: death/disability of principal talent; negative insurance; equipment/props/set/wardrobe insurance; property damage; workers compensation; etc.

4. Cash-Flow Risk.[129] Cash-flow risk refers to the possibility that the lender will receive less than the total of all the minimum guaranties when due. Failure of full payment may be caused by a number of eventualities. For instance, one of the licensees may seek to avoid its payment obligation once it has seen the finished product (and recognizes its unprofitability). In another case, the licensee may accept the picture, but make payment to the producer (instead of the lender), who then refuses to forward the funds to the lender. Under a different scenario, imagine an unscrupulous producer who assigns his or her right to receive payments under the contracts to a third party before the lender has been repaid. The lender can avert all of these hazards with the employment of instruments of assignment, security interests, and letters of credit.[130]

5. Box-Office Risk. A fundamental rule of discountable-contract financing is that lenders are not investors. With few exceptions,[131] lenders are not in the practice of assuming the risk that the film will perform well at the box-office. Typically, lenders will only loan funds against time-specific, quantifiable sources of payment, such as contracts that contain minimum guaranties, and letters of credit.

6. Currency Risk. Generally, lenders will require that all payments from foreign banks or licensees be made in U.S. dollars. This requirement eliminates the risk that the foreign funds will be less valuable than anticipated if the exchange rate fluctuates dramatically between the time of loan execution and loan maturity. Another type of currency risk exists where the lender must fund a production that takes place in a foreign country. In such cases it may be necessary that the lender disburse production funds in foreign currency. The lender can minimize this form of currency risk by entering a foreign exchange contract with a foreign bank. In such a contract the lender will agree to purchase, e.g., 50-million francs at a specified date for eight-million dollars. The contract thus enables the lender to agree to loan the producer eight-million dollars and disburse fifty-million francs during production, without any concern that eight-million U.S. dollars will be insufficient at the time of production to purchase the 50-million francs.

Generally, the lender will protect itself against the risks of completion and delivery, production risk, and cash-flow risk with a three-prong approach.[132] The lender:

Collateralizes the loan by taking security interests in various items relating to the production, including the film and the contracts;

Ensures that the film is completed in accordance with the delivery requirements via a completion guaranty; and

Ensures that the various contract obligors in fact make their payments to the lender, by effecting an irrevocable assignment of the right to receive such payment and by requiring letters of credit in conjunction with the discountable contracts.

C. The Completion Guarantor. In order to ensure that the payment obligations contained in the discountable contracts become absolute, the lender will require the producer to obtain a completion guaranty. In addition, as stated above, the lender will require the producer to obtain various forms of production insurance to protect against various risks relating to completion of the picture.[133]

D. Ensuring Cash Flow: Assignment of Rights and Letters of Credit. As discussed above, the lender uses contractual assignments, security interests, and letters of credit in order to eliminate the risks that the licensees will fail to pay the guaranties. Where an LC is not used, the assignment of the right to receive the guaranty is critical to repayment of the loan and the removal of the lender from the transaction. However, even where an LC is used, lenders require that the producer contractually assign his or her rights to payment under the licensing contracts.[134]

1. Assignment: Notice, Acknowledgment and Acceptance.[135] As discussed above, in conjunction with the assignment of rights to payment under the licensing contracts, the assignee (lender or guarantor) delivers to each licensee a special instrument. The instrument, usually signed by the producer and assignee, gives notice of the assignment and of other facts, and requires the licensee-obligor to acknowledge and accept various representations and notifications relating to the assignment.

2. Letters of Credit. The other means by which the lender can minimize the risk that payment under the minimum guaranties will be paid, is by the use of a letter of credit. LCs are issued by banks upon the request of a borrower, and contain a payment obligation running in favor of some third party, which obligation is triggered upon that third party's presentation of certain specified documents. In the discountable contract financing context, LCs are issued by one or more licensee's bank(s) in favor of the lender. Generally, once the film is delivered, the lender presents the specified documentation to the licensee's bank, which then honors its independent obligation to pay to the lender the minimum guaranty. LCs are discussed in depth in part VIII.

If the loan officer is satisfied that all the risks described above can be eliminated by means of incorporation, collateralization, guaranty, assignment, and the use of LCs, he or she will then will perform a series of computations to break down the proposed loaned funds into their component parts. This process is known as discounting, and is the subject of the next subpart.

E. Discounting. For some lenders, the first step in the discounting process is known as weighting. Weighting refers to the lender's determination of what percentage of the minimum-guaranties aggregate it is willing to lend against. Weighting analyses involve an evaluation of the risk that the particular licensee will not, or will be unable to pay, and the risk that the licensee would not be contractually obligated to pay. Generally, lenders will loan against 100% of a minimum guaranty from a company with good financial statements, such as a major studio, or a large independent domestic- or foreign-distributor. In cases where an LC is provided, the lender is also likely to make a loan totaling 100% of the guaranty. In other cases, the lender may agree to loan only a percentage of the minimum guaranty sum(s) (for example 60%, or 70% of the guaranty).[136] Once the lender weights the contracts and determines the total amount it is willing to loan, it then performs the second step in the discounting process--breaking down the loan amount into its various components: loan fee; interest and cushion; bank legal fees; guaranty fees; and production funds. An explanation of these component parts follows.

1. Loan Costs.

a. Loan Fee. Bank loan fees range from 1-3% of the loan amount, depending on the risk and complexity of the transaction. Non-bank lenders usually charge slightly higher loan fees, between 2-5% of the total loan amount. In either case, this fee is loaned to the producer on execution of the loan, and then immediately paid to the bank. Interest will accrue on these funds (which are loaned to pay the loan fee) while they remain unpaid.

b. Lender's Legal Fees. Lender legal fees range from $15,000, for the least complex single-licensor negative-pickup, to in excess of $200,000, for multi-party, complex financing-arrangements. The average transaction is estimated to cost around $35,000. These fees, like the loan fee, are paid by the producer at execution of the loan (or closing) out of funds loaned to the producer, and the producer pays interest on these loaned fees as well (explained more thoroughly below in connection with the reserve account, at subpart V.E.2. infra). The lender's legal fees are separate from whatever fees the producer pays his or her own attorney to represent him or her in the transaction.[137] In some cases the producer may successfully negotiate a ceiling on lender legal fees; many lenders, however, will not negotiate this point.

c. Interest Charges. Interest rates usually are based on Prime or LIBOR (London Interbank Offered Rate), and for banks, range from 1-3% (over Prime or LIBOR); non-banks charge slightly higher, with a margin of 2-4%. Interest is paid monthly out of a separate account--the reserve account--and is charged against the total outstanding balance monthly (or quarterly).

d. Guaranty Fees. The producer will have to pay the initial guaranty fee to the guarantor before the guarantor will issue the guaranty. This fee ranges from 1-3% of the film's budget. Like the other fees, the guaranty fee is loaned to the producer. The back-end guaranty fee, usually an additional 1-3%, will be necessary only in the event the guarantor is called upon to supply funds to the producer or otherwise incurs liability under the guaranty. The lender therefor places funds to cover this potential fee in the reserve account.

e. Guaranty Contingency. The guarantor will require that the lender place in the reserve account funds equal to 10% of the film's negative cost, and will condition its liability upon the expenditure of this amount (as well as upon payment of the back-end fee).

2. The Reserve Account. As explained above, in discountable-contract financing the lender loans the producer not only the production funds, but also the guaranty fee(s), the contingency cushion (if necessary), the loan fee, the lender's legal fees, and the interest payments due on all of the above during the term of the loan. Where interest is a floating rate (i.e., tied to prime or LIBOR) the lender will provide an additional two-percentage point cushion in case the rate rises dramatically during the term of the loan. The funds for all these expenditures are placed in a separate account controlled by the lender--the reserve account. The function of the reserve account is best explained by illustration of the cash flows commencing with execution of the loan and ending with repayment to the lender. On executing the loan, the reserve account will be created. Immediately funds will be drawn from the reserve account for: payment to the lender of legal fees and the loan fee; and payment to the guarantor of the initial guaranty fee.

At commencement of production the producer will make his or her first drawn-down of production funds (usually, funds for production will be available on a weekly basis in accordance with the cash flow schedule submitted by the producer).[138] At the end of each month (or other ageed-upon period) an interest payment on the total outstanding balance (including all production funds, the guaranty fee, legal and loan fees, and any funds previously loaned to the producer for the payment of interest) will be due the lender. The lender will therefor draw the necessary interest payment from the reserve account and pay itself the interest due. All interest payments are, in effect, loaned to the producer; thus as interest payments are drawn from the reserve account each month, the producer's outstanding loan balance is increased. Once the loan is repaid, any funds remaining in reserve belong to the lender.

F. Conditions Precedent to Execution of the Loan. Like the other principal agreements, the credit and security agreement, which provides for the making of the production loan, contains several conditions precedent to the loan execution. In addition to requiring the delivery to the lender of numerous documents,[139] the credit and security agreement may provide that the loan is contingent on the approval of all matters relating to the transaction by lender's counsel, and upon full-financing.

XV. COMPLETION GUARANTIES

Completion guaranty refers to the undertaking of a specialized industry business, known as a completion guarantor or completion bond company, to ensure that a film project is completed in accordance with certain specifications, or in the alternative, to repay the lender the outstanding loan balance.[140] The term completion guaranty also refers to: the two contracts that collectively embody the guarantor's agreement with the lender and the producer--the completion guaranty and the completion agreement; and to the document entitled completion guaranty, separate and independent of the latter. As indicated above, in consideration for the guarantor's providing the guaranty to the lender, the producer pays the guarantor a fee out of the production loan, usually between one and three percent of the film's budget.[141] In California, guarantors are equivalent to sureties.[142] Sureties are parties which agree to perform an act or to pay money if another party, the principal, fails to do so.[143] As noted below at subpart VI.B.6., guarantors are distinct from insurers,[144] although they are "backed" by large insurance companies such as Lloyd's of London, Transamerica, and Fireman's Fund.[145]

A. The Guaranty.

1. The Production Price. The guaranty sets out the specifics of the loan transaction, listing the various components of the loan, collectively known as the production price, or strike price. The production price usually consists of: the direct costs of production; the guaranty contingency; lender legal fees; and the guaranty fee. As explained above, the guaranty fee is broken down into two parts: an initial fee (usually one-half of the total guaranty fee); and the back-end fee (also one-half of the total guaranty fee).[146] Even though most guarantors require payment of only the initial fee upon signing, and do not require the back-end fee be paid unless and until the guarantor is called upon to expend funds for the production in order to satisfy its obligations under the guaranty,[147] the entire fee is usually included in the production price. And, as explained with regard to the reserve account, the guaranty contingency and back-end fee are held in-reserve until the guarantor's obligations are satisfied. The utility of referencing this aggregate sum of money as the production price, is evident by its use in connection with the conditions predecent to the effect of the guaranty.

2. Conditions Precedent. Most guaranties state that they are conditioned upon payment of the initial guaranty fee and upon the production price being made available to the producer on an as-needed basis. The latter requirement assures the guarantor that all necessary funds are available for the completion of the picture, whether ultimately completed by the producer, guarantor, or licensee.[148] Another common condition precedent to the guarantor's obligations to the lender is the commencement of principal photography by a specified date. This is critical since the guarantor is agreeing to ensure that delivery of the proper materials is effected timely.[149] Finally, some guarantors condition their guaranty on evidence that the producer has obtained the insurance required by the completion agreement.

3. The Undertaking. Guaranty contracts contain a section that sets out the standard terms and conditions of the guaranty. The guaranty is sometimes expressed as a promise to pay the producer additional funds necessary to complete the picture and/or to ensure that the delivery of the film--completed in accordance with the delivery specifications in the discountable contracts and the interparty agreement--is effected. In the alternative, the guarantor warrants it will repay the lender amounts actually advanced to the producer (and not recovered by insurance or otherwise) plus interest, not to exceed a certain amount. The guaranty will also provide the guarantor with subrogation rights to the lender's claims and causes of action to the extent of the repayments the guarantor makes to the lender. Thus, in the event the guarantor is required to expend funds for the production of the film or to repay the outstanding loan balance, the guarantor may sue the producer on the note, as if it were the lender.[150]

4. Exclusions. All guarantors provide for certain exclusions to the guaranty; i.e., guaranties will not cover budget overages or other liabilities arising from certain specified claims or events. For example, completion guaranties generally do not cover costs or damages resulting from the producer's infringing another's copyright relating to the picture, or costs/damages arising from related torts. Other exclusions include damages or expenses caused by, or in connection with: failure of the picture to meet rating or censorship requirements; war or hostile actions; failure of artistic quality of the film; expenses for reediting, re-recording, or making additional changes to the film after delivery has been made; expenses for supplying non-scheduled delivery items; fraud by the lender; legal or loan fees, and interest exceeding certain capped levels; non-budgeted guild or union payments; and labor problems.

5. The Lender's Role. Completion guaranties state that the lender has no obligation to oversee the use of the funds, only to ensure that the producer (or guarantor) has access to the funds as needed. This provision underscores the lender's limited role; lenders are not in the business of overseeing entertainment projects or in anyway involving themselves in production. Rather, the lender agrees only to loan funds to the producer, secured by collateral (however unique), in return for a promise to repay the loan plus interest, fees, and costs. Another provision relating to the role of the lender is the provision that the lender may make additional advances to the producer for the production without vitiating the guaranty. Essentially, this stipulation precludes the guarantor from making a claim that the lender contributed to cost overruns by encouraging budget overages that ultimately exposed the guarantor to liability.[151] A final set of provisions relating to the lender's role are the various "good-faith" covenants. These include the lender's promise to notify the guarantor of any events that prejudice the guarantor's interest in the production (such as the producer's replacing key personnel or making material changes in the screenplay or schedule), and the lender's promise to cooperate with the guarantor in the event of takeover.

6. Recoupment. From the completion guarantor's perspective, one of the most important provisions in the completion guaranty is the paragraph stipulating the guarantor's recoupment of expenditures made in completing or delivering the film, or made in repaying the lender. This right of recovery of the guarantor is the most conspicuous distinction between guarantors (or sureties) and insurers.[152] That is, while the guarantor has the power to recover from the party contracting for the guaranty (the producer) its expenditures made pursuant to the guaranty, the insurer has no such right under an insurance policy against the insured. Recoupment provisions usually provide that these expenditures shall be recouped, with interest, out of the net proceeds[153] of the film that are not obligated to the lender pursuant to the interparty agreement and the credit and security agreement. The negative-pickup or presale agreement will, of course, make some provision as to the licensee's allowable deductions for fees and expenses prior to payment of net profits. Some guaranties reference or repeat the licensee's allowable deductions and list additional allowable or non-allowable deductions for purposes of calculating and identifying funds recoupable by the guarantor. From the guarantor's perspective, allowable pre-recoupment deductions fall into four categories.

First, the licensee may recover all of its fees and expenses and may pay all deferments and participations defined in the net profit definition ("pre-net profits deductions"), except for those explicitly excluded by the guarantor. Second, the guarantor allows the lender to recover the loan amount. Third, the guarantor must allow deduction of any sums paid by the producer, lender, outside investor, etc., for the completion of the film, which sums the guarantor would have been obligated to pay otherwise. Fourth, the guarantor may allow for the deduction of payments made to certain investors, depending upon the structure of their repayment and profit-sharing rights. Items which guarantors may designate as non-allowable pre-recoupment deductions include: gross participations to the producer as payment for production services; contingent deferments or participations in net profits; and contingent deferments or participations after breakeven. Breakeven generally refers to the point at which gross revenues attributable to a picture cover all costs expended by the particular licensee or other entity in producing and exploiting the film.[154]

B. The Producer's Completion Agreement. The producer's completion agreement[155] is a somewhat lengthier document that stipulates the producer's rights and obligations vis-a-vis the guarantor, and the guarantor's right to involve itself in the production in order to minimize its exposure.

1. Producer's Representations. The producer represents in the completion agreement that he or she will use all production funds for production and delivery of the picture, and, as mentioned above, the guarantor reserves the right to name one of its representatives as a joint signatory on the production account(s). In connection with the production account, many completion agreements contain a representation by the producer that he or she will use reasonable best efforts[156] to persuade the lender to waive the so-called offset rights.[157]

2. Conditions Precedent. The completion agreement may set out one or more conditions precedent to the guarantor's obligations, such as the commencement of principal photography by a specified date, or the payment of the guaranty fee. Additionally, the completion agreement usually recites the condition that the producer (or lender) pay the back-end guaranty fee before making any claim under the completion agreement.[158]

3. Production Changes and Enhancement. Standard representations and warranties of the producer include a promise to produce the picture in accordance with the approved elements[159] and licensing contracts, and a promise not to make material changes respecting those elements, without the guarantor's approvals. These representations assure the guarantor that the producer in fact produces the product the guarantor guarantees, and that he or she does not seek to significantly modify or alter the film. Some agreements permit nonmaterial changes and variations and alterations necessitated by the exigencies of production, which in the guarantor's good faith sound business judgment,[160] do not increase the cost of the picture or jeopardize timely delivery. The guarantor may also expressly grant the producer the right to make costly changes so long as the producer deposits funds in the production account, which the guarantor, in its good faith sound business judgment, believes to be equal to the increased cost of production. With regard to enhancing the picture with costly additions of talent, equipment, etc., the agreement may set forth certain procedures. Such procedures may include submission of a written proposal, and subsequent approval by the guarantor, and/or payment of an additional fee for the increased risk associated with the addition.

4. Ownership of Rights. The agreement will state that the producer owns the copyright in the screenplay and will be the owner of all rights to exploit the film and the owner of all collateral. In addition, the producer agrees to grant a security interest under the Uniform Commercial Code and the Copyright Act.[161]

5. Union and Guild Considerations. Entertainment labor unions and talent guilds have promulgated extensive guidelines regarding working conditions, compensation, etc., as well as penalties for producers who violate such rules. Guarantors therefor provide that the producer is liable for costs arising from these kinds of violations.

6. Progress and Financial Stability. A common provision in the completion agreement states that the producer agrees to notify the completion guarantor of changes in its financial stability. Thus, if the producer is in danger of becoming incapable of completing the production due to insolvency or other problems, the guarantor is entitled to some advance warning. Respecting the physical production, the producer will also agree: to keep the guarantor fully informed as to its progress; to prepare and deliver to the guarantor daily progress reports and weekly cost statements; to submit copies of bank statements; and to submit future expenditure estimates upon request.

7. Services Agreements. The guarantor may require the right to approve all talent services agreements. Of particular interest to the guarantor are stop dates provisions, clauses in talent services contracts stating that the individual may not be required to perform after a certain date. Such provisions can expose the guarantor to devastating liability if the actor/actress/etc. is an essential element and completion of the production is delayed beyond the stop date.[162]

8. Monitoring and Auditing Rights. The guarantor may designate production representatives to monitor the production and audit the books, and will also require the right to receive explanations, demand attendance of the executive producer and other personnel (the individual producer and director, for example) at meetings, and require that all persons give full consideration to the guarantor's proposals. The guarantor will have the right to countersign checks and to receive and approve all production account draw-downs.

9. Insurance. Completion agreements state that the producer agrees to obtain specified production and errors and omission insurance, and provide that if events lead the guarantor to require the producer to obtain additional insurance, the producer agrees to do so. In such a case, the premiums for the additional insurance will be paid from the budget, if possible, or if not, from the contingency. The producer agrees to keep the policies in effect. If the insurance proceeds pay off the producer for a claim, the agreement provides that the guarantor will be repaid its expenditures. In the event the producer fails to take required insurance, the agreement states the producer must pay the guarantor its expenses incurred as a result of the producer's failure to take the insurance.

10. Takeover. Takeover describes the right of the guarantor or other party[163] to take charge of the production under certain circumstances that jeopardize the timely and on-budget completion of the picture. Typical conditions or events that empower the guarantor with takeover rights include: the producer's breach of the completion agreement or any of the licensing contracts; the producer's failure to confer and cooperate with the guarantor regarding schedule delays, cost overruns, or other production problems; and the guarantor's perception that there is a risk that it will incur liability under the guaranty.[164] Under some takeover provisions, the guarantor may be entitled to compel a meeting with the producer, director, or other personnel in order to discuss the resolution of the real or perceived problem(s). Depending on the problem and the specific takeover language, the responsible production persons are then obligated to comply with the guarantor's instructions in order to remedy the situation.

Where the guarantor exercises its right to take over the production, the guarantor is deemed appointed manager and agent for the producer, and the producer must place at the guarantor's disposal the production account and all persons, premises, and equipment. In this connection, the producer is required to execute a number of instruments peripheral to the guaranty, including a Takeover Agreement Letter, a Power of Attorney instrument,[165] a Production Account Takeover Letter, and Laboratory Access Letter or Laboratory Pledgeholder Agreement.

The takeover agreement letter[166] is a short letter signed by the producer in which the producer acknowledges the guarantor's contractual right to take over the production. The producer agrees to deliver all property, premises, contracts and rights in connection with the picture, including the production funds and account in the event the guarantor chooses to take over the production pursuant to the guaranty. The letter may also state the guarantor's right to recoup from the producer any budget overages in the event remaining production funds are insufficient to complete the film. In addition to the takeover agreement letter, and in order to empower the guarantor with the ability to smoothly take control over the production, the guarantor may require the producer to execute a power of attorney instrument.

11. Power of Attorney. The power of attorney instrument provides that the producer appoints the guarantor attorney in the name of and on behalf of the producer to perform various acts in connection with the production. Those acts include taking control of the production and the production account and appointing other individuals or entities to act with the power of attorney on behalf of the guarantor. Some power of attorney documents state that the producer ratifies the guarantor's lawful actions performed pursuant to the instrument, and provide that the producer indemnifies the guarantor for any costs or expenses incurred by it under the exercise of the power of attorney. An additional common provision refers to the irrevocability and term of the power of attorney; the document may state that it is coupled with an interest,[167] and is irrevocable. Delivery of the picture may be deemed to be the point of termination for the power of attorney.

12. The Production Account Takeover Letter. The production account takeover letter is a short agreement defining the relationship between the lender and the guarantor, particularly with regard to the eventuality of takeover. A primary function of this letter is to identify the authorized signatories on the account prior to takeover, and subsequent to takeover. The letter states that the lender agrees to give the guarantor sole control over the account upon demand, and that the lender agrees to redesignate the authorized account signatories at the direction of the guarantor in the event of takeover. Some lenders require that the guarantor agree to indemnify the lender from liabilities and claims arising from the lender's compliance with the account takeover letter, and such a provision may be included. The letter may also contain some representations by the guarantor regarding ownership of rights in the production. Specifically, lender's counsel may require that the guarantor represent that it is the rightful owner of the production account unencumbered by lawful claims of any other party,[168] and that the guarantor is exercising its right to take over the account lawfully. Another important provision in the account takeover letter is the lender's waiver of offset rights with respect to both the producer and the guarantor.[169] In some letters there may be a recitation that the lender acknowledges that the guarantor issues the guaranty in reliance on this waiver.[170] The letter ends with the lender's acknowledgment and acceptance of the above provisions.

13. The Laboratory Pledgeholder Agreement.[171] The last document used by the guarantor in connection with its takeover rights is one of two types of instruments to which the film processing laboratory is a signatory. When drafted by the guarantor the document may be entitled laboratory access letter, or in the alternative, laboratory pledgeholder agreement. Both documents are discussed in detail in connection with letters of credit.[172] Apart from their functions related to attachment and perfection of the security interest in the film materials, when drafted for the guarantor's benefit both documents stipulate the various parties' respective rights to take control of or deal with the physical materials of the picture. In this regard the document will state that upon notice that the guarantor has taken over the production, the laboratory will agree to effectuate new controls over the materials. Such controls consist of providing the guarantor exclusive and full access to the materials, including the right to remove them from the laboratory. These provisions are operative only until the delivery of the picture, and sometimes are made subject to the licensee's distribution/exploitation rights and the lender's rights against the producer under the credit and security agreement.[173]

14. Recoupment[174] and Indemnification. The completion agreement defines the sums for which the guarantor is entitled to recoupment as expenditures made by the guarantor relating to the production pursuant to the completion agreement or guaranty, plus interest. Excluded expenditures include: expenditures for which insurance proceeds have been paid to the guarantor; ordinary business costs of the guarantor prior to exercise of takeover rights (if such exercise ever occurs); and general overhead, including costs of negotiating the guaranty, salaries paid by the guarantor, etc. The method of identifying recoupable funds from the continual flow of exploitation revenues, as detailed in the guaranty, is recited in the completion agreement for the producer's benefit. Additionally, the completion agreement customarily affords the guarantor the right to recoup expenditures only from the revenues and profits received by the licensees and producer, and not from the producer's other assets. Some completion agreements will list in some detail the exceptions to this rule of limited recoupment sources. All of the exceptions are designed to discourage the producer from failing to obtain required insurance, exceeding the budget, and breaching any of the agreements, generally.[175] In order to facilitate recoupment from picture revenues, the guarantor requires the producer to execute a notice of assignment (assigning the right to revenues), which it then sends to the various licensees.[176]

After the above central contracts--the licensing agreements, the credit and security agreement, and the guaranty contracts--have been executed, various contractual inconsistencies and conflicts may appear. For example, the various grants of security interests must be prioritized, the parties' respective rights to receive insurance proceeds must be stipulated, and the obligations of the guarantor and the licensees must be clearly delineated in order to ensure payment of the minimum guaranty. In addition, other matters, such as arbitration and application of received funds must be addressed. These points are treated in a separate contract negotiated by the lender, producer, licensees, and guarantor--the interparty agreement.

XVI. THE INTERPARTY AGREEMENT

In the simplest negative-pickup arrangement, with only one licensee, the interparty agreement is the controlling document that embodies the collective agreement of the parties with respect to various risk-allocation issues. It is negotiated and executed by all parties involved in the transaction--lender, producer, licensee, and guarantor. If more than one licensee is involved in a transaction, there may be a separate interparty agreement negotiated for each licensee.[177] The interparty agreement provides for eventualities that may affect three or more of the parties and which therefor are more properly disposed of in a separate document to which all parties are signatories. Examples of such occurrences include takeover by the guarantor, abandonment of the production by the producer or other key talent, and repayment or recoupment following either of the above occurrences. Conceptually, the most notable aspect of the interparty agreement is its position as the superior document within and among the assortment of contracts and instruments in the financing system.[178]

A. The Primacy of the Interparty Agreement. Since the obligations of the various parties as expressed in the principal agreements often are inconsistent or stand in conflict with the requirements of other parties, the interparty agreement provides that it is the controlling agreement where such conflicts or inconsistencies exist. Common conflicts and inconsistencies include: over-extensive delivery requirements contained in boilerplate delivery schedules attached to licensing agreements; express rights of offset contained in licensing agreements; and express rights of the licensee to terminate the licensing agreement. All of these matters are addressed in the interparty agreement. Other matters contained in the agreement include issues such as the licensee's approvals of the film elements, and other acts relating to the licensing contracts.

B. Approvals. Since a motion picture is more than merely a group of physical materials, but contains story, subject matter, and other intangible qualities, there is potential for the licensee to claim that the producer has not delivered what he or she promised, at least with regard to the more subjective elements (such as story, theme, or concept). In order to foreclose any argument by the licensee that the picture does not "conform" to the producer's representations, the lender and guarantor seek to have the licensee approve in writing as many creative elements as possible. The interparty agreement therefor recites the elements that the licensee has approved in the license agreement[179] and states that the licensee acknowledges those approvals.

One aspect that historically is particularly problematic is chain of title (the successive conveyances of ownership in the copyright beginning with the original source[180]). Distributors have in the past refused to pay the minimum guaranty after some other party has asserted a claim of copyright infringement or a similar claim (trademark infringement, breach of quasi- or implied-contract, privacy claims) respecting the film.[181] The agreement may specifically state that the licensee has reviewed and approved the chain of title and agrees not to refuse to make any payment based on a claimed infringement or other defect in the chain of title.[182]

A final provision involving approval of creative personnel concerns the problem of replacing such personnel during production should replacement become necessary due to death, incapacity, contractual default, or due to the guarantor's election pursuant to its takeover powers. In this regard the agreement states that the licensee agrees to exercise its rights of approval in good faith and in a speedy manner. Some agreements contain lengthy provisions regarding time frames within which the licensee must approve or reject proposed replacements, and list constraints on acceptable replacements.[183]

C. Licensing Agreement. The interparty agreement states that no changes may be made to the licensing contracts without the bank's and guarantor's prior written approval until the loan has been repaid and until the guarantor's obligations have been satisfied. The lender and guarantor require this in order to "freeze" the producer's obligations to the licensee. Some agreements contain a statement clearly expressing that the licensee's rights to exploit the film under the licensing contract are conditional on the licensee's payment of the minimum guaranty. The interparty agreement may contain a representation that the licensing contract is in full force and effect, and that no party is in default under the contract. Further, the licensee will warrant that the contract will remain in force throughout the term of the loan. This provision may also state that the licensing agreement is a legal, valid, and binding obligation of the licensee which can be enforced against the licensee under its own terms.

D. Completion Guaranty. The interparty agreement may contain a covenant by the producer and licensee not to obstruct or interfere with the guarantor's obligations under the guaranty. A statement that the guaranty is in full force and effect is included, as well as representations by the producer and lender not to alter in any way the completion agreement or guaranty. Additionally, the interparty agreement often contains a statement that the guarantor approves the lender's cash flow schedule, and an acknowledgment that the lender has the right to make disbursements otherwise than in accordance with the cash flow schedule if the producer requests.

E. Mandatory-Delivery and the Duty to Pay the Minimum Guaranty. Another chief function of the interparty agreement is to provide a detailed and paramount description of the producer's--and indirectly, the guarantor's--delivery obligations. The definition of mandatory delivery, or effective delivery, is used by the lender to rigidly delineate what acts render absolute the licensee's duty to pay the minimum guaranty. Mandatory delivery is defined by reference to an appended delivery schedule, or by special notation to the delivery requirements in the licensing agreement. After setting forth the amount of the guaranty and the delivery date, the agreement will contain a statement that payment of the minimum guaranty is conditioned only upon mandatory delivery. Other agreements contain a stipulation that equates mandatory delivery with whatever performance is specified in the licensing agreement as necessary (and sufficient) to cause the licensee to pay the guaranty (often contained within the definition of delivery[184]).

Apart from the requirement of what must be delivered, is, of course, the element of when, and the interparty agreement often crystallizes the parties' agreement in this respect as well, incorporating the concept of force majeure.[185] Typically, the agreement provides that delivery will be made by a specified date, termed simply delivery date, subject to extension for some period of time (usually sixty-days) for events of force majeure. Further, the agreement provides that, in no event will the materials be delivered beyond the expiration of the force majeure period, or the outside delivery date. In some instances the lender requires the guarantor to deliver to the lender a certificate (appended to the interparty agreement) that serves as the guarantor's representation that delivery of the conforming picture is effected.[186]

This agreement also states that the licensee will pay all funds due under the contract to the lender without right of offset,[187] counterclaim, withholding, right of cross-collateralization, or the right to set up reserves, provided that mandatory delivery is made to the licensee. Alternately expressed, in positive, rights-granting language, the licensee may terminate its contract with the producer or refuse to pay the minimum guaranty if (but only if) mandatory delivery is not made by the outside delivery date. Additionally, the agreement may state that any failure of the producer to observe or perform any representation, warranty, term or condition, other than failure to make mandatory delivery does not excuse payment of the minimum guaranty.

F. Assignment of Receipts and Application of Funds Received. The interparty agreement references the producer's assignments of its rights to receive payment under the licensing agreements (the assigned receipts) to the lender and the guarantor.[188] Sometimes the agreement explicitly directs the licensee to make payment to the lender, or contains a statement that the licensee consents to such assignments. Usually stipulated in connection with this instruction are the rights of the secured parties--lender and guarantor--to examine the licensee's books and records until the producer has discharged his obligations (of repayment, if any) to each. The instructions and authorities contained in the interparty agreement are sometimes stipulated as coupled with an interest, or as irrevocable, and are stated to be contractually non-modifiable and non-rescindable absent written consent of the lender and producer.[189]

In addition, the interparty agreement also makes provision for the application of the funds received, in order to specify the lender's and guarantor's respective rights to be repaid. Initially, all receipts are agreed to be payable to an account under the lender's control--the collection account. In some cases, a separate document--the collection agreement--appended to the interparty agreement contains the agreement regarding the application of the funds to the producer's indebtedness to the lender and guarantor. The order of collection or repayment of the assigned receipts follows the priority of the lender's and guarantor's security interests. That is, the lender is entitled to recoup all receipts owed to it under the credit and security agreement and the guaranty before the guarantor is entitled to recoup under the terms of the guaranty and completion agreements. The interparty agreement states that the funds received will be applied in repayment of the production loan or as recoupment to the guarantor, and not towards any other indebtedness or account.

Some interparty agreements provide certain duties of the lender regarding actions it must take after repayment of the loan amount. In some cases the lender must notify the licensee and the guarantor of the full repayment. Any amount by which the lender's receipts exceed the producer's debt are made payable to the guarantor, if the guarantor claims any right of recoupment, and are otherwise payable to the producer. Additionally, the lender expressly agrees to execute and deliver termination statements to the producer for the security interest and copyright mortgage executed in connection with the picture.

The same obligations--notification, remitting excess funds, and delivering termination statements--are incumbent upon the guarantor upon its recoupment of its expenditures, or if there are no such recoupable sums, upon repayment of the loan. Upon full repayment to the lender and the guarantor respectively, the licensee's obligations to each are terminated, and certain other authorities and instructions to the licensee expire or are nullified.[190]

G. Priority of Security Interests and Collateral Execution. Since at least two parties, and usually three or more, take a security interest in the picture, some provision must be made for the priority of these interests. Further, in the event a party executes on the film collateral, the other parties to the transaction require assurances that their interests in the project will not be unduly jeopardized. The interparty agreement orders these competing security interests and contains certain covenants designed to protect the parties' respective interests in the event that the collateral is seized following abandonment or other failure of delivery.

The ordering of the security interests is stipulated in the interparty agreement and there may be a statement that all parties acknowledge and consent to the ordering. The lender always requires that its security interest take first position. Thus, in the event that the loan is not repaid upon maturity due to failure of delivery and breach of the guaranty,[191] the bank may seize the film materials and dispose of them to pay the outstanding balance. Once the loan is repaid, the lender relinquishes its security interest by executing the appropriate termination statements. Subordinate only to the lender's interest, is the guarantor's security interest. Thus, once the lender is repaid, and where the guarantor has a right of recoupment, the guarantor may execute on the film collateral, so long as the licensee has not paid the minimum guaranty.[192] The guarantor then terminates its security interest just as the lender. Since many licensees also take security interests in their negative-pickup or presale transactions, the interparty agreement may provide for the subordination of this security interest as well. In such a case, the licensee's interest is subordinated to both the lender's and guarantor's interests, and therefor is said to take "third position."

The interparty agreement should contain a representation by the lender and completion guarantor that neither will, absent failure of the licensee to pay the minimum guaranty, exercise any of their rights in the collateral in such a way as to interfere with the licensee's exploitation of the film.[193] This provision will also state that if the licensee fails in any of its payment obligations due to non-delivery (or failure of mandatory delivery), the lender or completion guarantor may foreclose, sell, or license the picture. That is, in the event the licensee fails to pay the minimum guaranty, all the licensee's rights terminate and the rights revert to the producer, bank, or the completion guaranty, depending upon the particular situation.[194]

H. Interparty Liabilities: Problems Relating to Assignment and Third-Party Beneficiary Claims. Since discountable-contract financing involves the execution of several contracts among and between several parties, there exists the potential for liability founded on third-party beneficiary theory.[195] The interparty agreement contains several clauses designed to protect against such claims. For example, one clause states that neither the lender nor the completion guarantor have any obligations under the licensing agreement. Therefor, a licensee that has not paid for and received the completed film cannot argue that the guarantor or lender has an obligation to complete and deliver the picture. Another clause states that the licensee has no obligations under the credit and security agreement, thereby refuting any assertion that the licensee may be liable to the lender under a third-party beneficiary theory. The completion guaranty sometimes also receives special attention respecting issues of third-party beneficiary theory, since the lender is a third-party beneficiary of the completion guaranty.[196]

I. Insurance. The interparty agreement also contains a lengthy paragraph setting out the priority of disbursement of insurance proceeds paid pursuant to the production insurance policies. Most interparty agreements base the priority on: whether the guarantor has already expended funds at the time the proceeds are paid and/or has taken over the production at such time; or at the time the proceeds are paid, whether the guarantor has neither made any expenditures nor taken over the production. In the former event, the interparty agreement makes the proceeds payable to the guarantor to the extent that the guarantor has advanced funds, and thereafter the proceeds must be used to pay production costs before the guarantor may called upon to make further expenditures. In the latter case--payment of the proceeds prior to the guarantor's takeover and prior to expenditures of funds for completion--the funds are to be deposited into the production account and used to pay production costs before the guarantor may be called upon to supply completion funds. The agreement may state that any surplus of proceeds, in either case, must be paid to the producer or to the lender "as their interests appear."

Another method of describing the priority of insurance proceeds recovery considers the status of the production at the time the proceeds are paid, and is as follows: in the event the picture has been completed and delivered, or the production has been abandoned and the loan remains unpaid, the proceeds will be applied first to the outstanding balance. The remainder is to be paid to the guarantor for recoupment of completion funds. In the event the picture has not been completed and not abandoned, the proceeds are to be used first for the payment of production expenses. However, in such event, if the guarantor has made expenditures (for an insured event) prior to payment of the insurance proceeds, the proceeds are to be paid first to the guarantor for recoupment. Thereafter, the proceeds are to be applied in accordance with the priority of payment in the case where delivery has been made or the production abandoned.

J. Arbitration. All interparty agreements contain a lengthy provision regarding arbitration in the event one of two common points of dispute arise--the issue of mandatory delivery, and the issue of whether money is owed pursuant to the completion guaranty. Since arbitration terms vary greatly, provisions from a fairly representative arbitration provision are discussed below. Arbitration paragraphs state that if any of the parties elects to submit the issue of mandatory delivery (or the issue of liability under the guaranty) to arbitration, the decision of the arbitrator will be binding on all parties. This provision may be quite specific with regard to the following terms.

1. Appointment of Arbitrators. Usually at least two of the parties will have the right to choose one or more of the actual arbitrators or persons delegated the obligation to appoint the arbitrators. This provision may specify the time period within which the parties must make the appointments, and specify what penalty such parties suffer, or what rights are waived, due to failure to make timely designations.

2. Arbitration Rules and Procedures. The arbitration provision will specify what rules and procedures the arbitration will follow. The most common set of rules and procedures are the ones promulgated by the American Arbitration Association.

3. Arbitration Discovery and Schedule. The arbitration provision will state what discovery methods the parties may engage in prior to the arbitration. Commonly, the provision states simply that the parties agree to discuss the disputed matter prior to arbitration and to allow reasonable discovery, including the use of depositions and document inspection. The time period within which the arbitration must begin after the election of any party to arbitrate is also stated, as is the maximum period allowable for the actual arbitration (usually 10-15 days).

4. Arbitrator's Decision. The arbitrator(s) will decide either that mandatory delivery has been made, or that it has not been made.[197] In the case where the arbitrator finds mandatory delivery, the arbitrator will order the licensee to make payment to the lender within a certain period of time (2-5 days). If mandatory delivery has not been made, then the arbitrator will specify in what respects delivery is deficient and allow the lender and guarantor a certain period of time (10-60 days) to correct, or cure, delivery. This provision will further specify the procedure in the event that mandatory delivery is still disputed after the lender and guarantor have made cure. Again, if mandatory delivery is found, the licensee will be ordered to pay within a number of days; if the cure is found to be ineffective, the arbitrator will order the completion guarantor to pay the lender the full amount of the outstanding balance. In such a case where there is a final determination of no mandatory delivery, the arbitrator will order the licensee to return all of the production materials to the guarantor, and the licensee and lender will relinquish all rights to exploit the picture.

5. Costs of Arbitration. The costs of the arbitration include the arbitrator's fees, attorneys fees, court reporter's fees, and other expenses incurred in connection with the arbitration. These costs will be paid by the losing party to all the prevailing parties. Additionally, the losing party may be forced to pay any additional interest charged by the lender resulting from a delay in repayment of the loan.

K. Miscellaneous Provisions. Common miscellaneous provisions in interparty agreements include the following:

1. First Negotiation. Many licensees will require the right of first negotiation for the purchase of rights in the film in the event delivery is not made. Thus, if the guarantor abandons the production, the licensee will have the right to negotiate first with the lender or guarantor (whichever party has the prior valid security interest) for the distribution and other exploitations rights.

2. Budget Overruns. This provision provides that the producer must pay for any budget overruns with funds available to the production company, and that the guarantor is not obligated to pay such expenses unless and until the producer is unable to do so.

3. Notices and Other Communications. The interparty agreement specifies what methods of communication are acceptable (facsimile, telex, personal delivery, etc.), and to what addresses and phone number such communications should be directed.

4. Choice-of-Law/Jurisdiction/Venue/Forum. The interparty agreement provides which state's (or country's) law is to apply to the agreement. Additionally, it may state that all parties irrevocably submit to the jurisdiction of the particular state or country, and that all parties waive objections to venue and claims of inconvenient forum.

XVII. LETTERS OF CREDIT

As stated above, LCs are the third form of legal paper used to facilitate discountable-contract finance. These unique instruments are neither contracts nor negotiable paper; thus principles of contract construction and interpretation and other law that apply to contracts are not applicable to LC arrangements. And as LCs are not negotiable paper, Article Three of the Uniform Commercial Code is not applicable. However, there are two bodies of rules that do apply to LCs--UCC Article Five and the Uniform Commercial Practices Code[198] (the "UCP").

Section 5-103(1)(a) of the UCC defines a letter of credit as "an engagement by a bank or other person made at the request of a customer and of a kind within the scope of this Article (Section 5-102) that the issuer will honor drafts or other demands for payment upon compliance with the conditions specified in the credit."[199] LCs are usually issued by banks on behalf of a customer (here, a licensee), who has an account or other relationship with the bank, and the LC runs in favor of some third party (the lender--see Diagram One, Stage One infra). LCs contain the bank's independent and (usually) irrevocable[200] obligation to make payment to the third party (or beneficiary) upon the occurrence of certain events. In the case of the commercial LC in a negative-pickup or presale transaction, the underlying event that triggers[201] the payment is the delivery of the film to the particular licensee, the customer of the bank that issued the credit. In the standby LC situation, the triggering event is the failure of the licensee-customer to make payment of the minimum guaranty to the beneficiary of the credit, the (production loan) lender. The two LCs are discussed separately.

A. Commercial Letters of Credit. The commercial LC is also known as the documentary LC, or the direct-draw LC, and is governed by the UCC[202] and the rules of the Uniform Customs and Practices for Documentary Credits where applicable.[203] The commercial LC identifies the beneficiary and states that the beneficiary is authorized to draw on the issuing bank[204] in an amount not to exceed a specified sum. The LC states that the funds will be made available for a specified period of time upon presentation of the beneficiary's drafts at sight (or sight drafts), accompanied by certain other documentation. A sight draft is simply an order by the beneficiary directing the customer's bank to make payment under the credit.

The accompanying documentation required under the LC varies with the bank issuing the credit. In the simplest cases, the LC merely requires the beneficiary of the credit to submit the completed drawing certificate that is attached to the LC upon the lender's receipt. The drawing certificate may be a statement, signed by the lender and producer, that the film has been completed and is available for delivery in accordance with all requirements. In some cases, the completion certificate discussed in connection with the interparty agreement[205] is the necessary drawing documentation. A more sophisticated form of commercial LC transaction in the discountable-contract context involves the use of a separate contract, the laboratory pledgeholder agreement.

As explained above,[206] the laboratory pledgeholder agreement is an agreement among the lender, the guarantor, the producer, the film laboratory, and--where it is used in conjunction with LCs--one or more of the licensees. In addition to making provision for perfection of the security interest in the film materials, and stipulating the parties' respective rights to obtain access to the negative, the laboratory pledgeholder agreement may be used to effect delivery of the film materials, and to effect payment of the LC. In this regard the agreement sets out the laboratory's obligations with respect to delivery of the film, referring to a list of items constituting mandatory delivery.[207] The laboratory pledgeholder agreement instructs the laboratory that it must, once all the materials are complete, prepare and forward two crucial documents, one to the lender and one to the licensee.

The first document, the laboratory access letter,[208] is sent to the licensee. The lab access letter states that all materials required for mandatory delivery are available for the licensee to take into its possession (see Diagram One, Stage Two infra). The lab sends to the lender what is sometimes called a laboratory letter, which states that the lab has made available all materials to the licensee. This letter is crucial to the lender because it is the required drawing documentation under the terms of the LC. The licensee's bank (or the confirming or advising bank[209]) then pays the credit upon the lender's presentation of the lab letter accompanied by the necessary sight draft (see Diagram, Stage Three infra). After payment of the credit, the licensee reimburses the issuing bank for the payment of the credit and pays a fee for the transaction.[210]

Regardless of the particular drawing documentation required, the commercial LC functions as the minimum-guaranty payment conduit between the licensee's bank and the production-loan lender. Use of the commercial LC assures the lender that the licensee's bank is independently obligated to honor the bank's draft on the credit provided the lender presents the documentation specified under the LC.[211] Further, where the laboratory access/lab letter mechanism is used, the licensee is assured that the film materials are available prior to or simultaneous with the payment of the credit. In contrast to the payment-vehicle nature of the commercial LC is the surety/guaranty aspect of the standby LC, the other common LC used in discountable contract financing.

DIAGRAM ONE

Stage One

Licensee ────────────── Licensee's Bank ────────────Lender

causes bank to issue letter of credit

Stage Two

Producer completes

film at

Licensee Laboratory

lab delivers laboratory access letter

upon producer's completion of film

in accordance with specifications in

laboratory pledgeholder agreement;

allows distributor-licensee access

to completed film lab issues lab letter

simultaneously with

laboratory access letter; Lender

Stage Three

lender presents lab letter and sight draft,

and licensee's bank pays the credit

Licensee's Bank Lender

funds

│ licensee

│ reimburses

│ bank upon

│ payment of credit

Licensee

B. Standby Letters of Credit. In the discountable-contract film-finance context the standby letter of credit, or guaranty letter of credit, issued by a licensee's bank (see Diagram Two, Stage One infra), contains the bank's promise to pay the minimum guaranty in the event the licensee does not. Essentially, the standby credit functions as a surety agreement or guaranty since it embodies the bank's independent obligation to make payment on behalf of the borrower if, as, and when necessary.[212] Standby LCs are subject to Article Five of the UCC and to the UCP.[213] As opposed to the commercial LC, where payment under the LC is anticipated in any event, payment under the standby LC is not contemplated unless the licensee fails to pay the minimum guaranty.

Like the commercial LC, the standby LC identifies the beneficiary and the issuing, confirming, and/or advising banks,[214] and states the amount of the credit, and the time period for presentment. And like the commercial LC, the standby LC states the necessary documentation for drafting on the credit. In addition to a sight draft, the standby LC may require an additional document, or drawing certificate, which states that the licensee-customer has failed to pay an outstanding indebtedness to the beneficiary-lender. After honoring the credit, the licensee reimburses the issuing bank.[215] It is important to note that the issuer's obligation to honor the drafts on the credit is conditioned only upon delivery of the specified certificate and sight draft (see Diagram Two, Stage Two infra), and not upon resort to the facts surrounding the underlying loan transaction.[216]

DIAGRAM TWO

Stage One

Licensee----------------- Licensee's Bank ──────────────Lender

causes bank to issue standby LC

standby LC

Stage Two

[Licensee fails to pay.]

Licensee's certificate and sight draft

Bank ═════════════════════════════════ Lender

bank pays lender the amount of the credit

│

│ licensee reimburses

│ bank

│

Licensee

XVIII. CONCLUSION

In addition to providing for the terms of commercial exploitation and compensation of motion pictures, negative-pickup and presale contracts facilitate a unique form of production financing. In order to ensure the satisfactory production of the picture, the negative-pickup and/or presale agreements must designate the defining characteristics of the finished product in terms of substantive elements, such as principal talent, screenplay, etc., and in terms of the physical materials. In some cases the licensee may obtain certain rights to oversee or dictate the course of the production, including the right to approve various elements of the picture and other rights relating to the physical production of the film. The (eventual) other parties to the transaction advise and recommend this element of control (to the extent that it does not interfere with their own controls), while the producer typically resists these accessions.

Since the lender is the party that must eliminate or attenuate the risks of the producer's default on the loan, and simultaneously make the transaction profitable, viewing the transaction from the lender's perspective provides a valuable vantage point for understanding these transactions. Initially the lender must determine whether the total of the guaranteed sums of money under the licensing contracts will be sufficient to pay interest and fees, in addition to the costs of production. With regard to the latter, the lender requires the assistance of a party that specializes in knowing the costs of production and in assuring timely, on-cost production of movies, the completion guarantor. Beyond the talents of estimation and oversight, the guarantor must also protect itself against the potentialities of contractual default and other disasters relating to the production.

The lender and the guarantor both must safeguard their interests by ensuring that if they do not ultimately receive the benefit-of-the-bargain, then they (at least) do not suffer a devastating loss. To that end, both lender and guarantor effect the dual devices of assignment and security. The responsibility of counsel for both lender and guarantor with respect to attachment and perfection of the security interest and creation of an effective assignment is therefor a shared task, although each must account for differences of priority and clearly define the extent of the assignment. In addition to the above, the parties must attend to the necessities and potential consequences of the guarantor's (and perhaps, the licensee's) right to take control of the production, ousting key personnel and taking other extreme (and rare) actions. Finally, the parties must determine the legal ramifications of the cluster of contracts entered into by the parties, and deal with them in a separate and supreme contract, the interparty agreement.

This distinctive form of film finance is, as the reader should now recognize, documentation-intensive even where only one licensee and one lender are involved. Where there are five- or ten-licensees and two- or three-lenders, as is sometimes the case, the volume of paper increases dramatically. Further, the difficulties of negotiation are compounded, as counsel for the various parties (who sometimes have little or no experience with the transaction system) become aware of the functioning of the finance design. Issues such as priority of security interests, mandatory delivery, approvals, guarantor's exclusions, insurance, takeover, and assignment often bog down negotiations. Essentially, the lender and guarantor seek to eliminate all risks relating to repayment of the loan and timely, on-budget delivery of the picture. The licensees, as the "buyers" of the producer's product, sometimes resist these maneuvers either because their counsel perceives this to be their role, or because the licensees wish to reserve some flexibility with regard to their payment obligations. In between these parties is the producer, who often is concerned with little more than securing the production funds. Regardless of the relative merits of discountable-contract finance, it remains a viable means of obtaining production funds, as well as a heavily contractual and negotiation-infused form of financing independent-features.

---

[1] See subpart I.C.1. infra regarding the definition of independent producer.

[2] See Lancer, Bank Financing of Independent Theatrical Film Productions, in 1984 Entertainment, Publishing and the Arts Handbook 71, (M. Meyer & J. Viera ed. 1984).

[3] See Hoffman, A Practical Guide to Transactional Project Finance: Basic Concepts, Risk Identification, and Contractual Considerations, 45 Bus. Law. 181 (1987). While the subject of Hoffman's article is a particular financing method for the construction of industrial, civil and commercial facilities, much of its observations and analysis are valid in the film finance context. Hoffman defines project finance as "the arrangement of debt, equity, and credit enhancement for the construction or refinancing of a particular facility in a capital-intensive industry, in which lenders base credit appraisals on the projected revenues from the operation of the facility, rather than on the general assets or the corporate credit of the promoter of the facility, and in which they rely on the assets of the facility, including the revenue-producing contracts and cash-flow, as collateral for the debt." Id. at 181 n.1.

[4] The term licensee in the film distribution context refers to any one of the numerous parties that acquire one or more of the commercial exploitation rights arising from and incidental to feature films.

[5] The calculations of necessary weekly funds are usually made by the unit production manager, sometimes with the help of production personnel employed by the guarantor, and are reviewed and approved by the lender and by the guarantor's legal personnel.

[6] Under negative pickup deals, the producer is usually accorded a share of net profits. In homevideo presales the producer usually receives a royalty. Foreign presales sometimes provide a share of profits to the producer. Television presales, however, do not provide such compensation due to the nature of the medium. Other types of presales vary greatly in their means of compensating the producer.

[7] See J.Cones, Film Finance & Distribution, p.6, 1992.

[8] Most broadly used, negative pickup means the licensing of theatrical-distribution rights (and usually other rights) in a feature film by a producer to a theatrical distributor. (See, e.g., J.Kenoff & R.Rosenberg, Entertainment Industry Contracts, ¶27.O1, (D.Farber 1991)). Professor Lon Sobel adopts a similar definition, defining the term as "a deal in which a distributor acquires the right to distribute a completed motion picture that has been fully financed by someone other than the distributor itself." Sobel, Introduction, 12 Loy. L.A. Ent. L.J. xi, xiii (1991). Under these definitions, a distribution agreement that is entered into after completion of the film and that does not provide for payment to the producer upon delivery could be called a negative-pickup. Industry commentator and author John Cones suggests that such an agreement is more accurately characterized as an acquisition/distribution agreement, and prefers to restrict the term negative-pickup to distribution agreements that are executed prior to completion of the film and that promise payment when the film is delivered to the distributor. Mr. Cones states that the more narrow definition is more in-line with current usage of the term among industry professionals. J.Cones,, supra note 7, at 322.

Both Mr. Farber and Professor Sobel acknowledge that negative-pickups are now often executed prior to completion and used as financing vehicles. Confusingly, however, Mr. Farber states that this is the traditional meaning of the term ("a sale made prior to completion of a picture as a means to obtain financing"), J.Kenoff & R.Rosenberg, supra, while Professor Sobel (citing Robert A, Geary, VP, Business Affairs at Orion Pictures) remarks that negative-pickup deals traditionally involved completed pictures (and thus were not used to finance pictures). Sobel, 5 Ent.L.Rep. 12, May, 1984, p.4. One may conclude by these contradictory statements by two of the industry's distinguished experts that common usage of this term has varied, and continues to vary widely among industry personnel. The reader will note the same lack of uniformity with respect to the term presale.

Another term that relates to negative-pickup contracts (and presales) is distribution guaranty. The term is used variously to refer to negative-pickup contracts, presale contracts, and other contracts not used for production financing that contain a promise to pay a sum of money for distribution rights and/or a promise to distribute a film.

[9]  Although the author will sometimes refer to these discountable contracts as "collateral," it is important to note that these agreements are usually deemed the primary source of repayment, and thus are not collateral in the more common meaning of the word. See Part III and subpart IV.D. infra regarding assignment of the contractual rights to payment under the licensing contracts.

[10] E.g., see Arnold Kopelson, One Producer's Inside View of Foreign and Domestic Pre-Sales in the Independent Financing of Motion Pictures, 12 Loy. L.A. Ent. L.J. 1, 4 (1991). Mr. Kopelson classifies negative-pickup financing as a form of "studio-financing," and not "independent financing." Thus, Mr. Kopelson refers to all non-studio minimum guaranty contracts as presales. Other industry scholars state that negative pickup often is used to mean a minimum guaranty contract that licenses rights in all media worldwide or all media in the U.S. See, e.g. Sobel, Introduction, 12 Loy. L.A. Ent. L.J. xi, xiii (1991).

[11] The UCC is a model act that contains an integrated body of law that prescribes a system of rules surrounding the use of, among other things, letters of credits. See Uniform Commercial Code, Art. 5 (1972). The UCP is another set of rules, regulating the use of commercial letters of credit, and is incorporated by express language into many letters of credit. Uniform Customs and Practices for Documentary Credits (1974), International Chamber of Commerce Publication No.290. See part VIII infra.

[12] The major studio-distributors are: Disney; MGM; Orion; Paramount; Sony Pictures; Tri-Star; Twentieth-Century Fox; Universal; and Warner Bros. Studio sources state that approximately one-third of all major-studio released pictures are financed via negative-pickups.

[13] Among the former are the Samuel Goldwyn Company, Miramax, New Line Cinema, and Trimark. The latter include Carolco, Castle Rock, Largo, and Morgan Creek.

[14] Examples include The Movie Group, ITC, Sovereign Pictures, and the Samuel Goldwyn Company.

[15] Examples of such foreign international-distributors include: Alliance (Canada); Canal Plus and UGC (France); Village Roadshow (Australia); RCS (Italy); and Rank and BBC Channel 4 (U.K.).

[16] Foreign sales agents' contracts do not license the agent to exploit rights in the film but merely authorize the agent to negotiate the licensing contract on behalf of the licensor.

[17] Some of the studio homevideo-distributors have entered into multipicture deals with independent production companies for pictures to be sold into the direct-to-video market. It is of course, possible, if not likely, that some of the individual films produced pursuant to these deals are financed via discountable contracts.

[18] Cable companies involved in discountable-contract financing include: Home Box Office; Showtime Pictures; The Family Channel; Lifetime; and Turner Network Television.

[19] By market share (and designating Canada part of the "domestic" territory) the eight-major territories are: Japan; France; Germany; Britain/Ireland; Spain; Italy; Australia; and Sweden.

[20] See Part I.D. infra.

[21] In addition to the above listed rights in feature films are nontheatrical rights. These rights include distribution: on airlines and ships; at educational and military institutions; at social, charitable, & community service organizations; and at military installations. Due to the relatively low value of these rights, instances of nontheatrical presales are rare.

[22] Banks (in Los Angeles) involved in discountable-contract finance include: Bank of America, Bank of California, Daiwa Bank, City National Bank, Fuji Bank, Imperial Bank, Mercantile Bank, and World Trade Bank. An example of a non-bank lender is the Lewis Horwitz Organization.

[23] The four largest guarantors are: the Completion Bond Company; Film Finances, Inc.; International Film Guarantors; and the Motion Picture Bond Company.

[24] Above the line personnel include the key creative personnel, such as the writer, director, producer, and cast. The "line" to which the phrase refers separates the so-called creative personnel from the technical personnel in the budget. In addition to the above listed elements, the producer may also include in the package: narrative biographies (including production credits of the producer(s), director, director of photography, cast members, and other key creative personnel); a screenplay synopsis; location information; rights clearance documentation; press clippings related to those involved in the project; and any documentation relating to existing licensing agreements of rights in the film.

[25] See Hodel & Nix, Avoiding Traps in the Letter of Intent, California Lawyer, July 1991, p.54.

[26] "GAAP" is the acronym for "generally accepted accounting principles," a legal and accounting term denominating a body of rules and principles that are widely used and accepted by accountants. Curiously, while the producer's records must be kept in accordance with GAAP, licensees generally are not subject to the same restriction.

[27] See subparts VI.B.13. and VIII.A. infra regarding laboratory access letters.

[28] A legal term of art. The terminology means that failure to comply with certain specified terms (here, delivery) justifies the licensee's termination of the agreement and relieves it of any obligations to the producer, including the obligation to make payment to the lender. The inclusion of a force majeure clause should be used to counter the potentially inequitable consequences of the time-of-the-essence clause. Force majeure clauses are clauses "intended to excuse a party from performance of its obligations in the event that such performance is prevented by forces outside the control of such party." J. Cones, supra note 7, at 202. Typical events of force majeure include acts of God, labor disturbances, and acts of war or civil disturbance. Cf. subpart VI.A.4. infra regarding exclusions under the completion guaranty.

[29] A. Corbin, Corbin on Contracts § 628 (1960).

[30] Briefly, the distributor must ensure that it does not release a film that infringes another's copyright or otherwise violates one's rights relating to trademark, service mark, or unfair competition law. See subpart II.E. regarding chain of title infra.

[31] See note 129 infra.

[32] See subpart II.A. supra.

[33] Rights to commercially exploit a literary or artistic property may be variously termed "licensed," "assigned," or "granted." The distinction between a license and an assignment has become relatively insignificant with the near abolition of the doctrine of indivisibility. See M.Nimmer & D.Nimmer, Nimmer on Copyright, § 10.01, 1992. The term "grant" is a term of broad meaning, which encompasses both "license" and "assign," as well as "transfer," "gift" and other related terms.

[34] See, e.g., Sills & Axelrod, Profit Participation in the Motion Picture Industry, Los Angeles Lawyer, April 1989; and Nochimson & Brachman, Contingent Compensation for Theatrical Motion Pictures, Entertainment Law Reporter, Vol.X, Number X, [need cite] p.3. See also P.O'Donnell & D.McDougall, Fatal Subtraction, 1992; and Dekom, The Net Effect: Making Net Profit Mean Something, American Premiere, p.6, May-June, 1992.

[35] Net profits are usually defined as those sums of money, if any, that remain after the deduction by the distributor of the following: distribution fees; distribution expenses, including prints and related materials, advertising, taxes and duties, trade association dues and assessments, freight, checking and collection, residual payments, and miscellaneous others; production costs ("negative cost"); interest on unrecouped negative cost; and gross participations and deferments. Sills & Axelrod, supra note 34, at x.

[36] See subpart II.B. supra.

[37] See J.Cones, supra note 7, at 82.

[38] Restatement of Contracts (Second) § 317(1) (1984).

[39] The guarantor will