C. Foy, Esq :: Investor's Resource Center [Negative Pickup and Presale Article]

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]