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Contract Basics

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Money In, Money Out and Control

Many transactions in the film industry do not fit within any standard paradigm. At the extreme, transactions can involve contributions of property, services or money by a number of entities in different countries, all of which may end up owning various rights to recoupment, distribution rights and profits in one or more underlying films. No matter how complex (or how simple) a transaction may be, it may always be understood if it is broken down into the three basic elements: Money in, money out and control. Whenever I hear a highfalutin film financing transaction that I do not understand, I always ask for an explanation in terms of these three basic elements:

• Money In: Who is contributing money? What triggers the contribution? When do they contribute it? How much are they obligated to contribute? What if you need more? What is the legal mechanism for enforcing the contribution?

• Money Out: What is the order and priority for distributions of money? Is anyone getting compensation? Are there tax distributions? Is there interest on capital contributions? Are capital contributions returned first? How are profits divided? Are the sources of distributions different for different parties?

• Control: Who has control? Is it joint, so any party can lock-up the others? Is it allocated (e.g., party A has creative control and party B has financial control)? Does one party have veto rights? Can control rights be transferred to a third party?

By asking these simple questions, you can have a basic understanding of any transaction.

Keep It Simple!

If you are doing the structuring, keep it simple! You will have more than enough chaos without heaping it on yourself by starting off with an inordinately complex structure. The analogy is building the foundation of a tall building -- cracks and fissures in the foundation will result in the entire edifice falling of its own weight. A well thought-out, solid, logical structure is far more important than the wording of the documents. Also, always remember the immutable law of quantum legal physics:

T = L2

Which means that the Time it takes to close a transaction equals the number of Lawyers squared. Note that the relationship is logarithmic, not linear. This alone is adequate reason to keep the structure as simple as possible. Recently, a client decided to produce a film as a multi-country co-production in Europe on the theory that it would save money. So many lawyers were telling the client to do so many contradictory things that the film went vastly over-budget and ended up being taken over by the completion bond company. Not that these things never work, but forewarned is forearmed.

Drafting

The informality with which contracts are concluded in the film industry is staggering. Napkin deals do occur, and perhaps the majority of agreements are signed after the transaction is over, if at all. This informality is disastrous, and spawns the endless litigation for which the film industry is infamous.

The height of informality is the oral agreement, which should simply be thought of as an unenforceable moral promise, if that. Sadly, I have had many clients act in reliance on oral agreements, including commencing production, making pay-or-play commitments, and issuing press releases. Don't do it! It ain't over 'til it's over, and it ain't over until a binding contract is signed.

One plague in the industry is the propensity to use "letters of intent," "term sheets," and "deal memos" (collectively referred to below as "deal memos"), instead of long-form binding contracts. This tendency is caused by the fast pace of the industry and the impossibility of closing the ponderous tomes that are used for the long-form contracts. However, most deal memos are rife with a number of fatal flaws, including the following:

• They are often ambiguous on the key issue of whether they are legally binding, which is inexcusable. At a minimum, they should clearly state whether they are intended to create legal obligations on the parties or are merely expressions of non-binding intent.

• They are invariably sloppy and ill-thought-out, because the drafters have the excuse that the "other issues" will be dealt with in the long-form contract. The problem is that the long-form contract rarely follows. The majority of the time, it is not even drafted -- people simply rely on the deal memo and go on with their business.

• Quite often, the deal memo purports to incorporate one party's "standard terms and conditions" or, just as bad, incorporates "customary terms and conditions in the industry." In either case, the parties always argue about just what was intended by this ambiguous reference, as there are many gradations of "standard terms" and "customary terms."

Because of all of the foregoing problems, deal memos often end up in litigation, so they should be avoided at all costs unless absolutely necessary.

As alluded to above, the reason that people opt for deal memos is because long-form contracts can run fifty or more pages and include such absurdities as defining the words "and" and "or." In addition, long-form contracts often incorporate pages upon pages of boilerplate that merely restate the default rules that would be implied by law even in the absence of such language.

The solution to both ambiguous deal memos and ponderous long-form contracts is to draft contracts that are short, concise, and final, which forces the drafter to think carefully about each word. The goal should be to give each contract the beauty and brevity of the equation, E=MC2. Also, contracts are a whole lot easier to follow if they contain a table of contents and an alphabetical list of defined terms up front. It is inexcusable to force the reader to slog through the entire contract looking for the definition of every capitalized word they come across. Another suggestion is to drop all the long-winded recitals of facts, which don't amount to a hill of beans -- every word in a contract should have legal significance.

The most important aspect of any contract is for your team to control the drafting, even if it costs more legal fees, because the battle can be won or lost at this stage. People usually negotiate off of what is in front of them, as opposed to what is not. They typically do not think about what is not in the draft. Also, by controlling the revision process, you control the wording of the resolution of each open issue, and ultimately you wear down the enemy.

And never accept that old saw: "This is our standard form contract; it can't be changed." The studios will always tell you this, particularly with respect to their lengthy exhibits defining net profits. (The best quip I've heard on these exhibits is from a producer who said that the top of each page should be labeled, "And here is another reason why you won't receive net profits"). Licensors, too, are fond of giving licensees a form license prepared by the International Film and Television Alliance, and these licenses are grossly one-sided and unfair. Always attempt to be anointed as the drafter of every contract, but failing that, never accept a "standard form" contract at face -- everything is negotiable.