02/08/2013 01:05 pm ET

Napoleon Dynamited on Its Own Petard

The recent case of Napoleon Pictures Limited v. Fox Searchlight Pictures, Inc., decided by the Los Angeles Superior Court, is instructive on what film participants should not do on a number of levels if they ever expect to be paid by a studio.

The case dealt with the surprise box office hit, Napoleon Dynamite, which was the sweetheart of the Sundance Film Festival in 2004. The producers engaged John Sloss to sell the film for them, and he sold it to Fox Searchlight ("Searchlight"). When the film ended up being a sleeper hit, the participants felt that they were badly shortchanged, and they sued Searchlight for what they thought they were owed. Unfortunately for them, the court ruled against them on all the significant claims, awarding them only a few bucks that barely covered their gas to and from court. So here is a litany of what went wrong for the producers:

The first mistake was that they entered into an oral agreement to sell it to Searchlight based on only a few terms and a handshake, thus taking the film off the market before the rest of the key terms were locked down in writing. If there is any surefire way to get into trouble, it is to start with an oral agreement.

The next mistake was to memorialize the agreement in a Term Sheet, the darling of Hollywood. For reasons that escape me, parties in Hollywood are willing to bet the farm on half-baked ambiguous documents that are called term sheets, deal memos, or letters of intent, all of which cover only a few issues and are silent on many critical issues. This Term Sheet had the classic mistake of stating that a long-form agreement would follow (miraculously, it actually did in this case), and that the "other terms shall be in accordance with Searchlight's standard agreements of this type subject to good faith negotiations within Searchlight's standard agreements of this type." Thus, the producers had effectively agreed to whatever Searchlight's "standard agreements" said without having read them.

Next, the producers entered into Searchlight's standard voluminous long-form documents, consisting of the main agreement, an attachment of Standard Terms and Conditions, and -- count them -- 19 further exhibits and schedules. The totality was mind-boggling, and the key exhibit, which defined Net Proceeds, was itself 50 pages long. Indeed, it was so long that it had to be mailed, not faxed, and it was apparently so long that the lawyer negotiating the deal didn't bother to read it and later couldn't even find it in his files. But the producers were held to be bound by it. As is usual with such long-winded documents, there were capitalized words that did not match the wording of the supposed definitions, and there were incorrect internal cross references. A much better approach would have been to use a shorter, concise contract, and best of all if it were drafted by the producers to make sure that it reflected their understanding.

Next, the producers bought into the standard approach of accepting the studio's calculation of net profits. As I heard one producer quip, the studios should type at the top of each page of the fifty page exhibit, "And here is another reason you won't receive net profits." The approach is so complex and so fraught with ambiguities and opportunities for misunderstanding that it is a miracle when anything is paid. And worst of all, it almost always requires an audit to ferret out what is owed, and this case was no different on that score: The auditor sent an audit notice in July 2006 but was told that the audit queue was backed up, so they weren't allowed to audit until August 2008, and they didn't finish until October 2010 -- four years later! There is an alternative to this madness, but that is a topic for another blog.

Next, the case was decided by judicial reference by a retired judge, not by a jury. Juries are sympathetic to independent "little guy" producers -- judges, not so much. The case might well have been a happy day for the producers if they got in front of a jury. The choice to use judicial reference appears to have been voluntarily chosen by the producers after the action was filed and is somewhat puzzling.

And finally, the heart of the case: The producers had agreed to a royalty rate of only 10 percent on DVD sell-through (in contrast to a higher rate on rentals), and when sell-through exploded and swamped the rental market, the producers were left holding an empty bag. But in fact that is what Searchlight's standard documents said, and they were incorporated into the Term Sheet and attached as part of the final long-form agreement. The producers hoped to overcome this detail by alleging that Searchlight's representative had represented to John Sloss that the 10 percent rate would only apply to a de minimis number of sales and not to worry, since the impact would not be material. But the court held that the contract said what the contract said, and that everyone was bound by it. Heck, even in Hollywood the parties can't change the written script.