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A Better Way to Pay Hollywood

Illustration: Neil Webb
Illustration: Neil Webb

Switching to a formula based on box-office gross would end lawsuits and lure investors back to movies.

The investors in a slate of Paramount movies, including Transformers and Mission: Impossible III, who sued the studio Nov. 30 are only the latest to complain about "Hollywood accounting." I am not taking sides in the dispute, but like the hundreds of lawsuits brought by actors, filmmakers and financiers through the years, the case filed by the Melrose 2 investors shows how badly the industry needs to change the system for paying profit participants.

Nearly all Hollywood dealmakers agree that the contractual language that dictates how participants are paid has gotten out of hand. Contracts were once simple and straightforward, but thanks to overaggressive lawyers and accountants, profit definitions can now stretch more than 100 pages, requiring months of negotiations and leading to litigation over how much money actually is owed. Rightly or wrongly, studios are losing the recent cases that go to court. And widespread distrust of studio bean counters has contributed to the retreat of investors from Holly-wood and escalating demands by talent for higher upfront pay because they're skeptical of getting anything on the backend.

The silliness of it all is that there is a perfectly logical alternative that is fair to both sides of the equation: tying participations directly or indirectly to U.S. box-office numbers as reported by Rentrak. To some extent, this is already happening in the form of box-office bonuses for talent; what I am proposing is expanding the concept to embrace all financing and talent participations.

I am not suggesting box office should be the endpoint, but it should be the starting point. If a star negotiates a 5 percent stake in a movie that has a box-office gross of $100 million, he or she gets $5 million -- simple. This formula could be supplemented by adjustments based on (a) the average ratio of DVD revenue to box-office gross at the time of payment, (b) the ratio of foreign revenue to U.S. revenue at the time of payment, (c) a preset distribution fee (calculated as a percentage of box office), (d) a preset distribution expense (as a percentage of box office) or (e) a preset production cost. But when I say "preset," I mean that in no event can any of the calculations be based on actual revenue or expenditures because that would drag us back to the current lunacy of endless negotiations, audits and litigation.

Assume a studio intends to produce a $100 million film but wants to limit its risk to $50 million. It raises $50 million of equity from an investor and agrees to fork over 50 percent of box office. If the film flops at the box office with only $10 million, the studio pays the investor $5 million, keeps the $45 million balance of the outside investment and is happy. If the film gets to $100 million at the box office, the studio gives the investor a break-even payment of $50 million, and the studio is happy because it will keep worldwide rights and profits from a successful film. If the film scores big with $200 million in box office, the studio will pay the investor $100 million, and the studio is still happy because it accepted that possibility as a trade-off for reducing its risk.

Contrast that approach with the Melrose 2 lawsuit against Paramount, the culmination of months of negotiations over hundreds of pages of arcane accounting concepts followed by years of audit disputes.

My approach creates a transparent system that allows actors and filmmakers to know their worth and investors to know the value of their investments just by opening the trades, rather than waiting for months only to receive accounting statements they don't understand. This approach eliminates the perceived opaqueness (right or wrong) of Hollywood accounting and leaves a spotlight on the thrill of "owning a piece" of a film. Private-equity funds would come back to Hollywood, talent negotiations would be easier and everyone would benefit because the more the studios can hedge risks, the more they can spend on a film and the more films they can make.

Schuyler M. Moore is a lawyer at Stroock and the author of The Biz, Taxation of the Entertainment Industry and What They Don't Teach You In Law School. He can be reached at smoore@stroock.com.

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HOW IT WOULD WORK: Here is a more sophisticated example of converting a net-profit interest to a box-office calculation, if an actor or other profit participant's contract provides as follows:

  • Share of net profits: 5%
  • Cost of film: $30 million
  • Distribution fee: 35% of gross revenue
  • Distribution expense percentage: 40% of gross revenue
  • Gross revenue to studio: 3x U.S. box office  

Based on these assumptions, if a movie has U.S. box office of $100 million, the studio would be deemed to receive gross revenue worldwide from all media of $300 million (equal to 3x U.S. box office). The calculation of net profits would thus be as follows:

  • $300 million: Deemed gross revenue
  • — $30 million: Cost of film
  • — $105 million: Distribution fee (35% of $300 million)
  • — $120 million: Distribution expense (40% of $300 million)
  • $45 million: Net profit

The participant would thus be entitled to a net-profit payment of $2.25 million (5% of $45 million).