Netflix Battles Judge's Suspicions of "Bad Faith" Streaming Plan

A hearing in bankruptcy court examined whether Netflix has cause to put Relativity's "Masterminds" and "The Disappointments Room" on its service next month.
'Masterminds'

Is Netflix purposely trying to get out of a nine-figure licensing deal with Relativity Media by demanding the right to stream as early as possible Masterminds, a comedy starring Zach Galifianakis, and The Disappointments Room, a horror film that features Kate Beckinsale? Or is the streaming giant merely attempting to do everything it can to hang onto users at its most content-desperate hour? 

In a New York federal bankruptcy court, Netflix finds itself having its integrity challenged. After the judge who authorized Relativity's Chapter 11 exit voiced his concern about Netflix's plan to stream these two pics ahead of a theatrical release, the few people who managed to stick through tedious proceedings got an inside look at Netflix's dealmaking strategy from one of its top content gurus. No ruling has come yet, but over the last couple of days, the judge's authority has been questioned and secrets have been spilled.

Relativity and Netflix have been feuding for months. Under the terms of a deal that pays Relativity hefty sums, the studio has to deliver 12 films to Netflix each year. Netflix felt that Relativity couldn't deliver after Relativity declared Chapter 11 and it fought the assumption of the licensing agreement. The streaming giant was unsuccessful in getting out of the deal and also couldn't stop U.S. Bankruptcy Judge Michael Wiles from confirming Relativity's plan for reorganization. Then, Netflix switched its strategy, dropping an appeal and letting Relativity know it would be stream Masterminds and Disappointments Room in June. According to testimony today from Netflix vp content acquisition Robert Roy, he and Ted Sarandos made the decision in April to "follow the letter of the contract" and make no material changes — that is, unless Relativity was willing to terminate its lucrative agreement with Netflix. 

The prospect of Netflix streaming Masterminds and Disappointments Room next month terrified Relativity, since the movies aren't scheduled to be released until later this year. Relativity, which is projecting both films to earn about $200 million in lifetime revenue, brought a motion to compel Netflix into a "routine date extension," warning the judge of the "disastrous effect" of permitting Netflix to do this. According to Relativity, its successful reorganization is being threatened, and Netflix is ignoring the import of the judge's earlier findings as well as industry custom that requires Netflix to promptly enter into date extension amendments upon the request of its lenders. 

As far as Netflix is concerned, after making $3.7 minimum guarantee payments for each film, the contract clearly allows it to stream them at defined "start dates." But the latest dispute is more than a difference of opinion on contractual interpretation. Netflix argues that the bankruptcy judge doesn't even have jurisdiction to rule thanks to an arbitration provision in the contracts. And so, Neflix has been proceeding under protest.

On Thursday, at the beginning of the hearing, Wiles told Netflix that he wanted to know if this was a "real or made-up issue," saying he was skeptical how Netflix could have heard last February about Relativity's theatrical release plan and financial projections when the feasibility of the reorganization plan was being examined without raising its arguments then. "It is suggested to me that you are collaterally estopped from taking the position you are taking and bringing it in bad faith," said the judge to Netflix's attorneys. 

Relativity called two witnesses to the witness stand.

The first was Linda Benjamin, formerly a vice president in the business and legal affairs department at Relativity. Benjamin negotiated the deal with Netflix in 2010, and she proudly notes it was "groundbreaking." She and others regard the deal in such lofty ways because it represented the first time ever that Netflix got major motion pictures to stream in the pay-tv window. Afterwards, other distributors like Disney also licensed to Netflix, but back then, Netflix was largely still a DVD-by-mail company that no big studio was willing to risk with its prime content. Benjamin also talked about what was important to the parties when they made their deal — and how they arrived at specific provisions

Relativity also called upon Ronald Hohauser, who formerly worked at such companies as Summit Entertainment and Marvel Studios before becoming a financial consultant at Latus Advisors. After giving Relativity chief Ryan Kavanaugh credit for many of the financing ideas behind Marvel's evolution from licensor to production giant, he testified that the Netflix agreement is "fundamental" to Relativity's new strategy of revitalizing its film production business. That's not only because of the in-flowing money, but also because Relativity is able to use the promised payments as collateral to lenders.

Hohauser also spoke how the value of Masterminds and Disappointments Room would be "destroyed" if streamed before a theatrical release date.

"There are at least two instances where Netflix has streamed films simultaneous with box-office release," said Hohauser. "First was Beasts of No Nation. I checked on Box Office Mojo. … It generated $100,000 in the theater. ... The other was a sequel to Crouching Tiger, Hidden Dragon, which got a very limited theatrical release. It generated very limited revenue. In fact, Netflix declined to announce what it was. My industry sources says it generated $12,000.”

Over the course of the past two days, there have been plenty of revelations about how the Neflix-Relativity licensing agreement operates. For starters, getting Relativity to allow its films to be streamed in the pay-tv window was costly to Netflix back in 2010. That much is known, but what's not generally appreciated is how (according to testimony) Relativity once tried to do a bit of arbitrage by acquiring cheap third-party content for its output deal with Netflix. That didn't make Netflix very happy, so it paid Relativity $12.5 million to change definitions to ensure it was getting prime meat. At some point, it became contractually required that films being delivered by Relativity to Netflix be theatrically released. In fact, Netflix's licensing fees to Relativity are based on a percentage of box office. If Masterminds and Disappointments Room never come out in theaters, for instance, Netflix might be entitled to recoup the $7.4 million it paid to Relativity.

In Relativity's view, as partly expressed by Benjamin, Netflix wants to benefit from the marketing associated with a big release. Relativity's attorneys are seizing on these contract details, expressing the importance of a theatrical release as evidence that Netflix's latest positions amount to pretext for shadier goals.

But that's not it at all, insists Roy, who was called to the witness stand by Netflix. According to him, provisions that films be theatrically released really amount to just a quality-control measure and no more.

Roy testified that the value of having Masterminds and Disappointments Room right now is "high" for Netflix and that it doesn't matter if those films haven't been released in theaters just yet. He expressed confidence that Netflix users would find it thanks to the star actors involved and the service's algorithms that will present the movies to users who might like it. Plus, there's a timing issue.

"We have an immediate need," said Roy. "To wait is painful."

Explaining there is a gap between expired content from Epix and incoming films from Disney, he said Netflix wouldn't have a film like Masterminds for some time. (Netflix's non-original content is at the moment indeed light, as some have recognized, but it was notable to have a Netflix openly acknowledging this.)

On cross-examination, Roy also spoke about Beasts of No Nation (3 million streams, he said, and the theatrical release was more about awards), The Interview (the judge got to hear the story about how Netflix got the Kim Jong-Il assassination film the day it came out in theaters) and was asked whether there was ever a time when Netflix was given a major film ahead of its theatrical release.

Roy answered, "It hasn't happened, but the distribution landscape is changing."

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