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When consulting for the Directors Guild in 2006, I was asked to help formulate clauses that would establish objective standards for determining fair market value when a studio is licensing rights to affiliated or related entities. The clauses we came up with — known as the “three-pronged test” — were negotiated as a Side Letter to the DGA’s 2008 collective bargaining agreement with the Alliance of Motion Picture and Television Producers, and were adopted by both the Writers Guild and SAG. The clauses have survived in later guild negotiations through 2020.
The guts of it reads: “Employer’s gross received by the Employer [studio] from the licensing of [New Media or digital] rights shall be measured by the exhibitor/retailer’s [e.g., HBO Max, Peacock, Disney+] payments to unrelated or unaffiliated entities in arms’ length transactions from comparable pictures or, if none, then the amounts received by the Employer from unrelated and unaffiliated exhibitors/ retailers in arms’ length transactions from comparable pictures, or, if none, a comparable exhibitor/retailer’s payments to comparable unrelated and unaffiliated entities in arms’ length transactions for comparable pictures.”
On Dec. 3, WarnerMedia revealed plans to exhibit its slate of 2021 features simultaneously both in theatrical venues and on its affiliated streaming platform, HBO Max. Its announcement triggered hostile responses from the guilds and representatives of profit participants on those pictures. Focusing here on the guilds, there are two interrelated issues that need to be addressed.
First, what is the initial use for the 2021 Warner Bros. picture that is now heading to HBO Max? To answer that, we need to look at another clause in the Side Letter, because the definition of “Employer’s gross” applies only to “all reuses in New Media of motion pictures and television programs made for traditional media.” Since the picture was intended for initial theatrical release, the reuse would be the transaction between Warner Bros. (the producer/distributor) and its affiliate HBO Max (the exhibitor/retailer). Therefore, the studio would have to pay all the guilds and unions involved in the aggregate sum equal to 12.4 percent of the “license fee” payable by HBO Max under the Side Letter. But what is the appropriate “license fee” or fair market value under the three-pronged test?
The answer to that takes us immediately to the second issue. Let’s look first at the range of distribution plans for features. Traditional sequencing of distribution windows dictates a theatrical release first and exclusivity against uses in any other media for a period of time. The industry pattern for “how long” an exclusive pattern has changed over the years, primarily due to the emergence of technological discoveries permitting viewers legally to watch features outside the theatrical venue first via ’ linear over-the-air television in the Sixties, premium pay television in the Seventies, physical home video and ad supported cable in the Eighties and digital exploitation (VOD/EST/SVOD/AVOD) over the last thirty years.
Today, each major studio has or will choose its own exclusivity schedule. Paramount and Sony appear for now to be opportunistic “arms’ dealers,” exhibiting in the theatrical market when economically preferable, but licensing to SVOD (or PVOD) on an unaffiliated platform when not. Disney seems to follow a traditional sequencing for its tentpole or franchise features, but opportunistically otherwise, e.g., directly to Disney+, in theatres only for a month and then PVOD, etc. (Disney is unique among major studios in not having a premium pay output deal.) Universal has moved to theatrical exclusivity for three or five weekends (performance dependent) followed by premium video on demand (“PVOD”).
WarnerMedia has prospectively carved out (for its 2021 slate only) simultaneous usage (theatrical and SVOD) for 31 days, and continuing theatrical exhibition thereafter (theaters permitting). It has offered the guilds (and, more favorably, profit participants) an imputed license fee (“ILF”) on the HBO Max license, which the guilds (and participants’ representatives) have rejected as nonconforming to the Side Letter because any picture made for the theatrical market automatically triggers a reuse payment when it is exhibited elsewhere under all collective bargaining agreements.
Warner Media claims its ILF will give the Guilds and unions millions of incremental residual dollars, in excess of what it has paid in prior years on comparable pictures. The Guilds point out that the proposed domestic ILF is transfer pricing, based on a bastardized version of what constitutes a “comparable picture” because Warner has eliminated the exclusive domestic theatrical release. Further, Warner has not given the Guilds the empirical basis on which the ILF was arrived upon in order to meet the three pronged test and has retreated from its commitment to the DGA to deal as if third party pricing was present. Back up for just a minute. In any scenario in which there is no affiliated transaction (as commonly practiced by the other major studios), there shouldn’t be a valuation issue because the studio in question will have the same motivation and goals — to maximize net revenues on as limited a media, licensed term or territory as is feasible — as the guilds (or participants, for that matter).
So here’s my proposed solution — not by any means the only one. The guilds should have a seat at the table whenever a picture is going to be licensed to any affiliated entity. Whether prior to photography or after the picture has been screened/delivered, the studio must make disclosure and discuss valuation and/or alternatives with the guilds before licensing to an affiliate or related party. I’m reasonably confident that there will be “comparable pictures” available for analysis and a marketplace solution will result. In the absence of conferring and revealing data as I suggest, the end result could be dozens of guild arbitrations, not desired by anyone.
A more challenging scenario will likely arise in the not too distant future in dealing with downstream distribution in addition to or in lieu of the current distribution sequence. This would occur when a studio wants to substitute its affiliated SVOD service for the physical or transactional home video marketplace, or as opposed to a premium pay or ad supported (aka “free”) TV outlet. We’re likely to be dealing with those decisions and the resulting controversies in the next round of collective bargaining (2023). Stay tuned!
Ken Ziffren is a veteran entertainment attorney and has served as L.A.’s film czar since 2014.
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