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Calling it “one of the greatest heist stories ever told in the movie business,” the Aramid Entertainment Fund on Wednesday filed a lawsuit against Relativity Media, Fortress Investment and others for breach of contract, intentional interference with contractual relations, fraud, fraudulent transfer and much more.
Aramid, a hedge fund based in the Cayman Islands, says in the suit it is owed at least $44 million plus damages and possibly more, depending on what else it learned during the legal discovery process.
The suit says that a huge deal to co-finance movies made by Sony Pictures has been prematurely ended (apparently on Dec. 16, 2011). Sources say about half the movies envisioned under the fund (called Beverly Blvd.) were funded, at least 18 pictures in all. Others that were considered for funding, including 21 Jump Street, ultimately were not included.
The suit says that Relativity, while holding itself out as a successful film financier, was actually in serious financial distress; and that New York hedge fund Fortress used the guise of possibly doing business with Aramid to get information it used to destroy the Aramid position in an investment in a fund that financed movies for Sony Pictures.
The suit says (with named companies added in parenthesis) that it “involves a stunning cast of corporate characters: one of the world’s largest entertainment companies (Sony); the third largest bank in America (Citi), one of the world’s largest hedge funds (Fortress), and a vehicle two of them help bring to life (Beverly Blvd LLC) in order to finance over $1 billion worth of feature films. Behind the scenes this vehicle was ultimately hi-jacked, forcibly dismantled and ruthlessly plundered in order to line the pockets of the defendant and to knowingly deprive (Aramid) of their rights.”
At the center of the lawsuit are “slate deals,” big money financings used to lay off the risk of movie production by major studios. According to the filing, Relativity was formed by Ryan Kavanaugh in 2005 to make slate deals. At first the company borrowed money from banks and other sources to do these deals, but beginning in 2008 it received backing from Elliott Management, another large New York-based hedge fund.
Over time, says the suit, Kavanaugh turned Relativity from a passive investor into a participant in part by negotiating a producing credit for himself on each movie the fund co-financed. “Kavanaugh wanted people to believe that he really was ‘the producer’ of such films in spite of the fact he never provided any actual producing services,” says the suit.
The suit says Relativity “holds itself out to the market as a successful film financer” and describes itself as a “next generation studio” that to date has produced or financed over 200 movies which have grossed more than $17 billion worldwide.
In 2007, Relativity worked with Sony to crate the Beverly Blvd. slate financing, which it told investors would be “a watershed event in the evolution of slate finance.”
Relativity was to be paid $1 million per picture as a producer, plus a fee of 2 percent of the gross participation (money to the studio off the top with no deductions).
“Kavanaugh stood to benefit more than anyone else from the Beverly slate transaction,” says the suit. “Regardless of whether Kavanaugh or anyone else from Relativity ever read a script, visited a set or rendered any producing services…that meant as much as $45 million in producing fees alone over five years. If the slate generated an additional $3 billion in receipts, which was entirely possible…they would have meant an additional $60 million paid to Kavanaugh and Relativity – or over $100 million in fixed fees and contingent gross participation.”
Sources say that none of the money in Beverly came from Relativity or from its backer Elliott (who did finance a slate deal at Universal Pictures, which it took over from Relativity last year).
What made the Beverly fund special, says the suit, was that Relativity got the right to actually choose or “cherry pick” which of the Sony movies it would finance, rather than just be told by the studio which it would allow Relativity to participate in, as long as it put up half the money for three-quarters of Sony’s movies during the term of the deal.
The suit says Kavanaugh was able to assert that due to an “allegedly proprietary financial model” used in picking films, Relativity could reduce risk. The system actually did not pick movies; but rather excluded films which did not meet certain criteria.
The Beverly fund was to cover up to 45 movies over five years. Beverly would contribute $500 million and Sony would put up a matching amount. The money was to go only to production costs, not to marketing or other expenses. Some of the proceeds could be re-invested in other movies to help extend the life of the deal, giving investors as many opportunities to be “at bat” as possible – because investing in more movies was seen to increase the chance of the fund’s overall profitability.
The fund could end before that if it ran out of money. However, an analysis done by the Salter Group, per the suit, indicated that was unlikely unless the movies massively underperformed.
The suit says Relativity did not actually have the $555 million needed to capitalize Beverly, so it convinced Citibank, N.A. and affiliates to raise the money or put it up itself. Citi agreed to guarantee that money. Sony did not finalize the agreement until it had that assurance from Citi. In return, it guaranteed Cit fees of at least $14.7 million.
Beverly actually consisted of three classes of investment. The A investors had senior notes and got the first money to come in. The B investors got higher rates of return (so called mezzanine notes), but didn’t get paid until after the A investors. The C investors would be paid even higher rates but only after everyone else ahead of them were paid. There were also class D notes that went after all of those.
Citi did its own detailed analysis and told investors to expect that recoupment of capital invested would be 20 percent greater than what they would invest in 90% of the cases.
The problem was, 14 months after they started – in March 2008 – Citi had still not found any outside investors, according to the suit. So Citi guaranteed the $525 million itself.
Shortly after that, Citi went back to Aramid, which had refused to be part of the deal several times over a year, and sweetened the terms. If Aramid would make a “mezzanine level” investment, Citi would pay them up to 21 percent interest when and if the deal paid off as expected. Aramid created a subsidiary to handle the notes and signed on as an investor.
Meanwhile, according to the suit, Relativity was struggling financially and was experiencing a high level of executive turnover. “2011 was a year of acute financial distress for Relativity,” according to the suit. Even so, the Relativity payroll grew to over 200 people as it transformed into a movie distributor that could compete with major studios. Part of that was done by acquiring Rogue Pictures from Universal – in what is described as a “seller financed” deal, meaning Universal paid them to take it away – and absorbing “significant overhead” with the acquisition of staff from Overture Pictures. The suit says Comerica and Union Bank were refusing Relativity any more credit.
“By 2011,” says the suit, “(Relativity) was in a financially precarious situation with a bleak outlook: Kavanaugh and Relativity had lost critical financial backing from Elliott, suffered departures en mass from within the senior ranks and watched costs soar from ill-fated acquisitions.”
A loan in late 2011 of $200 million to Relativity from Colbeck Capital (using money invested by Ron Burkle) “only worsened Relativity’s financial distress.”
Fortress, meanwhile, had said it wanted to invest in Aramid and signed a non-disclosure agreement, after which it did extensive due diligence. However it never followed up with an offer to buy certain securities from Aramid. Among the things Fortress studied most closely, says the suit, was the Beverly deal, which is so complicated, it would be impossible to understand it without Aramid walking Fortress through it.
After the recession hit, Citi fell on hard times and looked to sell its position in Beverly. Citi informed Aramid that it was considering a sale and Aramid offered to buy the position or bring in another investor. Per the suit, Citi declined saying it had a potential buyer, which turned out to be Fortress.
Much to Aramid’s surprise, Fortress bought Citi out for 50 cents on the dollar (paying $113.5 million for notes valued at $226.7 million). To get the deal done, Fortress got Sony to end Beverly early in return for a reduction in the amount it currently owed Beverly, about $214 million, (saving them $6 million immediately) and by agreeing to forgo all the future revenues those moneys might make in TV, home video and other markets, which saved them, per the suit, over $200 million. It also meant the Beverly investors would not share in revenue from sequels to hits including Paul Blart: Mall Cop and Grown Ups.
The last piece for Fortress was to get Relativity to approve their deal. They did this, per the suit, by paying Relativity $14.5 million at a time the company was desperate for cash.
“Fortress,” says the suit, “having masterminded the break-in and switcheroo, booked a minimum gross profit of approximately $96.1 million.” That was less the $14.5 million paid Relativity, so Fortress made $81.6 million.
However, that meant there would never be any money for the Class B investors, most notably Armaid.
A spokesman for Aramid had no comment but did not rule out the possibility that they would add as defendants Citibank and Sony in the future.
Relativity declined to comment.
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