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In early 2020, the ever-competitive entertainment landscape — rife with content wars — had Hollywood companies spending (and borrowing) more than ever, taking on increasingly large amounts of debt, and causing ripples of concern to spread throughout the industry.
Six months ago, industry debt ratios were approaching double that of the average communication services sector, and the era of COVID-19 threatens to turn these ripples into waves of widespread economic fallout. Many companies are treacherously poised at the mouth of bankruptcy, tenuously tethered by low interest rates.
Between Annapurna’s narrow avoidance of bankruptcy, Distribber’s downfall, and the continued uncertainty surrounding the industry push for legislative relief, the risk of financial woes is at the forefront of many media companies’ minds.
But insidiously lurking behind these financial anxieties is a related, but often unacknowledged, uncertainty: What happens to a party who co-owns a copyright with a company that declares bankruptcy? Of particular interest in this era of reboots and franchise sequels: What derivative rights (if any) can the non-bankrupt co-owner claim in the face of the devious bankruptcy monster? How can the co-owner parry such a foe?
In the nascent stages of film and television development, copyright co-owners dedicate incredible amounts of money and time to negotiating specific contractual rights with respect to their productions. Rights to initiate sequels and/or spinoffs, creative say-sos, lifetime attachment to credits, and financial back-ends are just a sampling of the hotly negotiated details in co-production agreements. However, when a bankruptcy threat arises, a unique — and, for many parties, unexpected and counterintuitive — set of rules kicks in to govern the copyright ownership during the bankruptcy.
Immediately upon a bankruptcy filing, all property of the bankrupt party is monolithically labelled the bankruptcy “estate” and placed under an automatic stay, which is essentially a cease-fire on any rights that a third party may have on the estate’s assets. That stay remains in place until the court is convinced to decide otherwise.
In the interim, without court intervention, no money may leave the estate and, with limited exceptions, no contract rights may be enforced against it (though the estate itself can enforce contract rights owed to it).
The duration of the automatic stay is as unpredictable as the length of pre-dinner speeches at a Beverly Hills charity dinner. At best, a judge may lift the automatic stay from the copyright, allowing the non-bankrupt co-owner to freely exercise its rights during the bankruptcy proceedings. At worst, the non-bankrupt co-owner is abandoned in legal purgatory, barred from exercising its rights until the bankruptcy proceedings have completed.
If an automatic stay sounds bad, that’s because it is. Yet it’s a mere annoyance in comparison to the possible outcomes left in the bankruptcy’s wake. Co-production agreements are most often considered “executory contracts,” a special bankruptcy designation afforded to contracts that are still materially ongoing on both sides at the time of the bankruptcy filing. During bankruptcy proceedings, each executory contract must be assumed or rejected in full by the bankruptcy trustee (or the debtor-in-possession, depending on the type of bankruptcy — here, we’ll say “trustee” for simplicity). Their desire to assume or reject is rarely overruled by the court, effectively granting unfettered reign over deciding the bankruptcy estate’s own best interests. Third parties must either convince the trustee that assuming the contract will maximize the estate or face the loss of future benefits.
If the contract is rejected, it is considered breached, and the non-bankrupt co-owner is entitled to monetary damages. However, these damages (absent a lien) are treated as a general unsecured claim, meaning that they’re put at the back of the pay-out line. Since the average bankruptcy creditor’s claim recovers mere pennies on the dollar, the chance of seeing any money at the back of the line is uncertain at best.
Worse, all of the highly negotiated contract rights may now disappear, leaving the parties with the “bare” copyright rights. Bare copyright ownership is not nothing: a party can still exploit the production, make sequels, and license, or even sell, its portion of the copyright. However, so can its bankrupt co-owner.
Without the co-production agreement’s rules of engagement, both co-owners have free reign to do whatever they want with their copyright, limited only by the requirement to share the financial boons. This new landscape effectively pits the co-owners against each other, locking them into a race-to-release. Whoever exploits their rights first — say, in a sequel film or subsequent television show season — gets to tell fans the story, simultaneously nullifying the slower production.
The only possible result is massive inefficiencies in the industry, subpar viewer outcomes, and decreased economic results for the competing producers. And the punches don’t stop there: If the co-owned property cannot be efficiently partitioned, the bankruptcy code permits the sale of the entire property (i.e., a sale of both co-owners’ property) with only an obligation to proportionally share the payout.
If, however, the contract is assumed, then its terms are reinstated and once again become fully binding on the parties — but risk still looms. While the trustee is bound by most of the contract’s provisions, the bankruptcy code expressly overrides restrictions on assignment.
So the estate might assume a contract then sell its rights to a third party, even if the contract specifically bans such a sale. If this happens, the non-bankrupt co-owner will be saddled with a third party that it had no approval over, who could have wildly disparate creative opinions, workplace ethos, and/or industry resources.
This is not some far-fetched horror story; recent industry bankruptcies, such as Relativity Media’s 2018 bankruptcy (its second in three years), have highlighted that the world of post-bankruptcy co-owners often includes woefully inexperienced entities.
The good news is co-owners do not have to be hapless bit players in the bankruptcy drama. Co-owners can arm themselves against some of the particularly loathsome bankruptcy outcomes by obtaining a security interest on rights and obligations under the co-production agreement governing the creative property (including in the underlying copyright).
Security interests are legal designations that indicate the party receiving the security interest has high-priority protected rights to certain property (here, rights under the co-production agreement). A security interest has many benefits, but for these purposes, the most significant one is to disincentivize the trustee from rejecting the underlying co-production agreement and selling its rights to an unwanted third party.
Without a security interest, the estate would reap all the financial rewards of selling valuable rights to a third party or otherwise exploiting rights the bankrupt co-owner was not entitled to exploit under the existing co-production agreement. With a security interest, a co-owner’s interests are entitled to “adequate protection” as provided for under the bankruptcy code. Therefore, any profit from a sale of rights that are subject to the security interest would be directed into the non-bankrupt co-owner’s pocket, rendering such sale efforts valueless to the bankruptcy estate (and making maintaining the status quo by assuming the co-production agreement much more appealing).
Unfortunately, putting security interests in place does mean investing time and money in legal fees up front, and their value often does not manifest itself until years later. This makes security interests easy to overlook and hard to sell internally, especially with the current market pushing companies to make short-sighted decisions in an attempt to simply stay afloat. With all the time and money spent negotiating for contractual rights, parties should take the extra step to adequately shield those rights. Companies are being bombarded with tough decisions, but this one should almost always be easy.
Evie Whiting and Ashleigh R. Stanley are members of the entertainment transactions team in the Century City office of O’Melveny & Myers, regularly representing major studios, production companies and investment funds.
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