On Thursday, a trustee for a bankrupt home video company filed a complaint against The Weinstein Company, accusing the mini-major film and television studio of perpetrating a fraud and demanding the return of more than $130 million that was allegedly siphoned from the company since 2007.
The lawsuit was lodged in California bankruptcy court as part of the ongoing strife of Genius Products, LLC, which has distributed works from ESPN, Discovery, IFC Films, Sesame Workshop and others through big box retailers like Target and Wal-Mart. Genius was forced into involuntary bankruptcy in 2011 by World Wrestling Entertainment and two other companies over $8.5 million in debt.
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But according to the new complaint from Chapter 7 trustee Alfred Siegel obtained by The Hollywood Reporter, by 2011 Genius was already insolvent thanks to “onerous and one-sided” agreements forced upon it by TWC. The lawsuit essentially accuses Harvey Weinstein‘s company of treating Genius as his personal piggy bank and transforming ESPN, Discovery and Genius’ other licensors into unsecured creditors.
“We think that the trustee’s claims are gravely mistaken and will not succeed,” responds Alan Friedman, attorney for The Weinstein Company, who says his client lost tens of millions of dollars on Genius. “The story the trustee tries to tell in the complaint does not square with what actually happened.”
Weinstein formed Genius in 2005, according to the bankruptcy papers. That year, it got the exclusive rights to distribute Weinstein home videos in the United States. In 2006, Genius would reform itself as an independent company, and pursuant to an operating agreement, TWC held onto 70 percent.
The independence, though, was a “sham that was intended to and did mislead third parties,” states the lawsuit, as Weinstein is said to have exercised complete control over Genius and dictated the terms of distribution agreements that created “no practical possibility” that Genius could operate profitably.
As the litigation proceeds, the charge of “sham” independence will be challenged by the defendant. Friedman says the distribution terms “were approved by Genius’ entirely independent board of directors before Genius and The Weinstein Company went into business together. They were also fully disclosed in a public SEC proxy statement that was sent to all of Genius’ shareholders who then approved the very terms that the trustee is now challenging nine years later.”
Genius got a distribution fee of five percent of net receipts on Weinstein films, and according to the lawsuit, that fee paled in comparison to a market range of 15 to 17.5 percent for other distributors. If a Weinstein film title performed better than expected, Genius’ fee was retroactively reduced to as low as three percent, adds the lawsuit.
Friedman points again to what Genius’ management touted to shareholders. According to a 2006 proxy statement, the company wrote, “We believe that the Distribution Agreement is a valuable and highly sought-after right and, when combined with our employees, management team and existing distribution business, will help transform the Distributor into a large and well-recognized entertainment distributor.”
If that statement was forced, it will surely be examined as the lawsuit moves forward. Genius was also allegedly disadvantaged in other ways in its relationship with TWC, like a requirement that it keep about 40 employees exclusively working on Weinstein titles at a cost of $2 million per year. The lawsuit also says that despite an exclusive right to distribute Weinstein titles, it wasn’t permitted to distribute them in Blu-Ray and other new formats. Plus, Weinstein allegedly hamstrung the home video company’s business by being allowed to review deals that Genius made made with others. According to the lawsuit, “TWC exercised its veto rights to require the Debtor to expend resources on unprofitable Weinstein titles instead of profitable third party titles.”
“In summary, through its control of both sides of the transaction, Weinstein dictated the terms of the Distribution Agreement so that substantially all of the revenue from the home video distribution of the titles was transferred to Weinstein, while substantially all of the expenses of the distribution were paid by the Debtor,” states the complaint. “The effect of Weinstein’s scheme was to utilize the Distribution Agreement to transfer to Weinstein, as a result of Weinstein’s ownership of the Debtor, the Debtor’s cash by charging the Debtor above-market rates in the Distribution Agreement instead of the net revenues that could be obtained if the Distribution Agreement reflected market terms and industry norms.”
This is all said to have gone on for two years, until 2008 when Genius was running out of money. What happened next was a purchase agreement that transferred its majority ownership to the investment firm, Quadrant Management, Inc., allegedly so that Weinstein could “extricate itself from the relationship… at minimum cost to Weinstein.” Genius also signed an “onerous” amended distribution deal, and later, a restructuring agreement that “no independent distributor would have entered into.”
During all this time, Genius was hemorrhaging money with nearly $20 million in reported net losses for 2006, nearly $19 million the following year, and nearly $90 million for the first nine months of 2008. At that point, it had $11 million in assets against $195 million in liabilities. Genius stopped operating in September 2009 when it sold its distribution rights to Vivendi Entertainment.
Until then, according to the lawsuit, “in order for the Debtor to operate at a loss to facilitate the Weinstein scheme, the Debtor needed third parties to extend credit, which borrowed funds could be used to make transfers to Weinstein and pay overhead expenses.”
“To obtain such borrowed funds, the Debtor entered into distribution agreements with third party licensors at market terms,” continues the lawsuit. “Pursuant to the distribution agreements, the Debtor was obligated to timely pay proceeds to the licensors after retention of the negotiated distribution fee. Instead, the Debtor used the proceeds to make transfers to Weinstein and pay overhead expenses, thereby turning the third party licensors into unsecured creditors who were not paid timely.”
Siegel, and his attorneys at Robins Kaplan, count $130,459,452 that was transferred by Genius to TWC after December 27, 2007. The plaintiffs are now claiming the allegedly fraudulent transfers are avoidable and recoverable. TWC is also facing claims for allegedly breaching fiduciary duties.
Friedman says the reality is far from TWC using Genius as a piggy bank.
“In fact, the Weinstein company was the biggest loser of all,” he says. “It has written off tens of millions of dollars that were due to it from Genius under the distribution agreements. And the Weinstein Company had nothing to do with Genius’ management for nearly three years before it went into bankruptcy and Quadrant Management was in control of Genius beginning of 2009.”
