Legislators gone wild: California bill would cause chaos in profit participations

New law would harm the narrow slice of talent community it intends to help.

ABOUT THE AUTHOR: Robert Schwartz is a partner in the Century City office of O'Melveny & Myers Llp, where he heads the firm's entertainment & media litigation group. He represents, among others, motion picture studios, television networks, and participants in contingent compensation disputes.

On Feb. 22, California Sen. Sheila Kuehl introduced a bill that would complicate the relationships between studios and contingent-compensation participants, form a dark cloud over the licensing of content for distribution and ultimately disadvantage the narrow slice of the talent community the senator wants to help.

What's piqued Kuehl's interest is the common practice of studios licensing their film and TV product to affiliated broadcasters or cable channels. Some think the license fees are less than what unaffiliated parties would be willing to pay, and that those who have a participation tied to those products are shortchanged as a result.

Even assuming that the practice exists (more on that below), should it be addressed and "cured" by the government? This writer thinks not.

The bill, S.B. 1765, amends the Business and Professions Code through a new section, 17048.7, which states:

(a) It is unlawful for the holder of rights in a motion picture, television program, or series, or radio program, to sell or license those rights for less than their fair market value where a third party, including, but not limited to, an actor, writer, director, producer, musician, composer, or health and welfare or pension trust fund is entitled to receive payment based, in whole or in part, on the proceeds from the sale or license.

(b) For purposes of this section, "fair market value" means the most likely price that the assets being sold would bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller acting prudently, knowledgeably, and in their own best interest, and a reasonable time being allowed for exposure in the open market.

For several reasons, so-called "below-market licensing" isn't the problem Senator Kuehl believes it to be. The proposed solution isn't necessary, and in fact will likely end up harming those it seeks to help.

Is there a self-dealing problem?

In the 1990s, a stream of cases were filed against 20th Century Fox on behalf of participants on "M*A*S*H" and "The X-Files" over the alleged practice of licensing rights to those shows to its affiliate, F/X, at supposedly "below-market" rates. The phrase "vertical integration" (referring to the fact that the media entity owned means of production, distribution, and exhibition) was coined. Similar suits followed.

Putting aside competing fact assertions, why would a studio take less than the market price for its product? An economist would reject such conduct on the grounds that it is against the studio's self-interest. But as the talent explains, by selling product to an affiliate at a below-market price, the licensor reduces its payments to participants and the licensee obtains product for less. Since the licensor and licensee are owned by the same parent, the theory goes: on a consolidated balance sheet, the megamedia company comes out ahead. A related theory is that the corporate parent may have other interests, such as launching a cable channel with desirable programming, and may view a revenue shortfall as a short-term cost of entering the market.

But does that really happen? Not at the major entertainment companies where the divisions and affiliates compete fiercely against (or are outright hostile to) one another. They are not about to sacrifice their revenue for the "greater good" of an affiliate or the parent. Public spats over licensing terms between Warner Bros. and HBO and between Paramount and Showtime (prior to their separation), suggest that it's unlikely that the executives of any of those divisions would hurt their own "numbers" (and take a hit on their bonuses) by licensing their product to an affiliate at below-market rates.

Further, it's not clear-cut that any suspect affiliate license is "below market." Usually these legal disputes are resolved with the help of "experts" who attempt to reconstruct the market as it existed when the license was entered into. The experts act much like real estate appraisers do: They look at contemporary license terms and make highly subjective judgments about the comparability of their "comps." On that field of play, it's not hard for someone working with a lawyer to come up with a basis to argue that a license was "below market."

But content is not fungible, and license terms such as initial availability dates and number of showings, and product characteristics such as cast, length, subject matter, boxoffice performance and prior ratings, make head-to-head comparisons difficult and often suspect. In short, it's much easier to allege that a movie was licensed for less than "fair market value" than it is to show that it really happened.

Okay, but if it goes on, shouldn't something be done about it?

Sure. But remedies already exist. Many contracts (particularly those for established talent that is most likely to be involved in shows and movies that could be affected by the concern) either prohibit the practice of licensing to affiliates, or establish "fair market" or other standards that protect the participant against any "unfair" intra-company licensing. For talent with such contracts, S.B. 1765 is unnecessary.

For the rest, California common law -- through the claim of breach of the implied covenant of good faith and fair dealing -- already provides protection against affiliate self-dealing. If the studio or its parent "pocketed the difference," there already exists a claim and a long list of lawyers (just ask Fox) willing to sue on behalf of those who say they've been hurt.

Even so, what's the harm in passing a law to make it "clearly unlawful"?

First, with all that ails the state, should our government be spending its scarce legislative resources worrying about the problems of a very few well-compensated creative types?

Second, the bill places the new statute (section 17046.5) in Chapter 5 of the Business and Professions Code, the Unfair Practices Act, section 17000, et seq. That chapter contains some noteworthy, if not daunting, provisions and remedies. For example, section 17051 makes any contract in violation of the chapter illegal "and no recovery thereon shall be had." Does that mean that a "below market value" license can be voided? How does that help the participant? Do any third party rights need to be taken into account? What about the rights of other participants on the movie or TV show who don't share in the view that a license was "below market"? Should their slice of that revenue stream be wiped out, too?

Third, Article 4 of Chapter 5 authorizes extraordinary injunctive relief (extending not only to the particular product involved in the case, but "every article or product" involved). Does that mean every affiliated license (e.g., every motion picture in a licensed slate), no matter the terms, would be voided at the same time? Also, there are provisions for the recovery of treble damages (section 17082), separate discovery rights (sections 17083 & 17084) and plaintiff-only attorneys' fee entitlements (section 17082).

More alarmingly, in any action under the chapter, "it is not necessary to allege or prove actual injury or the threat thereof, to the plaintiff." These provisions would create incentives to bring a suit in every situation in which a company licensed its content to an affiliate, regardless of what the terms of that license looked like. The standard of proof and remedies are just too enticing.

Fourth, the statute's standard of liability is unrealistic and full of language that will lead to even more disputes. What does it mean for a given price to be the "most likely" one that would have been achieved? What's actually required for a "competitive market"? How many buyers have to be aware of the availability of the product, or actually bid on it, for it to be "competitive"? What are "all" of the conditions that would make it "fair" (and what does "fair" really mean or require in this context)? How long is a "reasonable time" to test the market? One week? Two days, if it's during a film market? What makes anyone think judges or juries will know the answers to these questions, with or without self-serving "expert" testimony?

None of this is in the talent's interest. The reaction of the typical content owner would be to minimize the risk of liability by contracting around the problem, either through waivers of the statute (to the extent enforceable) or, more likely, eliminating contingent compensation for those on the margin of bargaining for it, or excluding the revenue stream from the participation "pot" (and either substituting a higher share for some other revenue stream, or giving no value for it), or taking other action. The risk of exposure from this legislation, assuming these related remedies are applicable, will inevitably result in less economic value being transferred from studios to talent for their contributions to successful motion pictures and television product. That's not what Sen. Kuehl thought she was accomplishing.

Finally, where would this legislative "cure" end? There are other elements of participation agreements that talent doesn't like, and may not be able to bargain around. For example, agents routinely complain about home video royalty rates, on the basis that the actual margin on DVDs is higher than the 20% royalty included in "gross" for those without the leverage to negotiate for more. Why not require the content owner to pay a higher percentage, just because? There's no end to how the legislature could interfere with the sophisticated bargaining that goes on in the industry.

A better approach would be to leave the parties alone and let them decide what conduct is acceptable, and rely on existing remedies to resolve their differences. Once the legislature gets involved in this issue, everyone is going to regret it.