How a New Studio-Backed Union Contract Hurts Independent Producers (Analysis)

The Hollywood Sign - H 2015
Courtesy of RexUSA

Independent producers may find themselves paying more in residuals to the pension and health fund of a key Hollywood union as a result of a new and previously undisclosed provision of a deal ratified last month, The Hollywood Reporter has learned.

The three-year contract, agreed to by IATSE, the labor union that represents movie crew members, and the Alliance of Motion Picture and Television Producers, revises the residual formula in a way that is not expected to affect the major studios but could have a significant impact on indie producers, who were not represented at the bargaining table but who will have to live with the consequences of the agreement.

First, some background: All film producers and studios that shoot union-covered movies pay residuals to individuals — writers, directors, actors and sometimes musicians — as well as to the pension and health fund for IATSE crew members, which is known  as the Motion Picture Industry Pension and Health Plans, or MPIPHP. The total residuals cost can exceed 10 percent of a movie’s television, home video and Internet revenues. Total entertainment residuals across all unions are about $2 billion per year, according to published data and estimates developed by this reporter.

Up until the new IATSE deal, film residuals have been based on various percentages depending on the medium in which the movie is reused, such as TV, home video and Internet. While each of the guilds and IATSE have negotiated a panoply of rates and formulas, no film residuals have previously been based on theatrical box office revenues (nor on so-called “film rentals,” which is the studio share of box office).

The fact that the percentages range from zero (for theatrical revenues) on up often leads to arguments over how independent film revenue should be allocated, since allocating more revenue to a medium that bears a high percentage rate produces a higher contribution to the overall residual, while allocating more revenue to theatrical — where the rate is zero — produces a lower overall residual.

To the producer, a residual is a tax, and the allocation arguments are loosely analogous to what a sophisticated taxpayer might do, which is to argue that much of her income should be treated as long-term taxable gains, which are subject to a 15 percent federal tax rate, rather than ordinary income, which is subject to rates as high as 39.6 percent. And if the taxpayer can argue (for whatever reason) that some of her income is actually subject to a zero percent rate, that lowers her overall tax bill even more.

Not surprisingly, residuals allocations are fraught with judgment calls and disagreements — and that results in costly audits.

Under previous versions of IATSE’s Basic Agreement, the varying percentages for film residuals were 5.4 percent for television, 6.75 percent or more for home video and up to 14.625 percent for Internet revenues. The new IATSE deal overrides those varying percentages and instead applies a “blended” residuals formula of 4.5 percent to all revenues, including, for the first time, revenues attributable to theatrical exhibition.

But because of the way the language in the contract has been crafted, the new formula affects independent producers and not studio-produced movies. As spelled out in the 40-page Memorandum of Agreement between the AMPTP and IATSE, the new provision applies the blended residuals percentage to “motion picture license agreements that provide a minimum guarantee or non-returnable advance in exchange for theatrical distribution rights as well as distribution rights in at least one other residual-bearing market (i.e., home video, pay television, free television, electronic sell-through and streaming).”

The mention of a minimum guarantee, or MG, reflects the way independent producers sell their movies, territory by territory, in exchange for an MG from each territory that covers rights in multiple media, such as theatrical, television, home video and often at least some Internet rights. But the new IATSE formula has very little application to the major studios, which generally don’t do multi-rights deals in most significant territories: instead, they license the theatrical rights directly to theater chains and, separately, the television rights to one or more networks or pay TV services. As for DVDs and Blu-rays, they distribute those directly to retailers, a business that as in the U.S. has declined dramatically in most foreign countries over the last half-dozen years.

The AMPTP, which bargains on behalf of the major studios, declined to comment on the implications of the new contract. The new provision is expected to save money for the IATSE pension and health fund by reducing the need for costly audits, and it imposed no new costs for the studios sitting on the other side of the bargaining table. But indie producers and smaller companies, who were not part of the negotiations, are affected by the change, and their representatives are concerned.

“We were surprised to learn that these provisions were included in the new [IATSE] Basic Agreement for the obvious reason that the producers most affected by them – the independents – were not at the table and not consulted, to my knowledge,” says Jean Prewitt, president and CEO of the Independent Film & Television Alliance, the trade association that represents indie producers and puts on the annual American Film Market in Santa Monica each November.

IATSE and its pension and health fund, the MPIPHP, did not provide comment in response to requests.

The new 4.5 percent flat rate might sound like a bargain for producers when compared to the previous rates of 5.4 percent and up. But the fact that the formula now encompasses theatrical revenues, on which a zero rate previously applied, represents an increased expense and major change, which will affect all license agreements entered into since Aug. 1, when the new contract took effect.

Mathematically, the blended number is roughly equivalent to allocating the MG and any overages (in the relatively rare cases where a producer receives additional revenue above and beyond the MG) in three equal parts: one-third theatrical, one-third television and one-third home video. That’s an allocation that the MPIPHP often advocates for, according to a management-side source. (Internet revenues are generally so negligible that they’re typically ignored for allocation purposes.)

“While independents have advocated that the unions adopt a simplified formula for residuals,” Prewitt tells THR, “the lack of consultation here suggests that the blended rate agreed by the union and the majors may well be out of touch with the independents’ actual sales experience in today’s international marketplace.”

In contrast to the IATSE pension and health fund position, attorneys representing independent producers generally argue for allocating 40 percent, 50 percent or even as much as 80 percent of the MG to theatrical revenues. That means that those portions of the MG don’t contribute to residuals, leaving as little as 20 percent of the MG on the table as the calculation proceeds.

“The all-rights buyers are pricing independent films based on theatrical value,” Prewitt explains, “since there is no longer a DVD market, no online markets have matured financially and television slots for feature films are limited. Residuals calculations should reflect these realities.”

Theatrical-heavy allocations translate to equivalent blended rates that would be much lower than the 4.5 percent in the new IATSE deal. A simple example: if you allocate 50 percent of the MG to theatrical (yielding a zero contribution to the total residual) and 50 percent to television (yielding a residuals contribution of 50 percent of 5.4 percent, or 2.7 percent), the total residual is 2.7 percent of the MG.

Or, suppose you allocate 80 percent to theatrical and 20 percent to television. Now the total residual is 20 percent of 5.4 percent of the MG, or 0.9 percent of the MG.

Either way, you arrive at numbers that are far lower than 4.5 percent. That’s the way indie producers might like it, but that new 4.5 percent formula is now binding on them, or at least on those who use IATSE crews in the region covered by the Basic Agreement – generally 13 western states including California.

The new rate amounts to a take-it-or-leave-it proposition for indie producers because they have no representation in collective bargaining. IFTA is not an employer representative for labor law purposes and doesn’t represent its members in dealings with the guilds and unions. “We can only comment from the sidelines,” says Prewitt.

Nor is the oft-noted Producers Guild of America a labor organization. Despite its guild-like name, the PGA has no involvement in collective bargaining and is instead a membership organization for people who are producers on both studio and independent movies. The group did not respond to a request for comment.

Indie producers do have attorneys, of course, and while they can’t barge into the bargaining room, one prominent attorney for independent producers, Stroock & Stroock & Lavan’s Schuyler Moore, is outspoken in his criticism of the new approach. “In an era when most films lose money, to permit residuals to be calculated on gross receipts is economic suicide,” he said.

Moore, who has previously proposed that film residuals be based on budgets rather than revenues, doesn’t like residuals at all. “Residuals were originally applied to new media that generated less than about 10 percent of the total revenue from a theatrical film. That original concession by the studios permitted the camel’s nose under the tent, and residuals have grown from those humble beginnings to now being applied to all minimum guarantees for all rights.”

Now that the new formula has been used in the IATSE deal, it could be taken up by the other unions. Much of the Hollywood residuals system exists in parallel patterns between unions: if the DGA rate for a residual is 1.2 percent, for instance, then the WGA rate is usually the same, the SAG-AFTRA rate is three times as much and the IATSE rate, if any, is 4.5 times as much, or 5.4 percent in this example.

Running the math in reverse, the IATSE 4.5 percent rate correlates with one percent for the DGA and WGA and three percent for SAG-AFTRA, should they choose to embrace the blended approach.

But they might not do so, because it’s usually an above-the-line union, generally the DGA, that sets the pattern. And the above-the-line unions may have a different focus than the IATSE pension and health fund: the MPIPHP may have been motivated to reduce the number and cost of residuals audits by baking in a blended percentage that corresponds to its usually-requested allocation, while above the line unions, sensitive to concerns of individual members who scrutinize the residuals checks they receive, may focus more acutely on whether a blended number actually increases the residuals take and be less concerned about reducing audit and enforcement costs.

That raises the question of whether the new approach will increase residuals. In a few cases, it might not, and might instead create a perverse incentive: if a film would otherwise be released only to television, home video and Internet – meaning that the old percentages like 5.4 percent and up would apply – adding a token theatrical release would actually reduce residuals by bringing the 4.5 percent blended rate into play. Of course, today there are few such films, but if Internet viewing comes to supplant cinema attendance overseas, IATSE could one day come to regret the blended percentage as a discount on what would have been higher rates.

For now, though, it seems that the new approach marks an uptick in residuals expense for indie companies, who arguably face unique challenges in international deals. “Our members are extremely concerned about how to ensure that the other guilds take these facts on-board over the next few years,” says IFTA’s Prewitt.

Like everything in the residuals world, it’s complicated, Still, with the next round of above-the-line negotiations set to start in about a year, indie producers are bound to wonder whether this time IATSE has set a pattern that will increase their costs – and, without a seat at the bargaining table, whether there’s anything they can do about it.

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