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A Case Study: Guild Residual Calculations – Studio vs. Independent Film Finance Models

Expert Witness: Kathryn Arnold
While serving as an Expert for a production/distribution company who was being sued by one of the major guilds to pay outstanding royalties on a slate of pictures, the fundamental difference between the way Studios and Independent production/distribution companies finance and distribute films became very apparent.

The Writers Guild of America (WGA), Screen Actors Guild (SAG), and the Director’s Guild of America (DGA) track the international box office, DVD, VOD and television revenues of films around the world in order to assess the correct residual amounts for their members. The challenge facing the Producer however is that the Guilds utilize the same accounting methods to assess royalties with independently financed films as they do the studio financed films, and therefore the producer can be overcharged dramatically on an indie film.

The studios are a one-stop shop—they funnel both their investment and distribution
through in-house channels and therefore have made decisions regarding the level of theatrical distribution vs. DVD/VOD/Television a film will receive before it is made. This level of control allows them to produce films without securing minimum guarantees from outside entities, and thus are able to easily generate at-source revenue statements for residual purposes..
This is critical to understand: the Studios get actual numbers for theatrical, DVD, VOD and television sales and the Guilds can correctly generate residual calculations—important information given that Guild residuals are paid as a percentage only on the non-theatrical windows.

The independent production finance model usually requires the engagement of a Sales Agent (who can also act as the producer) to generate pre-sales of distribution rights to third party distributors in each territory. The financial consideration given by a distributor in exchange for the local distribution rights is usually expressed as a Minimum Guarantee (MG). These third party distributors are then responsible for generating the at-source revenues, and are responsible for generating revenue statements, which they don’t always do. There’s the rub: the sales companies are frequently not forthcoming or unable to report actual sales numbers, and the Guilds must then calculate residuals based on the MG (a projection of sales,) rather than the actual sales numbers. And this can affect the residual numbers greatly as most films do not perform as well as projected.

The respected entertainment attorney Schuyler Moore starts the second chapter of his guide to the film business, THE BIZ (Silman-James Press, 2000, p. 11), with the heading, “MOST FILMS LOSE MONEY!” In fact, many films fail to even recoup their theatrical release expenses. The industry bible, DAILY VARIETY, often features stories of significant write-downs. Here is one article presenting the potential losses and possible write down on the Warner Brothers film JACK THE GIANT SLAYER and how it relates to the known Disney flop JOHN CARTER.

Box Office: ‘Jack’ Looking Like Giant Disappointment at $23 Million.

It doesn’t look like there will be a fairy tale ending for Warner Bros.’ “Jack the Giant Slayer.” The $200 million-plus budgeted retool of the “Jack and the Beanstalk” children’s story bowed to $7.7 million Friday, and is looking at a three-day gross in the low $20 million range.

It’s too soon to say if this will be a flop of “John Carter”-sized proportions. That Disney tentpole bowed around this time last year to $30 million, and turned into a $200 million write-down for the Mouse. (March 2, 2013 by Michael Sullivan)

Let’s look at the concept that the Studio system of allocation favors the Studios when the film loses money and can cost the Independents greatly with respect to required residual payments. Though the write down for JACK isn’t known publicly, the article mentions that Disney wrote down $200 million in costs for JOHN CARTER (the movie was rumored to have cost $250 million and global marketing costs might have added $100 million to that.)
As discussed, based on the creative elements of the film, Disney’s distribution division would have projected sufficient revenues to cover production and distribution costs prior to the film being approved for production.

This is analogous to the process by which an Independent film is funded through agreements with international and domestic distributors (the MG) to pay a fixed amount and in many cases to agree to spend an additional amount on release costs. Again, for simplicity we will say that the entire $250 million budget is funded through pre-sales in the Independent model. To be clear, the process that the individual distributors go through in negotiating their MG amounts is like the process Disney goes through to decide how much to invest in the film.

The difference is that the Independent film must pay residuals based on the pre-sale amounts that funded the budget, whereas Disney will only pay residuals on the film’s at-source revenues in non-theatrical windows. If they wrote down $200 million after spending a total of $350 million then we should assume that this amount was $150 million (and about 1/3 of that was from theatrical revenues, leaving $100 million to allocate towards residual payments.)

Obviously the distributors made the decision to invest heavily because the film was perceived to be a theatrical title. Disney, though, pays residuals on $100 million while utilizing the MG method, while the Independent would pay residuals 75% of $250 million (The MG) or $187.5 million. Clearly this method represents an unreasonable allocation process.

It bears repeating that most films lose money – though hopefully not as much as JOHN CARTER and JACK THE GIANT SLAYER. In percentage terms, though, losses like this are very common and I have seen many distribution statements on Independent movies from Major Studios (where they have handled domestic or select foreign territory distribution) and other distributors where only a small portion of the MG was recouped. Thus it is not fair or reasonable to assess residuals on 75% of the MG, because often times the MG is not recouped and does not come close to representing a model for at-source revenue allocation in the absence of factual reports, which are often not possible to obtain.

ABOUT THE AUTHOR: Kathryn Arnold and Rob Aft
Kathryn Arnold has over 20 years experience in the film production and distribution arenas. Having worked in both the studio and independent film environments, Ms. Arnold understands the inner workings of the entertainment industry, its hiring practices, business development, financing and the economic complexities and the nuances involved.

She has served as an expert and consultant on 3 dozen cases, with plaintiffs and defendants, such as producers, production companies, investors, writers, directors, on-air personalities, crew, and other entertainment personnel.

She has provided expert testimony, reporting, consultation, and financial forecasting on cases regarding economic damage and lost wages from copyright infringement, breach of contract, disfigurement, personal injury, wrongful death, and economic downturn. Clients include Gibson, Dunn & Crutcher; Bowles & Verna LLP; Haynes & Boone; Shook, Hardy & Bacon, Dummit, Buchholz & Trapp; Hosp, Gilbert, Bergsten.

Copyright Kathryn Arnold

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.

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