False Representation vs. Breach of Contract in Film Financing – Who Wins?

Investment in film has the potential for high reward but is always combined with high risk. Little or no collateral, lack of liquidity, changing consumer demand, market competition and over zealous promises made by the filmmakers all contribute to the risk factor. Investors must rely on strong market analysis, distribution pre-sales and the integrity of the filmmakers who are making the proclamations in the prospectus. If any one of these elements is fraudulent, that can mean disaster for the investor and potential violation of contract elements.

In a recent case, investors, (Defendant,) who were putting up the Prints and Advertising money for a film’s distribution were sued by the producers (Plaintiff) for breach of contract because they pulled out of the investment.  A close examination of the facts however, presented a scenario of gross exaggeration and misrepresentation that supported the move that the Defendants made.

Where did the producers go wrong?

1. Producers did not disclose outstanding debts and liens.

General industry standards and practices provide for full disclosure of all information regarding a film’s budget, licenses (production, financing, distribution and music among others,) and any agreements or settlements that must be paid prior to the film being considered “complete.”   This is important because individuals/vendors/guilds and unions that have a financial interest in the film will come out of the woodwork to get paid, when a film goes into the marketplace via a film festival, theatrical, home video or television release.  It is well known that any one of these individuals, investors, or vendors, if not paid (in full or based on a settlement agreement,) can file a judgment or lien against the film and preclude the producers from earning revenues of any kind from the exploitation of the film property

Plaintiffs did not disclose to Defendants the Unsecured Creditors debt of over $750,000

2. Producers did not disclose that the film had been shopped around and no distribution deal was entered into.

After the Film’s premiere at the Toronto International Film Festival, Plaintiffs received several offers for distribution from legitimate film distributors, but did not accept them because the dollar amounts offered were not as high as they had hoped.  Plaintiffs continued to seek distribution for the Film through their representatives at a reputable talent agency, but still did not secure a theatrical distribution deal.

Lack of interest in the marketplace (if the film has been shopped with no takers,) is an indicator that there is little or no interest in the film and will have an impact on revenue projections, which would advise the appropriate amount for an investment in the film’s marketing and distribution plan.

3. Producers overrated the valuation of the film.

Plaintiffs signed a 2-page deal memo (Agreement) with the Defendants, outlining an $8 million investment on behalf of Defendants for the theatrical release of the Film, along with an equity ownership in the Film worth $2 million. It was outrageous that they would ask for $8 Million in distribution release funding with the prior knowledge that the film had a lower market valuation dictated by the low offers they had already received.

Furthermore, the producers had overly exaggerated the project revenues and the time frame for cash flow from receivables.

• They presented a leap from a Low Theatrical Box Office of $100,000 to a Medium Theatrical Box Office of $7,500,000 and a High Theatrical Box Office of $25,000,000 is quite extreme.  Although financial projections are somewhat arbitrary they are based on market analysis and qualifiers for a particular film (including cast and genre.)   With independent films, a general rule of thumb is to utilize a 25% increase between the low, medium, and high revenue scenarios.

Within a volatile and mercurial arena such as the entertainment industry, it is better to under-promise and over-deliver with your projections, so that no party is taking undue risk because they trust an overly exaggerated ROI.  The “Low” number in a financial projections table is the conservative estimate, and is the one most investors usually work off of, as the medium and high numbers are most often speculative in nature.

• The Projected Cash Flow as presented was not consistent with the release cycle that a movie goes through.  In the Cash Flow Plaintiffs present the entire theatrical box office revenue number will be known in the same month the movie would be released. They also state that the total DVD/Broadcast revenue would have been generated a near 3 months after the theatrical release, and the Foreign revenue would be totaled out 5 months after the theatrical release.  This simply is not how the complete release cycle works.

The Theatrical, Home Video, Pay TV and Free TV channels are referred to as “windows” of distribution through which a film can be sold.  There is a sequential nature to these windows, with each channel of distribution having an exclusive period of time within which the movie is released through that channel.  These windows are sequential in that a motion picture is generally released in theaters before it becomes available on DVD, and then later becomes available first to pay TV platforms, and finally to free television.  Depending on the contract terms with each sub-distributor, it can take from 3-9 years to complete a film’s distribution cycle.

4. Misrepresentation in Warranties and Investor Deck.

Story Rights: Producer had not paid for the Underlying Story Rights for a NY TIMES article that was the catalyst for the screenplay. Potential for a lawsuit against the Film.

Music Rights:  Defendants initially viewed a copy of the Film with a soundtrack that included cuts from well-known musical artists.   The music not only added to the entertainment value of the film, but the marketability of the film was heightened due to the recognizable names in the sound track.  However, after signing the Agreement, Defendants found out that the music rights had not been cleared/licensed and that new music needed to be placed into the film.  Potential for a lawsuit against the Film.

Cast: The Project Summary of the Deck listed “Cast” with well-known names inferring that those actors were the leads in the movie and that the audience could expect to see them throughout.  In fact, those well-known actors all had small or supporting roles in the film and had less than 20 minutes screen time each. The actual lead of the film, and the friends that she hangs out with were all unknown actors, rendering the “Cast” description in the deck misleading and fraudulent.

As you can see, the producers misled the investors in their initial conversations and presentations, and induced the signing of the investment agreement with false representations.

The case went to a jury trial, and although they acknowledged that the Defendants had signed an agreement to put up an $8 Million investment for Prints and Advertising, the jury found that the misrepresentations and withholding of vital information were so egregious that they found in favor of the Defendants on all counts.