Today's entertainment law discussion is about "Net Profits" as they exist in Hollywood. This article is a little on the long side, but it can be an important topic in the career of anyone who works on a movie or TV show, so let’s get right to it.
First things first, understand this.
Depending on the contract, Net Profits can be your best friend ... or your worst enemy. And, I would argue, that the percentage is the very “least” meaningful aspect of the determination of whether your Net Profits are worth something or not. Yes, you read that correctly.
First, let’s start with a hypothetical.
A Hypothetical Discussion.
Imagine that you plan to be a Director, and you just graduated from film school. NYU, USC, UCLA, somewhere cool. Congrats!
A month later, you meet two producers and they offer you the opportunity to direct a small feature film. You read the script, and it's 57 levels of wacky past Sharknado. It’s a sci-fi sports flick where Babe Ruth beams into the future to convince the Detroit Lions to become a baseball team. But Babe accidentally signs the Lions up for the NHL, and they win the Stanley Cup using baseball strategy, thus throwing the entire sport’s world into mass confusion for everybody but the Oakland As.
Because you've never been hired to direct a feature film about baseball hockey, you decide to take the gig if you can rewrite the script and if they pay you DGA scale.
So, you meet in a Beverly Hills coffee shop and tell the producers how you feel. "The project seems cool, but the story is unrealistic," you explain. Then you hand them 10 pages of notes and casting ideas. “The way I see it, the team should be the San Francisco 49ers, and they’re going to become a kickball team. Genius, no?”
Two hours of nodding later, the producers agree to change the Detroit Lions to the Cleveland Browns. Everything else will remain the same.
Your Director’s Fee fee will be $15,000 USD plus 5% net profits, and they tell you who the lead actor will be -- their friend Bob, who has never acted before.
You sign the deal.
You didn't have the time or money to hire a lawyer to review the contract, but you don't care. It's your first feature, and besides--the producers agreed to give you 10% of the net profits from the movie, which they increased from 5% after you asked.
If the film hits, you'll be rich. Rock-n-Roll.
So, you pack your bags and fly to Toronto or wherever they got tax credits to work, you wake up early and shoot a lot of weird scenes of Bob pretending to be an Italian dictator peering through a fence at an NFL football team. Somehow, someway, you get the crazy movie done. In fact, you knock their stupid script out of the park.
Post-production becomes a celebration of cinematic excellence. The film gets done, and everyone is hyping.
And then Lightening Strikes.
Then somehow, someway, that kooky film wins Sundance and Cannes. Sales agents buy you stupid-expensive bottles of champagne and fight over the right to sell the film. Next comes a new poster and a major league distributor. Everyone and their brother put crazy money into P&A, and your formerly-little movie makes a huge splash in Hollywood, breaking box office records along the way. You get lots and lots of press, the film makes lots and lots lots of money. People go nuts.
Woah. Grab more champagne...
1 year later...
Your kooky movie is famous, Bob has a new career, and random nerds at college parties everywhere act out your scenes and quote dialogue. Then suddenly, Variety reports the film made $250,000,000.
Your friends congratulate you. Your alma mater brings you in to give a speech. People cheer and cheer. You've made it.
But, where are you, really?
Well, you've already been paid $15,000. It was a pittance, true. But legally speaking, you were paid an agreed-upon sum for agreed-upon services. You're not in a guild or union. Barring fraud, trying to invent a lawsuit that your fee was too low will result in ridicule and courtroom laughter.
But wait!
You have 10% net profits!! Which is the reason you signed the deal. This is GENIUS. It has to be. You haven't seen the money yet, but the producers just bought new homes in Malibu. Bob just bought a Ferrari and crashed it into a Jack in the Box on Santa Monica Blvd. Then suddenly, in the midst of all of that craziness, your net profit statement arrives. Finally. And your statement does not say "zero."
It says less than zero. You are $300,000 in the red.
Technically speaking, you have a ham sandwich.
WTF is going on? How is this possible?
IMPORTANT CONCEPT - NET PROFITS
My friends, please understand one thing. There are a million different ways to name and/or define contingent compensation on a movie. Your contingent compensation may be called "net profits" or "adjusted gross profits" or "gross profits" or "profits" or "distributable cash" or any number of other things.
The key to understanding = the phrase “net profits” only means what the contract says it means.
Ponder this.
A good entertainment attorney can draft a contract that will give you 1% net profits and make you insanely rich if the film hits as described above. On the other hand, that same attorney can draft a contract that will give you 25% net profits and ensure you never see a dime, no matter what.
The point is not to suggest renegade contract drafting by renegade lawyers (it happens), but rather that you cannot know what ANY profit numbers mean until an attorney or very experienced "somebody" takes a good long look at your contract.
Don’t get fooled by contractual smoke and mirrors. There is no standard or universal definition of net profits in Hollywood. There are some basic principles that most producers uphold, but there is no guarantee that your definitions will not differ wildly from your expectations. The only way to know what your "net profits" mean, is to read and understand the definition in your contract. Otherwise, you have no idea what that 10% means. Zero.
Furthermore, a "net profits" definition can be one sentence or 10 pages, depending on the studio. There might even be multiple levels and definitions. If you're working on a film with Spielberg, your net profits definition will differ from his, no?
Point of fact, everyone on a movie may have a different definition of contingent compensation, especially on a studio film.
Accordingly, it is possible in the above hypothetical, your movie could bring in $250 million and you have zero net profits. And you might have to pay your own way to the premiere. And even if your film wins an Oscar, you will still have zero. You will likely have an opportunity to direct again, yes. But what about the net profits from the movie, which might be the most valuable project of your life?
Forget it. Game over.
OK, enough about the problem. Now, let's chat about solutions.
HOW TO AVOID A NET PROFITS NIGHTMARE
First and foremost, Rule 1 - get a good entertainment lawyer to review your contract. Enough said.
Now, let's look past the lawyer answer. Here are a few general big-picture issues to look out for in a contract. This is general info to help you in the initial stages of looking at your contract, not legal advice, nor a substitute for good counsel. But this will get you started.
A. MOST FAVORED NATIONS.
As stated above, you have no idea what your 10% net profits mean unless and until you read the definition in your contract. But if the movie is big enough and/or counsel it is crazy enough, your profit definition could be about as easy to decipher as unlocking an iPhone with psychic powers.
What do you do?
You can hire counsel and he or she can negotiate the net profit definitions.
And/or -- you can use a trick of the trade called a "most-favored-nations" reference. "MFN" for short.
Most-favored-nations is a term of art from the days of people trading spices on big ships, fighting pirates and all that. Basically, the concept is to tie your profit definition to another party on the movie. And if you're smart, a VIP.
There are many variations, but here is a basic example of the contract language:
.... the Producer shall pay to the Performer TWO POINT FIVE PERCENT (2.5%) of the “Net Profits” of the Picture. Statements of account and the associated Net Profits, if any, shall be paid at the same time and calculated and defined in the same manner as for the lead producer of the Picture.
See what just happened?
There are 100 different ways to word it, but suffice it to say, I just tied your profits definition to the lead producer -- who will have the best definition on the film, because he or she (or their lawyer) came up with it. So, instead of negotiating a definition, jump on the bus with a VIP such as the lead producer, an executive producer, the director etc.
When that VIP receives any profit from the movie, so will you. Genius, no?
You can also add language that ensures there will be no more favorable contingent compensation on the film, regardless of what that term is actually called in anyone's contract. Producers won't agree to add this unless: (i) you're an A-list star; or (ii) they only have one definition of net profits; or (iii) they know with 100% certainty no one will have a better profit definition than you.
B. FINANCIAL STATEMENTS.
Beyond your profits definition, you need a provision that addresses financial statements. Because if you don't, you're at the mercy of the producer as to when and you’ll get “anything" concerning your net profits. Which may be never (it happens).
There are many ways to word this, but here's a basic excerpt:
Within ninety (90) days after the last days of March and September of each year, the Producer will prepare and furnish semi-annual statements to the Director hereunder, and each Statement shall be accompanied by payment of all royalties due thereby.
C. AUDIT RIGHTS
OK, cats, a mission-critical concept. If you don't have audit rights in your contract, you have no legal right to look at the financial records. Read that 2x. Because if the producer won’t cooperate, the only way to look at the financial records from the film will be via a lawsuit. Which will suck, one way or another.
Here is a basic example of audit rights:
Accounting records relating to Net Profits shall be available for audit on thirty (30) days notice, at reasonable times during business hours at the Producer’s principal place of business, to a duly authorized person or firm acting on behalf of the Performer. Said audit rights shall not be exercised more than once in any twelve (12) month period, and only with respect to new activity reflected in statements received by the Performer within one (1) year prior to the commencement of the audit.
D. PAYING FOR THE AUDIT?
And finally, if you audit someone who should be paying you royalties or net profits, and the books are way off, you shouldn't have to pay for the audit. There are many ways to word this, but here is a basic excerpt:
If an audit reveals that the Producer underreported any item bearing upon the computation of amounts payable to the Contractor by five percent (5%) or more, the Producer shall, in addition to re-calculating and making payment of the amounts due based on the actual and true items, pay the Contractor's actual out-of-pocket audit costs.
CONCLUSION
You cannot know anything about your "net profits" (whatever they are called) on a movie -- unless and until you read and understand the definition in the contract. Tying your definition to VIPs on the movie is one way to mitigate risk.
For more information about film finance, check out my article - A Simple Guide to Financing an Independent Film with Private Equity.
I enjoy helping filmmakers. If you need counsel, give me a shout.
Thanks for reading
Lee