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Less Than Zero
Studio Accounting Practices in Hollywood

By Joseph F. Hart, Esq. and Philip J. Hacker, C.P.A.

continued from page one

Not surprisingly, any number of these accounting practices have been the subject of legal challenge. Perhaps the most basic weapon available to the profit participant is a claim for breach of contract, on the theory that the studio has failed to account properly under the express terms of the SPD. These claims can be broken down further into two major categories: (1) failing to properly itemize an element of cost or income under normal accounting practices, usually a clerical reporting error, and (2) interpreting the SPD in such a manner that favors the studio over the participant. The studios usually make prompt adjustments to resolve the first category of claims. Claims in the second category, however, invariably result in protracted negotiations, or ultimately, litigation.

The second category of breach of contract dispute arises as a result of the studio interpretation of the SPD. Studios will invariably interpret the SPDs in a manner most favorable to their position vis-a-vis the participant, while the participant may find that some of the studio interpretations are not justified by the language of the contract. The participant will have the advantage of arguing the basic contract interpretation rule that, to the extent that the SPD is ambiguous, it must be interpreted most strongly against the party creating the ambiguity.(12)

Since the SPDs have been developed over the years by the studio legal departments, there is little room for the studio to argue that it failed to create the ambiguity. Instead, the studio's defense will usually be either that the contract is not ambiguous, or that "industry custom and practice" mandates that the studio's interpretation be followed. This begs the question as to what is meant by "industry custom and practice." In an industry where the studio interprets SPDs in one manner, and the profit participants and their representatives interpret the SPDs in another manner, there is no single "industry custom and practice" which is accepted by all contracting parties. In any event, there is virtually no reported case law interpreting the SPDs, and no reported decision that expounds upon motion picture industry's customs and practices.

The breach of contract challenge to the SPD of Paramount Studios in the Buchwald case revolved around a theory of unconscionability. Art Buchwald and his partner, Alan Bernheim, sued Paramount Studios for breach of a written agreement to pay for the use of Buchwald's treatment It's A Crude, Crude World as the basis for the Eddie Murphy film Coming To America. Buchwald's contract with Paramount called for him to be paid a portion of net profits, using Paramount's SPD. The case was tried to Los Angeles Superior Court Judge Harvey Schneider in three phases. In the first phase, the court found that Paramount had used the Buchwald treatment to make Coming To America; in the second phase, the court found that portions of the Paramount SPD were unconscionable under California law; and in the third phase, the court awarded damages in favor of Buchwald and Bernheim of $900,000, based upon its reformulation of the contract after finding portions to be unconscionable.

The Buchwald court's decision in the unconscionability phase of the trial relied upon the two leading California decisions on unconscionable contracts, Graham v. Scissor-Tail, Inc.(13) and A & M Produce Co. v. FMC Corporation.(14) In Graham, the California Supreme Court set forth a two-step approach to determine unconscionability. First, the court must establish whether the contract is one of adhesion. Second, assuming that the contract is an adhesion contract, the trial court must determine whether enforcement should be denied, either because 1) the contract, or a provision thereof, falls outside the reasonable expectations of the weaker party; or 2) the contract, or a provision thereof, is unduly oppressive or unconscionable, even though it falls within the reasonable expectations of the weaker party.(15)

In A & M Produce Co., the court held that unconscionability had two elements, a procedural element and a substantive element. The procedural element focuses primarily upon the factors of oppression and surprise. Oppression arises "from an inequality of bargaining power which results in no meaningful negotiation and 'an absence of meaningful choice.'"(16) Surprise is a factor where "supposedly agreed-upon terms of the bargain are hidden in a prolix form drafted by the party seeking to enforce the disputed terms."(17) The substantive element of unconscionability is found when the risks of the bargain are reallocated in an objectively unreasonable or unexpected manner.

The trial court in Buchwald made specific findings that the Paramount SPD was an adhesion contract, and that portions of the Paramount SPD were oppressive, and therefore unconscionable,(18) and Paramount appealed. By settling the case before any decision could be issued by an appellate court, Paramount saved itself and the other motion picture studios from a potentially damaging finding which could have resulted in a precedent that many of the clauses in studio SPDs are unconscionable.

Under California law, the issue of unconscionability is a legal issue to be decided by the court prior to submitting any breach of contract claims, which are legal in nature, to a jury.(19) The court is required to hear evidence as to the "commercial setting, purpose, and effect" of a contract in order to decide if a contract is unconscionable in whole or in part. The court has great latitude in formulating relief if it determines a contract to be unconscionable. The agreement may be enforced in whole or in part, and unconscionable clauses may be interpreted in such a manner as to benefit the profit participant over the studio.(20) The Buchwald trial court actually heard the claims for breach of contract prior to making a determination on the issues of unconscionability, a procedure that would presumably not have been available in the event that the plaintiffs had not waived their right to a jury trial.(21)

A more recent case pending in federal district court against all of the major motion picture studios(22), alleges that the SPDs of the major studios are unconscionable and violate California's antitrust laws, as set forth in the Cartwright Act.(23) The lead plaintiff is the estate of former New Orleans district attorney James Garrison, net profit participant under a deal with Warner Bros. for the motion picture JFK. The complaint seeks to certify a class of plaintiffs composed of all "Talent"(24) that has entered into a compensation arrangement with a major studio which contains an SPD from January 1, 1988 to the present. Thus, in addition to the typical demurrers that may be anticipated in any case involving studio accounting policies, the plaintiffs in Estate of Garrison will face the procedural hurdle of class certification.(25) Assuming that a class is certified, the lawsuit represents perhaps the most serious challenge to date to the major studios' use of SPDs.

In addition to breach of contract, a profit participant may assert a claim that the studio has breached a fiduciary duty to properly account for monies. While in an ordinary contract no fiduciary relationship is created, the contract between a profit participant and studio may in fact create such a relationship, because the studio collects all of the monies from the exploitation of the film product, and is obliged to share in the profits from the exploitation with a profit participant who does not have any involvement in the distribution and collection efforts.

In the case of Waverly Productions, Inc. v. RKO General, Inc., the court noted that a motion picture studio, while not a fiduciary for all purposes, has at least the limited fiduciary duty to properly report to a profit participant for monies received in the course of distributing a film(26). Asserting a claim for breach of fiduciary duty gives the profit participant some additional leverage because the claim sounds in tort as well as contract, and can support an award for punitive damages if the plaintiff can prove wrongdoing by clear and convincing evidence.(27)

Another potential claim, although it has not been asserted in any published decisional, is that the SPDs employed by the major studios constitute an illegal restraint of trade under state or federal antitrust laws. Broadly stated, the Sherman Antitrust Act prohibits all monopolies, contracts, combinations and conspiracies in restraint of trade.(28) Similarly, California's Cartwright Act prohibits any "combination of capital, skill or acts by two or more persons" that "create or carry out restrictions in trade or commerce", or that fix prices so as to preclude free and unrestricted competition. The California courts have held that cases interpreting the Sherman Act are applicable in interpreting the Cartwright Act.(29) Antitrust laws can be a powerful tool because a plaintiff prevailing under either state of federal law is entitled to recover treble the amount of actual damages sustained, plus attorneys' fees.(30)

As a class action against the major studios alleging antitrust claims under the Cartwright Act(31), it would seem that the plaintiffs in Estate of Garrison would be able to establish fairly easily that the six major studios occupy a position of monopoly power with respect to the profit participants involved. While the studios are likely to argue that any single profit participant is not compelled to sign an agreement containing the SPD with any single studio, it is a fact of life in Hollywood that a net profit participant does not have any meaningful alternative in that respect, because all of the major studios use very similar SPDs. The writer, actor, director, or producer who signs a deal with the SPD is invariably presented with a "take-it-or-leave-it" ultimatum from the studio, because the studio knows that the SPDs of the other studios are similar, and will provide nothing better for the artist.

The more difficult issue confronting the plaintiffs in Estate of Garrison is proving that the studios have acted in concert in requiring adherence to the SPDs. The studios are likely to argue that they have acted independently in imposing SPDs upon talent, and that their actions are a form of "conscious parallelism", rather than a concerted action. The Supreme Court has held that "conscious parallelism", standing alone, is not definitive proof of a conspiracy under the antitrust laws.(32)

The major motion picture studios have had some negative historical experience with the antitrust laws, most notably the case of United States v. Paramount Pictures, Inc.(33), in which the Supreme Court held that a number of the distribution and exhibition practices of the major studios violated the Sherman Antitrust Act, and, inter alia, approved an order divesting the studios from their ownership of theaters. The Estate of Garrison case is potentially as important to net profit participants as the Paramount case was to independent theater owners.

In addition to these broad-based challenges, interest expenses, alone, could be challenged as a violation of the California usury statutes.(34) The studio might well offer the defense that what is called interest in the SPDs is not really interest subject to the usury laws, because no loan or forbearance of funds is involved. At least one California trial court has sided with the studios on that issue, sustaining a demurrer to that portion of a claim based upon violation of the usury statutes, on the ground that no loan or forbearance was involved in a television net profit participation deal.(35) No appellate court has dealt with the issue. And notwithstanding a ruling that the usury statutes are inapplicable, the profit participant still has the argument available that the interest aspect of the SPD is unconscionable, as the Buchwald court, in fact, found.(36)

Whether an appellate court will ever be asked to sort out these issues remains to be seen. As in the Buchwald case, the studios seem intent on settling any dispute out of court before precedent-making law can be issued,(37) and the talent, for the most part, seems willing to go along. So, absent specific direction by an appellate court, disputes over net profits will continue to be resolved between studios and the participants by strenuous and protracted negotiations, and costly and time-consuming litigation.

First Page of "Less Than Zero"


(12) Cal. Civil Code §1654; Victoria v. Superior Court (1969) 40 Cal.3d 734, 745, 222 Cal.Rptr. 1, 710 P.2d 833. The rule of interpreting ambiguities against the drafting party has "particular force in the case of the contract of adhesion." Neal v. State Farm Ins. Co. (1st Dist. 1961) 188 Cal.App.2d 690, 695, 10 Cal.Rptr. 781. In Buchwald, the trial court found that the contract between Buchwald and Paramount was a contract of adhesion, but did not discuss contract interpretation rules, because the issue for decision was whether or not the contract was unconscionable. Fatal Subtraction, Appendix B, at 542-43. The trial court in the Batfilm case, L.A.Sup.Ct. consolidated Cases Nos. BC051653 and BC051654, found that the plaintiffs had presented evidence to prove that the agreement between the plaintiffs and Warner Bros. was a contract of adhesion that should be strictly construed against Warner Bros., but found nonetheless that the contract was not unconscionable. The court also found that the plaintiffs had not offered any evidence as to how they expected certain aspects of the contract to be interpreted. See 16 Entertainment Law Reporter Number 4, at 3-6 (September 1994) for the trial court's opinion in Batfilm.

(13) Graham v. Scissor-Tail, Inc. (1981) 28 Cal.3d 807, 171 Cal.Rptr. 604, 623 P.2d 165.

(14) A & M Produce Co. V. FMC Corp. (1982) 135 Cal.App.3d 473, 186 Cal.Rptr. 114.

(15) Graham, supra, 28 Cal.3d at 819-20.

(16) A & M Produce Co., supra, 135 Cal.App.3d at 486, quoting, Williams v. Walker-Thomas Furniture Company (D.C.Cir. 1965) 350 F.2d 445, 449.

(17) A & M Produce Co, supra, 135 Cal.App.3d at 486.

(18) Fatal Subtraction, supra, Appendix B, at 542-52.

(19) Cal. Civil Code §1670.5; See Legislative Committee Comment -- Assembly 1979 Addition, section 3 (9 West's Annotated California Codes 494 [1985]). Vance v. Villa Park Mobilehome Estates (2d. Dist. 1995) 36 Cal.App.4th 698, 42 Cal.Rptr.2d 723.

(20) Cal. Civil Code §1670.5(a).

(21) The trial court in Buchwald had ordered the trial bifurcated, with the question of whether Paramount's film was based upon Buchwald's treatment to be tried first to the jury, and the accounting issues to be tried by the court in the event that the jury determined liability. Fatal Subtraction, supra, at 218. According to Pierce O'Donnell, lead trial counsel for the plaintiffs in Buchwald, the plaintiffs waived a jury trial after considering that a jury would be more likely to be receptive to the testimony of Eddie Murphy, who was anticipated to be a "star" witness for Paramount, and because they were favorably impressed with the independence and intelligence of trial judge Harvey Schneider. Once the case was tried to the judge, Eddie Murphy never testified as a witness for Paramount. Id., at 228.

(22) Estate of Garrison v. Warner Bros, etc., et al., U.S. District Court Case No. CV95-8328. The complaint names as defendants Warner Bros., Inc., Paramount Pictures Corp., Twentieth Century Fox Film Corp., Universal City Studios, United Artists Corporation, Metro-Goldwyn-Mayer, Inc., Sony Pictures Entertainment, Inc., Columbia Pictures, Inc., The Walt Disney Company, Walt Disney Productions, Inc., Touchstone Pictures, Inc., Hollywood Pictures, Inc., Tristar Pictures, Inc., and the trade organization Motion Picture Association of America.

(23) Cal. Business and Professions Code §16700 et seq.

(24) The complaint defines "Talent" as "the writers, directors, producers and actors whose ideas and skills create the magic on the screen."

(25) The case was originally filed in Los Angeles Superior Court (Case No. BC139282 [Nov. 17, 1995], but was removed to the United States District Court for the Central District of California, under the Labor Management Relations Act Section 301, 29 U.S.Code §185. It has been assigned to Hon. Robert M. Takasugi.

(26) Waverly Productions, Inc. v. RKO General, Inc. (2d Dist. 1963) 217 Cal.App.2d 721, 731-734, 32 Cal.Rptr. 73. Waverly involved a dispute between the producer and the studio/distributor of the motion pictures Enchanted Island and From The Earth To The Moon.

(27) Cal. Civil Code §3294.

(28) 15 U.S.Code §1.

(29) Bert G. Gianelli Distributing Co. v. Beck & Co. (1st Dist. 1985) 172 Cal.App.3d 1020, 1042, 219 Cal.Rptr. 203; Marin County Bd. of Realtors, Inc. v. Palsson (1976) 16 Cal.3d 920, 925, 130 Cal.Rptr. 1.

(30) Cal. Business and Professions Code §16750(a). (Cartwright Act). 15 U.S.Code §15(a). (Sherman Act). The availability of attorneys' fees in an antitrust claim is significant, because it avoids one of the problems involved in most claims involving net profits, namely, that the SPDs do not contain a reciprocal attorneys' fees provision, and profit participants must usually bear their own attorneys' fees, even when they are successful.

(31) Estate of Garrison v. Warner Bros, etc., et al., Los Angeles Superior Court case no. BC139282; see text at notes 13-16 supra.

(32) Theatre Enterprises, Inc. v. Paramount Film Distributing Corp. (1954) 346 U.S. 537, 541-43, 74 S.Ct. 257, 260-61.

(33) United States v. Paramount Pictures, Inc. (1948) 334 U.S. 131, 68 S.Ct. 915, 92 L.Ed.2d 1260.

(34) California Constitution, Article 15, Section 1 provides that the interest rate for a loan or forbearance of any money "shall not exceed the higher of (a) 10 percent per annum or (b) 5 percent per annum plus the rate prevailing on the 25th day of the month preceding the earlier of (I) the date of execution of the contract to make the loan or forbearance, or (ii) the date of making the loan or forbearance established by the Federal Reserve Bank of San Francisco on advances to member banks. . . ." California Civil Code Sections 1916-1, 1916-2, and 1916-3, uncodified provisions of Stats. 1919, p. lxxxiii, provide further limitations upon the allowable interest rates which may be charged, and provide treble damages for interest improperly charged.

(35) DeGuere v. Universal City Studios, Inc., Los Angeles Superior Court case no. BC 061389 (Aug. 4, 1992). The case involves a net profit participation contract on the long-running television series Simon & Simon, brought by writer-producer Philip DeGuere. Under Universal's accounting methodology, interest on production costs totaled $76,371,441 through June 30, 1994. This has resulted in a deficit of $62,723,795 being reported to DeGuere, on reported gross receipts of $317,330,941.

(36) See Carboni v. Arrospide (1st Dist. 1991) 2 Cal.App.4th 76, 2 Cal.Rptr.2d 845, applying the doctrine of unconscionability to a loan transaction which was exempt from the usury laws because the lending party was exempt from application of the usury laws by reason of being a licensed real estate broker.

(37) According to the authors of Fatal Subtraction, Lew Wasserman, then chairman of MCA/Universal, told friends that Paramount should not have allowed the Buchwald decision to happen, and "should have paid Buchwald the five dollars" (meaning $5 million). Fatal Subtraction, supra, at 470.

Copyright 1996, Philip J. Hacker and Joseph F. Hart

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About Joseph Hart & Philip Hacker

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