Question:

In simple non-specific terms, if an investor contractually agrees to provide funding for a movie in exchange for certain profit participation, and subsequently reneges upon that agreement by failing to deliver said finance, thus leaving the film only able to finish by seeking alternative funding, what rights to the finished film will the reneging investor retain if any? Does a breach of contract provide entitlement to the filmmakers to seek reparation in the form of damages?   

Answer by Brandon Blake, Entertainment Lawyer:

There is no more important issue facing independent producers than how to successfully arrange investor financing for a film or television project and the renewed IRC Section 181 tax deduction for film and television productions is bringing fresh interest from private equity investors. Not only was Section 181 extended again through December 2016, but for the first time live theatrical productions are also covered by the IRC Section 181 tax deduction.

I am not sure what structure you are using to raise the investor financing, so I will discuss a few different options for what can happen when investors renege on investor financing. There are two main questions above: First, what rights will the investor keep in the project if the investor does not deliver financing, and second, what damages can the producers pursue against the investor.

The investment structure will determine what happens to the rights in the project if an investor leaves, and what liability the investor will face. The following structures would each have different consequences on these two questions.

Development or Production Offering: If a producer has set up a development or production offering with the intent of relying on the Section 181 tax deduction, the producer should file for exemption from registration with the SEC and each of the states where investors reside. If the offering paperwork is set up correctly, the investors will not get any interest in the underlying rights to the film, and the investors failure to provide the funds will be a straight-forward matter of cancelling the subscription agreements. No rights will transfer to the investors.

Moreover, there really should not be a problem with investors reneging, because the offering cannot close until the producers raise the minimum. The investors will not be granted any interests until the check or wire transfer has cleared. There would be no liability for the investors either, because only by signing the subscription agreements and sending payment can the investor make a binding pledge of funds to the film or television series. Most states allow a 5-day period after that to cancel the subscription, after which time the investment becomes irrevocable.

Co-Production: In a co-production situation where both companies are in the film or television business, it will depend entirely on the terms of the co-production agreement. In general, if the financing was one of the conditions of the co-production agreement then if the financing is not raised, the rights will simply transfer back to the producer. Regarding investor liability, that liability should be specified in the contract, and if the contract is breached, then both compensatory and punitive damages may be available to the producer.

Investment Contract: The investment contract can be problematic in this situation for a couple of reasons. If the investor is a private individual and not a company that is in the business of financing feature films, then the investor is owed the SEC and State disclosure statements. The SEC also requires certain financial statements and informational filings about the issuer, and the state where the investor resides will also usually separately require much of this same information.

When an investor is only provided an investment contract, the investor typically has the right under federal and state securities laws to renege on the investment. So in this case, there might not be any liability at all for the investor breach. The investor can easily raise the issue of insufficient disclosures, or even make a claim against the producer for securities fraud, in order to get out of the investor’s commitment.

Investment LLC or Partnership: Once the investor becomes a member of the LLC or partnership that investor will have an interest in the rights of the film, regardless of whether or not the investment funds have been transferred. There should be some way specified in the operating agreement for removing members, although such action might require a majority or unanimous vote of the members.

Much like the investment contract mentioned above, when the producer sets up an LLC or partnership with the intention of raising investment money for a film or television show, the investor often does not receive the required SEC and state disclosures. So for private investors, there may be no liability at all for reneging on the investment. In many ways this is the worst way to set up a film or television investment.

There can be reasons to set up an arrangement like this, and sometimes when both parties are sophisticated investors it makes sense, but there is nothing in the basic structure of the LLC that will protect the producer from an investor who does not deliver on the promised funds.

The renewed IRC Section 181 tax deduction has given a huge gift to producers who missed out in 2014 on starting a fully tax deductible production. If producers set up a compliant offering and shoot at least 1 day of principal photography this year, the deductibility of the production can continue on into 2017 or longer, provided the photography continues in the ordinary course of production. A development or minimum/ maximum offering will allow the initial funds raised to start production, thereby locking in IRC Section 181. The best way to avoid issues like the ones discussed above is to set up an offering, protecting both the investors and the producer.

As with any entertainment matter, please do not make a decision about complex matters without consulting an experienced entertainment lawyer first. I have been representing feature film projects and television series for more than 16 years. Please feel free to contact my office about a quote.

- by Brandon Blake, Entertainment Lawyer