Hollywood docket

By Neville L. Johnson and Douglas L. Johnson

In the entertainment industry, highly desirable producers, directors, writers and actors are often able to negotiate for “backend” profit participation on projects. These profit participants share either in the gross or net receipts of a given project or receive a deferment, i.e., a lump sum payment when the receipts of a film reach a pre-negotiated level. Deals based on “gross revenues,” traditionally reserved for highly desirable talent, are increasingly uncommon, with the majority of profit participants receiving a share of “adjusted gross” or net receipts, where many deductions are made. It has been estimated that less than 5% of productions “earn out” and go into profits. Six studios—Disney, Sony/Columbia Pictures, Paramount/CBS, NBCUniversal, Warner Bros., and Twentieth Century Fox (the Studios)—control the entertainment industry and wield enormous power in negotiating contingent compensation contracts with talent. Yet for those players fortunate enough to obtain the right to receive contingent compensation, the Studios have created serious impediments to hinder profit participants from obtaining fair accounts for the fruits of their labors. 

First, while contingent compensation contracts typically include accounting and audit provisions, the Studios make auditing as onerous as possible. The Studios always require forensic auditors to sign strict confidentiality agreements before commencing an audit. They claim they do this because the business is competitive, but auditors and the plaintiffs’ bar believe it is done to ensure that other profit participants (sometimes ones on the same property) will not discover the Studios’ unfair practices. This is underscored by the general practice that when “errors” are discovered and/or adjustments are made, the Studios do not necessarily correct the error retroactively or going forward for other profit participants on the same property or as to other properties where there may be similar wrongdoing. The confidentiality requirement allows this practice. An auditor may represent two clients on the same property but cannot tell either what he or she has learned from each respective audit. Consider this real situation: An auditor concluded an audit for a producer and later for an actor on the same television show. The auditor could not advise the actor what he learned in the first audit. Further, this may cause the audit to be cost prohibitive for the actor. Sometimes the Studios will permit joint audits.

Virtually all agreements restrict access to audit records covering an incontestable time period and incorporate artificial “contractual” statutes of limitation to make objections and file litigation. Agreements often contain clauses that waive punitive damages and/or injunctive relief to try and knock out otherwise legitimate claims. While these contractual limitations are usually upheld, some courts have found these provisions unenforceable where they are held to be unreasonable. At least one court has ruled that such a provision was barred because the talent could not possibly know an audit was warranted.1

The Studios have a reputation for refusing to provide documents to auditors on many types of data sought, including “overall deals” of various kinds, such as pay cable, Video On Demand (VOD), Subscription VOD (SVOD) and Electronic Sell-Through (EST) deals, for example, which could lead to the discovery of unfair allocations in connection with those agreements or other monetary hanky-panky. One studio, Universal, even has a “policy,” where the studio refuses to provide talent with copies of their own contracts where the talent has misplaced or lost the originals, so that lawsuits must be brought to obtain the same.

The Studios sometimes prevent auditors from doing more than one audit at the same time and/or from working on a contingency basis (although they may allow auditors to audit for the same project, but require a “Chinese wall” to be erected between or among the talent). Some agreements provide that the auditor must be approved by the studio, and from a “nationally recognized firm.” The problem with this is that there are only four major profit participation auditing companies, all based in Los Angeles. Moreover, one should be able to pick one’s forensic accountant, just as one should be able to pick any other professional, such as a lawyer or a dentist. At least one studio has asserted that auditors who leave firms it previously allowed to audit because they are “nationally recognized” are not qualified when the auditors set up on their own. This egregious “rule” means that, as the other auditing companies “age out,” the pool of authorized auditors will become even smaller, making auditing all the more difficult for talent.2

 

Auditors complain that the Studios intentionally under-staff the audit departments so that even when audits are granted, they can take three or more years just to be scheduled and take even longer to settle. Most audits settle because working talent is understandably fearful of being blackballed. Aging talent and heirs of talent are not so intimidated, except by the cost involved. It is not uncommon for audits to cost talent tens of thousands of dollars and talent-imposed attempts to limit the costs of a particular audit can expose talent to certain risks associated with failing to conduct a diligent audit. 

For years, the biggest issue facing talent has been mandatory arbitration provisions. In nearly all agreements entered into during the last 15 years, the Studios have almost uniformly required that any controversies be heard in a confidential, binding arbitration, before one provider—JAMS—and thus preventing the establishment of precedent and any of the publication of information unfavorable to the Studios. These arbitration agreements are invariably “non-negotiable” when deals are made (even for top talent), because the Studios are fearful of juries, public judges and the public disclosure of any wrongdoing. Since Buchwald v. Paramount Pictures Corp.3 when Eddie Murphy dubbed net profits “monkey points,” and generally the public was advised that net profits were usually illusory, the Studios have since referred to them as “contingent compensation” in an attempt to limit any expectation or presumption such monies would be forth- coming.

A recent article, echoing what many representing tal- ent believe—Nessim & Goldman, “Mandatory Arbitration Provisions Involving Talent and Studios and Proposed Areas for Improvement,”4 (the Article)—suggests that there is at least a perception of repeat player/provider bias in the current reality of all of the Studios requiring mandatory arbitration before one provider. There are but 14 entertainment arbitrators working for JAMS in Los Angeles, and six studios that employ them. Moreover, in 26 contracts the authors reviewed from the six studios, 22 required mandatory arbitration and 21 required JAMS. Kaiser Permanente, which has a market share of 40% of the healthcare market, has long been criticized for a similar practice, as it has its own set of arbitrators and plaintiffs’ attorneys practicing before them believe that any arbitrator who issues a big award against Kaiser will probably never be selected again by that company. Similarly, rule once for serious damages against the Studios, so the argument goes, and that arbitrator will not adjudicate another profit participation case. It is not just repeat business for arbitrations but also for highly lucrative mediations.5

JAMS refused to provide the authors of the Article with any information about arbitrations of talent versus studio disputes in JAMS’ Los Angeles area offices, or involving any of the neutrals in JAMS’ Entertainment Group where the Studios were a party. Thus, it cannot be ascertained as to how frequently a particular studio is involved in a dispute before JAMS, the nature of claims involving the Studios, how often JAMS ruled in favor of the Studios, and what, if any, monetary damages were awarded. There are other worrisome issues, including the methodology as to how neutrals are selected, and that at JAMS many of the neutrals have an ownership interest in JAMS and thus an economic incentive to keep the Studios satisfied.

Further, JAMS provides sample language as to how to effectuate a waiver of punitive damages in a contract. This smacks of bias. In light of what is at least a perceived bias, JAMS (and other providers) provide greater transparency than the minimum and limited requirements of state and federal law. California consumer arbitration rules, which require increased disclosures by the providers and all arbitrators affiliated with them, should apply.6 Providers should also be required to furnish information about how its neutrals are selected, whether its neutrals have heard disputes involving the Studios and their affiliates, and how often its neutrals have ruled in favor of the Studios. Without greater transparency, talent selecting a neutral for arbitration has very little idea as to how a neutral has ruled in prior studio-talent cases, or as to the history of JAMS overall in ruling on profit participations. These facts must be unveiled if there is to be full disclosure.

Add to the foregoing the cost of arbitration, which ordinarily will be in the tens of thousands of dollars. The American Arbitration Association requires a filing fee based in part on the amount of the claim. The fees for a dispute of $500,000 to $1,000,000 is $6,300, and escalates thereafter. If a small amount is arguably owed, talent is priced out of the market on a risk/reward basis, given the administrative costs and the hourly fees charged by ar- bitrators, which range up to $900/hour. A recent engagement in an arbitration, where the fees were approaching six figures for an arbitrator who allowed the opposition to file multiple demurrers, demolished the idea of quick and economic justice, especially when costs of the arbitration are not part of the award. There is no way realistically to challenge the fees of arbitrators, some of whom can be accused of “churning” cases. There are few qualified contingency fee attorneys willing to take on these types of cases, made even more problematic because the Studios habitually do not provide attorneys’ fees clauses in their agreements, which might otherwise be attractive if there was fee shifting.

As part of their policy of discouraging claims being filed against them, the Studios make it as difficult and expensive as possible for talent who do bring a claim. The Studios are prone to hiring firms where “scorched earth” are not dirty words. These tactics also discourage claims by other profit participants.

In arbitrations, discovery is usually limited, sometimes with one deposition per side permitted. This can be prejudicial to talent, as there may be many more witnesses on the studio side who need to be heard.

Recommendations

It would be beneficial to have neutrals selected ran- domly and not just from JAMS, thus limiting the “repeat business” issue, and ensuring a large enough pool and arbitrators who are less likely to be subject to repeat player bias. Moreover, the arbitration tribunal should be required to disclose information regarding all prior talent-versus- studio cases, no matter the studio. 

A database should be maintained by talent-side counsel to share information about arbitrations and arbitrators. Here, the confidentiality requirement would have to be navigated as to what information could be disclosed, but a good start would be to identify the participants.

Another alternative is to litigate the forum issue, which would necessitate a claim that arbitration is procedurally and substantively unconscionable. As the Studios are intractable on this provision, the procedural half of the unconscionability argument might work. It would be helpful if all talent representatives from this point forward confirm in writing to Studio counsel when negotiating deals that the arbitration clause is non-negotiable.

As to substantive unconscionability, challenges should assert that inadequate training of the arbitrators, the “repeat player” effect, the restrictive discovery limitations, the refusal to make full disclosure by the provider and the arbitrator, and the confidentiality requirements so as to eliminate precedent, collectively mandate a courtroom proceeding. The problem for plaintiffs’ counsel is whether and what type of discovery would be required (and allowed) to mount an effective assault, including a serious examination drilling into the repeat player/provider business. This would undoubtedly be expensive.

Furthermore, another problem is who would decide the issue, the trial court or the arbitrator? While the traditional rule is that the court determines the enforceability of an arbitration agreement unless the parties agree otherwise, most arbitration provisions utilized by the Studios (as well as the sample arbitration clauses suggested by JAMS) include a delegation clause that expressly ensures any disputes, including disputes over the formation, existence, validity, interpretation or scope of the arbitration agreement will be decided by the arbitral institution. While several California courts held that such delegation clauses create an inherent conflict of interest for an arbitrator, recent California case law suggests courts only have the ability to get involved when a party challenges the enforceability of the delegation clause itself, and not the arbitration clause as a whole.7

For now, profit participants are unfortunately forced to play by the Studios’ rules in a game that is unfairly one-sided. Hopefully, the system can be changed for the better.

Endnotes

1. See Davis v. Capitol Records, 2013 WL 1701746 (N.D. Cal.).
2. Disclosure: the authors are currently litigating this issue with

Disney.

3. Buchwald v. Paramount Pictures Corp., 1990 WL 357611 (Cal. Supp. Ct.).

4. 22 UCLA Ent. L. Rev. 223 (2015).
5. Some mediators will not do arbitrations, so they will not confront

this potential dilemma.
6.
See Cal. Civ. Proc. Code §§ 1281(a)(3), (a)(4),(d).
7.
See Malone v. Superior Court, 226 Cal. App. 4th 1551 (2014).

Neville L. Johnson and Douglas L. Johnson are entertainment and business litigators at Johnson & Johnson LLP in Beverly Hills, CA.

Reprinted with permission from: Entertainment, Arts and Sports Law Journal, Summer 2016, Vol. 27, No. 2, published by the New York State Bar Association, One Elk Street, Albany, NY 12207.