HD&Co. A BRIEF HISTORY OF PROFIT PARTICIPATION

The motion picture industry, as we know it today, is relatively young when compared to other major United States industries. The advent of the talking motion pictures in the late 1920’s created a dynamic new industry that was centered in Southern California for production activity and New York City for financial activity. A fundamental business concept of the industry was the development of the star system whereby studios retained the services of actors and actresses over a number of years under a contract system. These stars almost immediately became household names to the American public and attracted huge audiences to the theaters. These performers, however, worked under a strict weekly salary arrangement whereby all profits earned by the motion pictures they performed in were retained by the studio employer.

In 1936 this system began to change. When Groucho Marx agreed to star in the motion pictures Night at the Opera and Day at the Races, he agreed that his compensation would be 15% of the gross receipts derived by his employer who at the time was MGM Studio. This agreement proved most lucrative to Groucho Marx and later to his heirs. Although the MGM Studio’s film library was acquired by Turner Entertainment in the 1980’s which in turn was acquired by Time-Warner in the 1990’s, the participation payable to the heirs of Groucho Marx continued unabated.

Just preceding World War II through the 1940’s the star system was beginning to crumble. In the 1950’s major performers and directors would no longer sign long-term contracts with the studios; generally contracts were negotiated with the talent on a picture-by-picture basis. The early 1950’s directors and stars such as Cecil B. DeMille, James Stewart and William Holden were able to negotiate a participation in the net profit derived by the films in which they directed or starred. The net profit definitions provided for the deduction from gross receipts of specified expenses and fees to the studios before any net profits were reported. Despite these restrictions, many of the early films such as The Ten Commandments, Samson and Delilah, Winchester 73 and The Bridge Over the River Kwai reported significant net profits resulting in large payments to the profit participants. When the studios recognized that substantial sums were being paid to the profit participants, changes were effected in the standard net profit definitions which in many cases made it almost impossible for net profits ever to be reported.

In the 1980’s and 1990’s, as major directors and stars such as Paul Newman, Robert Redford, Barbra Streisand, Jack Nicholson, Dustin Hoffman, Harrison Ford, and Steven Spielberg rose to international fame, they insisted that their profit participation be based on a percentage of gross receipts only. Since this type of talent has significant power and studios felt that their involvement in the motion picture was essential, these gross participations were reluctantly granted and the participants derived huge sums therefrom. Still, the vast majority of profit participants was subject to the studio net profit definitions. For them, the net profit reported was Less Than Zero.

Art Buchwald, the nationally known humorist, obtained a net profit participation in the motion picture Coming to America because of an idea he presented to Paramount Pictures which was used as the basis for the story line of the motion picture. This picture was released in 1988 but by 1990 the net profit statement issued to Art Buchwald still showed that the motion picture’s profits were substantially Less Than Zero. In 1990 Art Buchwald sued Paramount, stating that the net profit definition employed by Paramount was unconscionable and should be changed by the court. The court agreed with Mr. Buchwald and eventually awarded him $900,000 as damages which was immediately appealed by the studio. The case was subsequently settled between the studio and Buchwald but the terms of that settlement were never made public.

In 1996, a lawsuit was instituted by Jeffrey Katzenberg, a former executive at The Walt Disney Company, claiming that Disney deprived him of his fair share of the net profits as set forth in his employment contract. After a long and acrimonious feud between Katzenberg and Michael Eisner, Disney’s chief executive, over the valuation of a 2% bonus based on past and future profits of all films and television shows produced while he was at Disney, Katzenberg in 1999 was awarded a settlement reputed to be about $275,000,000.

With vertical integration, whereby the studios are acquiring their own distribution channels including broadcast networks, cable channels, and television syndication stations, come allegations by actors and producers that their films and television series are being sold at below-market prices to the affiliated entities. The self-dealing results in revenues which would otherwise be shared with the actors and producers that remain within the studio’s empire in the form of cost savings and increased profits to the studio. A rash of lawsuits was filed in the late 1990’s and early 2000. Wind Dancer Productions sued Disney, alleging that Disney offered Wind Dancer’s hit television series Home Improvement to ABC at below market prices after Disney acquired ABC in 1996. In separate lawsuits, Alan Alda sued 20^th Century Fox over M*A*S*H, David Duchovny sued Fox over The X-Files, Langley Productions, Inc. sued Fox over Cops, and Steven Bochco sued Fox over N.Y.P.D. Blue, all alleging that Fox licensed their television series to Fox’s affiliates including the Fox broadcast network and FX, Fox’s cable network, without seeking competitive bids and at below market value. Some of these cases have been settled but others are still pending.

The traditional channels of distribution are currently being challenged by the Internet. The music website Napster permits users to digitally download their choice of songs by their favorite artists at no charge. This challenges the traditional brick and mortar distribution system utilized by the major record companies. Although the courts are trying to shut down Napster, other websites are appearing that provide the same kinds of free access to music. The idea of a subscription model under which subscribers will pay a monthly fee is being considered as a possible solution. Once the market develops, the potential exists for artists to share in new streams of revenue such as advertising income and to restructure their existing royalty agreements with the major record companies, which typically provide for deductions such as container and packaging costs that have no bearing in the digital market. The new technology also provides artists increasing opportunity to produce their songs independently without the intervention of the record company. The role of the record company may evolve into that of a marketing partner with the artists, thereby increasing the opportunities for profits the artists can command.

Whereas in the past most profit participation disputes were resolved through strenuous negotiations between the participants and the studios, now more and more disputes are going through the formal litigation process. As the motion picture industry has grown to be part of vast entertainment conglomerates, the business disputes that heretofore were resolved through negotiation are now more and more the subject of much contentious litigation.

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