Doyle Lonnegan: Your boss is quite a card player, Mr. Kelly; how does he do it?
Johnny Hooker: He cheats. – THE STING written by David S. Ward.
Over the past couple of years, Pierce Law Group LLP has developed an expertise in representing innocent producers and investors who have been scammed by shrewd thieves who present themselves as the answer to our clients’ filmmaking dreams.
— “My money is burning a hole in my pocket! Close this deal now! Match the funds! The process for how my funds come is complicated but it works!”
— “We’ll prepare the budget. We’ll contract for all the equipment. You just need to focus on the creative and we’ll handle the business stuff!”
— “Look at my long list of credits. Why would you need to actually speak to anyone I worked with on those films who can attest to my abilities?!”
— “Completion bonds are a waste of money!”
— “Lawyers are a waste of money! Plus we have no time for lawyers — if its not done now the deal is over!”
— “Private placement offerings are a waste of money!”
— “We can’t disclose the other sources of financing because of a non-disclosure agreement!”
— “I thought we were friends! You’ve got to be willing to trust me!”
— “I’m horribly offended that you would not trust my word and insist on due diligence!”
— “Let’s not over-lawyer this!”
Below is a summary of some common mistakes which can land investors in business with conmen (or at very least, with careless producers that place investor money at risk):
Common Mistake One: Failure to Research Company and its Individuals
There is no substitute for good old due diligence. Investors should research every company and the individual connected with the proposed film production.
— Ensure the company is a bona-fide company in good standing as either a LLC or corporation on the Secretary of State website in the state in which it claims to be organized and that the official name of the company is as it appears in the State records.
— Research the company and individuals online. IMDbPro.com is essential. However, a long resume of films does not mean the individual is on the legitimate— in fact, some of the biggest conmen have the longest resumes. Investors need to do more than just see the films. Investors need to contact individuals tied to those films to inquire as to whether the named executive producer responsible for financing and the particular line producer responsible for budgeting the film actually conducted themselves in an above-board and honorable manner. A quick “party name search” on the LA Superior Court website, as well as the court websites of other jurisdictions where you know the company or individual does business, can uncover past disputes.
True Story: An indie writer/producer who raised money from friends and family hired a seasoned line producer because of his impressive IMDb resume, which included working as a line producer for a famous actress on her self-financed/self-produced independent film. Had the indie producer taken the time to reach out to that actress (or at very least her representatives or other key crew members), the indie producer would have discovered that the particular line producer actually stole from that actress and ruined the production. Even if that actress refused to comment, that refusal would have been illuminating and provided more insight than simply assuming that that actress was happy with the work.
Common Mistake Two: Failure to Fully Understand and Research the Interrelation between Parties
A prudent investor should know the identity of all of the companies and key players connected to a film project, and not just rely on the one individual with whom they may be directly dealing. A good way to ensure that everyone is familiar and comfortable with one another is via an “Interparty Agreement” — this agreement sets forth what each party is bringing to the table, how they are involved with the project, and where they sit in relation to all other parties in the “revenue waterfall” (i.e. the order distribution of revenues in the event revenues are realized).
True Story: An individual financier provided a gap loan with the following terms: in exchange for a $5 Million loan to keep the film afloat until a primary bank loan closed, the financer would receive $6.5 Million payable when that bank loan closed. However, as part of the deal, if the bank loan was not repaid within 18 months, the individual financier (via a letter of credit guarantee given to the bank) would be responsible for paying back any remaining unpaid portion of the $5 Million loan, plus interest, which was not recouped from the proceeds of domestic distribution from the film.
This would have been a prudent gamble given the strength of the film. However, the individual financier never did a full search on the copyright of the project and failed to use an interparty agreement, which would have revealed how the producer/borrower was truly interrelated to other participants tied to the film. The individual financier felt that if the bank was comfortable with the loan and the method of return from domestic distribution, then the individual financer could be equally comfortable. The financier believed the producer/borrower when he advised the financier that an interparty agreement was simply the individual financier’s attorney trying to rack up a bill and engage in over-lawyering. “After all,” claimed the sly producer, “if the bank is comfortable with the method of repayment via domestic proceeds, you should be as well.”
It was later discovered that while the producer/borrower was a producer on the project, he did not have the right or authority to assign domestic distributor proceeds to repayment of the bank loan. And since the bank lender had a letter of credit guarantee from a high net worth financier, the bank had no reason to engage in the due diligence which the high-net-worth financier assumed had been done.
That producer, with the long IMDb track record, had an outstanding judgment for a similar fraud perpetrated against high-net-worth individuals in Arizona. Even worse, that producer is still out there and no doubt touts his successes and level of trustworthiness by pointing to the films he’s been a part of and the successful people he’s been tied to.
Common Mistake Three: Reliance on So-Called “Finders” and Lack of Understanding of Securities Laws
The film industry revolves around relationships. It also revolves around “aggregators.” For example: Content aggregators bundle similar projects and utilize their relationships to sell similar content to buyers that they know will like that particular niche. Television syndicators utilize aggregators of bartered commercial time from multiple markets to monetize those ad barter deals based on their relationships with advertiser. Tax credit aggregators bundle together those looking for tax credits and introduce them to those desiring to sell off those tax credits. There are also finders that shop great projects for sale to producers and finders that can introduce producers to co-production joint venture opportunities with active investor financing money or to sales agents tied to sophisticated lenders.
Generally, all of these types of finder deals are legal and the contract terms can be readily agreed upon by negotiations. However, a finder who has no ownership interest in the production company itself, and is contracted to introduce passive investors to the actual owners of the production company, is acting within the very definition of a “securities broker.” Unless that individual finder has a bona-fide securities broker license, his actions are criminal. Moreover, the unsuspecting producer that hires that finder can be jointly culpable for such criminal behavior.
The fact that so many in the film industry rely on so-called finders of money for their film has created a mistaken folklore that, somehow, the rules governing securities’ brokers/dealers in all other industries doesn’t apply to the entertainment industry. That assumption is mistaken.
True Story: A producer hired a finder to raise money for a film. The finder ran a “boiler room solicitation” scam and told an unqualified, unsuspecting investor that the film was going to star celebrities who were, in fact, not attached to the film. The federal authority arrested the finder and desired to arrest the producer, but did not, only because the producer had never signed the finder’s contract and emails supported the notion that while the producer was considering using the finder, the finder actually jumped the gun and began his boiler room solicitation before actually being contractually attached, or even informally retained by the producer.
Common Mistake Four: Producer’s Failure to Provide Full Disclosure to Investors
Federal and state security laws protect investors. Public offerings require extensive paperwork and rule-compliance, which most independent filmmakers cannot afford to undertake. Private placement offerings permit an easier method of compliance, but, nonetheless require the producer to disclose all material information that a reasonable prudent investor would desire before rendering an investment decision. Producers that simply copy the PPO of another film and believe that it will be sufficient for their film can run into significant problems if that prior PPO fails to disclose the unique circumstance confronting their own particular film.
The full disclosure rules have now also been adopted with some modification for equity based crowd funding which is a radical change from the old clear cut distinction between a public and private offering. Equity Crowd Funding authorized by the relatively recent passage of the JOBS Act has led to 2 types of cons.
First, there is the traditional con of producers promising more than they should and not disclosing all material information. But, there is also now the potential con by so-called “internet trolls” who may seek to invest in a producer’s film. Where these investments were once only available to friends and family and those whom the producer had a pre-existing relationship, the producer has no way of knowing with whom he/she is dealing in these cases.
A Story Certain To Unfold Soon: Under the Private Placement structure, a producer has a better understanding of who is giving him or her money. You can readily accept Aunt Annie’s money because she is a qualified investor and you know and trust Aunt Annie. But you can also decide to turn down Uncle Ernie’s money because even though he’s qualified to invest, everyone knows Uncle Ernie is a jerk and likes to file lawsuits against anyone. But, with the new Equity Crowdfunding, you don’t have the ability to gauge each potential investor. A troll could invest a small amount, wait for the film to not achieve a profit, and then bring a class action on behalf of all investors under a 10(b)(5) securities violation based on a failure to disclose all material information that a reasonable investor would want to know — and after the fact, it’s pretty easy if someone is litigious enough, for them to make a claim that something was omitted.
Common Mistake Five: The Indecipherable Complex Loan
Fans of the Popeye cartoon are familiar with Wimpy’s classic con in which he obtains free meals by soliciting assistance from unsuspecting individuals with a promise to “Gladly pay you Tuesday for a hamburger today.” An age-old film loan scam applies this same con artist principal. The pitch is always the same and despite this con’s existence for well over 20 years, desperate filmmaker has difficulty avoiding the lure of this illegitimate offer.
True Story: The representative of the private lender tells you the producer that they want to lend you all of the money necessary to produce your film, but you need to first contribute $X dollars into an escrow account that can only be controlled by the private lender. Often the escrow term includes an escrow fee that isn’t refundable even if the money is returned for reasons unrelated to the producer’s failure. In any event, the private lender tells you that this transaction needs to occur immediately with little time to consult lawyers or negotiate terms.
The reason for rushed closing is always blamed on some hard to understand banking principal or tax deadline — i.e. if the lender does not immediately invest the money they will lose the money. Often they haven’t even read the script or required detailed budget breakdowns, which have been vetted by their own experts. Rather it all about getting you to pay something today for a promise of them matching or paying more tomorrow.
These lenders do deals that no other well established film lender will make, but they claim to have a different business model. Also, they give you the name of five other producers who are currently being funded this same way, and if you don’t sign the deal now, the fund may have to withdraw their offer to you because their money is in such high demand.
There is something so alluring to producers about this deal that the con is run over and over again in different variations and incarnations. Sometimes the money received from one filmmaker is used to make good on the money the lender promises to another filmmaker in a classic Ponzi scheme—allowing these lenders to have temporary credibility while enlarging the amount of money they take in.
Another variation has the loan racking up high interest rates with a payback due sooner than the normal time period for which revenue returns from the film’s distribution could be expected. If payback on a portion of the loan is not made to the lender even while the film is still in pre-production, then the lender need not make any further disbursements of the loan and, in fact, can call in the entire outstanding amount and take over the copyright of the producer’s film before production even began.
Common Mistake Six: Failing To Insist on a Completion Bond or Assigning Your Own Educated Executive to Monitor Investor Money
While completion bonds may be costly, there is a reason why every sophisticated investor demands them. Completion bond companies ensure the budgets really are bona-fide budgets which are properly funded. They also ensure that producers and key crew members are qualified and capable to produce the film on time on budget.
In the event a completion bond simply cannot be obtained for the size budget or other such reasons, a smart investor will insist on having a trust key person on set for the sole purpose of monitoring the production and protecting the investor’s investment.
A sophisticated investor should also carefully research and have approval power over the film’s production account, line producer, and production counsel. A weak or non-observant individual in any of these three positions is likely to wreak havoc on the productions in terms of cost overruns.
Common Mistake Seven: Believing Attorneys Are Not Needed or Believing All Attorneys Are Equally Knowledgeable and Skilled
Film finance transactions are incredibly complex. And like a cartoon boat that springs a new leak just when you plug the last leak, there are always new possible issues that need to be addressed just as one particular issue has been handled. Furthermore, unfortunately, just as many pitfalls can exist when the investment amount is $200,000 as when it is $2 Million. Yet the people that can least afford the loss are often the people who are least likely to pay for the proper legal diligence to protect their investment.
Attorney owe a duty of care to competently represent their clients and only take on matters that they sufficiently understand. Film finance attorneys must be well versed in both the laws governing general securities laws, lending laws, and finance issue, as well as intricate aspects of the production process. Not understanding and anticipating the unique problems that can arise during a film will have a real adverse affect on the budget, as well as the ultimate delivery of the picture.