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LAW OFFICES OF NICHOLAS A. CARLIN
Case Comment: The Grass Harp
by Nicholas A. Carlin (ABA Entertainment & Sports Lawyer, 1998)
Reports of the demise of the negative pick-up deal have been grossly exaggerated. The recent California Court of Appeal decision in LeFlore v. Grass Harp Productions, Inc.(1) has caused a wave of panic in Hollywood. The headlines in Variety were: “Harp Decision Hamstrings Rules” and “Attention studios: Despite what you think, a court recently ruled that you don’t own all the films in your library.”(2) Hollywood nerves were not eased by language in the opinion itself referring to the negative pick-up deal as a “somewhat cryptic term” and calling the deal itself a “tangled web” of agreements.
But careful analysis of the opinion shows that the reaction is a tempest in a teapot, and that negative pick-up deals, while perhaps a bit sullied, are alive and well.
The Negative Pickup Deal
Negative pick-up deals are a common form of independent film financing for budgets in the 5 to 15 million dollar range. Negative pick-up deals generally involve four main parties: the producer, the lender, the completion bond guarantee company and the distributor.
The producer agrees to make a film for a certain budget.
The distributor agrees that, upon the producer’s delivery to the distributor of the finished film negative (hence the term “negative pick-up”), the distributor will reimburse the lender (see below) for the cost of the film production and will distribute the film. In exchange, the distributor will generally earn distribution fees and a profit participation.
The lender, based upon the distributor’s agreement to reimburse and distribute, agrees to loan the producer the cost of making the film. After the film is completed, the distributor will pay the producer the cost of making the film, and the producer will then be able to repay the loan from the lender.
The completion bond company guarantees to the lender and the distributor that the producer will in fact complete the film within the agreed upon budget and other parameters. If the producer fails to meet these conditions, the completion bond company can step in and take over production of the film. The completion bond company will earn a fee and often a profit participation.
The Decision
The Grass Harp was a 1996 film, based upon a novel by Truman Capote, starring Walter Matthau, Jack Lemmon and Sissy Spacek. (The screenplay was co-written by the late Stirling Silliphant, whose estate is represented by the author of this article; the estate had no involvement in this case, however). The film did not do particularly well. According to Variety, domestic gross for 1996 was only $600,000.
In the Grass Harp case, the producer was Grass Harp Productions (“Harp”), the distributor was New Line Productions and/or New Line Cinema (more about this confusion later), the lender was Banque Paribas, and the Completion Bond company was Motion Picture Guarantors, Ltd. (“Guarantors”). Under the deal, Banque Paribas loaned Harp some $9 million to make the film, one or the other of the New Line entities agreed to distribute the film and pay Harp the production costs upon completion, and Guarantors provided the completion guarantee. There were ten separate agreements between the various parties and one “Interparty Agreement” including all of them. (This is what led to the “tangled web” comment.)
Litigation arose when one Simon LeFlore sued Harp for a finder’s fee of about $263,000 which he claimed Harp owed him for obtaining some earlier financing for the film (not connected with the negative pick-up financing). LeFlore obtained a stipulated judgment against Harp for $183,000 and attempted to execute on the judgment by having the sheriff seize the film negative, which was being stored at a film lab. New Line Cinema, New Line Productions and Guarantors then intervened contending that the negative pick-up agreements gave them superior security interests in the negative. The trial court (by Los Angeles Superior Court commissioners Murray Gross and Arnold Levin) held that none of the intervenors had shown a superior security interest and denied their claims. The appeal ensued.
The Second District Court of Appeal, in a unanimous opinion, carefully analyzed the negative pick up agreements in light of well established rules of commercial security transactions law and came to the conclusion that neither of the New Line entities, nor Guarantors, had satisfied the requirements of “attachment” and “perfection” in order to claim a superior security interest in the film negative. Therefore, the Second District upheld the lower court’s decision.
The court first discussed the applicable law, which it found to be the California Uniform Commercial Code provisions pertaining to security interests in personal property. A security interest is “an interest in personal property or fixtures which secures payment or performance of an obligation.”(3) The court found that the film negative fell within the definition of “goods” (all things which are moveable at the time the security interest attaches)(4) to which the U.C.C. security interest provisions would apply.
The court then noted that in order for a security interest to be enforceable against a debtor or third party, it must “attach” and must be “perfected.” In order to “attach,” there are two relevant requirements: first, the debtor must have signed a security agreement which describes the collateral, and second, the creditor must have given value.(5) In order to “perfect” the security interest, the debtor must file a financing statement (generally known as a U.C.C.-1) with the appropriate governmental agency in order to give notice to and assure priority over third parties.
The court found that none of the claimants had established all of these elements. Turning first to the New Line entities, the court made quite clear its displeasure with the way they appeared to the court to be almost interchangeable. Some agreements were signed by New Line Cinema, some by New Line Productions, and some just referred to “New Line.” Apparently the attorneys for the New Line entities also blurred the line between them in presenting their case at both the trial and appellate levels. The appellate court took a very strict view of corporate separateness in analyzing the case and so looked at each corporation separately to see if it satisfied the requirements of attachment and perfection.
New Line Cinema
New Line Cinema did satisfy the first requirement for attachment (signatory to security agreement). New Line Cinema was a party to the Interparty Agreement, which did grant a security interest to the “distributor,” which was defined in the agreement as including both New Line Cinema and New Line Productions. Although the court believed that New Line Productions was the real distributor, it grudgingly accepted that New Line Cinema did meet the first requirement of attachment. But the court found that New Line Cinema did not meet either of the other requirements. New Line Cinema did not prove satisfactorily that it “gave value.” Furthermore it did not perfect, since it did not file a U.C.C.-1. (U.C.C.-1's were filed, but by New Line Productions, not New Line Cinema.) In a potentially dangerous move, the New Line attorneys apparently urged the court to disregard the corporate separateness of the two entities and to consider that, since New Line Cinema is a subsidiary of New Line Productions, the U.C.C.-1 signed by New Line Productions should apply to the benefit of New Line Cinema. The court (probably fortunately for New Line in the long run) declined this suggestion. Therefore, New Line Cinema was out of luck.
New Line Productions
New Line Productions satisfied the signed agreement requirement, and it did file the U.C.C.-1's. The problem with New Line Productions was that it did not prove that it gave “value.” The value New Line Productions claimed it gave to Harp was by paying $4.5 million to Banque Paribas on behalf of Harp (paying back the loan (6) ), and by advancing $193,000 prior to the time production began. The problem here was insufficiency of evidence presented to the trial court.
New Line Productions’ proof of payment consisted of a declaration by an officer of New Line Cinema, stating that “New Line has paid to Banque Paribas the full amount . . .” No documentary evidence of payment, like a check, was presented. The trial court rejected the declaration on the ground that it was a legal conclusion, that the declarant did not state the basis for her knowledge, that it did not state how or when the money was paid, and that it did not specify which entity, New Line Cinema or New Line Productions, paid the money. The court held that New Line Productions likewise failed to prove satisfactorily that it had paid the claimed $193,000 to Harp. The trial court did indicate that it might have made a difference if checks had been produced. The court of appeal upheld, finding that the trial court had not abused its discretion in rejecting the declaration.
The New Line parties also argued that they gave substantial non-monetary value to Harp in the form of their agreement to pay the bank upon delivery of the film (which enabled Harp to get the bank loan in the first place). This might have been a winner but, unfortunately for New Line, this argument was not raised in the trial court, so the court of appeal held that it had been waived.
Motion Picture Guarantors, Ltd.
Guarantors had the same problem as New Line Productions. While the court found that it did sign a security agreement, and that it did file a U.C.C.-1, there was insufficient evidence that it gave value. Guarantors argued that it gave value in two ways: first, by agreeing to guarantee delivery of a completed film to Harp and, second, by agreeing to cover certain overbudget expenses.
With respect to the first argument, the court found that there was nothing left to secure. Harp had already completed the film and delivered it to New Line (or one of them). As for the second argument, there were two problems. First, according to the court, the applicable provisions of the security agreement did not specifically address overbudget expenses as being secured and, in fact, stated that an overbudget expense alone would not be a default covered by Guarantors’ security interest. Second, although Guarantors apparently presented some 500 pages of checks and invoices to the trial court, it did not demonstrate that it paid any of those types of expenses that were covered by its security interest. So, Guarantors lost too.
What lessons can we learn from this case?
First, the usual U.C.C. rules for attachment and perfection of security agreements apply to negative pick-up deals.
Second, keep your entities straight. Make sure that the entity that signs the security agreement is the same one that gives value for it and that perfects it.
Third, make sure that declarations are drafted properly. Judges don’t like and don’t have to accept conclusory declarations. Make sure the full basis for knowledge is included. Also, as Judge Wapner used to remind us, bring your checks to the hearing.
Fourth, if you’re a completion bond company, make sure that overbudget expenses are clearly covered in any security agreement.
Fifth, and most important, don’t get involved in financing films that lose money!
As should by now be obvious, the Grass Harp case should in no way deter anyone from entering into negative pick-up deals. While the court was obviously unfamiliar and somewhat uncomfortable with the complexity of the negative pick-up, this really had nothing to do with the result. The case was mainly about problems in presenting evidence at trial. The one thing that could be troubling was the court’s finding that Guarantors’ security agreement did not cover overbudget expenses, but this can easily be corrected by Guarantors and other completion bond companies (if their agreements are similar) by simply clarifying that portion of their agreement. Hollywood’s panic is misplaced. The negative pick-up deal is (or should be) alive and well.
Postscript: Appellate counsel for Guarantors and the New Line parties, Karen Dillon of Stein & Kahan in Santa Monica, claims that LeFlore’s victory is hollow. According to Dillon, even though LeFlore may be entitled to physical possession of the film negative, he is not allowed to make copies (as that would be copyright infringement) nor can he legally prevent the New Line from striking new prints (since he takes the negative subject to existing agreements pertaining to its use.) As a practical matter, however, LeFlore could make access difficult. LeFlore’s attorneys have declined to comment.
Endnotes:
1. 57 Cal. App. 4th 824 (2d Dist. 1997); 67 Cal. Rptr. 2d 340
2. October 6 - 12, 1997, pg 14
3. California Uniform Commercial Code §1201(37)(a)
4. Id., §9105(1)(h)
5. Id., §9203(1)
6. The other half of the original $9 million loan was paid for by a foreign distributor who was not a party to this case.
Copyright 1998, Nicholas A. Carlin
