Canada: Legal Considerations for Banks Lending to Motion Picture Productions in Canada

Last Updated: June 27 2002

By Arthur Evrensel* & Eva B. Schmieg*

1. Introduction

The purpose of this paper is to provide an overview of the various legal considerations which Canadian banks customarily address in providing loan facilities for the purposes of producing motion pictures and/or television productions. The most common of these interim financing mechanisms is known as a "negative pickup" transaction1, which will be the focus of the present paper.

Conventional lending rules, guidelines and remedies are not altogether applicable to interim financing by banks for productions of motion pictures and/or television productions. For example, the collateral upon which the bank acquires a security interest is transformed during the term of the loan from intangible rights in a literary or dramatic property, to include a film negative, a hard tangible asset. As a consequence, there are several agreements used in transactions involving bank financings of motion pictures, and/or television productions, which are not used in other types of bank financings, such as a film laboratory pledgeholder agreement. In addition, certain common law doctrine regarding enforcement, such as reasonable notice to cure required to be provided by banks to borrowers prior to seizing collateral or appointing a receiver-manager to take possession and control of the collateral of the borrower, should be applied very strictly due to the nature of the industry, the relative time frames involved for cast, and the fragile nature of the asset collateralized in such bank loans. These issues will be discussed in more detail below.

II. Canadian Banks

In Canada, the common form of financing provided by banks to motion picture productions is generally referred to as "negative pickup" transactions. While lenders in the United States and Europe have evolved to include other models of lending in which the lender may take an equity participation in the film’s revenue or lend against an unsold territory based on the estimates of foreign sales agents ("gap" financing) or distributors, bank financing to the motion picture industry in Canada has remained relatively unchanged. Canadian banks prefer to provide financing to the motion picture industry on a project by project basis involving negative pickups and interim financing of a portion of refundable tax credits and certain payments from funding entities. More recently, as several Canadian production companies have issued shares to the public and become listed on stock exchanges, banks are more willing to discuss loans which are cross-collateralized by several pictures, rather than on the traditional model of project financing.

Several banks in the United States and Europe have developed an expertise in "gap" financing which is the ability to lend against both: (i) guaranteed pre-sales as evidenced by "negative pickup" agreements and (ii) unsold territories, on the expectation that an experienced sales agent or distributor will, once the picture has been completed and delivered, license such territories for an amount which will be sufficient to cover the outstanding loan plus interest thereon. This paper will not discuss the essential elements of such financings since no Canadian bank at the present time is engaging in such loan practices.

III. Distribution Agreement / Negative Pickup Agreement

The generic appellation of "distribution agreement" or "negative pick-up agreement" refers to a contract between the producer and distributor for a production, granting to the distributor the exploitation rights in a particular territory, in consideration for a sum payable (i.e., advance) upon delivery. The distribution agreement will set out the conditions for payment and the requirements for delivery, which in most cases includes a list of delivery items which must be delivered to the distributor to trigger the payment of the advance (the terms "minimum guarantee" and "advance" in this paper are used interchangeably).

The bank will "discount" the amount payable under the distribution agreement and calculate an amount which it is willing to lend the producer based on such distribution agreement. The bank assumes the credit risk of the distributor; i.e., the risk that the distributor may default under the distribution agreement and not have the ability to pay upon delivery of the picture. Therefore the bank assesses the distributor’s credit worthiness. In determining whether to accept and to discount the proceeds of a distribution agreement, a bank will request financial statements of the distributor and assess the distributor’s ability to pay the minimum guarantee upon delivery of the physical materials by the distributor. Banks engaged in lending to the motion picture industry customarily have internal data bases and contacts with other banks who have had dealings with distributors in order to evaluate the specific distributor’s past performance.

A pre-condition for the bank to make the loan requires that the producer assign to the bank the right to receive the advance, payable upon delivery of the picture, from the distributor pursuant to the distribution agreement. While the producer is liable for the entire amount of the indebtedness, the bank will only be willing to lend to the producer based on the credit worthiness of the distributor and its ability to pay upon delivery. Since in most cases the producer is a company formed for the sole purpose of acting as a production company, for a specific film or television project, the bank’s concern with the producer is to secure the rights to the collateral in case the primary source of repayment of the loan, namely the minimum guarantee under the distribution agreement, fails to materialize.

In the event the bank rejects the distributor’s credit worthiness, the bank may decide to proceed with the loan if the bank obtains additional security. The bank may request a standby letter of credit from the distributor’s bank, naming the bank as sole beneficiary and drawable upon the completion guarantor certifying to the issuing bank that all physical materials which the completion guarantor has bonded under the completion guarantee have been delivered to the distributor, or are available at the laboratory to be picked up the distributor. Certain Canadian banks also do not accept letters of credit issued by certain United States banks and therefore the identity of the issuing bank becomes relevant to the lending bank. The need for a letter of credit to collateralize the distribution agreement inevitably creates additional costs for the producer and therefore may increase the total cost of the production. However, the lending bank may, in certain circumstances reduce the amount of the commitment fee, since the risk of the distributor’s credit worthiness is substantially reduced by the issuance of the letter of credit. The conditions for draw down on the letter of credit must be clear and should include: (i) presentation of the original letter of credit, (ii) a demand by the beneficiary of the letter of credit; and (iii) a letter of acceptance by the distributor of delivery of the picture or alternatively a certificate from the completion guarantor certifying to the issuing bank that all physical materials have been delivered to the distributor under the distribution agreement or are available at the film laboratory for delivery.

IV. Completion Guaranty / Completion Agreement

In addition to the credit worthiness of the distributor, there exists an additional risk that the producer, for whatever reason, may not be able to complete and deliver the physical materials to the distributor. In almost all cases, the bank will require a guarantor, specializing in the film and motion picture industry, to undertake to ensure that the picture is completed and delivered in accordance with the requirements of the distribution agreement, or if the picture is abandoned, to pay to the bank the full amount of the loan. The distribution agreement, on its face, provides for the payment of a sum certain, namely the revenue guarantee, upon performance, namely, completion and delivery of the physical materials to the distributor. A completion guarantor is required to guarantee to the bank that the picture will be completed on budget and in accordance with the delivery requirements contained in the distribution agreement. This risk of delivery is not a "credit" risk and is not a risk which a bank will ordinarily assume. For a fee ranging anywhere between 2% and 6% of the amount of the budget of the picture (although exclusions for purposes of calculating the amount of the budget may be negotiated), a completion guarantor (of which there are four (4) in North America with a track record acceptable to the major banks) will guarantee delivery of the physical materials to the distributor in order to trigger the payment of the revenue guarantee under the distribution agreement. However, completion guarantees are subject to the condition that the full amount of the budget be available for the producer to use on the production of the film. In most cases, if there is no call on the completion guarantee, the guarantor will reimburse part of the fees payable to it pursuant to the completion guarantee, which is commonly known as a "no claims bonus". The bank will customarily hold part of the fee in a reserve account and only advance this sum to the completion guarantor if the bond is called upon. In addition to the completion guarantee, banks may also require a "cut-through guarantee" or "loss payee endorsement" to be issued by a re-insurer which will in turn guarantee the performance of the obligations of the completion guarantor in the event that it is unable to fulfil its obligations under the completion guarantee.

The completion guarantor also enters into a completion agreement with the producer allowing the completion guarantor to take over production of the picture in the event that the producer has exceeded the budget or is in danger of so doing. In essence, under the completion guarantee, the producer need not have actually exceeded the budget but if the guarantor objectively believes that the cost to complete the picture shall exceed the budget, during production, the completion guarantor has the right and power under the completion guarantee to take over the production, completion and delivery of the picture. The provisions in the completion agreement are by necessity, rather draconian, permitting the completion guarantor to take control of the picture, remove the producer from the production and complete the picture in order to deliver the physical materials to the distributor, which in turn will trigger the payment of the revenue guarantee which is assigned as collateral to the bank. There has always been lingering doubt whether the provisions of the completion agreement are enforceable. However, given the nature of the relationship between the bank, the producer and the completion guarantor, and the limited time frame in which principal photography of a picture needs to be completed in order to meet delivery deadlines, and the serious consequences of going over budget and over schedule, it necessarily requires that the completion agreement be enforceable despite its potentially dramatic consequences.

Any proceeds, in excess of the budget, which the completion guarantor is required to spend to complete and deliver the picture is customarily recouped by it only after the bank has been repaid the full amount of its loan and interest thereon. Any security interest which the completion guarantor acquires in the collateral is automatically subordinated, by the terms of the assignment and interparty agreement, to the security interest of the bank.

V. Diagram of Various Parties Involved

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VI. Assignment and Interparty Agreement2

One of the most important and aggressively negotiated agreements required by banks in order to interim finance a negative pickup agreement, is the assignment and interparty agreement. The assignment and interparty agreement serves many functions: it is the agreement to which each of the bank, the producer, the distributor and the completion guarantor enter into in order to create a contractual link between the bank and each of those entities, most importantly the distributor. Since the assignment and interparty agreement is the only document to which both the bank and distributor are party, the practice has developed that his agreement is the fundamental agreement on which most of the negotiations focus. The assignment and interparty agreement is for the benefit of the bank and is used to alter the terms of the distribution agreement to comply with the requirements of the bank. The interparty agreement has been described as the controlling document that allocates the risks of the negative pickup transaction among the parties involved.3

It is very important that the completion guarantor be a party to the assignment and interparty agreement. Bank’s counsel will insist that the completion guarantor become a party to the interparty agreement for reasons of resolving disputes with the distributor. While there is no standard form of assignment and interparty agreement, most such agreements will cover at least the following minimal elements:

    1. Amendments to the distribution agreement providing that the bank’s security interest against the collateral is a first priority security interest and that the security interests of each of the completion guarantor and the distributor will be subordinate thereto.
    2. Agreement by distributor that all necessary approvals, consents and waivers in respect of such matters as chain of title, principal cast, budget or other production elements have been given or waived by the distributor before the funds are advanced by the bank.
    3. Notice of assignment from the producer to the distributor to pay the proceeds of the advance directly to the bank and any other amounts that the distributor may be obligated to pay, such as receipts in addition to the advance.
    4. A provision which clearly provides that the advance will be paid to the Bank notwithstanding any right of setoff, offset, claim, counterclaim, right of cross-collateralization, reserve or defence which the distributor may otherwise have against the producer or any third party. The relevant provisions should also clearly provide that the advance shall in no event be reduced, as against the bank, below the amount set out in the distribution agreement and shall be paid without any deductions, holdbacks or withholding taxes, or any other taxes or levies payable by the distributor. This provision is essential in the circumstances where the bank lends to a Canadian company, but the distributor is a foreign entity and which may be subject to withholding taxes or levies in its own jurisdiction.
    5. The assignment and interparty agreement will have specific provisions dealing with the conditions for payment of the advance. The bank will insist that notwithstanding any other provision of the distribution agreement, the sole condition under which the distributor shall have the right to refuse to pay the advance to the bank, shall be limited to lack of delivery of the physical materials of the picture by a certain date, subject to the cure and arbitration provisions described below. The ultimate goal of the assignment and interparty agreement is to create certainty between the bank and the distributor, that all rights or defences which the distributor may otherwise have to refuse to pay the advance under the distribution agreement to the producer, are waived against the bank. The distributor and producer also agree with the bank that they shall not have the right to terminate, amend or in any way change the terms of the distribution agreement without the bank’s consent or until the bank has been repaid the full amount of the advance. As well, no immaterial default or any casual or inadvertent failure by the producer to comply with the terms or conditions of the distribution agreement shall constitute a breach or default under the distribution agreement and shall not relieve the distributor from its obligations to pay the advance to the bank.
    6. Dispute resolution mechanism. In the event of any dispute relating to either the payment of the advance or completion of delivery of the picture, the assignment and interparty agreement provides that the parties will submit such a dispute to binding and expedited arbitration. The provisions for such expedited arbitration are detailed and are a key part of any assignment and interparty agreement. The dispute resolution provisions of the assignment and interparty agreement provide that the date of delivery is effectively extended for the duration of any arbitration. The arbitrator in such circumstances must make one of two findings, either:
      1. that delivery has been effected pursuant to the assignment and interparty agreement in which case the minimum guarantee is immediately payable; or
      2. that delivery has not been effected, in which case the arbitrator must issue a declaration stating what the producer or the completion guarantor, as the case may be, must do in order to effect delivery in which case the producer or the completion guarantor, as the case may be, shall have a certain period of time within which to comply with the arbitrator’s declaration, if it can, by delivering to the arbitrator or the distributor, what is required to complete effective delivery. In the event that the producer or the completion guarantor, as the case may be, satisfies the arbitrator’s declaration within the cure period, then the arbitrator shall issue an award against the distributor requiring the distributor to pay the minimum guarantee to the bank.

      Most United States distributors will not agree to the provisions of Canadian arbitration statutes to govern the arbitration, preferring to be bound by the American Arbitration Association rules or the American Film Marketing Association Arbitration rules, copies of which are available upon request from the respective associations or their respective websites.

    7. Waivers: In the assignment and interparty agreement, the distributor is obliged to agree solely for the benefit of the bank, that no items or elements in the picture shall be considered as "essential elements" or irreplaceable without which the distribution agreement is invalid. If any element which is the subject of distributor’s approval or consent under the distribution agreement must be replaced during principal photography of the picture, the distributor agrees to be consulted regarding such replacement. However, the assignment and interparty agreement provides that the distributor shall have no right of approval or consent with regard to same, in order not to frustrate or unreasonably delay the production and delivery of the picture. Notwithstanding such provisions, in practice, the producer collaborates with the distributor, who certainly is provided with an opportunity to discuss the matter with the producer and come to a resolution on a matter which requires immediate attention.

VII. Collateral Security

While the bank looks to the distributor as the primary source of repayment of the producer’s loan under the loan agreement, the bank nevertheless takes security over the rights to the literary or dramatic property on which the picture, is to be based. The bank also acquires a security interest in the picture and the copyrights therein, all distribution and exploitation rights, as well as the proceeds therefrom. The description of the collateral contained in the security agreement is usually comprehensive to include all literary and dramatic rights to the underlying property and the copyright therein, the physical property, namely all prints and negatives, all ancillary, allied and subsidiary rights such as publishing, merchandising, interactive, multi-media, commercial tie-ups, all proceeds from insurance, all copyrights, all proceeds from the exploitation of any such rights, all equipment, bank accounts and instruments. In the event there is more than one financial institution or entity providing funds, the collateral of each will be defined to exclude the other party’s security interest, in most cases by territory or by specified collateral. In such circumstances, the two financial institutions will also insist on an intercreditor agreement setting out their respective first priority security interest in their respective territories / collateral and crossing over and taking a second priority security interest in the other party’s primary secured rights.

Since completion guarantees provide for a guarantee to complete and deliver the picture in accordance with the delivery schedule, the enforcement by the bank against the collateral will be limited to circumstances where the completion guarantor is in risk of defaulting on its obligations to complete and deliver the physical materials to the distributor in order to trigger the payment of the advance; or the completion guarantor or the re-insurer decides to abandon the picture, but cannot repay the bank the full amount of the loan. In those circumstances the bank is forced to act expeditiously preserve and safeguard the physical material of the picture and to fulfill any delivery obligations necessary to trigger payment of advances or minimum guarantees that the bank has interim financed.

Since the collateral upon which banks acquire a security interest is transformed during the term of the loan from intangible rights in a literary or dramatic property, to include a film negative, there must be a public recording system to evidence the chain of title and to allow interested parties such as the bank, to search and verify with certainty whether a particular right or interest, whether intangible or tangible, has been transferred or encumbered. To the extent there are competing recordation schemes, this lessens the effectiveness and utility of each; when records are scattered in several filing registries, creditors must conduct several searches before they can, with certainty, be satisfied that the particular property is not encumbered. In Canada, the Canadian Copyright Office provides for recording of interests in copyright to literary, artistic, musical, dramatic or mechanical contrivance works. However, copyright in Canada arises upon creation of the work by the author and subsists even in the absence of the legal formality of copyright registration. Under the laws of Canada, an assignment of copyright may be effective even in the absence of the legal formality of copyright registration. Therefore, a search of the copyright registers of the Copyright Office may not reveal all copyright interests pertaining to a copyrighted work. The provincial Personal Property Security regimes establish a scheme for the recording of the security interests in personal property.

A bank will insist that a copyright mortgage and assignment: power of attorney instrument be executed in which the producer mortgages, assigns and conveys to the bank all of the producer’s right, title and interest, and all copyrights therein to the literary or dramatic property, which copyright mortgage will be registered in the Canadian Copyright Office, as well as the United States Copyright Office.

In addition, one or more Personal Property Security Act financing statements are registered by the bank against the producer to evidence the security interest in favour of the bank.

The risk of removal of the negative from the film laboratory is neutralized by providing for a laboratory pledgeholder agreement in which the laboratory acts as the pledgeholder of the picture, including all the prints and negatives, for the sole benefit of the bank. Such an agreement provides that the film laboratory is not authorized to remove the film without the bank’s prior written approval and that any security interest the laboratory may take in the picture to guarantee payment for its services, is subordinate to the bank’s security interest in the collateral, which includes the film negatives.

VIII. Enforcement

The line of decisions starting with Mister Broadloom Corporation (1968) Ltd. v. Bank of Montreal et al4 and Ronald Elwyn Lister Ltd. v. Dunlop Canada Ltd.5 with reference to the obligation of banks to provide reasonable notice to borrowers to cure after demand for payment and prior to seizing collateral or appointing a receiver-manager to take control of the collateral should be very narrowly applied in the context of bank loans to the motion picture industry. For example, since the borrower/producer is usually a single purpose entity created solely for the production of the picture, it has to other assets with which to remedy default of non-payment or a breach of the loan agreement. Assuming that the breach is not one which can be remedied by the completion guarantor, and given the limited period for which principal cast members are engaged to perform services on the picture, time is always of the essence during production of a picture. Therefore, banks can ill afford to delay enforcement of their rights, in conjunction with a completion guarantor, to ensure that a picture is completed and delivered on time and on budget to trigger the payment of the minimum guarantee from the distributor. The British Columbia Supreme Court in Royal Bank of Canada v. Cal Glass Ltd. and Coopers & Lybrand Limited6 applied the reasoning in Mr. Broadloom and held that one-half hour was reasonable notice under the circumstances. The court found that the debtor had not asked for any additional time to pay and there was nothing to indicate that even had such time been given, the debtor would have been able to come up with the required funds. It is extremely unlikely that any other financial institution will provide funding during production to a production company which has defaulted on a bank loan. Therefore, the ability of the producer, in the circumstances, to raise money required in a short period of time is highly unlikely. The decision of the Court in Cal Glass provides for the necessary flexibility in considering a number of factors in assessing what is reasonable notice. Using the Cal Glass decision as the guideline in reference to the motion picture industry: (i) the risk to the creditor losing its money or security, (ii) the potential ability of the borrower to raise the money required in a short period to cure the default, and (iii) the circumstances surrounding the demand for payment, are perhaps the three most important factors which a court should evaluate in any determination of the application of the doctrine of reasonable notice to cure in the context of motion picture loans.

IX. Conclusions

For borrower’s counsel, the exercise of reviewing a negative pickup transactions from the bank’s perspective provides valuable insight to understanding the bank’s limited ability to compromise. Counsel to the bank is shouldered with the responsibility of eliminating or reducing the various risks inherent in motion picture production. The use of letters of credit, completion guarantees, insurance and the use of documents which are specific to this type of financing, such as interparty and laboratory pledgeholder agreements, assist in reducing the inherent risks to the bank. Negative pickup transactions are by nature document-intense and time consuming. Despite the use of standard form documentation, no two transactions are identical and each requires substantial time and energy in creating a structure which is both acceptable to the distributor, and a mitigated risk to the bank. However, regardless of how extensive a transaction is papered, there is no greater comfort to the bank than the trustworthiness of the principals of the borrower-producer and past performance.

*Both Arthur Evrensel and Eva B. Schmieg are partners in the Vancouver office of Heenan Blaikie LLP. Copyright Heenan Blaikie LLP 2002.

1 See Foy, "The Recondite Discountable – Contract Finance: An Elucidation of Negative Pickup and Presale Financing Arrangements: in 1993-94 edition of Entertainment, Publishing and the Arts Handbook p. 221 (R. Thorne and J.H. Viera ed. 1994).

2 See Eshman, "Bank Financing of a Motion Picture Production" in 1992 V.12 Loyola of Los Angeles Entertainment Law Journal.

3 See Foy and Eshman.

4 (1979), 101 D.L.R. (3d) 713.

5 [1982] S.C.R. 726.

6 (1979) 18 B.C.L.R. 55.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

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