By Ezra Doner
The Creatives had a profit-sharing arrangement with the Fox Studio, which supplied Bones to the Fox Network, to Hulu (which is part owned by Fox), and to Fox-affiliated outlets in the UK, Italy and Spain.
But related company dealings like these can lead to claims of wrongful self-dealing. A studio, which shares profits with participants, can be accused of using a “sweetheart deal” to shift value to the books of an affiliated network. Meanwhile, the parent company of both may be seen as giving a wink and a nod to this kind of manipulation. In extreme cases, a studio may end up reporting zero profits to creatives, even on a highly successful show.
Last month, in a case brought by the Bones Creatives, a retired California judge, sitting as a private arbitrator, assessed an eye-popping $128 million penalty against Fox for what the judge called “shocking”, “egregious” and “reprehensible” conduct, including “intentional acts of fraud and malice” in relation to Bones’ profit participations.
First, the judge ruled that the Fox Studio failed to meet its obligation, under the governing agreements, to license to affiliates on monetary terms comparable to similar transactions, with third parties, for comparable programs. This breach of contract was found to have reduced the Creatives’ profit share by $25.7 million, which the judge awarded as actual damages.
But then, based on his finding of outrageous behavior, the judge applied a five-to-one formula to tack on an additional $128.4 million in punitive aka exemplary damages. In other words, for each $1 in profits the Studio had failed to pay, the judge added a $5 penalty.
The award of both actual and punitive damages ultimately derived from the judge’s finding that Fox companies, through self-dealing, had shifted many millions of dollars in value away from the Fox Studio, which had the profit-sharing arrangement with the Creatives.
The particulars of what the judge found to be outrageous conduct is not the subject of this Client Alert. Rather, my focus is on “the numbers” – the amounts which, the judge ruled, should have been reported as revenues, but weren’t.
According to the judge, how much value did Fox, through self-dealing, wrongly hide from the Participants? Was it:
(D) $113,831,519, or
For the answer, keep reading. But first a note about how changes in the TV business have created opportunities for wrongful self-dealing.
The Big Picture
As top TV studios increasingly operate in key media on a multi-territory and even worldwide basis, allocation of revenue between related companies can have an enormous impact studios’ profit statements to creatives.
In television, there’s an old distribution and licensing model, which harkens back to the so-called Fin-Syn rules (click here), and there are evolving models. For example, using the traditional model, the Fox Studio produced Modern Family not for the Fox Network, but for ABC, a Disney-owned competitor. And the series was also licensed to NBCUniversal’s USA Network, a competitor of both Fox and ABC. Given this configuration, Modern Family’s profit participants could have a fair expectation that these transactions were negotiated on an arm’s length basis, with the intention of maximizing licensor revenue.
But Bones was distributed and licensed via a new model. With Bones, the Fox Studio produced the Series for exhibition primarily on Fox owned or controlled networks and services: the Fox Network, Hulu, BSKYB and other affiliated platforms.
Pop Quiz Revisited
To return to the test: what, according to the judge, was the total value that Fox, through self-dealing, wrongly hid from the Participants?
** Was $7,627,011 the total amount that Fox wrongly hid?
Answer: If you picked this one, you picked wrong. According to the judge, $7.6 million was just the amount that Fox failed to recognize from licenses to its affiliates in Italy and Spain. These underpayments were determined in part by reference to license fees paid by Fox’s Italian affiliates for NCIS shows which ran on CBS domestically, and Fox’s Spanish affiliates for CBS shows Blue Bloods and Hawaii Five-O and also NBC Universal’s House.
** Was $59,811,000 the total amount that Fox wrongly hid?
Answer: No, this choice is also incorrect. Per the award, $59.8 million was just the amount of underreporting from Fox’s UK affiliate, BSKYB. The reference: license fees which SKY paid for Journeyman, a series produced for NBC.
** Was $96,103,452 the full amount of missing revenue?
Answer: Getting warmer, but no, not there yet. Per the judge, $96.1 million was just Hulu’s underpayment, mostly for current season stacking rights to 140 Bones episodes, computed at the rate of $685,000 per episode. Reference shows: Elementary, Blue Bloods and CSI, all from CBS.
** Was $113,831,519 the full amount that the judge found should have been reported?
Answer: Very warm, but no, $113.8 million was just the judge’s view of the undercount of payments by the Fox Network to the Fox Studio. Reference show: certain seasons of Universal’s House.
** Was $277,372,982 the total that Fox failed to report?
Answer: Yes, that’s it. The judge found that the total which Fox failed to include in gross receipts was $277.3 million. It’s the sum of ALL the individual items in choices A through D.
Per the arbitration award, the judge assessed $25.7 million in actual damages against Fox as the Creatives’ share of profits with respect to this $277.3 million, which is 9% of the total. By contrast, the judge’s staggering $128.4 million penalty against Fox is equal to an additional 46% of the missing $277.3 million.
The award contains additional pieces as well, such as prejudgment interest, attorney fees and court costs. Altogether, the award totaled $178,695,778. But the biggest individual pieces are the $25.7 million in actual damages and the $128.4 million in punitives.
Know when your interests are aligned with third parties, and when they’re adverse, and plan accordingly. This principle applies not just to profit participations but to many of your artistic and business relationships: writer and writer, writer and producer, writer and director, creator and agent, creator and investor, and so on.
If nothing else, think of your shareholders. You can always explain that you had to share profits with creatives. After all, you share profits with shareholders. But how do you explain a $128.4 million penalty?
If your show runs long enough, industry changes may affect participations in unexpected ways.
The document I reviewed in this case was a private arbitration award by a retired California judge sitting as arbitrator. The award only became available to the public because of a pending court challenge to it. Not long after the arbitration award was issued, The Walt Disney Company completed its purchase of certain of the Fox business units in question. In a number of instances, business information in the public version of the award has been redacted, leaving gaps as to details of the judge’s analysis. If anyone reading this post has any insights into this case, feel free to contact me.
Ezra Doner is an entertainment and copyright lawyer who focuses on the film, TV and other content sectors. He has worked both as an in-house business and legal executive and as a private lawyer. He did not represent any of the parties in this case.
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