Comparing Contingent Compensation in Entertainment Contracts

As originally published in the Entertainment Law column in the New York Law Journal on April 3, 2017.

Much can be learned about the entertainment industry by comparing how those who perform services or license rights in their works are compensated under agreements to which they are a party.  Some compensation in those agreements is fixed and essentially guaranteed, like advances and flat fees. Other types, which are the subjects of this article, are contingent.

The extent of contingent compensation that becomes payable, if any, depends ultimately on the monetary success of a work –whether from the number of units sold, such as books or tickets, or from license payments and similar fees.  A contingent interest based on a percentage of gross receipts is the highest level of participation, but other than in connection with sales of print books (see below), it has become increasingly rare in the entertainment industry. More commonly, contingent payment is based on a percentage of gross minus defined deductions. 

This article will provide a most general overview of basic provisions covering contingent compensation structures in literary publishing, live theater, television and theatrical motion picture agreements.

Literary Publishing

Authors of fiction and non-fiction books sold by major trade publishers (e.g. Penguin Random House, HarperCollins and Simon & Schuster), usually retain the copyrights in their works (although their license to the publisher can endure for the term of copyright, subject to reversion in some instances, perhaps after decades).  The fixed compensation they receive, paid in stages, can range from small amounts to well into seven figures. These payments are considered advances, recoupable from royalties primarily generated from sales of the work.

Authors of books sold in print form by trade publishers are unique among rights holders in entertainment in that their contingent compensation (in the form of royalties) is computed on a gross amount even greater than what the publisher receives. The publisher most often is paid a wholesale price for each book sold; the author usually is paid a percentage of the suggested retail price irrespective of the price at which the book actually is sold to the consumer. The percentages usually range between 10% and 15% of the retail price for hard cover, less than that for soft cover, and less in categories like discounted sales.

It has been suggested that the intention behind the rates based on retail prices of physical books is to pay the author an amount equal to roughly half of the profit earned by the publisher per copy sold, without having to calculate what the profit actually is.  Whether or not this is the case, the same rationale did not carry over to the digital world.  Publishers tend to pay authors 25% of the publishers’ receipts from sales of e-books, even though per unit costs are significantly lower than for physical books. Because those receipts often are 70% of the selling price, the author receives 25% of 70% of those sales.

Live Theater

In the past, an author of a straight play, or the book writer, composer and lyricist of a musical, would be paid a simple percentage of gross weekly box office receipts (“GWBOR”). In smaller theaters, including many not-for-profits, authors still are paid in this fashion, as are authors of dramatic plays for star-driven Broadway revivals.  Authors also may receive fixed compensation in the form of option payments and advances.

Beginning in the 1980s, an evolution of contingent compensation began.  First, in lieu of a share of GWBOR, the concept of “royalty pools” based on weekly operating profits was introduced.  With an eye on rising production costs and concern that payment on the basis of GWBOR can result in substantial royalties being paid even in losing weeks, producers wanted authors (and other erstwhile dollar-one gross participants) to share more risk and help accelerate the investors’ recoupment of capital.

A royalty pool is a “net” concept based on operating profits.  The royalty participants split weekly operating profits with the production’s investors, often with the investors as a group getting more than 50% of the profits and the aggregated “pool” of royalty participants getting less.  An author’s share of the pool is based on the relative size of what the author would have received as a share of GWBOR in the absence of the pool as compared to other royalty participants.  For example, if an author of a dramatic play traditionally would have been entitled to 6% of GWBOR and the total of all royalty participants’ shares of GWBOR (including the shares of the author, director, producer, and others) in the royalty pool would have been 18% of GWBOR, then the author would be entitled to one-third of the royalty pool each week.  Following recoupment of capitalization costs (and in some instances, as much as 125% of recoupment), the size of the pool would be likely to increase.  To protect royalty participants in the event of losing or low-profit weeks, a minimum weekly guaranty is paid and applied against such participant’s share of the pool.

More recently, the calculation of contingent compensation for Broadway productions — particularly musicals — has evolved from royalty pools to individually negotiated participations based on weekly operating profits.  The associated concepts are the same as with a pool, including the payment of minimum weekly guarantees, but without the constraint of a fixed pool in which all royalty participants share on the basis of their respective percentages. 

Authors of works for the stage generally own the copyrights in their works, so that even if the first producer’s efforts are unprofitable, its rights will lapse and other productions may follow.  However, compared to motion picture and television producers, those in the theater industry, producers tend to pay relatively small advances so that contingency payments usually constitute the bulk of the authors’ hoped-for compensation.

Motion Pictures

The primary source of generating gross receipts from a motion picture is the aggregate price of tickets paid by consumers at the box office. Generally, a bit less than fifty percent of that aggregate is paid by the exhibitors to distributors of the film and that distributor share is used to compute contingent compensation for screenwriters, directors, producers, and other participants, such as owners of underlying works.

In addition to box office receipts, other sources of revenue from exploitation of a motion picture contribute to the bucket of gross receipts such as pay-per-view, network, cable, and syndicated television; merchandising, soundtracks and other ancillary sources. The contingent compensation defined in motion picture contracts is very rarely based on anything approximating gross receipts — and even then participants bear “off the tops” such as collection costs, residuals, trade dues and taxes.

More commonly, there is a list of substantial deductions in the calculation of contingent compensation. These include recoupment of production costs with interest and overhead; distribution fees attributable to each market and type of exploitation; and expenses attributable to distribution such as costs for advertising and publicity, manufacturing and shipping prints (somewhat lessened in an era of digital distribution.)

Further, the definition of each element in this “net” calculation can be negotiated: gross receipts (what sources?), distribution fees (what percentages?), distribution expenses (what limits?) and production costs (including interest on advertising and overhead?). The resulting contingent compensation definition in a motion picture agreement ends up being lengthy and complex, involving concepts like Initial Actual Breakeven, Cash Breakeven, Artificial Break Point (which define the point at which the participant may start sharing), Soft Floors and Hard Floors (which establish minimum levels below which a participant’s number of points may not be reduced).

      With most definitions, the likelihood that participants will receive contingent compensation from exploitation of a motion picture is not high; usually the film’s success would need to be extraordinary. This tends to focus their attention on fixed compensation.

Television

Unlike motion pictures, gross receipts in television are not generated primarily by unit sales, but by licenses. In the traditional model, the initial broadcast of a series occurs on network television, and then, after the series has run its course, it is sold in syndication on a market by market basis. Each station or group of stations pays license fees for the right to make these “post-network” broadcasts and those fees, together with other sources of revenue, such as foreign broadcast fees, merchandising and music revenues, constitute gross receipts.

As with motion pictures, television contingent compensation when paid rarely is based on a percentage of true gross receipts. High level participants may share in Adjusted Gross Receipts or Modified Adjusted Gross Receipts and lower level participants share in Net Proceeds.

The categories included in the definition of “net” are similar to those in the motion picture industry although many of the negotiations involve more television-specific issues. Will there be an imputed license fee from the initial exhibitor included in gross receipts? Will there be a distribution fee taken on the initial network broadcast? How are agency package fees included in the definition? What limitations will be imposed on the distribution expenses that are charged? How are deficits incurred in the production of the series for initial television network broadcast, and recoupable from gross receipts, to be computed?

The industry has been evolving from the traditional model as pay cable and now streaming services rely more heavily on subscriber fees.  The result has been a variety of approaches to contingent compensation and in some instances, all rights are bought out and there is no contingent compensation at all.

Conclusion

Contingent compensation in the entertainment industry is an arcane subject and it takes some digging to become reasonably familiar with its depth and substance. Knowledge can be acquired in a variety of ways, including by reading literature on the subject, examining net profits statements, audit reports of such statements, and court decisions.