POSTED ON January 18, 2018

All major and mini studios utilize some form of subdistribution. In the foreign markets, a number of studios (mostly minis) only use subdistributors, and some minis use subdistributors in the domestic market as well. In many cases, the studios look for subdistribution relationships in certain territories based on various factors, such as financial (major studios may elect to go with a local subdistributor in smaller territories as opposed to setting up their own local branch), among others. The subdistributors have strong local market relationships and contacts, which are extremely vital for success in that territory.

With increasing revenues coming from the foreign markets, including those coming from territories which are subdistributed, it is important to develop a monitoring/auditing program of such relationships.

The reporting by the subdistributors, to the studios or other distributors, is based on a licensing or subdistribution agreement between those two parties. In most cases, the agreements are complex and subject to numerous variables, such as distribution fees, royalties, reportable share percentage, minimum guarantees, theatrical shortfalls, exchange rates, caps and cross-collateralization. Each of these might vary depending on the media being granted/distributed. As a result of the complexity and lack of consistent accounting processes between subdistributors, there is a risk of error of the underlying deal terms. This misunderstanding can potentially cost the studios or other distributors millions.

As studios look to develop a monitoring/auditing program, several key questions include:

  • Are the revenues from all territories and media, that were granted rights per the agreement, accounted for properly?
  • Are the distribution expenses charged allowable and legitimate direct (or directly allocable) title-based expenses?
  • Are the minimum guarantees calculated correctly? This is often a negotiated amount, or calculated as a percentage of the production cost budget and/or final actual production costs, and would require further review to verify. In some instances, the agreement may or may not allow for revisions to the MG based on budgeted vs actual production costs.
  • Are any overages due and/or delinquent? (e. was the MG exceeded?). This requires review of the agreement and statement to determine whether or not the proper distribution fees, expenses and reportable shares are in accordance with the agreement.

Examples of a typical deal structure to determine the reportable share to the studio are as follows:

  • Theatrical: Film rental less 10% distribution fee less all deductible expenses = net theatrical revenue subject to 75% reportable share to Studio
  • Television: Revenues: 70% reportable share to studio
  • Home Video: Revenues:
    • EST: 25% royalty reportable to studio
    • Sell Thru: DVD/BluRay 100% revenues less all deductible expenses = net home video revenue subject to 50% reportable share to studio
    • Rental: 40% royalty reportable to studio

If Total reportable share to studio is greater than the minimum guarantee (calculated based on 5% of Production Cost Budget, for example), then overages may be due. In many instances, it may be possible that the subdistributor did not anticipate exceeding the MG, and, therefore, has not prepared the proper statements. Historically, we find that it may result in an audit to ensure that the subdistributor can issue an overage statement and pay such overages due.

  • Keep in mind that in some instances (which should be delineated per the agreement), overages from one title might be cross-collateralized to other titles that have not exceeded their applicable MGs.
  • It is also possible that the agreement was written in the English language, but when translated to the local territory language, especially for complexities, it was improperly interpreted to the benefit of the subdistributor.

Overall there are numerous and varying pertinent elements of reporting from the subdistributors to the studios. Because of the complexity of the underlying agreement, and as previously noted, there is a higher risk of errors or other issues, causing underpayment to the studios. Due to the significant dollars involved, studios and distributors should ensure that a monitoring program is in place, which may include periodic audits. Although subdistributors might require that the audit take place in the local territory, it may also be possible to perform a “desk audit”, whereby the pertinent supporting documentation is emailed or otherwise delivered to the studio.

At GHJ, we have significant, first-hand experience auditing the statements and agreements between the subdistributors and studios. We have encountered various issues, ranging from simple errors to enormously complex contractual issues. If you have any questions or concerns, please reach out to myself or other members of GHJ and we can discuss, including available audit options or assessments.