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Producers Beware: What happens when your movie distributor files bankruptcy?

The Issue

There has been written a plethora of articles about Bankruptcy Code §365(n) regarding the rights of parties to license agreements when the licensor files a bankruptcy and rejects a license agreement. Generally, Code Section 365(n) allows the licensee to “accept” a rejection of a license agreement by the licensor or “reject” the rejection of a license agreement and retain its rights.

However, what has not been addressed, and what seems to be of frequent concern in recent years, are the issues that affect producer/licensors when their distributor/licensees file bankruptcy. We have seen these issues arise in a significant way in the recent bankruptcy filings by Relativity which filed in the Southern District of New York, and the more recent bankruptcy filing by Our Alchemy in the District of Delaware.

Damages Only Provisions

It is not unusual – and may be a standard provision – for many distribution agreements by which a producer authorizes another party to distribute a movie, a T.V. series or similar work, to contain a “damages only” provision. These provisions typically state that in the event of a breach by the distributor/licensee, the only right that the licensor has is a claim for damages (i.e. not to terminate the agreement and recover the intellectual property rights).  This type of provision is often inserted at the insistence of the distributor/licensee, which often has the bargaining leverage to require insertion of such a provision, except when it is dealing with a title produced by one of the “majors”.

When a distributor/licensee enters bankruptcy, notwithstanding any contrary terms in the agreement, bankruptcy law precludes the agreement from being terminated merely because of the bankruptcy filing or the financial condition of the distributor. A producer/licensor must therefore look to other failures of the distributor/licensee, other than the financial condition of the licensee or the fact that it entered bankruptcy, as a basis to terminate the agreement.  Usually distribution agreements will contain a series of provisions requiring the distributor/licensee to release the movie in a particular fashion, whether theatrically or non-theatrically, and to reach certain milestones by given dates.  When a distributor/licensee files a bankruptcy, its ability to meet these requirements timely is often severely hampered.  But for the “damage only” clause, failure to meet these deadlines would give the producer/licensor the right to terminate the agreement.  However with a “damages only” clause, the ability of the producer to terminate the agreement and seek recovery of its rights is severely limited.  When coupled with a bankruptcy, where the monetary recovery on a claim is often only pennies on the dollar, the negative impact of the “damages only” clause is exacerbated.

This issue came up in connection with a variety of license/distribution agreements in the Relativity bankruptcy case. Even though as a result of the bankruptcy filing, Relativity was severely delayed in meeting its contractual obligations, the ability of the producer/licensors to terminate their agreements due to the failure of Relativity to meet those requirements, was precluded by the agreement.

There appears to be scant law on the enforceability of such a provision. If it is enforced, both the producer and the distributor seem to be in a no man’s land:

  • From the producer’s point of view it cannot recover its rights, but only get damages, which in the case of a bankrupt entity is little consolation.
  • From the bankrupt distributor’s point of view, under applicable bankruptcy law, the distributor either has to assume or reject the license agreement. If the license agreement is assumed, then again under applicable bankruptcy law the distributor must “cure” all defaults and provide adequate assurance of future performance. Doing so would surely require payment of any monetary damages and performance under the agreement by the distributor. Thus assumption of the agreement would seem to render moot the “damages only” clause. Rejection of the agreement on the other hand, results in a breach of the agreement. Even though not tested by the bankruptcy judge in the Relativity case, it strains this author’s belief that a court would allow a distributor who rejected an agreement still to distribute under the agreement, and pay only pre-petition damages to the producer.

Because of this quandary, Relativity was able to obtain significant additional time to try to get its financial house in order before it was compelled to meet its contractual obligations. This in many instances resulted in producers’ rights being tied up for significant periods of time before they were sold, otherwise disposed of, or ultimately acted upon by Relativity.

Summary

Often not much thought is given to these “damages only” clauses. However they really can come back to haunt the producer if the distributor is unable to perform. So producers beware: take great care before you accede to one of these “damages only” clauses.