This is part of a series of book excerpts from The Independent Filmmaker’s Law and Business Guide: Financing, Shooting, and Distributing Independent and Digital Films
designed to introduce filmmakers and others interested in creating content on the legal issues involved in the filmmaking process.
The filmmaker’s role as business operator creates specific duties of care and loyalty to the investors. Because the filmmaker is also an employee of the company and a primary beneficiary of the film project, the filmmaker must take great care to respect these fiduciary obligations and to carefully disclose the various conflicts of interest to the investors before they agree to invest in the project.
Whether serving as a general partner, managing member, or corporate officer and director, the filmmaker has a primary duty to act in the best interests of the business rather than out of personal self-interest. As a general matter, this duty limits self-dealing transactions. A manager should never give herself a loan from the business, pay herself a bonus, divert business opportunities, or otherwise take for herself any benefit that should go to the company.
For example, if the film company owns the sequel rights to the movie, the manager should not buy those rights from the company for the purpose of reselling them at a substantially higher price. Similarly, the man-ager cannot agree to sell the sequel rights cheaply on behalf of the company in exchange for a highly lucrative contract to direct the sequel. Although a rights transaction might be perfectly appropriate between the manager and an unrelated party, the manager has a duty to maximize the profits off the sale for the business; she cannot take that benefit for herself.
To honor the duty of loyalty, the filmmaker should plan ahead. First, certain situations will create clear conflicts of interest between the filmmaker and the business. As much as possible, the filmmaker should dis-close the terms of any material conflicts to prospective investors. The disclosure should be in a private placement memorandum or other offering document as well as in the language of the operating agreement, bylaws, or subscription agreement:
When individuals choose to invest in the business after having received full disclosure of these preexisting conflicts of interest, they cannot effectively complain that the transaction unfairly benefits the managers rather than the business. On the other hand, if the information was not made available in advance of the investment, the investors may have grounds to charge that the manager misrepresented the transaction. Once the investment is made, the filmmaker is of course restricted from making further arrangements that benefit the managers to the detriment of the business or its investors.
In independent filmmaking, even when a manager is scrupulous about adhering to the duty of loyalty, conflicts of interest will arise throughout the filmmaking process. To be of concern to investors, the conflict must be material. Contracts to acquire rights, to distribute the film, and to compete with the film company by working for another company are among the types of transactions that are clearly material. Eating the catering on the set is not. The manager must use common sense in determining whether a reasonable investor would consider the conflict important, erring on the side of overdisclosure.
To resolve conflicts of interest, the operating agreement, partnership agreement, or bylaws should provide clear provisions. For example, the policy might mandate that when officers, directors, managers, or partners have a conflict of interest, such a transaction can only be completed after the following steps have been taken:
In many situations, no disinterested board of directors or managers will be available. In such a case, the operating agreement or bylaws should specify that substantially similar steps are taken by the members of the LLC, partners of the partnership, or shareholders of the corporation. In that situation, the best approach is to seek unanimous written consent of all investors by providing the information in writing and seeking signatures of approval.
Duty of Care
The duty of care requires that the officers, directors, managers, or partners act in good faith and exercise prudent decision making in the undertaking of the business for the benefit of the business and its investors. Whereas the duty of loyalty provides a very demanding standard, the duty of care sets a low threshold to meet. Independent filmmaking is a highly risky enterprise, so wide latitude is given to the filmmakers to act reasonably in an uncertain business.
The duty of care essentially requires that the filmmakers avoid being grossly negligent in the operation of the business. The filmmakers must be fully informed of their obligations and make every reasonable effort to meet those obligations. The duty of care would make the filmmakers liable to the company and its shareholders for failing to keep records, failing to acquire the rights necessary to make the film, or materially violating tax or professional obligations.
Other potential breaches of the duty of care are more ambiguous. Perhaps the most interesting and difficult situation would arise if the filmmakers determined that a film project would cost $100,000 to shoot under their business plan but they chose to begin principal photography when only $50,000 was raised. Is it unreasonable and grossly negligent to hope that an angel investor will appear before the money runs out? Certainly it would have been more prudent to adjust the shooting schedule or other expectations to make a $50,000 film or to wait until full financing was in place. It might have been more prudent to spend $10,000 to create a trailer to help raise the additional funds. Nevertheless, the filmmakers may not have been grossly negligent in going forward with the shoot, depending on how reasonable it was to expect that the additional funds would be raised. If the filmmaker’s expectations were low, then such a strategy may very well have been grossly negligent, in which case the filmmakers would be personally obligated to repay their investors. Fortunately, independent film investors know how risky the industry can be, so they are generally reluctant to seek personal reimbursement.
The duty of care should serve as a check on the risks that independent filmmakers are willing to take. If there is no reasonable likelihood of a return, then the investors’ money should not be spent. If the filmmaker goes into a project knowing the risks are very high, then she should disclose the high-risk strategy to the investors, or seek to fund the movie with gifts from friends and family.
* Jon Garon is admitted in New Hampshire, California and Minnesota.
Adapted from The Independent Filmmaker’s Law and Business Guide: Financing, Shooting, and Distributing Independent and Digital Films, A Capella Books (2d Ed. 2009) (reprinted with permission). Jon Garon is professor of law, Hamline University School of Law; of counsel, Gallagher, Callahan & Gartrell.