The Indies New Battle:  SAG Residuals A Holdover From Old Hollywood


Periodical: The Business of Film

Date: May 1998

From a legal viewpoint, where does the independent producer ‘sit’ when trying to address the issue of SAG Residuals?  Darren Trattner, an entertainment attorney at Rosenfeld, Meyer & Susman, LLP, who specializes in film and television related transactions, discusses when to fear the residual issue.

As if making an independent film were not hard enough, the Screen Actors Guild (“SAG” to most of us) has just made it harder.  The story goes like this: it is the day before principal photography starts on a $2,000,000 film and SAG threatens to shut down the production unless it receives a deposit in the amount of $200,000 to cover anticipated residuals.  The producer does not have the funds, and SAG shuts down the production.  Finally, after several days of negotiations, SAG and the producer strike a compromise on a residual deposit and the film begins shooting.

If you think this will not happen to you, think again.  Not only have I navigated through this SAG nightmare for some of my independent producer clients, but I have also heard horror stories about movies being shut down for failure to satisfy SAG that residual obligations will be met. While these residual obligations may have made sense in “Old Hollywood”-- that is, a film industry controlled by studios -- they have no place in today’s environment of both studio and independent productions.  That said, however, as long as this outdated monster lives on, independent producers must come to grips with it.

When Does The Indie Producer Have To Fear The Residual Issue?

SAG is presently getting tough on indies because, historically, many indie productions have failed to comply with residual obligations.  For example, one-shot productions often have failed to account for advances obtained by sales agents to get the film financed, or have declared bankruptcy once the film has been sold to distributors.  This history, along with the increasingly successful and profitable nature of independent films, has led SAG to regard indies as prime targets for eliciting increased revenue for its members. 

SAG does not generally consider a residual commitment to be threatened when a film’s distributors have signed residual assumption agreements because the distributors are then bound in writing to assume all SAG residual payments.  Residual obligations are also not threatened when a film’s sales agent guarantees that it will contractually obligate the distributors of the film to assume SAG residual obligations.  Many big-budget, star-filled independent films routinely comply with these requirements, and hence avoid the indie residual nightmare.  

SAG sees matters differently, however, when neither a film’s distributors nor its sales agents are willing to assume these commitments -- a situation that often arises when an indie producer obtains financing from a multitude of sources, such as banks, equity and gap financing.  In such cases, SAG has been known to wait until the film producer is weakest and then demand an unreasonably high residual commitment.

The Residual Obligations And Allocations

SAG members (aka actors) are entitled to residuals from secondary uses of a film.  The residual payments are between 4.5% and 5.4% of the gross revenue attributed to  videocassette exploitation and 3.6% for pay television and free television exploitation.  No residuals are due for theatrical uses.  While these percentages are not very high, they can add up, depending on the allocation of a film’s revenue.  For example, unless there is a clearly substantiated allocation in a distributor’s report, SAG will likely contend that for a given film’s international revenue, 15% is attributed to theatrical exploitation, 65% for videocassette exploitation, 10% for pay television exploitation and 10% for free television exploitation.  In short, SAG will want residual payments from 85% of the film’s international gross revenue.  Given the financing to make the film, which is usually based on foreign revenues, if SAG’s allocation formula is followed, the residual obligation may be hefty, sometimes approaching one-tenth of a film’s shooting budget or even equaling the compensation for the lead actor or actors. 

The Negotiations

Negotiating with SAG when it is threatening to close down a film is far from pleasant.  There are two matters to negotiate: (1) the residual deposit; and (2) various agreements to satisfy SAG that residuals will be paid.

The greatest concern that independent producers have under these circumstances involves raising the money for the SAG residual deposit.  The bond company will not allow the producer to apply the film’s contingency (usually 10% of the film’s budget) to the residual deposit.  The producer will also not receive assistance from the film’s financiers, particularly banks, because they are investing and loaning money based on pre-sales and foreign revenue estimates.  As it stands, even without SAG’s demand for a residual deposit, the indie producer will be hard-pressed to close the financing by the commencement of principal photography.  The “cushion” in the film’s budget will not help much either because it usually cannot cover SAG’s notably high residual projections. 

Consequently, the indie producer’s only option is to try to negotiate a lower  deposit by challenging SAG’s gross revenue estimates and SAG’s allocations.  In fact, the producer should challenge SAG’s residual allocations because distributors do not  always exploit pictures in the manner  that SAG likes to think they are exploited.  Further, SAG’s residual allocation formula seems to discount market forces that may lead to a very different allocation of residuals from what SAG’s formula dictates.  At a minimum, the producer may seek to convince SAG to agree to arbitrate any disputes over allocation.  The indie producer may even try to be creative and figure out how to pay the deposit over the course of, or by the end of, principal photography.  One possibility would be to roll over any SAG payroll security deposit, which is required for all SAG films, into the residual deposit at the close of principal; if this roll-over occurs, however, that money may no longer be used to complete post-production of the film.  In such instances, SAG would also require a guarantee (usually from the completion guarantor) that the payroll security deposit will be replenished if SAG needs to draw down on it for reasons other than the payment of residuals.

Another concern involves the agreements that SAG will make the indie producer sign.   Recently, SAG has been requiring what is known as a laboratory pledgeholder agreement, which essentially prohibits any film negatives from being moved until SAG is satisfied that residual obligations will be met.  Under such arrangements, SAG takes a security interest in the film’s negative that is subordinate to the interests of the bank and guarantor but senior to all other interests.  The overall efficacy of such arrangements is still being worked out by banks, completion guarantors and the guild. 

SAG also may require some sort of collection agreement, whereby all gross revenue is deposited into an escrow account and disbursed in a manner that will satisfy residual obligations.   Escrow matters become complicated if both bank loans and equity investors are involved because SAG generally will only subordinate its interest to a bank (though SAG is trying to change this), causing equity investors to have to wait behind SAG.  In such a situation, SAG will ask for a collection and disbursement agreement whereby once the bank (and only the bank) has recouped its loan, all gross revenue is deposited into an escrow account and is disbursed accordingly.  The equity investors will only recoup their investment, which may in some instances be equal to or more than a bank loan, after residual commitments have been met.  

Additionally, other issues may arise, and other agreements may have to be signed, depending on a film’s particular financing structure and its distribution or potential for distribution.

SAG’s Approach Is Misguided In The New Hollywood

While SAG’s representatives claim that ensuring residual obligations is the product of a straight-forward application of the rules set forth in the SAG Basic Agreement, residual obligations should be re-examined insofar as independent films are concerned.  Residuals made sense under the old studio system -- i.e., the pre-independent Hollywood -- because in that era, residual payments really were for secondary uses.  Studios made a motion picture for the big screen and then exploited it in other mediums.  Today, however, SAG is asking for residuals on small independent films whose primary exploitation (such as videocassette or television) may be the very medium for which SAG requires residual payments.  For example, most indie films today are, in reality, made for foreign television and video, and the secondary use is theatrical.  The actors who appear in such nontheatrical films are generally paid residuals on a use for which the actors were already compensated -- a result that is inconsistent with the intent and spirit of SAG’s Basic Agreement. 

Indies that are not released theatrically also never receive the benefit of what I term “the residual-free secondary use.”  For example, SAG does not require residuals for foreign theatrical exhibition, which is usually a secondary use of a film released in initially in the United States.  While studio films often benefit from this residual-free secondary use, nontheatrical-released indies never receive such an exemption or residual-free use. 

It is unfortunate that SAG has begun to target the indie producer for the payment of residuals, but it is happening.  Unless and until residual obligations for independent films are modified (a modification that should be researched by producers and actors as the next Basic Agreement is hammered out), the indie producer should be prepared for the worst, and should both budget for an unreasonably high residual obligation as well as enlist the support of people experienced with SAG to handle the ensuing crisis.  While far from an enjoyable experience, this aspect of film production is manageable with the right people and the right preparation.

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