BY:Neil J. Rosini, Michael I. Rudell
(Originally published in the Entertainment Law column of the New York Law Journal, February 24, 2006.)
Last year, and again last week, it was reported that the New York attorney general, Elliot Spitzer, issued subpoenas to major record labels in an investigation of whether they colluded to fix prices for their music sold online. The Los Angeles Times also recently reported that the focus of the probe was a common contract term known as “most favored nations” (“MFN”). According to the newspaper’s account, MFN clauses in record label contracts with online retailers guaranteed competing labels the same prices for their music. Some music industry executives reportedly defended the clause as a reasonable means to avoid long debates over pricing and to ensure that all musical artists are equally compensated. The attorney general’s office declined to comment.
The question of when, if ever, most favored nations clauses run afoul of antitrust laws is not the subject of this article. Rather, the action by the attorney general’s office presents an opportune time for a general overview of MFN clauses, which appear in a variety of entertainment agreements.
MFN Clauses Defined
The “most favored nations” concept had its start not in entertainment agreements but in treaties governing international commerce. The clause would ensure that one country to a trade agreement received no worse treatment – concerning import duties, for example – than the treatment accorded another trading partner. Similarly, in entertainment agreements, an MFN clause provides that an amount, a definition, or another aspect of a contractual relationship will be computed or defined in at least as favorable a manner as the computation or definition given to one or more third parties.
Ordinarily, those third parties also are bound by agreements with the same entity and for the same project as the party receiving the benefit of the clause (e.g., a net proceeds definition for a particular movie; a royalty pool definition for a particular theatrical production). In rare cases when the recipient has great leverage, the scope of the clause might extend beyond a single project. For example, “gross receipts” might be defined on a most favored nations basis for a recipient with respect to all motion pictures produced by a film company, not just the particular motion picture to which the agreement containing the MFN clause relates.
An MFN provision may apply not to a project but rather to one or more aspects of an executive’s employment agreement, such as with regard to stock option and restricted stock awards governed by an equity incentive plan. The executive may obtain the employer’s promise that if anyone else gets a particular modification such as accelerated vesting upon termination, so will the executive. An executive’s contract also might contain a provision that no one in a particular defined group will receive a greater number of stock options or shares of restricted stock.
The Issue of Specificity
Particularly from the perspective of the party obligated to apply the clause, the preferred MFN provisions are limited in scope and precisely written. In drafting an MFN clause, the applicable project should be named: a particular motion picture, television or live theater production, a record album or a compilation. Next, the contractual provision to be compared – an amount, a definition, or other terms – should be specified. For example, an MFN clause benefiting a recipient of contingent compensation in a motion picture might provide that for a particular film, no one else could receive a more favorable definition of contingent compensation. But because there are various levels of contingent compensation (e.g., gross receipts, adjusted gross receipts, net proceeds) involved in motion picture productions, even more specificity often would be advisable from the studio’s perspective.
On the other hand, the recipient of an MFN clause may sometimes do better with a broad description because a narrowly-tailored clause may not include the full range of benefits the recipient hopes to derive. For example, a producer may compensate an individual who works in several capacities more generously in one capacity that is not implicated by an MFN clause, compared to another capacity that is. If one co-executive producer also serves as a “creative consultant,” she can be compensated for both functions. A fellow co-executive producer may have a most favored nations clause that only reaches the compensation paid for executive producer services. The narrowly-written clause would not include compensation paid for similar or related functions with a different label.
For another example, in the context of contingent compensation, “adjusted gross receipts” is generally considered a more favorable participation than “net profits,” but even these terms can be accorded different labels, such as “modified adjusted gross” or “net proceeds.” Accordingly, the participant with a share of “adjusted gross receipts” might bargain for MFN protection respecting any form of contingent compensation no matter what the label (other than a participation in “gross receipts”). And each recipient will want to ensure that his or her entitlement is preserved even if the other party attaches a different label to the same contingent compensation.
Why Parties Use MFN Clauses
There are several reasons why one or both parties would wish to have an MFN clause. An MFN clause can eliminate significant transaction costs in both time and money through setting a specific level of compensation. (By standing firm on those terms, however, the company must be willing to lose content or services from third parties who refuse to accept that level of compensation.) MFN clauses also provide licensors and other recipients the comfort of knowing that no one else will be treated in a more favorable manner with respect to a particular term. This assurance is a security blanket for agents and other negotiating representatives who can assure their clients that a particular definition or amount is the best available for the project in question.
MFN clauses can be particularly helpful to parties with small bargaining leverage confronted by lengthy “standard terms.” In the case of deal terms covering contingent compensation from motion picture exploitation, studio boilerplate is often extremely long, and if every clause were negotiated, transaction costs would be extremely high for both parties. Further, studios usually are not overly eager to negotiate such terms in a meaningful way. MFN clauses can save both sides a good deal of time and trouble while providing a measure of protection for the party contracting with the studio.
For example, it often does not make a great deal of sense for a minor participant in “net profits” from the exploitation of a property to assume the burden of negotiating a lengthy definition. This is particularly so when the benefits of such a negotiation may not be substantial. That participant is usually better advised to seek the same treatment as a participant with greater bargaining power, more at stake, and more resources to sustain the costs (principally legal fees) of a lengthy negotiation. Accordingly, a screenwriter might choose to have his or her net profits defined on the same basis as the director or author of an underlying novel.
The daunting task of negotiating a full complement of contingent compensation provisions in motion picture deals also has led to a hierarchy of side letters and riders that are commonly used in the Hollywood community. A studio may offer an actor the benefit of the best rider (the “A Rider” as opposed to the “B Rider”) associated with a particular talent agency, relating to the studio’s boilerplate contingent compensation provisions. The reverse effect also may come into play: for example, an actor with significant leverage may be able to negotiate uniquely beneficial terms in his deal with a studio, but the studio would then want to exclude this “superstar” tier from any MFN protection afforded to others.
MFN Clauses Appear in a Variety of Contexts
In the theater, most favored nations provisions often appear in the context of royalty pools, which provide a formula by which persons who otherwise would share in the gross weekly box office receipts of a particular production, agree instead to participate in a share of weekly operating profits (with the balance of operating profits being allocated to investors). It is usually a precondition to a royalty participant’s agreement to the activation of a royalty pool that all other royalty participants be paid pursuant to the pool. However, exceptions are generally carved out for a star or the theater owner who may still be entitled to a share of gross box office receipts above a defined threshold, even when a royalty pool is in effect.
Credit is a non-monetary benefit that can be subject to MFN protection. The billing block – the text-filled box commonly seen in a film ad – is the common denominator of credits appearing in motion picture advertising, and MFN clauses typically are keyed to it. An exception from the most favored nations provision for credit to participants in the film often will be made with regard to billing in artwork afforded to a star or director. In many cases, an MFN clause also will be made subject to union requirements that are applicable to performers, directors and screenwriters.
MFN clauses are commonly used when a company assembles a product such as a compilation record album in which rights are sought from various record companies. The company assembling the compilation record may reduce the time and trouble of negotiation by assuring all licensors that they will receive the same license fee, or royalty entitlement, or both. The same concept might apply to the acquisition of rights for footage in a documentary production where, perhaps, on a per minute basis all fees will be the same.
In most instances, the clause will be self-enforcing in that the only way the recipient will know if another party has received a higher amount or better definition that triggers the clause, is for the company to disclose it. Other opportunities to learn third party deal terms do arise, however. In the event of a lawsuit, the contracts likely would be discoverable. Also, in the case of theatrical productions certain royalty participants – particularly those entitled to a share of net profits – may receive regular financial reports and have the right to inspect the books and records of the production. In addition, offering materials filed with state securities agencies may disclose compensation arrangements for major royalty participants making it relatively easy to find variations in terms.
Generally speaking, as with most contractual undertakings, as long as both parties are aware of differing approaches to drafting and potential outcomes, both the recipient and the offeror stand to benefit from the appropriate use of MFN treatment.