Superman Deal Isn’t a “Sweetheart”

August 28, 2009

BY:

Neil J. Rosini, Michael I. Rudell

When the widow and daughter of a co-creator of Superman challenge a Warner-DC agreement, the court sides with Warner for some unexpected reasons.

(Originally published in the Entertainment Law column of the New York Law Journal, August 28, 2009)

The U.S. District Court for the Central District of California refused to find that a grant of film rights in the Superman copyright from DC Comics, Inc. to its much larger corporate sibling Warner Bros. Entertainment Inc., represented a “sweetheart deal”.1Had the Court found that DC licensed rights to Warner for less than market value, the plaintiffs’ half-interest in the seminal Superman copyright would have brought them considerably higher payments from the Warner-DC arrangement.

The plaintiffs in the action were the widow and daughter of Jerome Siegel, co-creator of the comic book hero, who successfully had terminated the 1938 grant of copyright in the first Superman comic book, Action Comics No. 1, made by Siegel and his creative partner, Joseph Shuster, to the predecessor in interest of DC. (The termination date for Shuster’s statutory successors has been noticed for 2013.)

The Court considered other film rights agreements from the 1990s and early 2000s as it weighed whether direct economic terms (like purchase price and contingent compensation) and indirect economic terms (like the absence of a reversion provision) in the DC-Warner agreement placed the overall deal within the range of fair market value for the rights granted—that is, “what a ‘reasonable’ price would have been paid for it by a willing buyer.” The lengthy decision makes notable distinctions between “comparable” and “incomparable” deals but gives determinative weight both to a lack of key evidence and to the timing of the action itself.

The Superman Film Agreement

The contract in question conveyed an option to obtain exclusive rights to produce one or more films utilizing all the copyrights in the Superman works owned by DC as well as non-exclusive rights in Action Comics No. 1, which DC co-owned with the plaintiffs. The parties’ agreement, “memorialized” in 1999 but not formally executed until 2002, provided consideration in three major categories: first, an up-front “initial option fee” of $1.5 million; second, additional annual payments called “option extension payments” of $500,000 escalating to $600,000 and then to $700,000 totaling $18.5 million over the 31-year duration of copyright protection; and third, contingent compensation based on a percentage of “distributor gross receipts,” to the extent that it exceeded payments in the first two categories, which were treated as a “non-returnable advance” against contingent compensation.

Although the annual sums in the contract were designated “option extension payments” that entitled Warner to continue to make Superman films, the Court found that in the aggregate, they more closely resembled a non-refundable purchase price for acquisition of film rights payable in 31 annual installments. No specific “purchase payment” was required when Warner exercised the “option” to make its initial film; it merely needed to give notice that principal photography of a feature-length film had commenced; afterward, “option extension payments” continued to come due. The contract provided that if Warner failed timely to pay the initial fee or any installment of the annual fee or any part of contingent compensation, film rights would revert to DC unless Warner cured its failure within three months after receiving notice.

The contingent compensation was agreed to be 5% of the “first dollar of worldwide distributor gross” or 7 ½ % of the first dollar of domestic distributor gross, whichever was greater. The Court defined distributor gross as “[t]he money received by the film’s distributor (typically the studio)” which includes “most, if not all, the money received at the box office.”2 The Court noted that lesser forms of participation are based on “net profits,” which “normally must rely on the standard definition of a breakeven point…that requires deductions for all the costs, fees, and expenses incurred in making and releasing the film” before net profits participants receive any part of their contingent compensation. Those deductions include production costs (“all the costs directly attributed to producing and shooting the film so as to put it on a final film negative”); distribution costs (the cost of making prints and advertising and other costs “attributable to marketing and releasing a particular film”); and distribution fees collected by the film’s distributor (which are “assessed as a percentage of receipts, with the percentage varying based on the source,” such as domestic box office or foreign box office).

The deductions made in arriving at breakeven also include payments made to gross participants, which require a film to generate more revenue at the box office before a net profits participant receives payment than if gross participants did not exist. The Court further observed that the parties may agree to an “artificial breakeven point” that may be calculated by deducting some — rather than all — possible deductions from gross. The result can be an “adjusted gross” or “defined gross” target that functions in some respects as a net profits deal but achieves the breakeven point faster than the “standard formulation.” But regardless of how it’s defined, if the breakeven point is not reached, a participant who does not participate in gross receipts is not paid contingent compensation.

DC reserved certain rights in Superman — most notably merchandising rights, although Warner was entitled to a share of “net proceeds” from merchandising that used “new or additional characters or elements” found in any new Superman film of Warner’s. Merchandising “net proceeds” were calculated by deducting DC’s costs and expenses from revenues as well as a 20% “overhead factor.” What was to be Warner’s share? The agreement did not say but in practice DC took 75% of “profits” and Warner 25%. DC also reserved television rights but its ability to exploit them was limited to using an affiliate of Warner. The Court found this provision “not surprising” because the parties had entered into a Superman television rights agreement just prior to the Superman film agreement.

Comparables and Incomparables

To reach its decision, the Court needed to determine “what a willing buyer would have been reasonably required to pay a willing seller” for Superman film rights by reference to comparable deals involving other literary properties. The Court described this “market value approach” as an “objective analysis, focusing on such considerations as expert testimony as to market value, previous dealings between the parties, and the compensation obtained on the open market for the license of similar rights to other comparable literary properties.”

At a ten-day bench trial, the Court heard testimony from experts and received into evidence “dozens of third-party film and television licensing agreements apparently negotiated at arms length.” However, the Court did not feel itself well-informed by key experts whom Court singled out for their “lack of credibility.”

The Court also lamented that most of that limited universe of agreements in evidence were “incomparable.” Plaintiffs introduced rights agreements for well-known musicals (My Fair Lady, Annie, Chorus Line) and best-selling novels by “marquee authors” (Tom Clancy, Michael Crichton, J.R.R. Tolkien, Clive Cussler and Thomas Harris) that the Court declared to be “largely unpersuasive evidence” of the value of Superman. The Court instead found that best-selling novels were “much more valuable” from a filmmaker’s perspective compared to comic book properties because they present a more “known quality,” with stories already test-marketed to the public. Although comic books have well-known characters, a film producer still has to create a film script with a story that is “not necessarily known or well-defined at the outset.” Further, the Court found that novels and musicals offer relatively small potential for revenues from merchandising and video games, compared to comic book properties. On the other hand, audiovisual exploitation opportunities for comic books are more “broad-based,” so the levels of contingent compensation, the purchase price, and option payments are set relatively lower for them and the value of merchandising arrangements much higher. For all these reasons, the Court faulted agreements offered into evidence by the plaintiffs.

For their part, defendants offered agreements that suggested “Superman was equivalent to a low-tier comic book character that appeared mostly on radio during the 1930s and 1940s and that has not been seen since a brief television show in the mid-1960s” (the Green Hornet); or “an early 20th century series of books” (Tarzan); or “a 1930s series of pulp stories” (Conan), all of which the Court frowned upon. Where were the agreements, asked the Court, for “the most obvious comparable properties,” namely notable and contemporaneously popular comic book characters like X-Men, Spider-Man, Fantastic Four and Incredible Hulk? None was introduced into evidence by the defendants or by the plaintiffs, who bore both the burden of proof and the brunt of the Court’s criticism.

The X-Men Comparable

As it turned out, even without the X-Men agreement between Marvel Comics and Twentieth Century Fox in evidence, the Court designated it the best comparable for “adducing the fair market value for the Superman character and for judging the reasonableness of the terms” in the Superman film agreement. The Court learned of the “core economic terms” in the X-Men agreement from the testimony of the head of DC, Paul Levitz, who, having previously read the agreement, based his testimony on recollection, except when he was shown the agreement to refresh that recollection. The X-Men contract had been executed in the mid-1990s — a few years before the Superman deal — and evidence showed X-Men to be the most popular comic book published from 1997 to 2002 with sales surpassing those of Spider-Man, Batman and Superman. Further, the deal terms of the X-Men agreement represented the most that a film studio had paid for a comic book property up to that time.

Mr. Levitz testified to an initial option payment for X-Men film rights of $150,000 against a purchase price of $1.5 million and a contingent compensation formula that caused money to be paid out to the licensor, Marvel, at “some form of artificial break even.” Although no percentage participation in contingent compensation or the merchandising split in the X-Men deal was disclosed at trial, the Court found much of the Superman economic terms to lie in the same range. Importantly, DC received an up-front option fee of $1.5 million in the Superman agreement and Marvel was paid a $1.5 million purchase price at some point after execution of the X-Men film agreement. As for contingent compensation, the Court surmised that the 5% of “first dollar distributor worldwide gross” in the Superman agreement “is as good as and, indeed, may be better than, that in the X-Men film agreement” because the X-Men profit participants had to wait for some beakeven point and DC did not. The Court also compared the “direct economic terms” of film agreements for Iron Man, Conan, and Tarzan from 2001-2003, but because none of those properties was “in the same league” as Superman, none of their agreements was fully comparable.

Nevertheless, Superman’s up-front fixed fee was far less impressive compared to those in the Tarzan, Conan, novel and musical film agreements. The Court found that a reasonable market-driven purchase/initial option payment for Superman would have been far greater: in the range of $4 – $6 million rather than the $1.5 million paid to DC.

Nevertheless, this “market ‘defect’” in one part of the Superman terms did not win the day for the plaintiffs because they failed to distinguish at trial between the value of nonexclusive rights conveyed by DC to Warner in Action Comics No. 1 – in which DC and the plaintiffs each held a half share – and the exclusive rights conveyed by DC in 70 years of additional Superman works that comprised the remainder of the licensed property in which the plaintiffs had no share. As a result, despite all the prior analysis in the decision, the Court concluded that there was “simply no evidentiary basis upon which the Court could even engage in the process of determining whether the Superman film agreement ….was consummated at less than fair market value.”

Lack of A Reversion Clause

The Court’s market analysis did not end with direct economic terms, however. It proceeded to analyze another facet of the Superman deal to which the non-exclusive character of the transfer of rights in Action Comics No. 1 was “largely irrelevant”: the absence of a reversion clause. This placed the Superman deal in stark contrast to “nearly all” of the others in evidence because DC had no “mechanism to ensure the continued development and exploitation of the Superman property in film” — the “economic lifeblood” of film rights for “franchise” properties.

Compounding this deficiency was the absence of any purchase price to be paid when the option was exercised. Further, the so-called “option extension payments” that were “strung out in relatively small increments” over 31 years could be “largely or wholly wiped away” by a provision which allowed for recoupment of the contingent compensation generated by an initial Superman film from those subsequent payments. (In fact, that’s exactly what happened: the initial Superman film, Superman Returns, paid DC $12.1 million in contingent compensation, which relieved Warner from making further installments from 2003 to 2023.) And the merchandising revenue that subsequent releases could generate would not materialize if no subsequent films were made. As a result, under its agreement with DC, Warner “locked” its film rights for 21 years for $13.6 million, including the $1.5 million initial payment, with no obligation to make either another film or any further payment to DC. The direct economic terms – which appeared “on paper. . . to be largely, albeit not entirely, a reasonable price” – were thus “potentially illusory.”

The “tangled corporate and intellectual property web” existing between DC and Warner further compounded the problem; indeed, Mr. Levitz’s testimony indicated that within the corporate family, the payment terms of the agreement were “flexible” and “subject to change without formal amendment.” And, the difficulty DC would likely encounter should it want to buy out Warner’s rights, accentuated the Court’s concerns.

The Court concluded that “the value of the Superman film agreement may well be below fair market” and, if so, perhaps the contract should be reformed by doubling or tripling the price of the annual option extension payments and eliminating Warner’s ability to reduce them by the contingent compensation from the first film. Doing so would increase the overall purchase price to DC over the remainder of the copyright term from $20 million to $60 million (with commensurate benefits to the plaintiffs) and reduce the likelihood that Warner would “store away” Superman after making payments of that magnitude.

However, after laying out that path, the Court refused to follow it because the plaintiffs did not establish that “there would have been a film sequel or a reversion of rights by this point if the agreement contained such a reversion clause keyed to film development.” Yes, Warner had only released one Superman film over the seven years since the agreement was executed and no further development occurred after the first film, but film rights agreements for other properties, on average, gave the licensee three to five years after the first film during which to release another before reversion applied. What Warner might do or not do with its sequel rights during the next few years was only a matter of conjecture, making the plaintiffs’ damages too speculative. The Court invited the plaintiffs to return with an accounting action should the filming of a sequel not commence by 2011.

Accordingly, the Court found for the defendants because of insufficient evidence that the Superman film agreement – whether judged by direct economic terms or indirect ones – was “consummated at below its fair market value.”

Conclusion

Those who wish to delve into the finer points of contingent compensation and of the assessment of value in film rights — including related issues of proof — can glean much from this decision.

ENDNOTES

1 Joanne Siegel and Laura Siegel Larson v. Warner Bros Entertainment, Inc., DC Comics Inc., __ F. Supp.2d __, 2009 WL 2014164 (C.D. Cal.); the decision also paid brief attention to a television agreement, which it also refused to find below fair market value.

2 Distributor’s gross does not represent “most, if not all, the money received at the box office.” In the United States, the percentage ordinarily lies between 45% to 50% of such box office receipts.