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Aug. 30, 2023

TSG v. Disney is all about ‘Showing the Money’

Hollywood financier TSG Entertainment’s recent litigation against Fox and the Walt Disney Company is a tale as old as time.

Elsa Ramo

Managing Partner, Ramo Law PC

Laura LaBrecque

Associate, Ramo Law PC

TSG, a longtime investor in the juggernaut's film archive, sued 20th Century Studios for a breach of contract and Disney for taking part in said breach on Aug. 15. In its claim, TSG is taking the position that Disney is hiding their entitled profit participation. The claims are neither novel nor unfamiliar to the countless number of entities, funds and investors who attempted to shake hands with the studio system to participate in the "Hollywood dream" that almost always results in a Hollywood accounting nightmare.

Over the years, there have been a multitude of cases that highlight the issues within Hollywood accounting and studios that constantly claim no profits for films that gross hundreds of millions of dollars, largely due to the way that net profits definitions are crafted.

Most recently in 2019, Fox settled a lawsuit with the lead actors and executive producers on "Bones," the network's popular police procedural dramedy series, which ran from 2005 to 2017. After over a decade of onscreen forensic hijinks, some of the cast and producers alleged they had been defrauded of their profit participation on the show, claiming that the profits "became heavily dependent on what Fox's studio division...charged Fox's distribution affiliates..."

The case concerned whether Fox undercharged license fees to its sister companies in order to keep profits at the expense of other parties. The "Bones" actors and EPs were awarded $179 million in damages in arbitration, with the arbitrator finding it "inexplicable that the Fox studio producing "Bones" permitted its parent company to exploit streaming rights and license those rights to Hulu without much of anything in return" (Gardner, Eriq. "Fox Settles 'Bones' Suit, Ending Profits Case That Stunned Hollywood." The Hollywood Reporter, Sept. 11, 2019).

The Bones case was a foreshadower or perhaps, an inspiration to the TSG lawsuit where three significant issues are at stake:

"Hollywood Accounting" (breach of contract): TSG has financed more than 140 Fox films as part of a Revenue Participation Agreement with Fox dated as of Dec. 31, 2012, and amended multiple times since then. As part of that deal, TSG would receive a share of "Defined Gross Receipts" for the applicable films that it helped co-finance. But TSG noticed that its return on investment from these films was decreasing, leading to an audit commence. The audit found that revenue that should have been included in Defined Gross Receipts was not included. In fact, Fox charged TSG distribution fees that their agreement did not permit (e.g., for EST distribution, Fox charged a distribution fee that only applies when Fox itself is the sole distributor), and Fox deducted distribution expenses from TSG's share of Defined Gross Receipts that were not related to the applicable films that TSG co-financed (e.g., in connection with the operation of Movies Anywhere, Fox reported no receipts to TSG but allocated costs to TSG in connection with the operation of this company).

Self-Dealing: The audit also uncovered numerous examples of self-dealing by Fox and Disney, meaning a breach of implied covenant of good faith and fair dealing. This took centerstage in Fox and FX Networks' deal, which gave FX license exhibition rights to Fox films in exchange for pre-determined license fees tied to box office performance. However, Fox and FX ignored the terms of that agreement for certain films, including Guillermo del Toro's 2017 Academy Award-winning feature, "The Shape of Water." At the time, both entities did a secret side deal for less than fair value. Fox also had a deal with the network HBO, in which it would license its films to HBO exclusively. But after Disney acquired Fox, it restructured the deal with HBO to license its films non-exclusively. This would allow Disney to put its own films up on its streaming platforms such as Disney+ and Hulu for smaller license fees ("sweetheart" deals). Thus, losing a significant amount in license fees in order to boost its own streaming services.

Interference (intentional interference with contractual relations and inducing breach of contract): TSG tried to exercise the right in its deal with Fox that allowed TSG to sell back TSG's interests in a number of successful films to Fox. That way, TSG would be able to re-invest those funds in new films, like James Cameron's 2022 hit, "Avatar: The Way of Water." But Fox refused to engage on many of these - as expressed in an email from Disney's CFO Paul Shurgotv, who stated that they didn't want to provide an offer on "selected non-consecutive tranches that are among the most profitable tranches released to date."

In order to invest in "Avatar: The Way of Water" and other films, TSG had to take an advance from Fox, which resulted in their share of Defined Gross Receipts being reduced even more. This will make it harder for TSG to generate liquidity to invest in future films.

The TSG claims are familiar, but the timing of this lawsuit is unique and stands to threaten the whole foundation by which studios engage with profit participants (whether they are talent or investors). A few observations about this case are worth noting.

While this litigation is about a dispute in accounting practices, the real issue here is that studios and streamers can no longer hide behind accounting principles that were always meant to fail. How are studios going to engage with investors and high-level talent in a way that allows for participation? The solutions are continuing down a path for litigation or forcing more transparent accounting practices.

In recent years this has been effective when looking to the Bones case or in Frank Darabont's case against AMC Networks in 2021. Darabont, the former showrunner of the hit zombie apocalypse series, "The Walking Dead" (2010-2022), and his representatives at Creative Artists Agency had sued the network for faulty and shady accounting practices in 2013. After many years and a later zombie spin-off, AMC finally put an end to the profit debate and paid Darabont and CAA $200 million in settlement (Patten, Dominic. "'Walking Dead' Lawsuit Settled For $200M Between Frank Darabont, CAA & AMC." Deadline. July 16, 2021). This situation requires fairly strict auditing, though. A typical profit participant is likely not receiving great audit and accounting rights and being able to scrutinize to this degree. Only those with high-level audit and accounting (e.g., financiers like TSG, creators, etc.) are going to be aware of issues in order to bring forth a claim.

There should be a more transparent path for accounting. But this is impossible, especially given current waterfalls and definitions. The podcast, "The Town with Matthew Belloni," breaks down the revenue streams and waterfall for films, and highlights how even when films are not technically profitable, the studios often make money while other profit participants typically do not. In an episode featuring guest John Mass, the president of Content Partners, Mass and Belloni delve into a very hard truth about studios. "They don't want even the participants to know much," says Mass. "They try to hide as much as possible. Transparency to the viewers, I just don't think the studios want to do that." (Mass, John, guest. "How Much Money Does a Hit Movie Really Make (and a Flop Really Lose?").

This accounting nightmare between TSG and Disney came in time where transparency from the studios (or lack thereof) is being scrutinized as a central issue of both the WGA and SAG-AFTRA strikes alongside the collective stress of writers and actors of not being able to participate in projects' successes. This case highlights that even if content is successful or profitable, no one is really going to see and benefit from that besides studios and streamers. Studios get a portion of rentals from the theaters, revenue share from EST distribution, and license fees from streamers that are based on rate cards pursuant to box office receipts (except in the case of "sweetheart" deals like here with FX/Disney+/Hulu). From there, studios apply distribution fees, distribution expenses, P&A, etc. Moreover, a profit participant may not see much of anything.

"The dirty secret of streaming is nobody's profitable, except for Netflix," says Andrew Rosen quoted in Deadline. (Campione, Katie. "Inside The Battle For A New Streaming Residuals Model: Data, Transparency & "A Fight For Power."" Deadline. July 27, 2023.)

Live in formulaic buyouts and formulas on how to value exploitation, whether internal with monopoly companies or external, which are highly regulated. The consolidation and monopolizing of these companies also means that the self-dealing issues brought up in this case will likely continue to be exacerbated. Per the report by the WGA, as described in Gizmodo, Disney controls the means of production, Amazon controls the means of distribution, and Netflix controls the means of employment (Codega, Linda. "Here's What the WGA Has to Say About the Big 3 Streaming Monopolies." Gizmodo. Aug. 21, 2023). WGA proposes external regulation through legislative action like the Financial Interest and Syndication Rules that govern the big three networks.

The TSG litigation may intersect with legislation, collective bargaining agreements striking and a bigger existential awakening that the days of studio accounting may be long gone.


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