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Law 101
Conducting An Audit
| Monday, 03.05.2018, 07:20 PM |   (3246 views)


By Mark Litwak

Many filmmakers sign complex distribution agreements that they do not fully understand. Several years ago I was approached by a filmmaker who seemed certain that his distributor was cheating him. His film had been licensed to HBO for a large fee, and significant revenue was generated from foreign sales. Nevertheless, very little revenue was paid to the filmmaker. He asked me to investigate, and to arrange for an audit.

 I reviewed the distribution contract and the distributor's producer reports. The agreement allowed the distributor to deduct virtually any expense, with no caps or limitations. The distributor was therefore able to deduct several hundred thousand dollars in expenses. The contract permitted the distributor to take 35% of gross receipts as a distribution fee. The balance remaining was split 50/50 with the filmmaker. This formula allowed the distributor to retain almost all the revenue without resorting to cheating or creative accounting. It was a terrible deal for the filmmaker. I asked him why he had agreed to these terms. He replied that the distribu­tor told him the terms offered were "standard."

 Of course, these terms are not standard, and a savvy filmmaker would never accept them. A distributor is usually allowed to recoup specified market and promotional expenses only, and the total amount of recoupable expenses may be capped. The distribution fee charged was excessive, and for the distributor to also share in the balance remaining on a film it did not provide any financing for is just outrageous. I told the filmmaker not to bother with an audit since it was unlikely it would make any difference. This was not creative accounting; it was an instance of a gullible filmmaker being taken advantage of by a more experienced distributor.

 While creative accounting complaints are common, many films are not profitable by any measure, so the profit particip­ant will not bother to audit the books. For those films that do generate significant revenue, audits often recover more than their cost, which may be $20,000 to $30,000 or more.

 An audit may reveal two types of errors. The first type are clerical mistakes. A studio accountant might make a mathematical error when adding numbers. For some mysterious reason, these errors usually favor the studio. When such errors are discovered, distributors usually make corrections without much protest.

 The other type of error arises from contract interpretation. The philosophy prevalent at many studios is, "When in doubt, interpret it in our favor and we will fight it out later if someone objects." Despite the great care taken by lawyers to draft straightforward contracts, new areas of ambiguity constantly arise. As a result, contracts have become increasingly detailed and long. Every time a lawyer thinks that his client has been taken advantage of, he tries to clarify matters in the next deal by being even more explicit. This is why signing a short-form contract may not be wise. A deal memo addresses the major issues without spelling out the details. The resulting ambiguity often does not favor the filmmaker because in a dispute the distributor can better afford the legal expense of contesting the point

Mark Litwak is a veteran entertainment attorney and producer’s repbased in Los Angeles, California. He is an adjunct professor at USC Gould School of Law, and the creator of the Entertainment Law Resources website with lots of free information for filmmakers ( He is the author of six books including: Dealmaking in the Film and Television Industry, Contracts for the Film and Television Industry, and Risky Business: Financing and Distributing Independent Film. He can be reached at


Mark Litwak

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