Special M&A Legal Due Diligence Challenges in the Entertainment & Media Sector
March 2, 2017
updated September 4, 2017
With Discovery Communications aiming to build a "digital content engine" with the acquisition of Scripps Networks Interactive [Note 1] and with deals like AT&T's proposed purchase of Time Warner, Disney's purchases of Marvel, Pixar and Lucasfilm, Comcast's purchase of DreamWorks Animation, and Activision Blizzard's purchase of mobile game company King Digital, it's apparent that for entertainment and media M&A transactions, content famously remains king.
This presents attorneys and other professionals involved in such deals with special due diligence challenges. Even under normal circumstances — such as buying several musical compositions or sound recordings — due diligence investigation in the entertainment and media sector can be challenging, for instance due to the number of artistic contributors (such as songwriters, artists, musicians, and producers to name of few) from whom rights must be obtained. Similarly, such content actually consists of two, separate copyrighted works — the musical composition and the particular sound recording containing the performance of that composition — each of which requires its own copyright review.
The added challenge today comes from the motive driving many of these new deals. Acquirers such as entertainment and media conglomerates, cable system operators, wireless carriers, and video game publishers are not just seeking more content, but more content that can be used across multiple platforms and as raw material to be transformed into a myriad of new products. In other words, purchasers like these are often acquiring the content assets, not just to exploit those assets as they exist at the time of the deal, but also with the intent to repackage, repurpose, and transform those assets into a potentially unlimited number of new items for exploitation by various methods, some of which may not even be anticipated at that time. Under such circumstances, the due diligence investigation, typically critical in any such acquisition, gains additional significance and requires special care, lest the acquirer discover, for instance, that copyright issues hamper its ability to repackage the content assets as it planned or prevents it from exploiting those assets in certain jurisdictions.
Let us examine what such a due diligence investigation involves. Although each due diligence investigation is unique to the particular transaction, we can generalize by saying that there are three main challenges to legal due diligence investigations in this space that one must address: (1) copyright and other intellectual property matters; (2) the unique agreements and other contractual arrangements related to producing, distributing, and exploiting entertainment content; and (3) the large volume of content often at the center of the transaction.
Copyright and other intellectual property matters
The majority of entertainment content assets are subject to one or more forms of intellectual property protection, and these protections might exist, or have varying applications, on a state, federal, regional, or global level. These protections include copyright, trademark, and "rights of publicity" (the right to use the name, likeness, or other indicia of the identity of an individual).
For copyright issues, due diligence must include investigating and analyzing not just the ownership of the existing content but also the status of the underlying rights to the content, and determining how else the purchaser can use the content; in other words, determining the rights that are, and are not, controlled by the target. This includes confirming that as part of the production process each person who contributed to creating the content granted all of his or her rights to the commissioning party, including all of the rights needed to exploit those contributions without atypical restrictions, and that the terms of these grants conform with applicable requirements under the Copyright Act and related common law.
Specifically, a review should confirm several key elements: that the grant of rights includes, for example, language confirming that the "results and proceeds" of the contributor's services constitute a "work made for hire" under the Copyright Act as well as "belt and suspenders" language providing that if the results and proceeds do not constitute a "work made for hire" then the contributor assigns all of his or her rights to the commissioning party; that the parties contemplate that in the future new rights might be recognized and new exploitation methods might be developed and so the contributor intends for his or her grant of rights to extend to and include all such future rights and methods; and, preferably, a statement by the contributor waiving any "moral rights" (droit moral) he or she might have in the content, and also waiving any other present or future rights related to copyright to which he or she might now or in the future be entitled (such as "rental and lending rights" and other protections that EU member states are required to provide under applicable EU directives).
Similarly, the copyright analysis must determine whether any copyrights or other intellectual property rights are encumbered. For copyrights, this typically requires searching for filings of security interests or similar liens in two separate recording systems: the U.S. Copyright Office (for filings related to registered copyrights, which are governed by the Copyright Act), and the appropriate state office(s) (for filings related to unregistered copyrights, which are governed by the applicable state's Uniform Commercial Code).
In addition, because a proposed valuation might be affected if the term of copyright protection for (and therefore the exclusive rights to) any content ends earlier than anticipated, the copyright analysis also must determine the period of time that a specific item of content remains under copyright (which is particularly complicated for content created before January 1, 1978, the effective date for the Copyright Act of 1976).
The unique agreements and other contractual arrangements related to producing, distributing, and exploiting entertainment content
A second due diligence challenge here concerns the agreements and other contractual arrangements related to producing, distributing, and exploiting entertainment content. In reviewing the agreements related to the target's content, the purchaser’s due diligence team must be able to extract from those documents and understand key information relating to the content and its exploitation, including financial obligations such as royalties and other contingent payments, monies payable to other participants (such as override royalties), and amounts payable to the applicable union(s) (including residuals). Doing so requires understanding how the royalties or other amounts are determined, including the method for recouping advances, and reviewing the respective accounts related to the corresponding agreements to confirm that the status of each account accurately includes any paid contractual advances. It also involves comparing these with revenue and expenses as reported in other financial documents.
For transactions where the purchaser is also acquiring agreements in anticipation of acquiring more content to be produced in the future – such as exclusive recording agreements or exclusive songwriting agreements – the review must determine the amount of new product, if any, that remains to be delivered under the particular agreement.
Making this determination requires understanding how these industry-specific agreements operate. As an illustration, exclusive recording agreements customarily remain in effect for a “term” consisting of a series of contract periods, with the artist required to deliver one new album in each period, and with the extension of the term for the next option period at the sole discretion of the record company. Such an agreement, therefore, might be structured as an initial contract period for one album with the record company having five or six separate options, each to extend for an additional optional contract period in which the artist must deliver another new album.
If the purchaser designates several agreements or artists that it believes are under contract at the time of the transaction and from whom it expects to receive new product, the due diligence analysis should examine these agreements to confirm the amount of new product the purchaser will actually be entitled to receive under the agreement.
In reviewing the necessary contracts those conducting the due diligence review also must look for unusual provisions that sometimes find their way into entertainment and media agreements, such as “key man” clauses and “most favored nations” (or “MFN”) clauses.
A “key man” clause might be found in an agreement with talent and permits the talent to terminate the agreement if a particular individual — typically a senior executive — is no longer employed by the target company.
A “most favored nations” clause could also be included in an agreement with talent, or more likely, in a license agreement. This clause generally provides, for the benefit of one of the contracting parties, that no third party will be granted more favorable terms with respect to some aspect of the agreement, for example more favorable economic terms (e.g., payment of a higher (or lower) royalty) or more favorable exploitation rights (e.g., the right to exploit in a manner prohibited under the particular license, such as via the Internet).
The large volume of content often at the center of the transaction
A final challenge stems from the often huge number of specific assets subject to transactions like these; a target company might own thousands, hundreds of thousands, or even millions of individual items of content, many of which were created decades earlier or are now owned by the target company as a result of a series of prior acquisitions by the target or its predecessors. Examples include Disney’s purchase of Marvel in which Disney acquired the latter’s “universe” of 5,000 comic book characters, and the acquisition of the EMI Music Publishing catalog of 1.3 million musical compositions by a consortium led by Sony/ATV Music Publishing.
Proceeding here often requires balancing a demand on the business side to close the transaction quickly (as when the purchaser thinks a competitor might take the deal) against the risks of limiting the due diligence review. One typical solution is a two-step approach: first, to identify and focus primarily on a subgroup of the most valuable content, such as the top-10 highest grossing movies, or the compositions that together represent 25% or more of the target’s revenue, or every album that has achieved sales in excess of one million units, or any other form of “material” or “significant” content, and, second, to include in the acquisition agreement representations and warranties (and corresponding indemnities) applicable specifically to this content.
With media, entertainment, and technology companies seeking to acquire and deliver more content over a multiplicity of pathways, conducting a due diligence investigation in the entertainment and media sector can be challenging and requires a deep understanding of industry agreements, deal points, and practices. Particularly with purchasers here typically aiming to acquire content (1) that is an established brand, (2) that can be used in ways not yet anticipated, and (3) that can serve as the raw material for creating new content, meticulous attention to matters such as copyright and other intellectual property matters, rights confirmation, and contractual issues is essential if the goals of the deals are to be fully achieved.
Note 1: "Discovery Communications is looking to build a 'global content engine' with the acquisition of Scripps Networks Interactive", July 31, 2017, http://realscreen.com/2017/07/31/discovery-acquires-scripps-networks-interactive-for-14-6-billion/ (accessed August 2, 2017)