Profit participation agreements generally include incontestability language, which only allows the profit participant to audit statements issued up to two or possibly three years prior to the date of the audit notification. On one hand, the rationale for this restriction may come from the challenge of storing documents, so the longer the tolling period, the longer the studio has to maintain the books and records supporting the profit participation statements, which can be costly and administratively challenging.
It’s also likely that the tolling restriction is derived from a business risk mitigation standpoint, whereby the shorter the tolling period, the less risk there is of incurring audit claims. On the other hand, profit participant representatives (attorney, business manager, agent or talent manager) are frustrated with the complexity and difficulty of tracking the dates for each statement issued, which might potentially result in confusion and, consequently, in missing contractual deadlines.
SO WHAT TO DO?
As a first step, it is important for the profit participant’s representatives to come to an agreement as to who is tracking the tolling. Oftentimes, there is confusion and misunderstanding on this issue. Next, a tracking system should be developed to account for each agreement and subsequently issued statements. Depending on the volume of agreements and statements, the tracking system can range from a simple Excel file to a complex management system. Such tracking system would include each statement and its applicable tolling deadlines.
Once a system is in place, and as the statement tolling deadlines are likely soon to be reached, you should consult with a profit participation auditor like GHJ to assess the feasibility of an audit. If the client decides to pursue an audit, based on the auditors’ recommendation, an audit notification would be sent to the applicable studio. Depending on the circumstances, as opposed to sending an audit notification, one could negotiate a tolling extension, which can defer the decision of auditing while preserving the tolling rights.
It is important to note that the first several statements are critical to the viability of a participation audit, as such statements include the initial P&A and production costs, which often exponentially outweigh the remaining deductions. If the tolling rights expire for those statements, a significant portion of transactions would be incontestable and it’s quite possible that the entire audit would not be worthwhile. Also, during the recommendation stage, you should not be discouraged by large recoupment deficits as you review those first statements as often – particularly for television shows – the revenue will not come for some time, possibly years. However, considering that we may have queues at some studios, it is possible that by the time we audit, the statements may be recouped.
ONCE THE AUDIT NOTIFICATION IS SENT, ARE YOU DONE?
As a courtesy, while profit participation auditors may alert a client of a potential tolling expiration during an audit, it is the responsibility of the client (or a designated representative of the client) to track the applicable tolling.
While each studio operates differently, it is important to continue tracking the tolling and request for extensions, as needed. Examples could be as follows:
- The audit may not commence for another several years, and you may need to ask the studio to extend the tolling to commence the audit
- The audit may be in progress; however, the audit may not be completed in time to meet the tolling deadlines, and an extension may needed
- It is possible that while you were able to meet the deadline to submit the audit report, more time may be needed to assess whether litigation should be pursued, and tolling may need to be extended further
Considering each agreement may be different and each studio may have different policies and practices regarding tolling, please reach out to our participation audit group with any questions.
About Ilan Haimoff (Partner, GHJ)
Ilan leads the GHJ Entertainment and Media Practice, and his specialty includes profit participation audits on behalf of talent, investors, and co-producers at both the major and mini studios. He currently oversees participation audits at various studios, including 20th Century Fox, Sony, Starz, as well as other prominent studios. He is a co-author of GHJ’ recent White Paper, “New Media Trends: Consolidating to Meet Consumer Demands”.
About Michael Sippel (Principal, GHJ)
Michael is a senior manager within our Participations Audit Practice and specializes in contract compliance and forensics. Prior to joining the firm, he was a staff accountant at Hagen Streiff Newton & Oshiro, working within their Insurance and Forensic Litigation accounting practice. He earned his bachelor’s degree from the University of California-Berkeley in business and economics.
Originally published on 3/29/2016.