Follow me on Twitter @robcain or Sina Weibo @robcain, or connect with me on LinkedIn.By Robert Cain for China Film Biz

November 5, 2012

With the American Film Market going on this week, Chinese buyers are in town in L.A., haggling with non-Chinese producers over prices for their films and reportedly making record-breaking offers. As the non-Chinese producers enter into these deals, one thing that is sure to be on their minds is the concern as to whether Chinese distributors will pay them their fair, contractually negotiated share of box office receipts.

No other aspect of the film business is more important than collections, but when it comes to China, Hollywood has been uncharacteristically quiet on this topic. As far as I know there has been no public complaint from the studios, no claims of cheating, no audits.

Does this mean that producers are getting their fair share. The answer, I am certain, is an emphatic “no.”

This is an incendiary topic, one that few producers are willing to address publicly for fear that China’s major distribution companies will take offense and ban them from conducting further business in the PRC. None of the U.S. producers, studio executives or industry representatives with whom I’ve spoken on this issue would do so on the record.

But one bold Chinese producer did speak out, presumably because he felt he had nothing else to lose.

I’m referring to Hao Yaning, Chairman of United Film Investment, which co-financed and produced the Chinese comedy My Own Swordsman. China Film Group (CFG) released My Own Swordsman in 2011 to great success, at least for itself. Hao, who put up 30 percent of the film’s $2 million budget, was entitled to a commensurate 30 percent share of net distribution receipts, after marketing and distribution costs. But Hao claims he was paid only a minute fraction of what he was owed; although the film grossed at least US $30 million according to CFG’s reports (Hao believes the actual figure was more like $48 million), CFG paid him only US $800,000.

To put the numbers in context, distributor rentals in China typically amount to about 40 percent of gross after the exhibitor’s share and box office taxes are deducted. Using CFG’s figure of $30 million, then deducting an estimated $1.5 million for P&A (ad expenditures are typically very low in China), and another 20 percent (again, my estimate) for CFG’s distribution fee, that would leave a pool of at least a $8.4 million for Han and his company to share in. His 30 percent would amount, very conservatively, to over $2.5 million.

Hao believed that the profit pool was actually $16 million, not $8.4 million, and he was understandably less than thrilled with what he felt was CFG’s retention of at least 80 percent of the money it owed him (or at least 68 percent if we use CFG’s own numbers).

Fed up with the situation, Hao did what no one else had done before. In June he sued China Film Group, alleging that the studio violated a number of terms of their agreement for My Own Swordsman, including “severe falsification” of box office profit reports. Hao demanded that CFG pay him a sum working out to more than RMB 102 million, or roughly US $16 million.

A Chinese court accepted the case, which would never have happened unless higher-ups in the Communist Party wanted it to. Apparently, someone at or near the top has taken an interest in this issue.

For its part, China Film Group issued an aggressive statement of its own:

Before the courts have determined the relevant facts and passed judgment, United Film investment has repeatedly publicized remarks on CFG not giving the sufficient percentage to United Film as well as other complaints inconsistent with the facts. This has led to a serious misleading of the public, and has severely harmed the rights and interests of CFG. CFG retains the right to investigate legal liability on the part of United Film for severe infringement of CFG’s reputation.

CFG’s concerns are presumably less about My Own Swordsman and more about the potential grievances that could come from their major foreign suppliers in Hollywood (not to mention CFG’s own pending IPO, which could be negatively impacted by the lawsuit).

For their part those at the studios who spoke off the record had comments like this:

“I’m hearing the same things you’re hearing, that there is significant box office cheating going on.”

“Collection has been very slow in China, typically more than 90 days.”

“Skimming is one of the issues that’s an ongoing anxiety, it’s a reality of what’s going on not only in China but in a number of our territories.”

“China Film Group told us after a certain point that we had made enough money on our picture in China, and that even though the film was still making money they were not going to pay us any more.”

“The common wisdom is that there is skimming and under-reporting. No one knows exactly how much it is.”

As I wrote back in February, what I heard directly from box office reporting company executives was that skimming of receipts runs as high as 40 percent.

It’s not like the studios to stand by and do nothing when they believe they’re being short-changed. So what’s going on here?

For one thing, the studios do understand that this is a fraught and potentially dangerous issue for them in their most important international territory. As one studio executive put it, “The problem is that if you complain, you risk being put out of business in China.”

But the studios also have an ace up their sleeves, and they’re considering when and how to play it. The WTO memorandum of understanding on audiovisual products that was negotiated between China and the U.S. earlier this year includes a provision that allows U.S. companies to audit the records of Chinese distributors. Although they haven’t yet invoked this provision, one well-placed industry representative told me this:

The audit provision was a specific ask we had that was expressed through the United States government. It’s there because we want it and feel it’s important. There have been conversations about what to do and when and how to do it. We want to make sure we are able to conduct an audit in a way that will be definitive and dispositive.

This same individual told me that there have been cases in the past where several studios had concerns about whether full payments were being made, and there is an ongoing concern about the timeliness of payments, but he felt that “the process is getting back to normal.”

2012 has been an unusual year owing to the major changes wrought by the WTO MOU, and also because of the leadership transition that is now under way in the People’s Republic. The timing simply hasn’t been right for raising the collections issue. Once the dust has settled and China’s new leaders are in place, perhaps at some point early next year, the major studios will take action and enforce their rights to ensure that they are being paid properly.

Robert Cain is a producer and entertainment industry consultant who has been doing business in China since 1987. He can be reached at rob@pacificbridgepics.com and at www.pacificbridgepics.com.