Eclipse Film Partners No 35 LLP v Revenue & Customs [2012] UKFTT 270 (TC) (20 April 2012)
DECISION
Introduction
The appeal
1. This
is an appeal by Eclipse Film Partners No 35 LLP (“Eclipse 35”), a limited
liability partnership, against a decision of The Commissioners for Her
Majesty’s Revenue and Customs (“the Commissioners”) that, in the tax year ended
5 April 2007, Eclipse 35 was not carrying on a trade, or if it was carrying on
a trade, it was not doing so with a view to profit.
2. Eclipse
35 made a partnership tax return for the year ended 5 April 2007 claiming that
it was, in that year, carrying on a trade of acquiring and exploiting film
rights, although no profits from that trade had accrued in that year. The
Commissioners began an enquiry into that return under section 12AC Taxes
Management Act 1970 (“TMA 1970”). On 15 May 2009, and following a direction of
a Special Commissioner (Eclipse Film Partners No 35 LLP v The
Commissioners for Her Majesty’s Revenue and Customs (SPC00736)) requiring
the Commissioners to issue a closure notice, Mr N Hagan, an Inspector of Taxes
in the Specialist Investigations Section of the Commissioners, wrote to Eclipse
35 by way of a notice of completion of enquiry into a partnership return (that is,
a closure notice) under section 28B TMA 1970. Mr Hagan’s letter comprises the
decision of the Commissioners against which Eclipse 35 now appeals. In its
Notice of Appeal to this Tribunal, dated 9 June 2009, the grounds for appeal
stated by Eclipse 35 are that the Commissioners’ decision is wrong both in law
and in fact.
The issue to be decided
3. As
will become apparent, the transactions which Eclipse 35 (and its members)
entered into, and which form the basis of its case that it was carrying on at
the relevant time the trade of acquiring and exploiting film rights, are
complex. Nevertheless, the issue we have to decide is (in concept, at least)
simple: in the tax year ended 5 April 2007 was Eclipse 35 carrying on a trade?
4. Although
the point was a matter of dispute between the parties, as we describe below, we
consider, for the reasons we give below, that if we decide that Eclipse 35 was
carrying on a trade in that year then we should also decide two further related
questions: first, what was the trade it was carrying on (a question which is
inherent in the decision that it was carrying on a trade); and secondly,
whether it was carrying on its trade with a view to profit.
5. The
Commissioners also pressed us to decide (should we find that Eclipse 35 was
carrying on a trade) the further question of whether monies borrowed by Eclipse
35’s members and used by them to contribute capital to Eclipse 35 were monies
used for the purposes of such trade. For the reasons we give below we do not
consider that that is an issue which is within the scope of the appeal we are
required to determine.
6. At
first sight it may seem strange that this issue should be the subject of
substantial and protracted litigation when, in the tax year in question,
Eclipse 35 had no profits or income chargeable to tax. We explained the wider
significance of Eclipse 35’s appeal in the following terms in our decision in Eclipse
Film Partners No 35 LLP v The Commissioners for Her Majesty’s Revenue and
Customs (TC 01256) (a decision concerning Eclipse 35’s application for a
direction to exclude certain expert evidence which the Commissioners intended
to adduce in the hearing of the appeal, a matter we deal with below):
“The principal significance of [Eclipse 35’s] appeal
relates not to the tax position of [Eclipse 35] itself, but to that of its
individual members. Each of the [289] members of [Eclipse 35] borrowed funds
to make their respective investments in [Eclipse 35] and made a prepayment of
the interest payable on those borrowings for which they have claimed tax
relief. The aggregate amount of that tax relief is in the order of £117
million. It is a necessary precondition to a successful claim for such relief
on the part of the members that [Eclipse 35] should be carrying on a trade with
a view to profit in the tax year in which the members made the interest
prepayment. The members wait in the wings, as it were, whilst [Eclipse 35]
pursues its appeal against the Commissioners’ decision on the trading issue.”
A summary of the relevant transactions and the parties to those
transactions
7. As
mentioned, Eclipse 35 and its members entered into a complex set of
transactions with members of the Disney group of companies in relation to the
acquisition, distribution and marketing of film rights and with members of the
Barclays group of companies in relation to the financing of the acquisition of
such film rights. It is helpful at the outset to identify the principal
parties involved and to give a summary of the principal transactions.
The principal parties
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Eclipse
Film Partners No. 35 LLP (“Eclipse 35”)
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A UK limited liability partnership and the Appellant in this appeal
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The members of Eclipse 35 (“the
Members”)
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The 289 persons (individuals
and companies) who were the members (i.e. partners) of Eclipse 35 on 3 April
2007 and who had contributed capital to Eclipse 35, most of which capital
they funded by monies borrowed from Eagle
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Barclays Bank plc (“Barclays”)
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The issuer of a letter of
credit securing the payment by the Distributor of certain sums due to Eclipse
35 under the film distribution arrangements. Also the funder of Eagle
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Eagle Financial and Leasing
Services (UK) Limited (“Eagle”)
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A wholly-owned subsidiary of
Barclays, which made loans to the Members and received, as security for such
loans, the benefit of the letter of credit issued by Barclays
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Walt Disney Pictures (“Disney”)
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A US corporation and a member
of The Walt Disney Company group of companies which on 3 April 2007 as
grantor entered into a licensing agreement with Eclipse 35 (as licensee) in
relation to two films produced by the Disney group
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WDPT Distribution VIII LLC
(“the Distributor”)
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A US
corporation and a member of The Walt Disney Company group of companies which
on 3 April 2007 as licensee entered into a distribution agreement with
Eclipse 35 (as licensor) in relation to the distribution of the two films the
subject of the licensing agreement between Disney and Eclipse 35, and which
procured the issue by Barclays of the letter of credit to secure its payment
obligations to Eclipse 35 under the distribution agreement
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WDMSP Limited (“WDMSP Ltd”)
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A UK company which is a member
of The Walt Disney Company group of companies and which entered into an
agreement with Eclipse 35 for the provision of marketing and advisory
services in relation to the two films for which Eclipse 35 held a licence
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Future Films Limited (“Future”)
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A UK company with a business of
arranging financing of films and also the production and distribution of
films, which for a consultancy fee promoted Eclipse 35 and provided film
advisory and other services to Eclipse 35
|
A summary of the transactions
8. The
following will suffice as an introductory summary of the transactions involving
Eclipse 35 and the Members which are relevant for the purposes of this appeal:
(1)
Eclipse 35 is a limited liability partnership incorporated on 3 October
2006. Its partnership deed was entered into on 13 March 2007, and states that
Eclipse 35 will carry on the business of the production, distribution,
financing and exploitation of films, including the licensing and exploitation
of film rights acquired from Disney.
(2)
On 3 April 2007 Eclipse 35 had 289 Members (and two Designated
Members). All or most of the Members are individuals liable to UK income tax,
and for whom, if the relevant conditions are met, tax relief will be available
for interest paid on borrowed monies applied by them by way of contribution to
the partnership capital of Eclipse 35.
(3)
On 3April 2007 Eclipse 35 obtained a licence from Disney, for a period
of twenty years, of specified rights to exploit and distribute two films
produced by Disney and entitled respectively “Enchanted” and “Underdog”
(together, “the Films”) (“the Licensing Agreement”). As consideration for such
licence Eclipse 35 paid a licence fee (in aggregate, for the Films, of
approximately £503 million) and also a variable royalty. The licence fee was
divided into twenty annual instalments, and on 3 April 2007 Eclipse 35 paid
Disney the aggregate amount as an advance against its obligations to pay the annual
instalments.
(4)
Also on 3 April 2007 Eclipse 35 entered into an agreement with the
Distributor by way of sub-licence of the exploitation and distribution rights
in the Films for a term of twenty years (“the Distribution Agreement”). The
Distributor is required to exploit the Films and ensure their distribution. As
consideration the Distributor is obliged to pay Eclipse 35 specified sums
annually over twenty years (referred to as Annual Ordinary Distributions, and
totalling approximately £1,022 million), variable distributions (the variable
royalty which Eclipse 35 is due to pay to Disney under the Licensing Agreement
matches these variable distributions), and “contingent receipts”, being amounts
payable under a complex formulation if gross receipts from the exploitation of
the Films exceed a certain threshold after payment of prior charges
(“Contingent Receipts”).
(5)
As security for its obligations to pay the Annual Ordinary Distributions
to Eclipse 35, the Distributor provided a letter of credit issued by Barclays,
payments under the letter of credit directly corresponding to the Annual
Ordinary Distribution payments (“the Letter of Credit”). Issuance of the
Letter of Credit relieved the Distributor from its payment obligations to
Eclipse 35 (so that, in effect, Eclipse 35 substituted Barclays risk for
Distributor risk). The Distributor deposited the sum of approximately £497
million with Barclays and charged that sum to Barclays to secure the issue of
the Letter of Credit and to fund Barclays in respect of its obligations under
the Letter of Credit.
(6)
Eclipse 35 was financed by its Members, who on 3 April 2007 contributed
capital to the partnership in an aggregate amount of £840 million (thereby
providing Eclipse 35 with the capital to pay the licence advance to Disney and
to make the other payments which Eclipse 35 undertook on that day). Each
Member chose to finance his capital contributions in part from his own
resources but substantially (as to approximately 94 per cent) by undertaking
borrowings for that purpose, borrowing under a twenty year facility made
available to him by Eagle. In aggregate the Members borrowed approximately
£790 million from Eagle and contributed the balance of capital (approximately
£50 million) from their own resources.
(7)
The terms of the Eagle facility provided for a fixed rate of interest,
and required the borrowing Member to pre-pay the interest accruing over the
first ten years of the borrowing (a payment in aggregate of approximately £293
million, which the Members paid on 3 April 2007). The borrowing by Members
from Eagle was secured by a charge given by Eclipse 35 over the Letter of
Credit.
(8)
On 3 April 2007, following the contribution by Members of their capital,
and pursuant to a provision to that effect in the partnership agreement,
Eclipse 35 made a payment (expressed to be by way of loan on account of
anticipated profits) to the Members of an aggregate amount of approximately
£293 million (enabling Members to make the prepayment of interest to Eagle).
(9)
The payments made between the parties on 3 April 2007, and the payments
due over the twenty year term of the transactions, were in accordance with cash
flow statements produced from financial models devised by Future and used in
the promotion of the Eclipse 35 partnership to potential investors.
(10)
On 9 February 2007 Eclipse 35 entered into an agreement with WDMSP Ltd
(“the Marketing Services Agreement”) whereby WDMSP Ltd agreed, for a fixed fee
plus a share of any Contingent Receipts from the Films, to act as Eclipse 35’s
agent in developing marketing and release plans for the Films and to provide to
Eclipse 35 services relating to the supervision of the Distributor in its
implementation of such plans. Under the Distribution Agreement the Distributor
agreed to implement the marketing and release plans prepared by WDMSP Ltd.
(11)
On 3 October 2006 Eclipse 35 entered into a consultancy agreement with
Future, whereby Future was appointed to provide to Eclipse 35 a number of
services relating to the selection, acquisition and exploitation of films and
film rights and the management of such matters on behalf of Eclipse 35. For
these services Eclipse 35 agreed to pay Future a fee based on a percentage of
the partnership capital raised by Eclipse 35 and of the net proceeds from the
exploitation of any film rights licensed by Eclipse 35. Pursuant to this
agreement Eclipse 35 paid Future a fee of approximately £44 million on 3 April
2007.
Eclipse 35’s case in summary
9. Eclipse
35 contends that the only issue relevant to its appeal is whether or not it is
carrying on a trade. It argues that all the relevant transactions are genuine
transactions entered into for a commercial purpose, and following lengthy
negotiation, with a leading entertainment and media corporation, and that
Eclipse 35 entered into the transactions to which it is a party in the course
of carrying on its trade of acquiring and exploiting film rights. It argues
that it paid for and acquired highly valuable licences from Disney giving it
the right to exploit two films which were characterised as having franchise
potential, and that it exercised that right to exploit those films by entering
into the distribution agreement with the Distributor, licensing those rights in
consideration of specified periodic payments over twenty years (which in
themselves ensured over that period profits for Eclipse 35) together with the
possibility of receiving further earnings – the Contingent Receipts – if the
films’ gross income exceeded certain thresholds.
10. Eclipse 35
points to the arrangements it entered into with WDMSP Ltd for the creation of
release and marketing plans for the films, and the supervision of the
Distributor in the implementation of those plans, to show that it has an active
role in the distribution and exploitation of the film rights.
11. If it is
necessary to decide whether the trade carried on by Eclipse 35 was carried on
with a view to profit, Eclipse 35 argues that this was so, since over the
period of twenty years – and leaving aside the prospect of receiving any
Contingent Receipts – an aggregate profit of approximately £474.4 million will
accrue to Eclipse 35.
12. Eclipse 35
argues that the borrowings by the Members may be relevant to any claim which
the Members may make for tax relief for the interest paid on such borrowings,
but the manner in which and the extent to which the Members finance themselves
to provide their capital to the partnership cannot be relevant to the issue as
to whether or not Eclipse 35 is carrying on a trade.
13. Similarly, the
banking and security arrangements entered into by Barclays and its associated
company involving, variously, the Members, Disney and the Distributor are not
matters to which Eclipse 35 is a party, or necessarily privy, and, again, are
not relevant to the question which has to be decided.
The Commissioners’ case in summary
14. The
Commissioners argue a quite different case. They do not argue that the
transactions entered into by Eclipse 35 were a sham, but they argue that in
determining whether or not Eclipse 35 was carrying on a trade, the effect of
those transactions must properly be understood by examining them in their
entirety and context and with regard to the reality of what they effect, and
not just their form.
15. Taking this
approach, the Commissioners argue that the reality of the arrangements is that
Eclipse 35 organised a sophisticated financial model involving all the parties,
which was designed to give a series of pre-determined cash flows with the
ultimate object of giving the Members interest payments (accelerated by
prepayment) on borrowings for which they can claim tax relief to set against
other income they have which is otherwise taxable. The movements of cash on
financial close of the transactions entered into on 3 April 2007 set up the
cash flows, and in their commercial result achieve only one thing: the payment
by Eclipse 35 of approximately £6 million to Disney (referred to as “the Studio
Benefit”) in return for Disney making itself available to the transaction for
little more than a day and the remote possibility of Disney paying the
Contingent Receipts to Eclipse 35.
16. Therefore, the
Commissioners argue, Eclipse 35 was not, by reason of entering into the
transactions, carrying on a trade – at best it was making a speculative
investment with regard to the possible earning of the Contingent Receipts, and
all other amounts it received were determined by the cash flows set up on 3
April 2007, and without any reference to the earnings from the films.
17. The
Commissioners also assert that Eclipse 35 cannot rightly claim to be carrying
on the trade of acquiring and exploiting film rights in view of the terms of
the documentation it entered into with Disney and the Distributor, the overall
effect of which is that at no time were any film rights in the ownership or
control of Eclipse 35 – whatever rights were purportedly granted by Disney were
granted on terms which required them to be passed back immediately to the
Distributor. Further, the grant of those rights was expressed to be subject to
prior arrangements within the Disney group (“the Prior Agreements”), the nature
and scope of which were unknown to, and seemingly a matter of indifference to,
Eclipse 35.
18. Further, even if
it can be said that Eclipse 35 is licensing and sub-licensing film rights, in
the circumstances of its particular transaction with a fixed return unrelated
to the earnings of the films, there is no activity in the nature of trade, but
rather an investment or the carrying on of a non-trade business.
19. The
Commissioners also invited the Tribunal to determine that if Eclipse 35 were
carrying on a trade, that trade was not conducted “with a view to profit”, but
with a view to the tax benefits which it was intended that the Members should
secure by reason of the prepayment of interest on their borrowings used for
their capital contributions to Eclipse 35 – Eclipse 35’s actions had no
objective other than to put the Members in a position to achieve those
benefits.
Our decision in summary
20. We have
concluded that Eclipse 35 was not carrying on a trade, but that its activities
were a business involving the exploitation of films where the activities
carried on do not amount to a trade (a ‘non-trade business’ within section 609,
Income Tax (Trading and Other Income) Act 2005). Eclipse 35’s appeal therefore
fails and is dismissed.
21. If we had
concluded that Eclipse 35 was carrying on a trade, we would also have concluded
that it was carrying on a trade of the acquisition and exploitation of film
rights and that such trade was being carried on with a view to profit.
The relevant statutory provisions
22. There was no
dispute between the parties as to the legislation which is relevant to this
appeal, nor was the interpretation of that legislation in dispute.
23. Section 1,
Limited Liability Partnerships Act 2000 provides, so far as relevant:
(1) There shall be a new form of legal
entity to be known as a limited liability partnership.
(2) A limited liability partnership is a
body corporate (with legal personality separate from that of its members) which
is formed by being incorporated under this Act…
24. Since a limited
liability partnership is a body corporate, it would fall within the charge to
corporation tax, were it not for the special provisions which confer
“transparency” upon limited liability partnerships, to the effect that a
limited liability partnership’s activities are treated as carried on in
partnership by its members (rather than by the limited liability partnership
itself), and they are taxable accordingly. Thus where the members of a limited
liability partnership are individuals, section 863, Income Tax (Trading and
Other Income) Act 2005 (“ITTOIA 2005”) provides (as relevant to this appeal):
(1) For income tax purposes, if a limited
liability partnership carries on a trade, profession or business with a view to
profit—
(a) all the
activities of the limited liability partnership are treated as carried on in
partnership by its members (and not by the limited liability partnership as
such),
(b) anything
done by, to or in relation to the limited liability partnership for the
purposes of, or in connection with, any of its activities is treated as done
by, to or in relation to the members as partners, and
(c) the
property of the limited liability partnership is treated as held by the members
as partnership property.
References in this subsection to the activities
of the limited liability partnership are to anything that it does, whether or
not in the course of carrying on a trade, profession or business with a view to
profit.
(2) For all purposes, except as otherwise
provided, in the Income Tax Acts—
(a) references
to a firm include a limited liability partnership in relation to which
subsection (1) applies,
(b) references
to members of a firm include members of such a limited liability partnership,
(c) references
to a company do not include such a limited liability partnership, and
(d) references
to members of a company do not include members of such a limited liability
partnership.
25. There is a
corresponding provision in section 118ZA, Income and Corporation Taxes Act 1988
(“TA 1988”) for those cases where the members of the limited liability
partnership are themselves bodies corporate.
26. Where the
members of a limited liability partnership are individuals, so that section 863
ITTOIA 2005 applies and they are treated as carrying on in partnership the activities
of the limited liability partnership, the charge to income tax on their share
of the limited liability partnership’s income and profits is under Parts 2 to 5
of ITTOIA 2005. In particular, the provisions of Part 2 of ITTOIA 2005 apply
to charge income taxed as trade profits, with section 5 of ITTOIA 2005
providing: “Income tax is charged on the profits of a trade, profession or
vocation.”
27. It is, however,
the provisions relating to interest which is eligible for tax relief, and in
particular interest paid on a borrowing by a member (who is an individual) for
the purposes of contributing capital to a partnership, which underlie the issue
to be decided in this appeal. In short, such interest is eligible for tax
relief where the capital so contributed is used wholly for the purposes of the
trade carried on by the partnership. It is in this context that Eclipse 35 has
claimed that it is carrying on a trade, and has brought this appeal when the
Commissioners determined otherwise.
28. For the tax year
relevant to when the Members made their payment of interest on their borrowings
from Eagle, the interest relief provisions pertinent to them are found in Part
IX of TA 1988, and in particular sections 353 and 362.
29. Section 353(1)
TA 1988 provides:
Where a person pays interest in any year of
assessment, that person, if he makes a claim to the relief, shall for that year
of assessment be entitled (subject to sections 359 to 368 of this Act and
section 52 of ITTOIA 2005) to relief in accordance with this section in respect
of so much (if any) of the amount of that interest as is eligible for relief
under this section by virtue of sections 359 to 365.
30. Section 362 TA
1988 is headed “Loan to buy into partnership” and provides:
(1) Subject to sections 363 to 365,
interest is eligible for relief under section 353 if it is interest on a loan
to an individual to defray money applied—
(a) in
purchasing a share in a partnership; or
(b) in
contributing money to a partnership by way of capital or premium, or in
advancing money to a partnership, where the money contributed or advanced is
used wholly for the purposes of the trade, profession or vocation carried on by
the partnership; or
(c) in paying
off another loan interest on which would have been eligible for relief under
that section had the loan not been paid off (on the assumption, if the loan was
free of interest, that it carried interest);
and the conditions stated in subsection (2) below
are satisfied.
(2) The conditions referred to in
subsection (1) above are—
(a) that, throughout
the period from the application of the proceeds of the loan until the interest
was paid, the individual has been a member of the partnership otherwise than
(i) as a
limited partner in a limited partnership registered under the Limited
Partnerships Act 1907, or
(ii) as
a member of an investment LLP; and
(b) that he
shows that in that period he has not recovered any capital from the
partnership, apart from any amount taken into account under section 363(1).
31. Eclipse 35 is
prepared to accept that a Member seeking tax relief for the interest paid on
his borrowing from Eagle will have to establish, first, that Eclipse 35 was
carrying on a trade (see section 362(1)(b) TA 1988); and secondly that the
borrowed money he contributed to Eclipse 35 by way of capital is used wholly
for the purposes of that trade carried on by Eclipse 35 (see again section
362(1)(b) TA 1988). Eclipse 35 also accepts that if a Member wishes that the
activities of Eclipse 35 are attributed to him for tax purposes then he will
also have to establish that Eclipse 35 is carrying on its trade with a view to
profit (see section 863(1) ITTOIA 2005).
32. However, Eclipse
35 argues that the matter in dispute in the present appeal is its tax return
for the year to 5 April 2007 in which Eclipse 35 stated only that it was in
that year carrying on a trade: it is not germane to its tax position that it
should in that tax return state that it was carrying on the trade with a view
to profit; nor that the monies contributed by the Members were used wholly for
the purposes of the trade it was then carrying on, since its tax return
contained no item of expenditure. Thus, Eclipse 35 argues, the only matter
which properly falls to be decided in its appeal against the decision of the
Commissioners in relation to its tax return is the question of whether in that
tax year it was carrying on a trade. Anything further risks presuming upon any
appeal which a Member might subsequently wish to bring in relation to the
conditions he has to satisfy if he claims relief for interest on his borrowings
from Eagle and his eligibility for such relief is challenged by the
Commissioners.
33. The only
definition of “trade” in the tax legislation as it applied for the tax year in
question, is to be found in section 832(1) TA 1988:
“trade” includes every trade, manufacture,
adventure or concern in the nature of trade
As we refer to below in our conclusions, in addition case
law offers guidance as to the principles by which one may determine whether a
particular activity comprises a trade or the carrying on of a trade.
34. Finally, we need
to refer to Chapter 3 of Part 5 of ITTOIA 2005, which is headed “Films and
Sound Recordings: Non-Trade Businesses”, and provides for a charge to income
tax where the activities of exploiting a film do not amount to a trade.
Section 609(1) ITTOIA 2005 is in these terms:
Income tax is charged on income from a business
involving the exploitation of films or sound recordings where the activities
carried on do not amount to a trade.
Such a business is referred to in this Chapter as
a “non-trade business”.
The evidence before us
35. We had extensive
evidence before us at the hearing of the appeal. The documentary evidence,
including witness statements and the documents exhibited to those statements,
amounted to about a hundred lever arch files, impressively organised and
categorised by Freshfields Bruckhaus Deringer LLP, the solicitors acting for
Eclipse 35 in this appeal. In addition, Eclipse 35 produced four witnesses,
and the Commissioners produced two witnesses, all of whom gave extensive oral
evidence at the hearing.
The documentary evidence
36. The scope of the
documentary evidence included the following:
(1)
The partnership documents relating to the formation of Eclipse 35; the
terms of its partnership agreement; the deeds of adherence by which Members
became members and contributed their capital; and partnership minutes and
resolutions;
(2)
The documents relating to the promotion of Eclipse 35 to potential
members, including the information memoranda and correspondence with HSBC
Private Bank and independent financial advisers;
(3)
Correspondence, memoranda, promotional documents and similar
documentation relating to earlier film financing transactions devised and
promoted by Future which were precursors of the transactions involving Eclipse
35 and its Members;
(4)
The documentation relating to the engagement of Future by Eclipse 35;
(5)
Correspondence (including emails) between, variously, Future, Screen
Capital International Corporation and Disney relating to the negotiation of the
terms of the transaction for the licensing and sub-licensing of the rights to
the Films and the associated financing;
(6)
Correspondence (including emails) between Future and Barclays relating
to the negotiation of the terms of the financing of the transaction, including
the loan facility to the Members and the issue of the letter of credit, and
including memoranda internal to the Barclays group relating to credit risk and
risk-weighting of the financing for capital adequacy purposes;
(7)
The documentation relating to the report and opinion produced by The
Salter Group LLC in March 2007 setting out a range of possible gross receipts
from each of the Films and the likelihood of Eclipse 35 earning Contingent
Receipts from the Films;
(8)
The transaction documents whereby Eclipse 35 acquired and sub-licensed
the film rights and all the related transaction documents entered into by the
associated parties in relation to Eclipse 35’s transactions, including the loan
facility extended by Eagle to the Members, the deposit arrangements between the
relevant Disney companies and Barclays, the issue of the letter of credit by
Barclays in favour of Eclipse 35; the funding arrangements between Barclays and
Eagle; and related security documentation;
(9)
The documentation relating to the engagement of WDMSP Ltd by Eclipse 35;
the engagement by WDMSP Ltd of consultants and its arrangements with the Disney
group Buena Vista distribution companies for the secondment of advisers; the
release and marketing plans and promotional DVDs in relation to the Films; and
the arrangements whereby release and marketing matters were monitored on behalf
of Eclipse 35 and information on such matters was provided and reported upon to
Eclipse 35;
(10)
Bank account entries relating to the movement of funds on financial
closing of the transactions on 3 April 2007; and cash flow statements showing
such movement of funds and also income and payment streams consequent upon the
transaction for the period of twenty years; and
(11)
Annual statements for periods up to 30 June 2011 showing the financial
performance of the Films and the shortfall as against the threshold at which
the Contingent Receipts become payable; similar documentation relating to
Disney films licensed in earlier Eclipse partnerships promoted by Future;
similar documentation relating to Variable Distributions; and the financial
statements of Eclipse 35 for each of the years up to 5 April 2010.
The witness evidence – Eclipse 35’s witnesses
37. Four witnesses
appeared for Eclipse 35: Mr Timothy Phillip Levy of Future; Mr David Molner of
Screen Capital International Corporation (“SCI”); Mr Stuart Salter of Salter
Film Consultants Limited (“SFC”); and Mr Eric C. Briggs of The Salter Group LLC
(“Salter Group”). Each witness produced one or more witness statements as his
evidence-in-chief, and all were cross-examined at length at the hearing by Mr
Gammie, who appeared for the Commissioners. Mr Briggs gave his evidence by
video link from Los Angeles, and Mr Molner gave the final part of his evidence
by video link from New York.
38. Mr Levy was the
principal witness for Eclipse 35. He had prepared two witness statements. Mr
Levy is the Chief Executive Officer of Future Capital Partners Limited and
holds directorships in various other companies in the Future group of
companies. He is also a Member of Eclipse 35, in which he invested £1,032,000
by way of contribution to its capital. Mr Levy started working in the film
industry in 1997, and co-founded in 2000 what is now the Future group of
companies. He has extensive experience in devising and promoting structured
fundraising and financing transactions to provide capital from private
investors for investment in the production and acquisition of films and the
exploitation of films.
39. Mr Levy dealt
with two main areas in his first witness statement: an overview of the film
distribution business and the general background to the transaction entered
into by Eclipse 35 in relation to the Films.
40. In relation to
the film distribution business Mr Levy explained the usual pattern for the distribution
of films by reference to the territories in which films are likely to be
released and the different markets through which a film may be exploited
(theatrical exhibition (that is, cinema release); non-theatrical release (for
example, films shown in hotels and by airlines); home entertainment (video and
DVD); and television (pay TV and free-to-air)). He explained how a film can
generate revenues for a distributor over a number of years as it is released
sequentially into these different markets. He described film distribution
arrangements made entirely within the studio group which produced the film and
those involving independent third party distributors.
41. In relation to
the background to Eclipse 35 and its licensing of the Films, Mr Levy explained
the genesis of the structuring of the film licensing transactions entered into
by the Eclipse partnerships and its origins in sale and leaseback transactions
which provided tax shelter (by relief by way of deferral of tax paid). He
explained how Future developed a proposal to exploit “franchise films” produced
by major studios, being films of particular value (such as sequel films or
films based on existing media such as books, comics, a television series or
video games) with a likely long revenue-producing life through exploitation in
a wide number of territories and across the range of markets in which films can
be exploited; he explained the benefits of such a proposal for the investors
and the studio. Mr Levy described the discussions with Disney which resulted
in Future signing a term sheet with Disney in December 2005, and the first
tranche of Eclipse transactions which closed in April 2006, and subsequent
tranches based largely on the initial documentation. He explained how the
Eclipse structure was modified following changes in tax relief for losses in
March 2007 and resulted in the Eclipse 35 transaction with the feature of the
prepayment of interest by Members on their borrowings from Eagle. He outlined
the terms of the Eclipse 35 transaction and those of the principal transaction
documents. He described the financial performance of the Films since their
release, and the financial performance of films licensed in the earlier Eclipse
tranches.
42. Mr Levy’s second
witness statement was produced in response to the report submitted by Mr Marcus
Stanton and the report submitted by Mr Steven D. Sills, (Mr Stanton and Mr
Sills are witnesses who appeared for the Commissioners). Mr Levy challenged
various conclusions which Mr Stanton had reached in his analysis of the cash
flow statements which reflect the payments made between the parties over the
twenty year life of the licence arrangements. Mr Levy also challenged certain
statements made by Mr Sills in his report, as to what constitutes a “franchise
film”; the expectation which Eclipse 35 might reasonably have had in April 2007
as to the earning of Contingent Receipts; and the ability of Disney to
manipulate revenues from the Films to the possible detriment of Eclipse 35 (and
the protection against such a risk which Eclipse 35 had put in place in order
to secure the best opportunity to receive Contingent Receipts).
43. The
Commissioners submitted that Mr Levy’s evidence should be viewed with caution
by the Tribunal, since he had a direct and significant interest in the outcome
of the case, both as a Member who had made a substantial investment in Eclipse
35 and as a part-owner of Future which had benefited from fees in the
transaction. Mr Levy’s interest cannot be disputed, but the Commissioners did
not, to any significant extent, demonstrate that Mr Levy’s evidence was
unreliable or misleading, and we saw no reason to question the truthfulness of
his evidence.
44. Mr Molner had
prepared three witness statements. Mr Molner is the Managing Director of SCI,
a company based in Los Angeles which he founded in January 2001. SCI was
engaged by Future and by Eclipse 35 to conduct the commercial negotiations
(principally with Disney) relating to the earlier Eclipse transactions, the
licence and sub-licence of the Films, the gathering of information for the
preparation of the release and marketing plans through the agency and services
of WDMSP Ltd, and the monitoring of the implementation of those plans by the
Distributor. SCI also worked with Salter Group in the preparatory work
undertaken to enable Salter Group to formulate the opinion it gave as to the
likelihood of the Films earning Contingent Receipts for Eclipse 35 (including
compiling the financial model used in that exercise).
45. Mr Molner’s
career in the film industry began in 1995 when he joined Paramount Pictures,
where he was eventually promoted to the role of Senior Vice President of
Worldwide Corporate Business Development. In that position he had
responsibilities for obtaining film finance from syndicated public and private
limited partnerships, and those responsibilities extended to negotiating a
range of commercial transactions including the acquisition, financing and
licensing of film rights. SCI specialises in structuring film and sports
financing transactions, negotiating with the major US film studios on behalf of
investors from the United States and Europe.
46. Mr Molner’s
first witness statement dealt with the relationship between SCI and Future; the
background to the Eclipse transactions and SCI’s role in those transactions;
the commercial negotiations with various film studios in presenting the Eclipse
structure and the eventual detailed negotiations with Disney resulting in the
December 2005 term sheet between Future and Disney and the subsequent negotiation
of the tranches of Eclipse transactions; the negotiations with Disney resulting
in the Eclipse 35 transaction with particular reference to the key commercial
requirements and motivating factors for Disney; the significance of pricing
issues and the negotiation of the Contingent Receipts provisions in the
sub-licence to the Distributor, including the “cross-collateralisation” of the
rights to the Contingent Receipts as between each of the Films; the negotiation
of the Studio Benefit (the net cash retention for Disney); the negotiation of
the films chosen for the various Eclipse transactions and in particular the
choice of the Films for Eclipse 35; the negotiation of the provisions in the
documentation whereby Disney sought to protect itself from the insolvency of
Eclipse 35; and the understanding which he had of the effect of the Prior
Agreements (the undisclosed arrangements within the Disney group subject to
which the Films were licensed to Eclipse 35).
47. Mr Molner also
explained in his first witness statement the role of SCI in obtaining for
Future a range of estimates (based on different assumptions) of likely gross
revenues from the Films by engaging the services of Salter Group, as a basis
for estimating possible values for the Films and for estimating the likelihood
of Contingent Receipts becoming payable over the twenty-year lifetime of the
transaction. Mr Molner also commented on the earnings performance of the Films
to date and possible future earnings, in the context of the likelihood of
Eclipse 35 receiving Contingent Receipts.
48. Finally, in his
first witness statement, Mr Molner dealt with SCI’s role in relation to the
arrangements with WDMSP Ltd for the release and marketing plans for the films
and the monitoring of the implementation of those plans on behalf of Eclipse
35.
49. Mr Molner’s
second witness statement was prepared in response to certain statements
included in the report submitted by Mr Sills, with respect to the differences
between using independent and studio distributors of films; the extent to which
WDMSP Ltd influenced the marketing and distribution of the Films; the purport
of the Prior Agreements and their likely effect on the value of the rights held
by Eclipse 35; the definition of Contingent Receipts in the documentation, and
the likelihood of Contingent Receipts becoming payable; the effect of
“cross-collateralising” the Contingent Receipts from the two Films; and the
risks to Eclipse 35 of Disney, through its distribution network, entering into
arrangements for the distribution of the Films which might benefit the Disney
organisation as a whole, but to the possible detriment of Eclipse 35 as
investor in the Films.
50. Mr Molner’s
third witness statement was prepared in the course of the hearing in response
to challenges put to him by Mr Gammie in his cross-examination of Mr Molner.
It corrects Mr Molner’s first and second witness statements in relation to the
discussions which Mr Molner had with Disney executives as to the Prior
Agreements, and Disney’s refusal to disclose them or their terms (and certain
other matters, such as the terms of financial participation by the leading
actors and production team in films the subject of the various Eclipse
transactions) to SCI; and Mr Molner’s surmise as to the likely purpose and
effect of such agreements and his basis for such surmise.
51. The
Commissioners, in their written closing submissions, mounted a strong challenge
to the credibility of Mr Molner’s evidence, describing it as to a large extent
implausible and self-serving, so that it should not be accepted except to the
extent that it is corroborated by documentary evidence or third party witness
evidence. They argued that much of his evidence was based on speculation and
supposition, and that his experience in the film industry before he formed SCI
was limited in scope to financing, rather than the licensing of film rights.
They also argued that, in his challenge to the evidence of Mr Sills, Mr
Molner’s evidence must be regarded with caution, as his position was that of a
partisan party rather than that of an independent expert.
52. The
Commissioners were particularly critical of the evidence which Mr Molner gave
as to his understanding of the nature and effect of the Prior Agreements and
the discussions he had had with Disney as to their possible disclosure and
general purport, and the conclusions he had reached on the basis of those
discussions and his knowledge of industry practice. Certain inconsistencies
between the evidence which Mr Molner gave under cross-examination and his first
two witness statements, and a certain amount of confusion which thereby
resulted, led to the Tribunal to direct in the course of the hearing that Mr
Molner produce a third witness statement setting out his considered evidence on
this matter.
53. We do not accept
such a general challenge to Mr Molner’s credibility as a witness. He appeared
to us as a person of high intelligence with extensive and relevant experience –
the Commissioners argued that his expertise is restricted to film financing,
but it is clear from his witness statement that Mr Molner had responsibility at
Paramount for negotiation of commercial matters including film licensing
arrangements, and in his oral evidence he showed a detailed working knowledge
of such matters. Mr Molner gave evidence on a wide range of complex and
detailed matters, including intricate and protracted negotiations with a large
commercial team from Disney conducted some years previously, and his evidence
was articulate and convincing. That said, he could, we consider, be fairly
criticised for inaccuracies in his first witness statement, and, in particular,
for a failure to disclose or produce at the hearing a valuation of the rights
licensed by Disney to Eclipse 35, which he said SCI had made by working from
the Salter Group projections of estimated revenues from the Films (as to which,
see paragraph 317 below). Furthermore, on some matters, under
cross-examination, his recollection was correctly challenged on the basis of
contemporary statements in email exchanges. Nevertheless, in our view the
overall credibility of his evidence was not undermined.
54. As to the matter
of the Prior Agreements, the inconsistency in Mr Molner’s evidence related to
the possible nature of such documents which Disney would not disclose. It
seems that Mr Molner had revisited the transaction documentation when preparing
for the hearing, and had realised that the Prior Agreements are more precisely
defined (all as agreements between parties within the Disney group) than Mr
Molner had suggested in his first two witness statements produced some time
earlier (where the suggestion is that they may include agreements with “star”
actors and producers, as well as intra-group agreements). It is also fair to
Mr Molner to say that seemingly the Prior Agreements assumed a greater
significance in the eyes of the Commissioners as matters progressed than
perhaps Eclipse 35 and its advisers and witnesses had anticipated. In any
event, we do not consider that this matter calls into question Mr Molner’s
general reliability as a witness.
55. Mr Salter had
prepared two witness statements. Mr Salter, who is now semi-retired, has no
connection with Salter Group (see the evidence of Mr Briggs, below). Mr Salter
has since 2006 worked as a consultant to WDMSP Ltd in relation to the marketing
and distribution of a number of films produced by Disney, including the Films.
Mr Salter’s working life has been spent in the business of internationally
marketing and distributing films. From 1991 until 2006 he worked for Disney in
Paris and London, where he was an Executive Vice-President of Buena Vista
International, which was at that time the trading division within the Disney
group responsible for the cinema marketing and distribution of Disney films in
all territories other than North America. Mr Salter’s particular
responsibilities were for the marketing and distribution of films in Europe,
the Middle East and Africa.
56. Mr Salter’s
first witness statement dealt with his role as a consultant to WDMSP Ltd in
relation to films which have been licensed through the various Eclipse
structures, including the Films. In that role he has monitored the
distribution and marketing plans proposed by WDMSP Ltd (using Disney staff),
and subsequently implemented by the Distributor and has reported to WDMSP Ltd
on those plans and their implementation, advising on whether in his opinion
they are reasonable and appropriate. He explained the different key stages in
the marketing and distribution process for the cinema release of films: the
marketing campaign to support the release; the scheduling of release dates in
different territories appropriate to the nature and content of the films in
question; and setting the budget for the release process.
57. Mr Salter’s
second witness statement was prepared in response to certain statements
included in the report submitted by Mr Sills as to the extent of Mr Salter’s
work in his consultancy with WDMSP Ltd.
58. Mr Salter was
cross-examined by Mr Gammie, with a view to determining the scope and extent of
his consultancy activities for WDMSP Ltd and also the extent to which Mr Salter
relied on the information-gathering and collation activities of SCI, but the
Commissioners did not challenge Mr Salter’s credibility as a witness.
59. Mr Briggs had
prepared a witness statement. Mr Briggs is a principal of Salter Group, a
position he has held since its formation in 2003. Prior to that Mr Briggs
worked at an international investment bank primarily on forecast and valuation
projects in the entertainment and media industry. Salter Group is based in Los Angeles. Its business is the provision of financial and strategic analysis and advice
and valuations and forecasts in the film and entertainment industries, and Mr
Briggs has worked for a range of international media and banking clients on
forecasts and valuations of film libraries and music catalogues.
60. Mr Briggs’s
witness statement is concerned with Salter Group’s opinion dated 22 February
2007 issued to Future and relating to certain films, including the Films.
Salter Group was engaged to provide aggregate cash receipts forecasts for the
Films during different exploitation cycles over a period of twenty years.
Those forecasts were made on the basis of certain key assumptions and a range
of possible cases (“best”, “base”, and “downside”), using a methodology based
on the distribution strategies and plans which were then anticipated for the
Films and on the earnings performance of a range of films judged (by reference
to such matters as genre and plot, target audience, and key actors) to be
comparable to the Films. The forecast cash receipts thereby estimated were
applied to a financial model provided by SCI of likely expenses, prior
allocation of financial participations by key actors and producers, and similar
deductions from gross receipts to determine the possibility of Contingent
Receipts arising for Eclipse 35 across the range of cases identified.
61. Mr Briggs was
cross-examined by Mr Gammie as to the exact extent of his functions in
preparing the Salter Group opinion, and the extent to which he relied on
information and financial models supplied by SCI. The Commissioners did not
challenge Mr Briggs’s credibility as a witness.
The witness evidence – the Commissioners’ expert witnesses
62. Two witnesses
appeared for the Commissioners, both classified by the Commissioners as expert
witnesses: Mr Marcus Stanton, a consultant to a number of banks and government
agencies in the UK and overseas; and Mr Steven D. Sills of the firm Green
Hasson Janks LLP. Each witness produced a report and was cross-examined at
length by Mr Peacock, who appeared for Eclipse 35.
63. As we refer to
below, the evidence provided by Mr Stanton in his report was the subject of an
application by Eclipse 35 that all or some of it should not be admitted in
these proceedings.
64. Mr Sills is a
Certified Public Accountant and a member of the California Bar. He is a
partner in the Motion Picture and Television Participation Services Department
of the firm of Green Hasson Janks LLP and is based in Los Angeles. Since 1982
Mr Sills has specialised in the auditing of profit participation arrangements
in relation to films, which requires a review of distribution agreements
between the profit participant (an investor in the films, or a person such as
an actor with a share in the earnings) and the distributor and a review of the
accounts maintained by the distributor for the film in question in order to
ascertain whether the profit participant has received what is properly due to
him under the distribution agreements. Mr Sills always acts for the profit
participant in such cases, rather than the film studio or distributor. He has
also appeared as an expert witness in entertainment litigation matters
involving projections of film gross revenues and the application of financial
models for determining participation shares.
65. Mr Sills’s
report dealt with the following matters: the “vertical integration” nature of
the Disney group and the likely effect of the Prior Agreements upon the licence
(and its value) granted by Disney to Eclipse 35; the likely significance to the
Disney group of the marketing and release plans supplied by Eclipse 35 through
the agency and services of WDMSP Ltd; the Contingent Receipts provisions in the
distribution agreement between Eclipse 35 and the Distributor and the extent to
which they conform to industry norms; the likelihood of Eclipse 35 receiving
any Contingent Receipts; and the classification of the Films as “franchise
films”.
66. Eclipse 35
challenged Mr Sills’s evidence in general and specific terms. Mr Peacock argued
that Mr Sills’s report was presented as expert evidence, but that the nature of
his expertise is uncertain (it has neither a legal nor an accountancy basis),
and that his working life has been spent analysing profit participation rights
solely from the viewpoint of the profit participant. He also argued that Mr
Sills reached certain conclusions (such as his view that the licensing and
distribution arrangements could be viewed as a combined transaction which
resulted in a net consequence which was the true nature of that transaction)
which were not within the proper scope of an expert witness, as they are
submissions of fact or of law.
67. We broadly
accept Mr Peacock’s challenges to Mr Sills’s evidence and in consequence place
limited reliance on that evidence. We accept that he has wide experience in
the field of profit participation rights in film distribution arrangements, and
for that reason we give weight to his evidence as it relates to the terms of
the Contingent Receipts provisions in the agreement between Eclipse 35 and the
Distributor. However, beyond that, although his evidence was put forward as
that of an expert, much of his evidence (for example as to the likely purpose
and effect of the Prior Agreements, or the value or benefit of the marketing
arrangements put in place by WDMSP Ltd) was little more than surmise, and not,
as was revealed in cross-examination, surmise which was based on first-hand
knowledge or particular experience of the matters in question. Mr Sills’s
wider generalisations as to the true nature of the licensing and distribution
arrangements which Eclipse 35 entered into with Disney strayed beyond his
experience and in our view were not properly within his remit as an expert.
Mr Stanton’s report and Eclipse 35’s application to exclude it
68. A few weeks
before the hearing of its appeal Eclipse 35 applied to us for a direction
excluding the report (or the majority of it) prepared by Mr Stanton, and
submitted as expert evidence by the Commissioners, on the grounds that it is
inadmissible, since it relates to UK tax matters, which is the province of the
Tribunal itself, and since, further, it puts forward a partial version of the
facts, dressing as expert evidence matters which properly should be made by way
of submission by the Commissioners when they make their case at the hearing.
The Commissioners resisted that application, and we heard the application, with
detailed argument from each side, on 1 June 2011.
69. Our decision,
reported in Eclipse Film Partners No 35 LLP v The Commissioners for Her
Majesty’s Revenue and Customs (TC 01256), was to dismiss Eclipse 35’s
application at that time, and to hear Mr Stanton’s evidence with the benefit of
any cross-examination of him at the hearing, and also to hear any evidence
which Eclipse 35 wished to adduce by way of challenge to Mr Stanton’s evidence,
so that we would then be in a position to decide whether it should be excluded
in whole or in part, and if not, the weight we should attribute to it.
70. As already
indicated, Eclipse 35 did present evidence to challenge Mr Stanton’s report, in
the form of a second witness statement prepared by Mr Levy. Also, Mr Stanton
was cross-examined at length by Mr Peacock.
71. In closing
written submissions Mr Peacock and Mr Maugham renewed Eclipse 35’s application
to exclude Mr Stanton’s report, adopting the arguments which Mr Maugham had
advanced on Eclipse 35’s behalf at the June 2011 hearing of the application.
Mr Peacock and Mr Maugham argued, in the alternative, that if we did admit all
or any part of Mr Stanton’s evidence, we should attribute little weight to it
in view of (as they saw it) Mr Stanton’s limited expertise in the relevant
fields, the report’s partiality and selective nature, and the errors and
omissions in the report as established by Mr Levy’s evidence and in
cross-examination.
72. Mr Gammie (with
Mr Pillai and Miss Murray – who had appeared for the Commissioners at the June
2011 hearing of Eclipse 35’s initial application) also made written submissions
on this issue. They strongly rejected as unfounded the assertions of Mr
Peacock and Mr Maugham that Mr Stanton had acted with partiality in preparing
his report, or in any way had acted in a manner which implied a breach by him
of his duty as expert to the Tribunal. They pointed out that Eclipse 35 had
not particularised those parts of the report which it sought to exclude. Mr
Gammie and his junior counsel argued that the transactions which Eclipse 35 and
its Members entered into were structured finance transactions, consisting of
seeking some tax advantage without taking on credit risk, and that Mr Stanton
has manifest expertise in such transactions which enables him to give an expert
view on such matters. They also pointed out that Mr Stanton provided the only
evidence available to the Tribunal on the cash flow financial models underlying
the transactions between the parties which, in their submission, are essential
to a proper understanding of those transactions and their purpose: Eclipse 35
did not tender as a witness the employee at Future who was responsible for the
financial modelling of the Eclipse film finance transactions.
73. We extract the
following from our decision on the earlier application by Eclipse 35 as a
summary of Mr Stanton’s qualifications and experience and also the scope of his
report:
“12 The evidence of Mr Stanton to which E35
takes exception is set out in a document entitled “Expert Report of Marcus
Stanton” which is dated 8 April 2011 and is signed by Mr Stanton. The Report
runs to some ninety pages, and we were told that there were lengthy exhibits to
the Report (which we did not read). It is expressed to be Mr Stanton’s
professional opinion on the matter in dispute between E35 and the
Commissioners, that opinion having been requested by the Commissioners. In
preparing the Report Mr Stanton states that he has complied with Part 35 of the
Civil Procedural Rules and the accompanying Practice Direction.
13 Mr Stanton begins by setting out his
qualifications and experience. In brief, he qualified as a Chartered
Accountant and practised at one of the leading firms of chartered accountants,
specialising in international and corporate taxation. He then held a series of
positions with leading UK merchant and investment banks, including that of Head
of Structured Finance and Chief Operating Officer in the Global Capital Markets
division of Robert Fleming & Co. Since 2001 he has acted as a banking
consultant to banks and various government agencies in the UK and overseas and has also held a number of non-executive directorships in companies in
the financial sector.
14 Mr Stanton divides his Report into ten
sections, as follows (and adopting his section headings):
(1) The Role of
Structured Finance in Tax Driven Transactions: this is a general explanation of
the role of arrangers and banks in the context of tax-based products marketed
to individuals followed by a description of the funding arrangements entered
into by E35 and its members and the tax relief claimed by the members for the
prepaid interest;
(2) The
Transaction Arrangements: this is an overview of the transaction and a review
of the main transaction documents and cash flows, with Mr Stanton expressing
his view that the arrangements can be viewed as a combined transaction;
(3) The
Profits/Losses of the Eclipse Partnership and the Eclipse Partners: this is an
analysis of the likely profits and losses accruing from the transactions to E35
and to its members;
(4) The
Derivation of the Transaction Amounts: this is an analysis of the payments made
under the transaction documents, with the opinion expressed that such amounts
were determined by financial calculations rather than by reference to any film
activity;
(5) The Net
Profit Calculations Prepared by Future Films: this is an analysis of the profit
figures given in the promotional documentation sent to prospective members,
relating those figures to the outcome (expressed by Mr Stanton to be a loss)
where the members substantially borrow (as they all did) to invest in E35;
(6) The
Contingent Receipt Calculations: this is an analysis of the significance in the
financial calculations underlying to transaction documents of the right of
members to share in “Contingent Receipts” from the films in which the
investment is made (that is, earnings from the films over and above the fixed
royalties payable to E35);
(7) The Banking
Arrangements: this is an analysis of the loan and other facilities provided by
members of the Barclays Bank group of companies, the credit risk undertaken by
Barclays, and the risk-weighting of the arrangements for Barclays’ capital
adequacy purposes;
(8) The Prepaid
Interest: this comments on the prepayment of interest on their borrowings by
the members and the resulting tax relief claimed by them;
(9) The Risk
being borne by the Eclipse Partners: this is an analysis of the nature of the
risk to which the members are exposed in the event of default; and
(10) The Role of
the Tax Benefits in the Arrangements: this is an opinion that the amount of the
investment made by each member was based on the tax shelter sought by that
member and that a major factor in determining the size of the E35 partnership
was the amount of tax shelter sought by its members collectively, rather than
the requirement to finance particular films.
15 In the course of his Report Mr Stanton
uses the cash flow and other numbers supplied by Future Films (the promoters of
E35) and, by a process he refers to as “reverse engineering”, uses that
information to produce his own cash flows and calculations which he claims
support his views on the financial and tax basis underlying the transaction as
a whole and the individual transaction documents.”
74. Having now had
the benefit of hearing all the evidence and arguments in this case we are in a
position to decide whether or not to allow Eclipse 35’s application to exclude
Mr Stanton’s evidence. Our decision is not to exclude it, but to admit it and
to attribute to it – or to its different parts – the weight which we consider
appropriate in the light of all the extensive evidence and submissions which we
heard.
75. There is a case
for excluding part of Mr Stanton’s evidence: we agree with Eclipse 35’s
argument that in parts Mr Stanton proffers his opinion on matters which are
questions of law, most notably when he opines that “these arrangements can
reasonably be viewed as a combined transaction, in the sense that the main
transaction legs were all to happen together or not at all”, and where he
comments on the meaning and effect of transaction documents. We also accept
that in part his opinion is based on surmise, for example with regard to
possible further documents (further, that is, to those produced pursuant to the
exercise by the Commissioners of their information-gathering powers) within the
Barclays group as to the risk-weighting of the loan transactions. Eclipse 35
did not, however, make out a case for clear and specific surgical excision, and
in the overall context we think such an approach would not be particularly
helpful – we are well able to identify those areas where Mr Stanton was
trespassing into areas which are matters for our determination (and Mr
Peacock’s forthright and extensive submissions left us in little doubt as to
what those matters are), and the reliance we place on Mr Stanton’s evidence can
be calibrated accordingly.
76. The real value
of Mr Stanton’s evidence, as Mr Gammie indicated, was to introduce into the
case particular areas of evidence – most notably the cash flows underlying the
transactions and the issue of the risk-weighting for the capital adequacy
purposes of the Barclays group of the deposit and loan transactions – which in
our view have some relevance and might otherwise have received less scrutiny
than they did. If we take the cash flow statements which Mr Stanton produced
(which show the cash movements on financial close of the transactions on 3
April 2007 and the subsequent income streams between the various parties over
the following twenty years) they were in themselves unexceptional and not in
their general approach or result disputed by Mr Levy, but they shed light on
the financial basis of the transactions for the parties, the profitability of
those transactions, and the financial effect of their tax consequences. In
turn this led Eclipse 35, through the evidence of Mr Levy and Mr Peacock’s
cross-examination of Mr Stanton, to argue that the cash flows constructed by Mr
Stanton had certain deficiencies and took no account of certain contingencies
(in particular, the possibility of Eclipse 35 receiving Contingent Receipts)
and to challenge certain of the inferences which Mr Stanton had drawn from the
cash flow statements. We were therefore presented (helpfully) with a range of
pertinent evidence as to the financial effects and significance of the
transactions. In that way Mr Stanton’s evidence was “helpful in assisting the
court to reach a fully informed decision”: United Bank of Kuwait v Prudential Property Services Limited (unreported decision of the Court of
Appeal of 27 November 1995).
77. The significance
of, and the weight we attribute to, the different parts of Mr Stanton’s evidence
will be apparent from our findings of fact and conclusions.
Findings of fact
78. In paragraphs 80
to 252 below we set out our findings of fact from the evidence before us.
First we deal with the context of the Eclipse 35 transaction, setting out the
development of the Eclipse structure and transactions and the formation of
Eclipse 35, including the investment made by the Members. Then we deal with
the terms of the transaction documents. This is followed by the financial
terms of the transactions and the cash flows which underlie the transactions.
We then deal with the marketing services arrangements.
79. In paragraphs
253 to 367 below we make further findings of fact in relation to disputed
matters concerning the nature of Eclipse 35’s activities and the arrangements
it entered into.
The Eclipse structure and transactions and the formation of Eclipse 35
Eclipse partnership transactions prior to Eclipse 35
80. Eclipse 35 is,
as the name suggests, one of a series of partnerships which entered into
broadly similar transactions relating to the acquisition and distribution of
film rights. The Eclipse 35 structure of transactions has certain features
which are specific to it (as mentioned below), but the essential terms of the
agreement made with Disney were negotiated at an earlier stage in relation to
the transactions entered into by the predecessor partnerships. It is
necessary, therefore, to give this context to the transactions of Eclipse 35
which are our concern in this appeal.
81. The origins of
the transactions entered into by the Eclipse partnerships were sale (or lease)
and leaseback film financing transactions promoted over a number of years by
Future and other promoters engaged in procuring private finance from
individuals for the production or acquisition of films and the exploitation of
those films through distributorship arrangements. The immediate origin of the
Eclipse structure was a different transaction developed by Future and referred
to as the “Library” transaction.
82. Eclipse 35’s
transaction was the fourth in a series or tranches of transactions whereby film
rights were licensed from Disney to a number of “Eclipse” partnerships. In
each case Future promoted the partnerships and sought investors to contribute
capital to the partnerships to finance them for the acquisition of the licence
to the film rights, with the grant back to Disney (or, more accurately, another
member of the Disney group) of distributorship rights, and Future and SCI
negotiated with Disney on behalf of the Eclipse partnerships.
83. Prior to
concluding agreements with Disney, Future and SCI had also negotiated similar
transactions with other film studios, including Warner Brothers, Sony,
Universal and Paramount, but for a number of reasons (including the reluctance
of other studios to countenance the marketing and release arrangements which
Future and SCI on behalf of the Eclipse partnerships eventually agreed with
Disney) those negotiations came to nothing.
84. On 22 December
2005 Future (by Mr Levy) and SCI (by Mr Molner) entered into with Disney what
was termed a “non-binding letter of terms indicating our intention to work with
each other in good faith to close the Transactions” (“the Term Sheet”). The
“Transactions” identified in the Term Sheet related to partnership structures
which included the Eclipse partnerships. The Term Sheet (so far as it related
to the Eclipse partnerships) included the following matters:
(1)
Confirmation that preliminary internal approval within the Disney
organisation had been obtained for the Transactions, but that final approval
would be required from Disney’s audit committee and from the President of
Disney as to the definition of contingent proceeds (that is, Contingent
Receipts);
(2)
Successful execution of the Transactions was conditional on a number of
matters, including documentation satisfactory to Disney, the successful raising
of capital by the partnerships, the making of banking arrangements satisfactory
to Disney, and Disney being satisfied as to relevant tax, insolvency and
security matters;
(3)
The term of the deal for any Eclipse partnership would vary between 9
and 23 years, with certain early termination provisions;
(4)
Disney agreed to make certain specified films available in an agreed
order of priority (the list of films contained two films used in earlier tranches
of Eclipse transactions, but not the Films used in the Eclipse 35
transaction). Disney agreed to offer further films (satisfactory to SCI and
Future) if the value of the film rights for the specified films fell short of
US$3.6 billion;
(5)
Each Eclipse partnership was required at its cost to obtain a valuation
(based on independent advice) for the rights in each film to be acquired from
Disney; and
(6)
Credit enhancement arrangements were envisaged in relation to the
obligations of the Disney distributor party, to be facilitated by a deposit
made by the distributor. Such deposit was to equal 97.22 per cent of the price
paid by the respective Eclipse partnership for the licence of the film rights,
and the aggregate amount of such differential between the price paid and the
deposit for all films licensed to Eclipse partnerships was not to exceed US$35
million unless the aggregate value of the film rights exceeded US$3.6 billion.
(This differential is subsequently referred to as the “Studio Benefit”.)
85. On 5 April 2006
a number of Eclipse partnerships entered into transactions to take a licence
of, and to grant a distribution licence of, certain rights in the Disney film
“Pirates of the Caribbean: Dead Man’s Chest”. This was the first tranche of
Eclipse transactions.
86. On 21 July 2006
a further number of Eclipse partnerships entered into transactions to take a
licence of, and to grant a distribution licence of, certain rights in the
Disney film “Pirates of the Caribbean: At World’s End”. This was the second
tranche of Eclipse transactions.
87. On 19 March 2007
a further number of Eclipse partnerships entered into transactions to take a
licence of, and to grant a distribution licence of, certain rights in the
Disney film “National Treasure: Book of Secrets”. This was the third tranche
of Eclipse transactions.
88. In January 2007
Disney offered the Films as films to be licensed in an Eclipse transaction.
89. The Term Sheet
and the individual Eclipse transactions comprising each tranche were the
subject of extensive negotiation between Future, SCI and Disney, involving
senior management, legal, accounting, commercial and marketing executives
within the Disney organisation. The lead negotiator for Future and the Eclipse
partnerships was Mr Molner, but Mr Levy and his colleagues at Future were also
involved in negotiations on behalf of the Eclipse partnerships.
90. Matters which
were the subject of particularly intensive negotiation included the following:
(1)
The value to be attributed to the film rights licensed and the amount of
the fixed royalties paid by the Distributor;
(2)
The identity of the films, and the extent of the rights in such films,
to be licensed;
(3)
The protection of Disney’s rights in the films in the eventuality of the
insolvency of the Eclipse partnership;
(4)
The marketing arrangements carried out through WDMSP Ltd, including the
extent of WDMSP Ltd’s role and its accountability to, respectively, the Eclipse
partnership which engaged its services and Disney;
(5)
The amount of the Studio Benefit in the case of each tranche (which was
reduced from 2.5 per cent envisaged in the Term Sheet to 0.9722 per cent in the
case of the first three tranches and to 1.15 per cent in the case of Eclipse
35);
(6)
The terms on which the Contingent Receipts were to be ascertained, and
the proportion of the Contingent Receipts to which the Eclipse partnerships
were entitled; and
(7)
The extent of the rights which the Eclipse partnership had to audit the
gross income receipts earned by the films in order to monitor any entitlement
of the Eclipse partnership to Contingent Receipts.
91. By the time that
Eclipse 35 entered into its transaction most of the commercial terms and
documents concerning the licensing of the Films and related matters had been
agreed with Disney in negotiation of the earlier tranches. There were, however,
further meetings, conference calls and email exchanges between Disney
executives and (principally) Mr Molner in order to agree the particular
features of the Eclipse 35 transaction.
92. The Eclipse 35
transaction is distinguished from the transactions in the other Eclipse
tranches by the following features:
(1)
Eclipse 35 acquired the entirety of the rights to the Films (and not, as
had been the case with acquisitions of rights in the earlier Eclipse tranches,
rights limited by territory or media);
(2)
Eclipse 35 acquired the rights in two films, rather than a single film.
As described below, for the purposes of calculating the entitlement of Eclipse
35 to Contingent Receipts, the two films were “cross-collateralised”, that is,
their financial performance was aggregated;
(3)
In the first three tranches each Eclipse partnership was entitled to a
34 per cent share of Contingent Receipts, but in the case of Eclipse 35 the
share was 40 per cent;
(4)
In the first three tranches the rate of the Studio Benefit was fixed at
0.9722 per cent of the licence fee, but in the case of Eclipse 35 it was fixed
at 1.15 per cent; and
(5)
The Members of Eclipse 35 (unlike the members of the other Eclipse
partnerships) prepaid interest for the first ten years of the borrowings they
took to finance their capital contributions to Eclipse 35. This, as explained
below, had a consequence for the amount of the fixed royalties payable by the
Distributor (and in turn the amount which the Distributor deposited to secure
payment of those royalties).
93. In deciding with
which film studio to enter into licensing and distributorship arrangements, and
in selecting the films to be licensed, Future and the Eclipse partnerships took
account of the following matters:
(1)
Major film studios have fully integrated media and distributorship
businesses which enable them not only to maximise film revenues through their
international distribution arrangements, but also to exploit film rights
through the cycle of the film’s earning capacity (by cinema release, home video
release, pay-to-view TV, hotel and airline release, free TV, etc) and such
associated exploitation as merchandising and video games. Future carried out
negotiations with Warner Brothers and Disney (eventually concluding an
agreement with Disney), both of which, of course, are major film studios of
this type.
(2)
Films are potentially “long-tail” assets, not only because they have
different and successive cycles of exploitation over the years, but also
because the introduction of new technology can, years after a film has been
released, re-invigorate the capability of distributing a film in different
formats. Particular films which by their subject matter are “franchise” films
are likely to have an enduring attraction and longevity and are therefore best
placed to exploit the “long tail” and earn maximised income over time with the
best prospect for members of the Eclipse partnerships of receiving Contingent
Receipts. A “franchise” film is one which is based on an existing media
property, so that in some way (subject matter, established and specific genre,
characters) a potential audience already has a connection which is expected to
draw them to the film: it may be a film based on a book, a comic strip, or a
television series, or as a sequel to an earlier film. In the first three
Eclipse transactions the films selected were sequel films following upon very
successful earlier films. The “franchise” nature of the films for which
Eclipse 35 acquired rights is referred to below.
(3)
It follows that films which, by reason of their “franchise” attributes,
have the potential to earn high gross revenues over time, have premium value
which reflects that potential, and the studio will wish to see that premium
value in the licence fee it receives. It will also wish to see that distribution
arrangements ensure that there is the best opportunity to realise that value.
The significance to the studio of such value lies not just in the commercial
terms of the licence agreement it enters into, but in the impact it has on
values attributed to its portfolio of films which ultimately is reflected in
its group balance sheet.
(4)
Future was concerned that there should be a role for the Eclipse
partnerships (acting through WDMSP Ltd) in formulating the marketing and
release plans for the films to be licensed to the Eclipse partnerships. It was
not interested in films which were, so to speak, too far down the marketing
track. To that end it devised a scale by which, applying specified “threshold”
criteria, it could judge how far advanced were the marketing and release plans
of individual films, so that films which were judged to be too high on the
scale could be eliminated. In the case of all the films some element of
marketing, release and distribution planning had been undertaken by the Disney
group before the films were licensed to an Eclipse partnership.
94. The film
licensed in the first tranche of the Eclipse transactions is the Disney film
“Pirates of the Caribbean: Dead Man’s Chest”. The annual statement of gross
receipts and contingent receipts as at 26 March 2011 shows that at that date
(just under five years after the film was released) gross receipts from the
film totalled US$908 million and that there was then a “deficit” in the
contingent receipts calculation of US$82.5 million. In view of the likely
“life” of the film and its positive performance to date against estimates, it
is reasonable to expect that contingent receipts will eventually become payable
to the relevant Eclipse partnerships. Corresponding figures for the film
licensed in the second tranche of the Eclipse transactions, “Pirates of the
Caribbean: At World’s End”, released a year later, show aggregate gross
receipts as at 26 March 2011 of US$755 million and a contingent receipts
“deficit” of US$258 million (reflecting the high production costs for the
film).
The Films licensed by Eclipse 35
95. The Films which
Disney proposed to Eclipse 35 and which Eclipse 35 chose to licence were
“Enchanted” and “Underdog”.
96. “Enchanted” is a
story created by Disney with a princess as the main character and which draws
on the Disney animations of classic fairy tales. It is described as “a unique
twist on the classic Disney fairytale which showcases what happens when the
magical, idyllic animated world and the modern, gritty, real-life world of New York City collide”. Its leading actors include Amy Adams, Patrick Dempsey and Susan
Sarandon. It was created by Disney to be an addition to its portfolio of
“princess” films (comprising animation classic films as well as more recent
films) which have been very successful in their own terms with family audiences
and in the merchandising rights which they have generated for products aimed at
young girls. Both Disney and Future regarded “Enchanted” as a “franchise” film
in view of its connection to the Disney “princess” portfolio of films, of which
it was intended to be a part.
97. “Enchanted” was
released in the United States on 21 November 2007 and subsequently worldwide.
In 2008 it was nominated for three Academy Awards and twenty-nine other
awards.
98. “Underdog” is a
film based on a United States cartoon and comic strip series dating from the
1970s. Its leading actors include Amy Adams, Jason Lee and James Belushi.
Both Disney and Future regarded “Underdog” as a “franchise” film as it is
derived from a comic strip. It was released in the United States on 3 August
2007, and was nominated for three awards. Whereas it was anticipated that
“Enchanted” would, by reason of its subject, have an international audience,
both Disney and Eclipse 35 considered that the appeal of “Underdog” was less
certain: the comic strip on which it was based was known only to one generation
of the potential audience, and was not known outside the United States.
99. At Disney’s
insistence for all financial purposes in structuring the licence and
distribution arrangements with Eclipse 35 the two Films are aggregated. The
principal purpose and effect of this is to “cross-collateralise” the Films in
ascertaining the entitlement of Eclipse 35 to Contingent Receipts – the
calculations of that entitlement are made as if the Films were a single entity,
with aggregation of all production, marketing and distribution costs and
participations which are taken into account as debits in determining Contingent
Receipts, as well as the aggregation of all gross revenues which are taken into
account as credits for that purpose. Thus if one of the Films is successful
and, taken alone, would deliver Contingent Receipts, but the other Film is not
so successful and, taken alone, would result in a “deficit” Contingent Receipt
calculation, that deficit, in the combined calculation, reduces or eliminates
the Contingent Receipts otherwise payable in respect of the successful Film.
100.In agreeing
to “cross-collateralise” the Films in this way Eclipse 35 was able to negotiate
a 40 per cent share of any Contingent Receipts (as against a 35 per cent share
in the case of the earlier Eclipse tranches).
101.As at 26
March 2011 aggregate gross receipts for the Films (taken together) were US$362
million, and, taking account of the “cross collateralisation” of the contingent
receipt entitlement in respect of the two Films, there was a contingent
receipts “deficit” of US$184 million.
102.As a general
statement, “Enchanted” has been a success: its gross cinema release revenues
have been above the “base case” range identified by Salter Group in the opinion
they gave to Eclipse 35 as to likely performance of the film. “Underdog” has
not been a success: its gross cinema release revenues are below the “downside
case” range identified by Salter Group in that opinion. On current figures it
is thought to be unlikely that any Contingent Receipts will be received by
Eclipse 35.
The establishment of Eclipse 35 and its partnership deed
103.Eclipse 35
was incorporated on 3 October 2006 as a limited liability partnership with
registered number OC3228434. The members on incorporation were Future Films
(Management Services) Limited and Future Films (Partnership Services) Limited.
104.On 3 October
2006 Eclipse 35 entered into a Partnership Consultancy Agreement with Future.
It recites that Eclipse 35 “was organised principally to carry on the trade of
investment, acquisition and exploitation of films in the designated
territories”. Eclipse 35 engages Future to provide the “Partnership
Consultancy Services”, which are defined in Schedule 1 to the agreement to
include identifying, evaluating and selecting films suitable for Eclipse 35 for
its purposes of producing, acquiring, distributing, financing and exploiting
films; procuring the purchase of films and any rights in films for the purpose
of exploitation; procuring the exploitation of film rights by way of leasing,
licence and distribution agreements and disposal; and entering into agreements
to acquire and exploit films to maximise the scope and profitability of Eclipse
35’s business. All such services are undertaken by Future on behalf of Eclipse
35. Eclipse 35 agrees to pay Future for providing these services a fee
comprising 5.5 per cent of the partnership capital raised by Eclipse 35 and 15
per cent of the net proceeds from the exploitation of the distribution of film
rights licensed to Eclipse 35. Pursuant to this agreement Eclipse 35 paid
Future a fee of approximately £44 million on 3 April 2007.
105.On 9 February
2007 Eclipse 35 entered into the Marketing and Services Agency Agreement with
WDMSP Ltd. Its principal terms are set out below, but the broad purpose of the
agreement is that WDMSP Ltd is, for a fee, appointed as Eclipse 35’s agent and
engaged to provide specified services, including the preparation of marketing
and release plans in relation to the Films and overseeing the Distributor in
its implementation of those plans.
106.On 13 March
2007 the two founding Members of Eclipse 35 entered into a partnership deed in
relation to Eclipse 35 (“the Partnership Deed”). The Partnership Deed in these
terms has since governed Eclipse 35 and its Members, and the investing Members
became parties to the Partnership Deed (and thereby Members) by signing a Deed
of Adherence and contributing their capital. Provisions of the Partnership
Deed relevant to this appeal include the following:
(1)
Eclipse 35 is required to carry on “the Business”, defined to include
film production, distribution, financing and exploitation, and in particular
the licensing of the distribution rights in respect of such films owned or
controlled by Disney as Future may agree with Disney should be licensed to
Eclipse 35, and any business which is ancillary to such activities. Ancillary
matters are expressed to include: receiving nominations from Disney of films
suitable for Eclipse 35 to take a licence and grant distribution rights;
obtaining a “likely range of the market value of those film nominations, as
indicated by independent film valuation specialist”; using the services of
WDMSP Ltd to prepare a marketing and releasing plan for films licensed to
Eclipse 35; and thereafter to sub-licence the film rights to the Distributor
for the implementation of the approved marketing and releasing plan.
(2)
The Business is to be carried on to the extent expressly permitted by
the “Transaction Documents” (essentially the documents under which Eclipse 35
subsequently licensed and distributed the Films), or by way of other commercial
activities contemplated in conjunction with Disney, unless Disney consents to
some other business activity.
(3)
The liability of a member is limited to the amount of his capital
contributed, that amount to be specified in the Deed of Adherence by which he
becomes a Member.
(4)
The two founding Members are appointed the Designated Members for the purposes
of the limited liability partnership legislation, and they have the right and
duty to manage the business and affairs of Eclipse 35, subject to the
performance of those functions undertaken on behalf of Eclipse 35 by Future as
promoter of Eclipse 35 and pursuant to the Partnership Consultancy Agreement.
To the extent that Members have conduct of the affairs of Eclipse 35, matters
require the consent of Members who together hold 50 (or, for certain matters,
75) per cent of total capital contributed.
(5)
Profits and losses are allocated to Members in proportion to capital
contributed. Income of the partnership available for distribution to Members
is to be distributed annually in proportion to capital contributed. The
Designated Members have power to advance loans to Members against future income
profits in advance of such profits being recognised in the accounts of the
partnership, and any such advance is not to be treated as a reduction of
Members’ capital, and is repayable to the partnership on demand. (This power
was exercised on “financial close” of the transactions on 3 April 2007, when an
aggregate amount of approximately £293 million was advanced by Eclipse 35 to
Members.)
(6)
On the date which is six months after the expiry or early termination of
the Licensing Agreement the Members will cause Eclipse 35 to be wound-up.
The promotion of the Eclipse partnerships to investors
107.The Eclipse
partnerships (including Eclipse 35) were promoted to potential investors by an
Information Memorandum dated 9 January 2006 which included what is described as
a “Film Partnership Proposal”. This set out the nature of the investment which
would be made by investors if they became members of a partnership, summarising
that investment as “an opportunity to participate in the exploitation of new
Hollywood feature franchise films produced, owned or controlled by a US Major,
through an exclusive joint venturing arrangement”.
108.The Proposal
included the following matters: the nature of the film licensing, marketing and
related transactions which a partnership would enter into; examples of the
“franchise” films which might be licensed within the proposed arrangements; the
fixed royalties which a partnership would receive under the film distribution
agreement; the credit enhancement of those fixed royalties by the issue of a
letter of credit by a bank; the possibility of a partnership receiving
“contingent receipts”, dependent upon the success of the exploitation of the
films licensed; the tax treatment of a partnership (namely, that the
exploitation of the films should constitute a trade for such purposes); the
attribution of trading profits or losses of a partnership to its members for
their tax purposes; the expectation that a partnership (and hence investors)
would make a profit for tax purposes in each year of assessment; the investment
return (based on fixed royalties received and a range of assumptions as to
“contingent receipts”) which a member could anticipate (with financial
illustrations); the projected pre-tax internal rate of return inherent in the
licence and distribution arrangements; the terms of the partnership deed; and
the financial, legal and film risks to which investors might be subject.
109.The Proposal
explained that investors would make their investment by becoming members of an
Eclipse limited liability partnership for which they would be required to
contribute capital to the partnership. There was a minimum investment of
£400,000. There is no reference in the Proposal to any loan facility for
investors to enable them to borrow funds for their capital contributions.
110.On 13 March
2007 there was issued an “Addendum to Film Partnership Proposal” in respect of
investment in Eclipse 35. This modified the Proposal, as it related to Eclipse
35, in a number of respects, including the following:
(1)
The reference in the Proposal to the partnership entering into a joint
venturing arrangement was said to be incorrect: instead the partnership is said
to be entering into a licensing transaction as Disney’s licensee;
(2)
“Underdog” (but not “Enchanted”) is identified as a film which Disney
will licence to Eclipse 35;
(3)
The minimum investment by way of capital contributed is £700,000 per
Member;
(4)
There is a statement as to the possibility of Eclipse 35 receiving
Contingent Receipts, based on “advice from SCI, together with independent
valuations from Salter Group LLC”: in their opinion given on 22 February 2007
Salter Group expressed the view that if the Films performed in accordance with
their “best case” performance range, “a payment of [Contingent Receipts] is
possible”. There is reference to the provision in the Distribution Agreement
to the effect that the Distributor has no obligation to distribute any film
licensed to it, and if it does so, has no obligation to maximise revenues from
the films. This is described as protective language which is a standard
requirement of major US film studios included to minimise the risk of
litigation by contingent participants in their films;
(5)
There is a statement that Eclipse 35’s rights against Disney in the
event that Disney is in breach of any of its obligations under the transaction
documents are limited, but that on early termination the specified termination
amount should be payable by Disney (that amount being restricted to the balance
then secured under the Letter of Credit); and
(6)
There is passing reference to the loans which may be provided to Members
for the purpose of their subscribing capital to Eclipse 35.
111.Although the
Proposal makes limited reference to borrowing by members, it was a feature of
most, if not all, of the tranches of Eclipse transactions that facilities would
be available for members to borrow the greater part of the amount they required
to make capital contributions. In the promotional material the loan facilities
were described as “full-recourse” loans. In relation to Eclipse 35, such
facilities were made available by Eagle, on terms whereby the interest rate was
fixed for the term of the borrowing, and Members would pre-pay on financial
close of the transactions interest for the first ten years of borrowing. It
was not a requirement that a Member should borrow any part of the capital he
intended to contribute to Eclipse 35, nor that, if he decided to borrow, he
should borrow a specified amount (but the terms of the facility limited his
borrowing to 98 per cent of his capital contribution).
112.The
investment was marketed to potential Members on the basis that the Eagle
facility would be available to Members, and that if borrowings were made under
that facility (or any other borrowing arrangement a Member might enter into)
the interest paid would reduce the net profits received by a Member but, by
reason of the leveraging effect of the borrowing, increase the potential return
on the cash investment made by the Member (that is, the part made from his own
cash resources), especially if Contingent Receipts should become payable.
Financial illustrations given to potential investors assumed a borrowing by the
investor of 94 per cent of his capital contributed. The internal rate of
return implicit in the financial basis of the transactions (disregarding the
prospect of Contingent Receipts) was considered by Future to render the
investment attractive to Members who did not wish to borrow part of the capital
they intended to contribute.
113.Investors in
search of tax relief comprised a particular “market” for the Eclipse 35
structure, including individuals who had invested in previous years in other
film financings promoted by Future, and whose investments were by this time
yielding taxable profits for which they were seeking tax shelter. Certain
restrictions on tax relief introduced in the Budget in March 2007 caused Future
to make changes to the Eclipse structure used in previous tranches, and in
particular resulted in the arrangements whereby Members drawing on the
borrowing facility were required to prepay interest for the first ten years.
Members entered into such arrangements with the intention of claiming tax
relief for the interest so prepaid in the tax year in which it was so paid. To
the extent that such relief can be set against taxable interest in that tax
year Members will enjoy a cash flow benefit which will be partially reversed
over the twenty-year lifetime of the investment as they receive taxable income
comprising the profits earned by Eclipse 35 (that is, the fixed royalties under
the Distribution Agreement together with Contingent Receipts, if any) – (see
paragraphs 197 to 199 below for the detail).
114.The promotion
of Eclipse 35 was very successful. 289 investors became Members on 3 April
2007, subscribing in total £840 million. All investors availed themselves of
the Eagle facility, each borrowing 94 per cent of his capital contributed to
Eclipse 35 (so that approximately £50 million was contributed by Members from their
cash resources and £790 million from borrowings under the Eagle facility). The
success of the promotion is attributed to the following factors: the commercial
success by then apparent of the “Pirates of the Caribbean” films licensed in
previous Eclipse tranches; the attraction of Disney as the film studio
counterparty; and the “market appetite” for an investment which offered tax
relief at a time when other reliefs had been restricted by Budget changes.
The principal transaction documents
115.Eclipse 35
and the other parties to the transaction entered into the transaction documents
on 3 April 2007, following the successful raising of capital by Eclipse 35.
That was the date of what is described in the documents as “Financial Close”,
when, broadly, the immediate payment obligations in the transaction documents
were discharged. Certain of the transaction documents (including the Marketing
and Services Agency Agreement between Eclipse 35 and WDMSP Ltd and the Eagle
facility documents) were entered into in advance of 3 April 2007.
116.All of the
transaction documents are governed by English law.
117.The
transaction documents can be categorised into the licensing and distribution
documents (which deal with the grant of rights in the Films); the facility,
deposit and security documents (which deal with the borrowings by members and
the defeasance and security arrangements); and the marketing services
documents. The following is a summary of the key provisions in the principal
transaction documents.
The licensing and distribution documents
118.Eclipse 35
and Disney entered into the Licensing Agreement on 3 April 2007. It runs to 98
pages, including the detailed technical specifications relating to the Films.
It recites that Eclipse 35 is concurrently entering into the Distribution
Agreement, and that it has entered into the Marketing Services Agreement. It
also recites that Disney and Eclipse 35 “are entering into this Agreement for
the purposes of [Disney] licensing the Rights to [Eclipse 35] and providing for
the terms on which [Eclipse 35] shall exploit the Rights”.
119.Clause 2
comprises the grant of the licence of the Rights (“the Licence”):
(1)
The Rights are the “distribution and/or exploitation rights in the media
and in the Territory in respect of each of the [Films]” as set out in an
Exhibit to the Licensing Agreement. In relation to each of the Films the
specified media comprise “theatrical rights” (defined to include not just
exhibition in cinemas, but also sound recording, merchandising and video game
manufacture and distribution); “television rights”; and “video rights” (to
include video cassettes and video discs and other electronic and digital
formats including those transmitted on the Internet).
(2)
The “Territories” comprise all the countries of the world.
(3)
The grant of the Licence is in these terms: “[Disney] exclusively
licenses subject to and only with effect from Financial Close the Rights free
of all charges…to [Eclipse 35], its successors and assigns, throughout the
Territory for the Term”. The Term is the period of twenty years from Financial
Close.
(4)
The grant is expressed to operate “only as a terminable licence of the
Rights pursuant to and in accordance with the express terms of this Agreement”,
and that no grant of any other interest in the Rights is made.
(5)
The grant of the Licence is “expressly subject to the Prior
Agreements”. The “Prior Agreements” are specified licence agreements between
Disney and its principal group distribution companies, dating from 1990 (and
amended in the period up to August 2005), “and any and all other licences or
other agreements between [Disney] and any one or more of its Affiliates
relating in whole or in part to the [Films] and/or any of the Rights existing
as at the date of Financial Close”.
(6)
Certain intellectual property and similar rights in or relating to the
Films are excluded from the grant, except to the extent necessary to exploit
the Rights.
(7)
The grant confers on Eclipse 35 the right to exploit and sub-licence the
Rights, but only by entering into the Distribution Agreement, and Eclipse 35
agrees to enter into the Distribution Agreement concurrently with the Licensing
Agreement. The rights licensed to Eclipse 35 by the Licence Agreement are
personal to Eclipse 35 and cannot be assigned or sub-licensed except by
entering into the Distribution Agreement
120.By Clause 3,
the Licence takes effect upon the Letter of Credit becoming unconditional,
whereupon Eclipse 35 is required to pay Disney “the Advance” on account of the
“Licence Fees” payable during the Term of the Licence. If the Letter of Credit
has not become unconditional on or before 5 April 2007, the Licence Agreement
is then terminated.
121.The
remuneration which Eclipse 35 is required to pay for the Licence is specified
in Clause 4, and comprises the Licence Fees, being a fixed sum payable annually
(on account of which the Advance is made on Financial Close) and a variable sum
payable annually to the extent it accrues due in any year (“the Variable
Royalty”):
(1)
The Licence Fees are specified amounts payable on each anniversary of
Financial Close (3 April 2007) up to and including April 2027. In April 2008
the Licence Fee is £266,283, but in subsequent years the Licence Fee increases
year by year from £14,566,407 in April 2009 to £33,828,945 in April 2026. The
final Licence Fee payable in April 2027 is a “balloon” payment of £89,809,802.
The total of Licence Fees payable over the Term of the Licence is £502,929,537.
(2)
The Advance paid on account of Licence Fees payable over the Term of the
Licence was made by Eclipse 35 to Disney on Financial Close, and amounted to
£502,929,537. As a broad statement (the termination provisions in the Licence
Agreement are complex, and not directly material for the purposes of this
appeal), upon the early termination of the Licence Disney is liable to pay back
to Eclipse 35 the amount of the Advance less the aggregate of Licence Fees
payable in the period up to the termination date, and less the amount of the
Studio Benefit. However, that liability is discharged by the issue of the
Letter of Credit, so that Eclipse 35’s recourse is solely against Barclays
under the Letter of Credit, and the amount to which Eclipse 35 is entitled on
early termination cannot exceed the maximum amount which Eclipse 35 can claim
as at the termination date under the Letter of Credit.
(3)
The Variable Royalty in any year equals the amount of the “Variable
Distributions” (if any) to which Eclipse 35 is entitled from the Distributor
under the Distribution Agreement. (The mechanism for payment of the Variable
Royalty is that, under the security arrangements between Eclipse 35 and Disney,
Eclipse 35 irrevocably directs (i) the Distributor to pay the Variable
Distributions to WDMSP Ltd and (ii) WDMSP Ltd to pay the corresponding Variable
Royalties to Disney.)
122.By Clause 8
Disney provides physical delivery of the Films to Eclipse 35 by delivering the
specified prints, negatives and other technical representations of the Films to
a specified laboratory to be held for the account of the Distributor.
123.There is
provision as to the running length and rating of the Films, and provision for
Eclipse 35 to terminate the Licence Agreement, or accept a substituted film, if
either of the Films is not completed and released by a specified date. There
are extensive provisions dealing with protection of copyright and other
intellectual property rights, the preparation and use of foreign language
versions of the Films, and the rights of Eclipse 35 to publicise and promote
the Films.
124.The
provisions relating to termination provide for either party to terminate the
Licence Agreement on the occasion of specified default by the other (such as
material breach of a term of the Licence Agreement, or an event which could
result in insolvency). There is an automatic termination if the Distribution
Agreement is terminated. Eclipse 35 has the right to terminate the Licence
Agreement voluntarily at any time by notice.
125.Disney agrees
to provide to Eclipse 35 the marketing information and materials which Eclipse
35 agrees with WDMSP Ltd to provide to WDMSP Ltd in the Marketing Services
Agreement.
126.Clauses 17 to
22 comprise representations, warranties and indemnities given by each party to
the other. In addition to the usual warranties as to legal and financial
standing and proper compliance, the representations, warranties and indemnities
include the following:
(1)
Eclipse 35 warrants that it will have the financial resources required
to perform its obligations under the Licensing Agreement;
(2)
Eclipse 35 warrants that it is not a party to any agreement other than
the documents for this particular transaction, and that it has not taken any
action other than for the commercial purpose of acquiring and exploiting the
Rights and raising capital from the Members. It also covenants that it will
not, until the termination of the Licensing Agreement, conduct any business
other than by way of implementation of the transaction documents, unless it has
the prior written consent of Disney;
(3)
Disney warrants that the performance of the Licensing Agreement will not
violate any material agreement to which Disney is a party;
(4)
Disney warrants that (subject to the Prior Agreements), it holds or
controls all licences to the Rights and to the Films;
(5)
Both parties acknowledge that the Distributor will, under the
Distribution Agreement, exploit the Rights diligently in a manner consistent
with the Disney group’s prevailing and commercially reasonable practices;
(6)
Eclipse 35 acknowledges that Disney, WDMSP Ltd and other Disney parties
to the transaction documents are part of the Disney group, and may, in their
discretion, enter into arrangements with affiliated companies in connection
with the exploitation of the Rights and the Films;
(7)
Eclipse 35 acknowledges that no representation has been given by Disney
as to the likely financial or commercial performance of the Films, or as to the
likelihood of Eclipse 35 earning any Contingent Receipts;
(8)
Disney indemnifies Eclipse 35 and the Members against any third party
claims arising from any defect in the chain of title to each of the Films or
the Rights.
127.The parties agree
in Clause 37 that for the purposes of applying United States tax law and
financial reporting requirements, the transactions effected by the transaction
documents will be considered as a whole rather than only according to their
legal form, and “are to be treated solely as the purchase by [Eclipse 35] of
its right to participate in proceeds for an amount equal to the net financial
benefit of the transactions as of Financial Close to [the Disney group]”.
128.Eclipse 35
and the Distributor entered into the Distribution Agreement on 3 April 2007.
It runs to 128 pages, including the provisions for the calculation of any
entitlement to Contingent Rights and the detailed technical specifications
relating to the Films.
129.The
Distribution Agreement recites that Eclipse 35 is concurrently entering into
the Licensing Agreement and the Marketing Services Agreement, and that
“[Eclipse 35] and Distributor are entering into this Agreement for the purposes
of [Eclipse 35’s] licensing the Rights to Distributor and providing for the
terms on which Distributor shall exploit the Rights”.
130.By Clause 2
Eclipse 35, with effect from Financial Close, and subject to the Prior
Agreements, exclusively licenses the Rights to the Distributor throughout the
Territory (all the countries in the world) for the Term (twenty years from
Financial Close). The definition of “the Rights” accords with the definition
given to the same term in the Licensing Agreement.
131.The
Distributor agrees to perform all Eclipse 35’s obligations under the Licensing Agreement
to exploit the Rights, and Eclipse 35 agrees that:
“…pursuant to this Agreement [Eclipse 35]
exclusively and exhaustively licenses to Distributor … all of the rights in and
to each of the [Films] licensed to [Eclipse 35] pursuant to the Licensing
Agreement, and that [Eclipse 35] has reserved no such rights from the licence
granted to Distributor hereunder, and that accordingly during the Term [Eclipse
35] shall not be entitled to and shall not take any action with respect to any
of the rights or any of the [Films] except such actions as may be expressly
provided for pursuant to this Agreement.”
The Distributor is given the right to distribute,
advertise, publicise and exploit the Rights upon such terms as it alone sees
fit.
132.There are
provisions to terminate the Distribution Agreement if the Licensing Agreement
is terminated because the Letter of Credit does not go unconditional.
133.Clause 4
deals with the marketing and release plans provided for in the Marketing
Services Agreement: the Distributor agrees to undertake the detailed
implementation of such plans under the oversight of WDMSP Ltd. However,
Eclipse 35 agrees that the Distributor can modify such plans, or deviate from
them in order to exploit the Rights and the Films in compliance with the terms
of any relevant agreements between Disney group companies, or in circumstances
where Eclipse 35 has recognised that the Distributor has no obligation to
distribute the Films or to maximise the revenues from the Films.
134.By Clause 5,
the consideration given by the Distributor to Eclipse 35 for the sub-licence of
the Rights has, in each accounting period of a year, three elements: the Annual
Ordinary Distributions (“AODs”); the Variable Distributions; and Eclipse 35’s
40 per cent share of Contingent Receipts:
(1)
The Distributor is liable following each accounting period to pay the
AOD for that accounting period. As with the Licence Fees payable by Eclipse 35
under the Licensing Agreement, the AODs are specified amounts payable on each
anniversary of Financial Close (3 April 2007) up to and including April 2027.
In April 2008 the AOD is £2,520,316, but in subsequent years the AOD increases
year by year from £16,802,108 in April 2009 to £53,542,148 in April 2026. The
final AOD payable in April 2027 is a “balloon” payment of £349,842,695. The
total of AODs payable over the Term of the Distribution Agreement is
£1,021,873,047.
(2)
The issue of the Letter of Credit by Barclays satisfies all the
Distributor’s obligations to pay AODs, so that Eclipse 35 has recourse only to
the Letter of Credit.
(3)
Variable Distributions are payable annually in respect of each annual
accounting period during the Term. They are calculated, for each accounting
period, in US dollars by a complex formula by reference to different types of
revenues earned by the Films and royalty rates applied to certain of those
types of revenues, and from the resulting calculation the amount of the AOD for
the accounting period in question is deducted. For the years to the end of
March 2008 and 2009 respectively Variable Distributions of US$36.236 million
and US$47.4 million were paid, but no Variable Distributions have been paid in
subsequent years (because the amount of AODs in each of those years has
exceeded the amounts calculated by reference to the specified revenues from the
Films).
(4)
The amount of Variable Distributions received by Eclipse 35 is matched
by the amount of Variable Royalties paid by Eclipse 35 to Disney under the
Licensing Agreement. Eclipse 35 is required to appoint WDMSP Ltd as its
collecting agent to receive the Variable Distributions and to pay them (as
Variable Royalties) to Disney.
(5)
Eclipse 35 is entitled to its 40 per cent share of Contingent Receipts,
which is payable annually in respect of each annual accounting period during
the term. Contingent Receipts are calculated, for each accounting period, in
US dollars. The schedule to the Distribution Agreement setting out the formula
for definition and computation of Contingent Receipts extends to fifteen
closely-typed pages. In summary, there is deducted from the revenues earned
from the exploitation of the Films a series of detailed costs relating to the
production, marketing and distribution of the Films and profit or revenue
participations and similar contingent amounts paid to “talent”. The AODs
payable in each year are also deducted in the calculation of Contingent
Receipts.
(6)
The calculations relating to Variable Distributions and Contingent
Receipts for each annual accounting period are set out by the Distributor in an
annual statement produced for Eclipse 35. Eclipse 35 has the right to
challenge such annual statement and to have it audited.
(7)
The payment by the Distributor to Eclipse 35 of Variable Distributions
and Contingent Receipts is guaranteed by Disney under a separate deed of
guarantee entered into between Disney and Eclipse 35.
135.There are
provisions in the Distribution Agreement which directly correspond to
provisions in the Licensing Agreement, including provisions relating to
physical delivery of the Films; the release of the Films and the right to
substitute other films in the event of delay; foreign language versions of the
Films; and copyright and other intellectual property rights in the Films.
136.The
termination provisions in the Distribution Agreement largely correspond to
those in the Licensing Agreement. As well as each party having a right to
terminate on the occurrence of specified events of default, each party has a
right to voluntarily terminate the agreement upon notice. On termination of
the Distribution Agreement the Licensing Agreement is automatically terminated,
and all Rights in the Films revert to Disney. All sums due and owing by the
Distributor to Eclipse 35 at termination are payable (but not in respect of
AODs, since Eclipse 35’s recourse is to the Letter of Credit).
137.Each of
Eclipse 35 and the Distributor give warranties, representations and indemnities
which correspond to the commitments given by Eclipse 35 and Disney in the
Licensing Agreement. Eclipse 35 warrants that, subject to the Prior Agreements,
it holds licences to all such rights in the Films as it is licensing to the
Distributor, and that it has not taken any action other than for the commercial
purpose of acquiring and exploiting the Rights and related matters. Eclipse 35
acknowledges that the Distributor will exploit the Rights diligently in a
manner consistent with the Distributor’s and Disney’s prevailing and
commercially reasonable practices as applied to films owned by the Disney
group. Eclipse 35 also accepts that the Distributor may enter into
arrangements with other Disney group companies in relation to the distribution
of the Films without the Distributor first offering comparable arrangements to
third parties. Eclipse 35 also accepts that the Distributor may have certain
fiduciary and other duties to other Disney group companies in relation to the
Films and other Disney films which may compete or conflict with the
Distributor’s obligations to Eclipse 35, and that the Distributor may act in
the best interests of the Disney group which may not be in the best interests
of Eclipse 35 (and any such action by the Distributor will not be a breach of
any of the obligations owed by the Distributor to Eclipse 35 under the
Distribution Agreement).
138.There is a
clause, directly corresponding to the like clause in the Licensing Agreement,
dealing with the way in which the transactions are to be treated for the
purposes of United States tax law and financial reporting requirements.
The facility, deposit and security documents
139.The principal
facility, deposit and security documents comprise the Letter of Credit, the
Reimbursement Agreement, the Deposit Agreement and Deposit Charge, the Funding
Agreement, the Loan Facility Letter and the Financial Close Agreement.
140.The Letter of
Credit was issued by Barclays to Eclipse 35 on 3 April 2007. It was issued at
the request of Disney and the Distributor.
141.By the terms
of the Letter of Credit Eclipse 35 is entitled, on each “Annual Date” to make
an “Annual Drawing” of the “Annual Amount” for that Annual Date. The Annual
Amount fixed for each Annual Date corresponds exactly with the amount of the
AOD payable under the Distribution Agreement for the date in question. Eclipse
35 makes such an Annual Drawing by serving a “Demand Notice” on Barclays.
142.Eclipse 35 is
also entitled, on the “Termination Date” to make a “Termination Drawing” of the
“Termination Amount”. The Termination Date is the date on which the Licensing
Agreement terminates. The Termination Amount is calculated as the notional
balance as at the Termination Date on a deposit account where it is assumed
that £497 million has been deposited on 3 April 2007 at specified rates of
interest (fixed for successive five year periods) and from which Annual Amounts
have been withdrawn on each Annual Date (that is, a notional account which
corresponds to the actual deposit account at Barclays held by the Distributor –
see the Deposit Agreement and Deposit Charge below).
143.Eclipse 35
has the right to assign its entitlement under the Letter of Credit to any
person. (Eclipse 35 assigned its rights to Eagle as security for the facility
advances which Eagle made to the Members.)
144.The
Reimbursement Agreement is dated 3 April 2007 and the parties are the
Distributor and Barclays. It recites that the Distributor has entered into the
Reimbursement Agreement (and made the deposit in the deposit account with
Barclays which is the subject of the Deposit Agreement and Deposit Charge) to
induce Barclays to issue the Letter of Credit.
145.It provides
that if at any time Eclipse 35 demands payment of an Annual Amount or the
Termination Amount under the Letter of Credit, then the Distributor will pay
Barclays from the deposit account an amount equal to the amount demanded under
the Letter of Credit (such payment is by way of settlement of its
counter-indemnity obligations arising from Barclays issuing the Letter of
Credit).
146.The Deposit
Agreement and Deposit Charge is dated 3 April 2007 and is between the
Distributor and Barclays. It recites that the deposit made by the Distributor
with Barclays to which the agreement relates is made to induce Barclays to
issue the Letter of Credit.
147.The
Distributor agrees to open an account with Barclays and to deposit £497 million
in that account on 3 April 2007. The account is to earn interest at specified
rates (fixed for successive five year periods). On each occasion that Barclays
receives a demand from Eclipse 35 for payment of an Annual Amount or the
Termination Amount pursuant to the Letter of Credit (whereupon the Distributor
becomes liable to make payment to Barclays under the Reimbursement Agreement),
Barclays will release to the Distributor from the account an amount equal to
that Annual Amount on terms whereby the Distributor is required to instruct
Barclays to pay that amount to Eclipse 35 in settlement of Eclipse 35’s
entitlement to the Annual Amount in question. Barclays agrees to pay such
amounts without any set-off, deduction or counterclaim.
148.As security
for performance of these arrangements and of the Distributor’s obligations to
Barclays under the Reimbursement Agreement, the Distributor charges in favour
of Barclays its right, title and interest in and to the account and the deposit
in that account and agrees to hold such right, title and interest on trust for
application in accordance with the terms of the Deposit Agreement and Deposit
Charge and the Reimbursement Agreement. The security thus created is released
once the Distributor has no further obligations to Barclays and the Letter of
Credit has been discharged or has expired. Barclays is appointed as the
Distributor’s attorney for the purposes of operating the account whilst the
charge is in place.
149.Interest (at
the specified rates) is to accrue during each interest period of a year, and
accrued interest is to be credited to the account at the end of each interest
period. However, Barclays agreed that on 3 April 2007 it would credit the
account (so that it should form part of the deposit) with “interest equal to an
amount previously notified by [Barclays] to [the Distributor]”. Such amount is
referred to as “the Prepaid Interest Amount”, and is “credited on account of
the interest accruing on the [deposit]” for the first ten years of the
deposit. If the deposit arrangements are terminated prior to the expiry of
that ten year period (for example, if a Termination Amount is paid under the
Letter of Credit) an amount equal to the unearned portion of the Prepaid
Interest Amount is debited from the account and is paid to Barclays.
150.(It may be
noted here that the amount which Barclays credited to the account on 3 April
2007 as the Prepaid Interest Amount was £293 million, so that on that date the
total credit balance on the account was £790 million – equal to the amount
which Barclays advanced on that date to Eagle: see the Funding Agreement
below. That amount of £293 million exceeds the amount of prepaid interest
which Barclays would have been liable to pay on the deposit of £497 million had
it made a prepayment of interest for the first ten years of the deposit at the
interest rates fixed for that ten year period by the terms of the Deposit
Agreement and Deposit Charge.)
151.The Funding
Agreement is dated 3 April 2007 and the parties are Eagle (as borrower) and
Barclays (as lender). It recites that Eagle has entered into facility
agreements with the Members of Eclipse 35; that as security for the obligations
of the Members to Eagle, Eagle has taken an assignment of the Letter of Credit;
and that Barclays has agreed to make a loan facility to Eagle to enable Eagle
to make loans to the Members.
152.Barclays
agrees to make an advance to Eagle of an amount not exceeding the aggregate
amount to be advanced by Eagle to the Members. (The amount advanced was £790
million.) Interest is to accrue at the rate at which interest is payable on
the loans Eagle makes to Members, and is to be paid annually. However, Eagle
is, on the day the advance is made, to make a prepayment of interest for the
first ten years of the term of the advance. (The amount of interest prepaid
was £293 million, which is equal to the Prepaid Interest Amount which Barclays
credited to the Distributor’s deposit account with Barclays under the terms of
the Deposit Agreement and Deposit Charge.) If the advance is repaid in full
prior to the end of that ten year period, the unearned portion of the prepaid
interest will be refunded to Eagle by Barclays. Eagle is required to repay
Barclays the advance on terms which correspond to the repayments made by
Members of their advances from Eagle.
153.Both parties
have a reciprocal right of set-off in respect of amounts due and payable or
rights arising under the Funding Agreement or the Letter of Credit.
154.The Loan
Facility Letter is dated 30 March 2007 and is issued by Eagle to each Member
who decides to use the facility (all Members took that decision). It sets out
the terms on which Eagle is prepared to make an advance by way of loan to the
Member.
155.Eagle is
prepared to lend the Member not more than 98 per cent of his capital
subscription to Eclipse 35 as a member in that partnership. Certain conditions
precedent have to be satisfied before the advance can be drawn down, including
the provision of security for the advance (Eagle receiving a first fixed charge
from the Member of the Member’s share and interest in Eclipse 35; and a charge
over partnership assets of Eclipse 35 and an assignment by way of security from
Eclipse 35 to Eagle of the Letter of Credit and the entitlement of Eclipse 35
to AODs payable under the Distribution Agreement). It is also a condition
precedent that Eagle is satisfied that for its capital adequacy compliance
requirements “Eagle is entitled to accord to the exposure to the [Member] for
the [advance] a zero per cent risk weighting”.
156.Interest is
paid at a rate which is fixed for the first five years and for successive five
year periods. The fixed interest rates for each five year period are those
which apply to the deposit made by the Distributor to Barclays under the
Deposit Agreement and Deposit Charge. Interest is payable annually in
arrears. On the drawdown date the Member is required to pay Eagle prepaid
interest, being an amount on account of interest accruing on the advance for
the first ten years of the borrowing. If the advance is repaid in full prior
to the end of that ten year period, the unearned portion of the prepaid
interest will be refunded to the Member by Eagle.
157.The advance
is repayable in annual instalments as specified in a repayment schedule. The
Member undertakes that all AODs receivable by Eclipse 35 (or amounts due under
the Letter of Credit in place of AODs) are paid to a dedicated account from
which amounts will be applied in reduction of the advance. Upon certain events
(including the early termination of any of the transaction documents) there is
an acceleration of the repayment of the advance. Upon notice the Member can
prepay the advance in full, meeting any break costs incurred by Eagle.
158.There is a
declaration that Eagle has full recourse to the Member for repayment in full of
the advance, and nothing in the terms of the facility is to imply that Eagle
has recourse only to the AODs or the amounts due under the Letter of Credit, so
that the Member remains liable to Eagle for any amount of the advance which is
not discharged out of AODs or from amounts due under the Letter of Credit.
159.On 3 April 2007
the Members drew down under the facility in aggregate £790 million, and made
prepayments of interest totalling £293 million.
160.The Financial
Close Agreement is dated 3 April 2007 and is between Disney and Future. Disney
agrees to procure the issue of the Letter of Credit and to enter into those
transaction documents to which it is a party, provided that all “Letter of
Credit Conditions” are satisfied. The date on which the Letter of Credit
Conditions are satisfied is “Financial Close”.
161.The Letter of
Credit Conditions include: the receipt by Disney of the Studio Benefit from
Eclipse 35 (the Studio Benefit is an amount equal to 1.15 per cent of the
Advance payable by Eclipse 35 to Disney under the Licensing Agreement); the
offer of the Letter of Credit on terms which are acceptable to Disney; and the
due execution of all relevant transaction documents and documents relating to
the formation and capitalisation of Eclipse 35 and those documents being or
becoming unconditional.
162.Financial
Close occurred on 3 April 2007.
The marketing services documents
163.The principal
marketing services documents comprise the Marketing Services Agreement, the
Buena Vista Services Agreement, the SCI Services Agreement and the SFC
Consultancy Agreement.
164.The Marketing
Services Agreement is dated 9 February 2007 and the parties are Eclipse 35 and
WDMSP Ltd. It recites that Eclipse 35 is engaging in the trade of acquiring
and exploiting rights in films and that Future has recommended that Eclipse 35
should appoint WDMSP Ltd as its exclusive agent to provide the defined services
in order to assist Eclipse 35 in engaging in its trade.
165.By Clause 1
Eclipse 35 irrevocably appoints WDMSP Ltd to be its exclusive agent to provide
“the Services”. The appointment is to continue until the Licensing Agreement
is terminated, and Eclipse 35 agrees not to terminate the appointment of WDMSP
Ltd or direct how WDMSP Ltd is to perform the Services other than as provided
in the Marketing Services Agreement. There are provisions for early
termination by one party in the event of material breach or insolvency on the
part of the other.
166.The Services
are set out in Schedule 1 to the Marketing Services Agreement to include
“providing marketing and licensing personnel, equipment, perquisites,
locations, facilities and any other related marketing and licensing services or
elements which [Eclipse 35] may request from time to time” in relation to
theatrical release, home video and television, and to include providing
specified information and documentation on a regular basis. Specified matters
include “media planning”, “release planning”, “scheduling of key dates”,
“creation of key artwork”, “competitive analysis”. For each type of
distribution (theatrical release, home video and television) there is an
extensive and detailed list of matters on which information is to be provided
to Eclipse 35.
167.WDMSP Ltd’s
duties are set out in Clause 2. Those duties include the following matters:
(1)
To perform the Services “with due care and diligence in a manner
consistent with [the Distributor’s] and [Disney’s] then prevailing and
commercially reasonable practices” relating to the exploitation of films in the
territories in which the Films may be exploited, and it agrees that the
marketing and release plans prepared by WDMSP Ltd will be consistent with the
Distributor’s and Disney’s overall strategy for the exploitation of the Films
and other films which they may distribute.
(2)
To procure the provision of services by “the Designees” in accordance
with the terms of the Buena Vista Services Agreement and to secure the services
of Mr Salter/SFC by the SFC Consultancy Agreement.
(3)
To prepare “Marketing and Release Plans” in relation to the Films (being
“specific marketing plans prepared by or on behalf of [WDMSP Ltd] setting out
in summary terms the main aspects of a proposed marketing and exploitation
campaign for the Rights in the Territory”) for Eclipse 35’s approval; to
disclose such Plans to the Distributor; to oversee the conduct of the
Distributor in implementing the Plans; to prepare and provide to Eclipse 35 a
monthly report on the activities of the Distributor in implementing the Plans
and any deviation on the part of the Distributor from the Plans; and to hold
review meetings periodically with Eclipse 35’s management.
168.Eclipse 35
and WDMSP Ltd acknowledge that the Distributor has agreed in the Distribution
Agreement to exploit the Rights substantially in accordance with the parameters
set out in the Marketing and Release Plans, and WDMSP Ltd agrees to notify
Eclipse 35 if the Distributor materially deviates from the Plans to enable
Eclipse 35 to exercise its right to terminate the Distribution Agreement if it
wishes to do so.
169.Eclipse 35
and WDMSP Ltd acknowledge that WDMSP Ltd is a member of the Disney group and as
such may have obligations and duties to group companies in relation to the
Films which may compete or conflict with its obligations to Eclipse 35, in
which case WDMSP Ltd is entitled to act in the best interests of the Disney
group even if that is not in the best interests of Eclipse 35.
170.Eclipse 35
appoints WDMSP Ltd as its collection agent in respect of any Variable
Distributions due to Eclipse 35 under the Distribution Agreement, and directs
WDMSP Ltd to pay from such amounts the Variable Royalties due from Eclipse 35
to Disney under the Licensing Agreement.
171.Eclipse 35
agrees to pay WDMSP Ltd at Financial Close a fixed fee of £28,000 (to include
£3,000 as a contribution towards the cost of WDMSP Ltd engaging SCI under the
SCI Services Agreement and Mr Salter as a consultant under the SFC Consultancy
Agreement). In addition, if for any year Eclipse 35 is entitled to Contingent
Receipts, an additional fee equal to 2 per cent of Eclipse 35’s share of
Contingent Receipts will become payable. (It may be noted here that WDMSP Ltd
entered into similar agreements, with identical fee arrangements, with each of
the other Eclipse partnerships, so that the total fixed fees it earned by this
means exceeded £850,000.)
172.The Buena
Vista Services Agreement is dated 1 March 2007, and the parties are WDMSP Ltd,
Buena Vista Pictures Distribution, Buena Vista International, Inc, Buena Vista
Home Entertainment, Inc, and Buena Vista Television. The four Buena Vista companies (all of which are members of the Disney group involved with film
distribution and exploitation) are together referred to as the “Designee
Provider”. The agreement recites that WDMSP Ltd has been appointed the agent
of certain Eclipse partnerships (including Eclipse 35) under a marketing
services agency agreement to perform on their behalf certain promotion and
marketing activities in relation to the distribution of films; that the
companies comprising the Designee Provider are companies which promote, market,
sell and distribute films; and that the Designee Provider companies are willing
to make available certain of their employees to provide certain services to
WDMSP Ltd to enable it to perform the services it has agreed to provide to
those partnerships.
173.By Clause 2
the Designee Provider companies agree to make available to WDMSP Ltd “the
Designees” to perform “the Services” for WDMSP Ltd to enable WDMSP Ltd to carry
out its obligations under the respective marketing services agency agreements
with the Eclipse partnerships. The Designees are to be made available on a
non-exclusive basis, and are to devote such time as is reasonably necessary to
the provision of the Services.
174.The Designees
are listed by name and job title. There are 23 of them, and they hold senior
marketing, publicity and distribution positions in the relevant Buena Vista companies. There is provision to substitute other persons of sufficient
experience and status should any change be necessary to the Designees. The
Designee Provider companies undertake that the Designees have sufficient skill
and expertise to be able to perform the Services efficiently and competently.
175.The Services
which the Designees are to provide are set out in a schedule to the agreement,
and are identical to the services which WDMSP Ltd agrees to provide to Eclipse
35 under the Marketing Services Agreement.
176.The agreement
is for a term beginning on 1 March 2007 and ending eighteen months after the
first theatrical release of the last of the films to be released in any
territory.
177.WDMSP Ltd
pays a fee to the Designee Provider of £45,000 less an amount equal to a
quarter of certain of WDMSP Ltd’s costs.
178.The SCI
Services Agreement is also dated 1 March 2007. It is between WDMSP Ltd, the Buena Vista companies which are the Designee Provider, and SCI. It recites that the
Designee Provider has agreed to make available the services of the Designees to
WDMSP Ltd, and that SCI is willing to assist the Designees in their performance
of those services.
179.SCI agrees to
assist the Designees by acting as a liaison between them and “the Consultant”
(Mr Salter) and by assisting the Designees in preparing and providing to
Eclipse 35 and the other partnerships the reports which WDMSP Ltd is to provide
under the Marketing Services Agreement. For these services WDMSP Ltd pays SCI
a fee of £3,000 for each Eclipse partnership which is a party to the marketing
services arrangements.
180.The SFC
Consultancy Agreement originates from a consultancy agreement between WDMSP Ltd
and Mr Salter dated 23 March 2006 which was novated to Salter Film Consultants
Limited on 12 March 2007 and further amended on that date. It relates to all
the Eclipse partnerships, including Eclipse 35. It recites that WDMSP Ltd has
been engaged by the partnerships to provide marketing services; that WDMSP Ltd
has entered into the Buena Vista Services Agreement (or a previous form of it)
so that WDMSP Ltd has the services of the Designees to assist it in performing
those marketing services; and that WDMSP Ltd wishes to engage Salter Film
Consultants Limited (as “Consultant”) to oversee and facilitate the performance
of the Designees.
181.The agreement
is for a term expiring on 12 March 2009. The Consultant agrees to provide to
WDMSP Ltd “the Services”, which are itemised in 12 numbered paragraphs in a
schedule to the agreement. The Services include liaising with the Designees
and SCI in relation to the preparation of Marketing and Release Plans and the
other services which WDMSP Ltd has agreed to perform for Eclipse 35; assembling
the work product of the Designees and SCI in connection with the preparation of
the Marketing and Release Plans and ensuring that such Plans are in a form to
be presented to WDMSP Ltd for consideration; if WDMSP Ltd approves the
Marketing and Release Plans, presenting the approved Plans to Eclipse 35,
Disney and the Distributor; from the information supplied by WDMSP Ltd, the
Designees and SCI, tracking the performance of the Distributor in following the
Marketing and Release Plans, including identifying whether the Distributor
deviates materially from such Plans; reporting to WDMSP Ltd on the performance
of the Films (as informed by the Distributor); and generally providing written
reports to WDMSP Ltd on matters relevant to the services WDMSP Ltd is to
perform for the Eclipse partnerships.
182.The
Consultant agrees to work not less than three days per week for the first six
months of the term of the agreement and thereafter such hours as may be agreed
according to the reasonable requirements of WDMSP Ltd. The Consultant agrees
to provide the Services in an expert and diligent manner and to the best of his
ability and his commercial, technical and creative skills and in the best
interests of WDMSP Ltd. The Consultant is to be remunerated at the rate of
£700 per eight-hour day.
The financial terms of the transactions and the underlying cash flows
183.It is
necessary to examine in more detail the financial terms of the transactions
which Eclipse 35 and the other parties in the structure entered into and the
underlying cash flows which result from those financial terms in the period
during which Eclipse 35 has a licence of the Rights in the Films. Much of the
evidence of Mr Stanton related to such matters, and the essence of the case
presented by the Commissioners is that the transactions were no more than a
means to create a flow of funds with the ultimate purpose and result of giving
the Members an interest charge for which they could claim tax relief.
The movements of cash on Financial Close
184.As mentioned,
the principal transaction documents took effect on what is referred to in those
documents as Financial Close, as provided in the Financial Close Agreement – it
is the moment at which a number of conditions precedent (mostly relating to the
issue of the Letter of Credit) are satisfied, in effect when all the documents
and the transactions they comprise become unconditional. Financial Close
occurred on 3 April 2007. That date is, significantly, shortly before the end
of a tax year, and that factor was clearly recognised since some or all of the
arrangements put in place were to fall away if Financial Close were delayed
beyond 5 April 2007. The significance would appear to be that there is an
“efficiency” in the Members paying the prepaid interest just prior to the end
of the tax year for which they will claim tax relief for such interest so paid.
185.On Financial
Close all the licensing, banking and security transactions and arrangements
took effect, and funds moved accordingly. The flow of funds on that date was
as follows (all amounts are rounded to the nearest £1 million):
(1)
Barclays paid Eagle £790 million by way of loan under the Funding
Agreement;
(2)
Eagle paid the Members in aggregate £790 million by way of loan under
the Loan Facility Letters;
(3)
The Members paid Eclipse 35 in aggregate £840 million by way of capital
contributed to Eclipse 35 (using the borrowings from Eagle of £790 million and
£50 million from their own cash resources);
(4)
Eclipse 35 paid:
(a)
£503 million to Disney by way of the Advance (the sum paid on account of
the Licence Fees) due under the Licensing Agreement;
(b)
£44 million to Future by way of its fee due under the Partnership
Consultancy Agreement;
(c)
£293 million in aggregate to the Members as loans against future income
profits, pursuant to the Partnership Agreement;
(5)
The Members paid Eagle in aggregate £293 million by way of a prepayment
of interest under their respective Loan Facility Letters;
(6)
Eagle paid Barclays £293 million by way of a prepayment of interest
under the Funding Agreement;
(7)
The Distributor paid Barclays £497 million by way of deposit under the
Deposit Agreement and Deposit Charge to induce Barclays to issue the Letter of
Credit, and out of which Barclays is reimbursed for the payments it makes to
Eclipse 35 under the Letter of Credit in place of the AODs; and
(8)
Barclays paid the Distributor £293 million (being the Prepaid Interest
Amount, expressed to be on account of the interest accruing on the deposit made
in the deposit account which the Distributor holds with Barclays under the
Deposit Agreement and Deposit Charge, and credited to that account).
186.Disregarding
for the moment the different contractual and legal bases under which these cash
payments were made, and having regard only to the movement of cash, it will be
seen that, in net terms, on 3 April 2007 the sum of £497 million was circulated
around the parties (assuming that within the Disney group there was some
accommodation between Disney and the Distributor), and that £50 million was
introduced by the Members, and £44 million paid out to Future and £6 million
paid out to Disney (the difference between the £503 million Advance and the
deposit of £497 million made by the Distributor with Barclays). The £6 million
is the Studio Benefit.
The accounting profits of Eclipse 35
187.The accounts
of Eclipse 35, and the treatment in those accounts of the transactions to which
it is a party, are relatively straightforward.
188.Eclipse 35
brings into account each year as turnover the amounts to which it is entitled
under the Distribution Agreement for that year, being the AOD for that year
(that amount is fixed – see paragraph 134(1) above); any Variable Distributions
for that year; and any Contingent Receipts earned for that year. It shows as a
cost of sales for that year the amounts due under the Licensing Agreement for
that year, being the amount of the Licence Fee for that year (that amount also
is fixed – see paragraph 121(1) above); and any Variable Royalties for that
year. This results in the gross profit, from which is deducted administrative
expenses in order to arrive at a profit (or loss).
189.For any year
the amount of any Variable Distributions received is exactly matched by the
amount of any Variable Royalties payable.
190.The Advance
paid in respect of the Licence Fees is disregarded in accounting terms, since
it is refundable to Eclipse 35 on early termination of the Licensing Agreement
to the extent of any Licence Fees due after termination.
191.The
administrative expenses very largely comprise the amortised fee of £44.6
million paid by Eclipse 35 to Future on Financial Close under the Partnership
Consultancy Agreement. This fee is amortised on a straight line basis so as to
accrue evenly over the twenty year term of the licensing and distribution
arrangement.
192.No accrual is
made for any amount of Contingent Receipts until (presumably) such time as any
such amount is shown to have become payable.
193.The audited
financial statements of Eclipse 35 for the period ended 5 April 2008 show a
turnover of £20,638,455 (comprising the AOD for that year of £2,520,316 and the
Variable Distributions for that year of £18,118,129); cost of sales of £18,385,822
(comprising the Licence Fee for that year of £266,283 and the Variable
Royalties of £18,118,129); a resulting gross profit of £2,252,623;
administrative expenses of £2,247,179; and a resulting profit of £5,444.
194.The audited
financial statements of Eclipse 35 for the period ended 5 April 2009 show a
turnover of £48,802,919; cost of sales of £46,568,566; a resulting gross profit
of £2,234,353; administrative expenses of £2,228,861; and a resulting profit of
£5,492.
195.The audited
financial statements of Eclipse 35 for the period ended 5 April 2010 show a
turnover of £17,558,203; cost of sales of £15,302,536; a resulting gross profit
of £2,255,667; administrative expenses of £2,228,857; and a resulting profit of
£26,810. (No Variable Distributions – and hence no Variable Royalties – were
paid in the year ended 5 April 2010, hence the reduced turnover and cost of
sales.)
196.Since for
each year of the twenty year term of the licensing and distribution arrangement
the Licence Fee, the AOD and the (amortised) consultancy fee paid to Future are
fixed amounts, and since the Variable Distributions (if any) which are received
are exactly matched by the Variable Royalties which will then be paid, it is
possible to predict the minimum profits which will accrue to Eclipse 35 in each
year – that is, the profits without regard to any Contingent Receipts which
might become payable. Such an exercise gives the following results:
(1)
In each of years 1 to 10 Eclipse 35 will make a minimal profit (of the
order appearing in its audited financial statements for the years ended 5 April
2008, 5 April 2009 and 5 April 2010);
(2)
In each of years 11 to 19 Eclipse 35 makes a substantial profit (of
approximately £30 million in year 11 declining to approximately £17.5 million
in year 19);
(3)
In year 20 Eclipse 35 makes a profit of approximately £257.8 million (as
a result of the “balloon” AOD and Licence Fee in that final year);
(4)
Over the twenty year term Eclipse 35 makes an aggregate profit of
approximately £474.4 million.
Any Contingent Receipts received would, pro tanto,
increase such profit.
Interest payments and capital repayments made by Members and the
relationship to Eclipse 35’s profits
197.The amount of
interest paid by Members (in aggregate) on the advance from Eagle over the
twenty year term is fixed, and, in relation to the profits of Eclipse 35 (which
for tax purposes are attributed to the Members), shows the following:
(1)
£293 million of interest is paid on Financial Close, and Eclipse 35 has
no profit at that point (so that Members can claim relief for the full amount
of £293 million);
(2)
In each of years 1 to 10 no interest is paid, and in those years no
significant profit is made by Eclipse 35 (so that Members are taxable only on
the minimal profit made by Eclipse 35 in each of those years);
(3)
In each of years 11 to 19 the amount of interest paid equals, or nearly
equals, the amount of profit made by Eclipse 35 in the corresponding year (that
is, interest of £30 million in year 11 declining to interest of £17.5 million
in year 19) (so that Members can claim relief for the interest paid against the
equal amount of profits of Eclipse 35 attributed to them for tax purposes);
(4)
In year 20 the amount of interest paid is £16 million and in that year
Eclipse 35 makes a profit of £257.8 million (so that, after relief for such
interest, Members are taxable on £241.8 million of the profits of Eclipse 35
attributed to them in that year); and
(5)
Over the twenty year term a total amount of £524.7 million is paid by
Members by way of interest. When netted against the profits (disregarding the
possibility of Contingent Receipts) over that period made by Eclipse 35 (£474.4
million), there is an excess of interest of £50.3 million.
198.The following
points may be noted by way of comment on these figures:
(1)
The excess amount of interest of £50.3 million equates to the
aggregate of the amounts paid to Disney by way of Studio Benefit and to Future
by way of consultancy fee (so that if those amounts were not taken into account
in reducing the profits of Eclipse 35, those profits in aggregate would equal
the amount in aggregate of interest paid). The excess amount of interest can
be regarded as funded by the capital contributed by Members from their own
resources;
(2)
In determining the net of tax position of the Members it is too simplistic
to look only at interest paid and Eclipse 35 profits received: a full cash flow
statement, akin to that commonly prepared for a finance leasing transaction,
would take account of a notional (and taxable) return earned from the
re-invested benefit of the tax relief claimed by Members (particularly with
respect to the tax relief arising from the prepaid interest); and
(3)
Any amounts which might be received by way of Contingent Receipts would,
as mentioned, directly increase the profits of Eclipse 35 and in consequence
reduce or eliminate the excess amount of interest over profits in the hands of
Members.
199.Under the
terms of the Loan Facility Letter each Member is required to repay the sum
advanced to him by Eagle in accordance with a schedule of annual repayment
amounts. Disregarding the prepayment of interest at Financial Close, the
amount paid by the Members (in aggregate) in each year (capital repayment and –
from year 11 – interest together) matches the AOD receivable by Eclipse 35 for
that year. Eclipse 35 assigned, by way of security for the advances made by
Eagle, the right to the AODs. In this manner the Members were assured that, in
cash terms, and assuming no default, all payments of interest and repayments of
capital would be made to Eagle, and the profile of AOD payments over the twenty
year term was fixed to give this result.
The significance and consequences of the prepayment of interest by Members
200.The earlier
Eclipse tranches do not feature a ten year prepayment of interest by the
members of the respective partnerships who borrowed to make their respective
capital contributions. Interest is paid as it accrues annually over the
lifetime of the transaction.
201.The cash flow
statements produced for those earlier Eclipse tranches show that in each year
(until matters are reversed by “balloon” payments in the final year) the net
profit of the relevant partnership (AOD less accrued licensing fee and
administrative costs) which then falls to be attributed to the individual
members is, for each such member's share, less than the interest paid by that
member. In this way, until matters are reversed in the final year, a member
has each year excess interest which he can use to shelter other income arising
in that year, such as lease rental income from other film investments which, in
tax terms, have become “positive” as earlier reliefs are reversed over the
lifetime of those investments.
202.In the case
of Eclipse 35, as already described, each Member prepaid interest (which was at
a fixed rate) for the first ten years of his borrowing. This was introduced as
a feature of the arrangements following a change in the rules for loss relief –
so-called “sideways loss relief”, available in the case of earlier Eclipse
tranches, was no longer available as from early March 2007. The intention was
that by making a prepayment of interest in this way each Member should be able
to claim tax relief for the amount of interest so prepaid.
203.The
prepayment of ten years’ interest had a consequence for the cash flow implicit
in the Eclipse 35 transaction. As mentioned above, the profile (that is, the
amount and timing) of AODs payable matches the interest and principal payable
by members in respect of their bank borrowings. This is the case in respect of
the earlier Eclipse tranches. The prepayment of ten years’ interest at
Financial Close on 3 April 2007 means that, as compared with the earlier
transactions where interest was paid annually, a reduced amount of AODs is
required – the AODs are not required to fund the payment of interest annually
over the first ten years of the lifetime of the transaction. In turn that
requires a reduced deposit from the Distributor to secure the Letter of Credit
which is, in effect, substituted for the AODs.
204.It is
reasonable to assume that the bank lending to the members (in each of the
Eclipse transactions) required, as a matter of security, that the amount of
AODs should correlate with the interest and principal payments to be made by
those members. In the case of Eclipse 35 and the loan to Members by Eagle it
is reasonable to assume that Eagle required either a prepayment of interest if
the amount of AODs were reduced or a greater amount of AODs should there be no
prepayment of interest.
205.The
restructuring of the interest payment arrangements in the Eclipse structure so
as to accommodate a prepayment of interest as embodied in the Eclipse 35
transaction had the benefit for the Disney group that reduced AODs were payable
(requiring a reduced deposit), although since the corresponding adjustment in the
cash flow was reduced Licence Fees (see below) there is no discernible net
benefit to the Disney group. The amount of the Studio Benefit is a percentage
of the Licence Fees. In the earlier Eclipse tranches that percentage was
0.9722 but it was increased to 1.15 in the case of the Eclipse 35 transaction.
The quantification of the Licence Fees
206.The Licence
Fees payable by Eclipse 35 under the Licensing Agreement (being the
consideration paid for the Rights) comprise the third fixed element in the
calculation of the profits of Eclipse 35 (the other two being the AODs and the
amortised consultancy fee).
207.The Licence
Fees total £503 million payable over twenty years, but settled by the Advance
of that amount paid on Financial Close. Thus there was no discount for early
payment by way of the Advance.
208.The
contention of the Commissioners is that the amount of the Licence Fees (and the
payment – or, rather, the accrual – profile of the Licence Fees) was determined
solely by an arithmetic exercise in order to give the pattern of profit in
Eclipse 35 which in turn correlated to the payment of interest by the Members
as described above.
209.Eclipse 35
argues that although the Licence Fees are a factor which have to be
accommodated within the financial basis underlying the transaction, the Licence
Fees also are justified commercially, comprising a proper reflection of the
value of the Rights licensed to Eclipse 35 by Disney. Eclipse 35 points to the
work undertaken by Mr Briggs and his colleagues at Salter Group, and the
evidence of Mr Molner (which we see no reason to question since it makes
commercial sense) is that Disney had an expressed and legitimate concern that
there should not be an implicit undervalue (as Disney would see it) of the
Rights since that could have an adverse consequence for the values which third
parties might attribute to the Disney portfolio of films (and in this
connection it has to be borne in mind that Disney had a concern about this
issue not just with the Rights in the Films in Eclipse 35’s transaction, but
with the films in the range of Eclipse transactions). The Eclipse Term Sheet
with Disney provides that each Eclipse partnership will seek a valuation of the
licensed rights based on independent advice.
210.The opinion
which Eclipse 35 sought from Salter Group related to the forecast of the likely
pattern of revenues (both as to amount and timing) earned by the Films. That
information could be applied, in the context of Eclipse 35’s transaction, for
at least three purposes: to enable a view to be formed as to the likelihood of
any Contingent Receipts being earned by Eclipse 35 (we deal with this in
paragraphs 223 to 228 below); to measure whether the amount of AODs broadly
corresponded to projected earnings from the Films; and to enable a valuation,
or range of valuations, to be attributed to the Rights.
211.Salter Group
is recognised as a leading practitioner in forecasting film and other media
revenues and in valuing film and other media rights. It was engaged by Eclipse
35 to develop aggregate cash receipt forecasts for the Films (from all forms of
exploitation) over the twenty year period of the Licensing Agreement on the
basis of a ten-year first cycle of exploitation and two five-year subsequent
cycles.
212.The approach
adopted by Salter Group in carrying out this task was, in concept at least,
fairly simple (and was individually applied for each of the Films). A set of
key assumptions was used as to the following matters: the content, genre,
target audience and casting of each Film; the production costs of each Film;
the likely cost of releasing each Film in the USA and in the rest of the
Territories in which it was to be distributed; and the likely domestic (that
is, USA) and international distribution strategies. From its extensive
database Salter Group identified what it considered to be a range of films
comparable to each Film, and then the financial performance (that is, gross
receipts – referred to in the business as “Ultimates”) of each Film was
forecast by reference to the key assumptions and the actual performance of the
comparable films.
213.Much of the
information comprising the key assumptions was provided by SCI which in turn
used information provided by Disney or assumptions made from negotiations with
Disney. Some information was publicly available.
214.The
identification of a list of comparable films was a joint exercise by Salter
Group and SCI. The list originally compiled in relation to “Enchanted” was
adjusted to include a wider range of films in the family/children genre of
films when initial calculations showed a range of Ultimates which Disney
indicated fell short of Disney’s internal forecasts. From the list of
comparable films, three groups were identified: those which had under-performed
as against expectation; those which had performed to expectation; and those
which had out-performed against expectation.
215.In their
opinion addressed to Future and dated 22 February 2007 (for Eclipse 35 it was
re-issued on or before 3 April 2007) Salter Group gave a range of Ultimates for
each Film – what it described as the Downside Case Scenario (based on the
under-performing comparable films); the Base Case Scenario (based on the
comparable films which had performed to expectation); and the Best Case
Scenario (based on the out-performing comparable films). In each Case the
Ultimates were itemised by reference to the distribution cycles Salter Group
had predicated, domestic and international distribution, and the different
types of release (cinema, home entertainment, etc). The forecasts were phased
by reference to the anticipated timing of receipts over those cycles (referred
to as “timed Ultimates”).
216.For
“Underdog” the forecast Ultimates provided by Salter Group were: US$293,375,000
Downside; US$391,806,000 Base Case; and US$540,390,000 Best Case.
217.For
“Enchanted” the forecast Ultimates provided by Salter Group were:
US$498,171,000 Downside; US$600,287,000 Base Case; and US$927,822,000 Best
Case.
218.To date
“Enchanted” has performed a little better than the phased Base Case forecast of
Ultimates provided by Salter Group. “Underdog” has performed significantly
below the phased Downside forecast.
219.The Ultimates
do not in themselves give a valuation of the Films (or, more strictly, the
Rights). They form the basis of a valuation, but to reach a net present-day
valuation in pounds sterling two further factors must be applied: a discounting
factor to take account of the time delay in the receipt over twenty years of
the revenues; and an exchange rate factor. As mentioned, Salter Group
provided, from their workings on the Ultimates, assumptions as to the forecast
timing of revenues to give the timed Ultimates to which a discount could be
applied.
220.Eclipse 35
was unable to produce in evidence a valuation of the Rights produced
contemporaneously with it entering into the transaction. Mr Molner’s evidence
was that SCI had carried out a valuation exercise (on the Base Case Ultimates)
using an exchange rate of US$1.62 to £1.00 (that being a ten-year average rate
in early 2007) and a range of discount rates from 2.5 per cent upwards. The
resulting sterling figures ranged from about £500 million to in excess of £600
million.
221.Mr Molner’s
further evidence, which we accept, was that the aggregate amount of the Licence
Fees to be paid under the Licensing Agreement was one of a range of matters for
commercial negotiation with Disney – in that process each party would have had
in its mind a sense of the range of likely valuations of the Rights to provide
some kind of benchmark for the negotiation, but agreement as to a precise
valuation was not an essential issue for either party in the context of
agreeing the overall commercial deal. Disney would, however, for the reasons
given, be cautious about agreeing to what it might see as an undervalue of the
Rights.
222.Therefore, whilst
we accept that the amount of the Licence Fees is, to a degree, fashioned by the
cash flow which underlies the transaction, it also represents the likely value
of the Rights licensed by Disney to Eclipse 35 or, at least, the value which
the parties agreed to place on those Rights in the context of the overall deal
which they struck after having regard to expert advice on the estimated
financial performance of the Films.
The Contingent Receipts
223.As described
(see paragraph 134 above), the Distribution Agreement gives Eclipse 35 a right
to 40 per cent of any Contingent Receipts earned by the Films (taken together)
– in essence a share in any “super profits” should the Films be very
successful. As indicated, the terms upon which Contingent Receipts are calculated
are a matter of great complexity in the Distribution Agreement. Eclipse 35 has
audit rights to ensure that those terms are complied with.
224.There were
detailed and lengthy negotiations between SCI (for Eclipse 35) and Disney as to
the exact terms of the Contingent Receipts. Contingent receipt definitions and
calculations are, for each film studio, a matter of standard form from which
the studio is most reluctant to depart (not least because they have been shaped
over the years in response to many disputes). The negotiations in the present
case covered matters of detail in relation to the types and percentages of
revenue to be included in the calculation, as well as the share to which
Eclipse 35 would be entitled (increased from the 34 per cent share agreed in
the earlier Eclipse transactions). It was a requirement of Disney that for the
purposes of calculating Contingent Receipts the two Films should be regarded as
one, that is, their financial performance “cross-collateralised”.
225.Eclipse 35
sought from Salter Group its opinion as to the likelihood of the Films earning
Contingent Receipts. This was principally required for the Addendum to Film
Partnership Proposal (effectively the prospectus prepared for potential
investors in Eclipse 35).
226.The scheme of
the calculation of the Contingent Receipts and the financial model which
produces that calculation is referred to in the film industry as a “waterfall”
(no doubt with imagery in mind of gross revenues gushing forth, cascading into
different channels, one of which is Contingent Receipts which it is hoped will
be more than a dry stream – it is in any event an engagingly picturesque term
for some 15 or so closely-typed pages of dense legal drafting). Salter Group
used the waterfall financial model (an Excel spreadsheet) produced by SCI from
the Contingent Receipts provisions negotiated for Eclipse 35 (the accuracy of
the waterfall was not assessed by Salter Group) and applied to it the Ultimates
as calculated by Salter Group for each of the three Cases it posited. Salter
Group expressed their opinion in these terms: “Based upon The Salter Group’s
understanding of the deal structure reflected in the Waterfall and upon the
projected performance of the Films as reflected in the Best Case Ultimates, The
Salter Group determined that a payment of [Contingent Receipts] is possible.”
227.If both
Films, over the twenty year licence period, respectively were to perform to the
Best Case envisaged by Salter Group, Eclipse 35 would receive over that period
Contingent Receipts of at least US$95 million. If “Enchanted” were to perform
to the Best Case and “Underdog” to the Base Case envisaged by Salter Group,
then Eclipse 35 would receive Contingent Receipts of between US$49 million and
US$59 million. “Underdog” alone would generate Contingent Receipts only if it
performed to Salter Group’s Best Case, and then the Contingent Receipts would
be between US$4 million and US$5 million (disregarding the performance of
“Enchanted”).
228.The
consequence of having the Films “cross-collateralised” is to reduce the
likelihood that Contingent Receipts would be payable – both Films have to
succeed. Unless both Films are equally successful, even if the Contingent
Receipts threshold is achieved, one Film will, by its relative underperformance,
reduce the Contingent Receipts which would otherwise be paid in respect of the
other Film on a “stand alone” basis.
The effect of the security arrangements and the
nature of the Members’ borrowings
229.There was a
dispute between the parties as to the effect of the security arrangements and
two related questions: first whether the advance made by Eagle to the Members
was on a full-recourse or a non-recourse (or limited recourse) basis; and
secondly, whether for the capital adequacy purposes of Barclays and its group
the advances made by Eagle were zero-risk weighted (that is, in short, fully
secured by cash collateral), and if so, whether that necessitated that the cash
simply moved in a circle. The Commissioners pursued these issues as part of
their case that no commercial risk was undertaken by Eclipse 35 or its Members
(or, indeed, for that matter, by Barclays/Eagle) with regard to the
transactions or the flow of cash pursuant to the transactions, which in their
view is a matter germane to the question of whether or not Eclipse 35 is
trading.
230.As we have
mentioned, the Loan Facility Letter in its terms states that Eagle has full
recourse to the borrowing Member in the event that it could not recover
repayment out of the AODs or the Letter of Credit (both of which were assigned
by Eclipse 35 to Eagle as security for the borrowing by Members). The
Commissioners, however, point to the Funding Agreement (by which Barclays funds
Eagle for its advances to Members) and the mutual right of set-off included in
its terms. This permits (but does not require) Eagle to set-off its debt due
to Barclays under the Funding Agreement against Barclays’ debt due to Eagle
under the (assigned) Letter of Credit. Thus if Barclays defaulted under the
Letter of Credit then Eagle could set-off its debt due to Barclays under the
Funding Agreement – Barclays would thereby be treated as having paid out under
the Letter of Credit (exercising its own right of set-off) and Eagle would then
have no recourse against the Members (and, indeed, no reason to recover from
them since its debt due to Barclays would have been discharged by operation of
the set-off). The Commissioners argue that the non-recourse nature of the
borrowing is a feature of the arrangements by which the Barclays group makes finance
in the transaction available without cost to its capital base, that is, on a
zero-risk weighted basis.
231.In reply
Eclipse 35 argues that the nature of the borrowing by the Members is irrelevant
to the question of whether Eclipse 35 is trading; that Eagle has a security
interest only in the Letter of Credit rather than a full beneficial interest,
so that its right of set-off in relation to its borrowing from Barclays is
thereby constrained; and that, under the Deposit Agreement and Deposit Charge
Barclays is prevented, by its agreement with the Distributor, from exercising
any set-off with regard to its obligations to pay sums due under the Letter of
Credit. Eclipse 35 also points to the testimony of Mr Levy to the effect that
legal advice was received by Future from Clifford Chance (the lawyers who had
acted for the Barclays group in relation to the documentation) that the loans
were full-recourse, and to the members in another Eclipse partnership
re-negotiating their loans (taken on similar terms), following the Lehman
Brothers bank failure, to provide that they were non-recourse to those members.
232.For the
reasons we give below, the exact nature of the borrowing by the Members is not
a matter which we consider is relevant to the issue we have to decide, nor, in
any event, is it a matter essential to the decision we have reached. We have,
however, concluded that Eagle could have recourse to the Members. That is the
express and unequivocal provision of the Loan Facility Letter. Any attempt by
the Members to argue that there is no personal recourse to them would be
confronted by their agreement to the contrary. The Commissioners offer an
ingenious argument, but it is by no means certain that in the event of the
insolvency of Barclays (at which point the nature of the liability of the
Members to Eagle would be tested) matters must unfold in the way they specify.
Eagle has a right to set-off amounts due under the Letter of Credit against
amounts it owes to Barclays under the Funding Agreement, but that right is not
automatic – Eagle could choose instead to recover any balance due from a
shortfall in payments under the Letter of Credit by proceeding against the
Members personally and it is not clear that the Members could in that case
compel Eagle to exercise any set-off entitlement it might have. In any event,
as Eclipse 35 points out, that right cannot be exercised whilst Eagle has
merely a security interest in the Letter of Credit, and (it would appear) it
would acquire a beneficial interest in the Letter of Credit only after it had
enforced the security, that is, after it had failed to recover from the Members
the payments due from them under the Repayment Schedule.
233.As to the
zero-risk weighting issue, the Commissioners point to the terms of the banking
and security documents and the resulting cash flows and also to the evidence of
Mr Stanton.
234.The starting
point, they argue, is that it is a condition precedent to the Loan Facility
Letter that Eagle is satisfied that for its capital adequacy compliance requirements
“Eagle is entitled to accord to the exposure to the [Member] for the [advance]
a zero per cent risk weighting”, so that it is to be presumed that the
arrangements entered into at Financial Close achieved that result.
235.In support of
this they rely on Mr Stanton’s view that it is necessary to judge whether such
risk weighting is achieved at the Barclays consolidated group level, and that
the inference from the documentation and cash flows is that it is, with the
deposit of £790 million (increased to that amount by the Prepaid Interest
Amount of £293 million paid by Barclays in respect of the deposit) held by
Barclays under the Deposit Agreement and Deposit Charge and charged as security
for the Letter of Credit ultimately providing what amounts to “ring-fenced”
cash collateral for the advances made by Eagle to the Members. The
Commissioners point out that, in addition to such charge, the Distributor, as
part of the security arrangements, agrees to hold its interest in the charged
deposit account on trust for the application of the security arrangements in
relation to the Letter of Credit, and that thereby Barclays has put in place
arrangements by which the sums held in that deposit account would be
unavailable to the creditors of Barclays should Barclays become insolvent.
This shows, the Commissioners argue, first that the Members are not even at
risk of Barclays default, and secondly that the monies deposited by the
Distributor will always be available to repay Eagle in full so that there is
zero-risk weighting for the Barclays group in relation to the loans to the
Members. The Commissioners argue that even though Eclipse 35 was not a party
to the funding and security arrangements, it was assured that they achieved
zero-risk weighting (and had an interest in that fact) by reason of the
condition precedent in the Loan Facility Agreement and the cost of the funds
advanced to Members (a higher risk weighting would have increased that cost).
236.Eclipse 35
accepts that the Members have an interest in the advances being zero-risk
weighted, but argues that the manner in which Barclays achieved that
(internally and in its dealings with the Disney group) is a matter of
commercial indifference to the Members and to Eclipse 35. It points to an
internal Barclays document relating to the funding (produced to the
Commissioners as a result of an information disclosure notice) which states
that zero-risk weighting will be achieved by Eagle taking a charge over a
Member’s interest as a member of Eclipse 35; by Eagle taking a charge over the
Letter of Credit and the AODs and the account into which amounts due under the
Letter of Credit (or the AODs) are paid; and by Eclipse 35’s irrevocable
instructions to Eagle to transfer sums received into that account in repayment
of the advance to the Member. It points out that no mention is made in that
document of the deposit account and security arrangements created by the
Deposit Agreement and Deposit Charge. It argues that the Commissioners have
misunderstood those deposit and security arrangements: first the deposit is
charged in favour of Barclays as security for the Letter of Credit, and
secondly since a deposit account is no more than a debt by the bank to repay
cash to the account holder, any trust over such an account cannot be a trust
over an amount of cash: if Barclays were to fail the cash deposited by the
Distributor would in no way be specially protected for the benefit of the
account holder or anyone having an interest in that account.
237.Eclipse 35
therefore rejects the Commissioners’ contention that the cash simply passes
round in a circle without consequence. The movement of cash should not be
regarded in isolation: the real issue is what rights and liabilities are
created by the transactions which result in cash moving between parties. The
Members are indebted to Eagle and have a personal liability if Barclays is
unable to make payments in full under the Letter of Credit. Despite the
security arrangements, should Barclays fail there is no “ring-fenced” cash
asset which is available to Eclipse 35 or the Members or which discharges their
debt to Eagle.
238.The
Commissioners ask us to find that the advances by Eagle to the Members were
zero-risk weighted for the capital adequacy purposes of the Barclays group. It
is a reasonable inference that this was so. It was a condition precedent to
the Loan Facility Letter that the advances should be so treated, and there is
no evidence that such condition was waived. That is persuasive. The internal
Barclays paper sets out the steps which the authors of that paper consider are
necessary to achieve zero-risk weighting (all of which steps were
implemented). (The Commissioners point out that this paper was prepared by the
tax group within the bank, and that there must be other internal documents
which demonstrate how cash was collateralised to achieve such weighting, but
that is speculation on the part of the Commissioners since Barclays has been
subject to a number of information disclosure notices served by the
Commissioners and there is no suggestion that Barclays has failed to comply
with those notices.) Mr Stanton, with his experience of structured finance
transactions, surmises that the lending was zero-risk weighted.
239.Whilst we can
make a reasonable inference that the advances were zero-risk weighted (at least
to the satisfaction of Eagle), what remains uncertain is how this was
achieved. The Commissioners say, with Mr Stanton’s support, that the steps
outlined in the Barclays paper would not achieve that end. But the Commissioners
did not persuade us, from the only other evidence available, namely the banking
and security documents, that it was achieved in any other way. We have already
concluded that Eagle has, ultimately, recourse against the Members, and we do
not accept that cash representing the deposit is in some way “ring-fenced” so
that it remains available to meet the Letter of Credit liabilities of Barclays
notwithstanding the insolvency of Barclays. On this matter we prefer the
construction of the security documents proposed by Eclipse 35 to that proposed
by the Commissioners.
240.The
discussion between the parties as to the recourse nature of the advances to the
Members and the risk weighting attributed to those advances is something of a
diversion (Eclipse 35 would say an irrelevance), or perhaps a means to an end.
The Commissioners wish to establish that the advances have these
characteristics (and, moreover, that zero-risk weighting was achieved in a
particular manner) in order to argue that cash moved around between the parties
without in reality creating any commercial risk. We do not agree with that
view. Eclipse 35 is right to point out that it is necessary to look to the
rights and liabilities created by the individual transactions under which the
cash payments were made.
241.Eclipse 35
was dependent upon Barclays meeting its liabilities under the Letter of Credit,
and the Members in consequence were so dependent. There was a cash deposit
with Barclays by way of a defeasance account enabling Barclays to meet those liabilities,
but neither Eclipse 35 nor the Members had any prior claim to that account or
to the balance on that account should Barclays be unable to meet its Letter of
Credit liabilities. In April 2007 the risk of Barclays defaulting may have
seemed remote almost beyond imagination, but subsequent events showed it to be
at least within contemplation. That, in our view, was the commercial risk
which Eclipse 35 and the Members undertook when they embarked upon the
transaction.
The marketing services arrangements
242.Eclipse 35
places reliance on the marketing services arrangements in its case that it is
carrying on a trade of exploiting film rights. Its case is not that it carried
on the marketing and distribution of the Films, but that, through the agency
and services of WDMSP Ltd, it supervised the Distributor’s marketing and
distribution of the Films, in that it prepared a marketing plan and monitored
the Distributor’s adherence to that plan.
243.The
Commissioners argue that Eclipse 35 had divested itself of the Rights in the
Films to the Distributor, and therefore had no standing to have any realistic
part in the exploitation of the Films, and that in any event the Films were
exploited by the “Disney distribution machine”, to which Eclipse 35 could
contribute nothing of value.
244.The
contractual arrangements through which Eclipse 35 supervised the marketing of
the Films are set out in paragraphs 163 to 182 above. In summary, Eclipse 35
engaged WDMSP Ltd to act as its agent and to provide specified services
relating to the marketing and release of the Films, such services to be
provided in accord with the Disney group’s practices in relation to film
distribution and exploitation. WDMSP Ltd agreed with the Buena Vista companies
(the Disney distribution companies) that they would provide to WDMSP Ltd the
services of certain personnel, and WDMSP Ltd also agreed to engage the services
of Mr Salter, who in turn would be supported by SCI.
245.The marketing
services arrangements were the subject of detailed negotiation between Mr
Molner of SCI (on behalf of the Eclipse partnerships) and the Disney group.
Disney were concerned that their distribution plans, and the execution of those
plans, would be subject to external scrutiny and review. There was also
concern about the duties which WDMSP Ltd owed to Eclipse 35 and possible
conflict with its position as a subsidiary of the Disney group, and a possible
conflict between Disney’s standard practices in relation to the marketing and
release of films and possible requirements of Eclipse 35.
246.WDMSP Ltd
prepared on Eclipse 35’s behalf an initial Marketing and Release Plan for each
of the Films. These were “master plans” setting out the marketing and
distribution strategies for the Films, covering all the territories, and the
range of media, in which the Films were to be exploited. They were primarily
prepared by SCI on WDMSP Ltd’s behalf using information supplied by the
Designees (the Buena Vista executives) and with input from Mr Salter. They are
extensive and detailed, running to approximately 50 pages for each Film. They
take account of the different attributes of, and expectations for, the
respective Films: for example, whereas it was expected that the “princess”
theme of “Enchanted” would have equal recognition in the United States market
and the international market (and hence would require a similar marketing
strategy in both markets), it was anticipated that “Underdog” would have little
recognition outside the United States, and so the plan provided initially for
strong marketing in the United States in the hope that success there would
provide a platform for marketing internationally.
247.The Disney
group had not previously prepared, prior to the release of a film, a
comprehensive marketing plan similar to the initial Marketing and Release Plans
created for the Films covering marketing in all media and across all
territories.
248.Once the
initial Marketing and Release Plans were agreed, the role of WDMSP Ltd was to
monitor the Distributor’s exploitation of the Films to check whether it was
proceeding in line with the Plans, and to question any variations proposed by
the Distributor to the strategy laid out in the Plans, or to suggest any
variations which it thought appropriate as matters unfolded following the
release of the Films.
249.Under the
arrangements put in place SCI obtained information on marketing plans and
matters from the Designees and used that information to assist Mr Salter in
preparing regular reports to Eclipse 35. On the basis of those reports Eclipse
35 then instructed WDMSP Ltd to carry out the marketing plan, with WDMSP Ltd in
turn instructing the Distributor (the Distributor having agreed in the
distribution Agreement to implement the plan, subject to certain limitations)
and subsequently monitoring implementation of the plan. Within these
arrangements Mr Salter was in regular contact with his former colleagues at
Buena Vista International (who acted for the Distributor in relation to the
exploitation of the Films in the international markets), enabling him to keep abreast
of the information available as to the performance of the Films and to discuss
the implications of such performance for the future release and marketing of
the Films. Mr Salter was most active in the weeks preceding the cinema release
of each Film (producing fortnightly reports in this period for Eclipse 35), and
then again in the period leading up to the DVD release of each Film (producing
reports every four weeks). Thereafter his role was largely receiving (through
SCI) information on the financial performance of the Films and their release
across the territories and reporting on that to Eclipse 35.
250.In view of
the expertise within the Disney group as to the marketing and distribution of
film rights there was little by way of intervention by WDMSP Ltd in the
marketing activities of the Distributor following the release of the Films. Mr
Salter made specific recommendations to Eclipse 35 (which in turn WDMSP Ltd
made to the Distributor) on one occasion and, less formally, expressed his
views to the Distributor on another occasion.
251.The first of
those occasions concerned “Underdog”. In August 2007 it became apparent that
the film was not achieving box office expectations, and the plan for an
international release had been predicated on success in the US domestic market. Mr Salter, in consultation with Buena Vista International executives,
considered whether a cinema release of the film internationally (a high cost
operation) should be abandoned or modified, and whether to do so risked
damaging the revenues from other media in those territories where there the
cinema release was abandoned or severely curtailed. WDMSP Ltd’s eventual
recommendation on Eclipse 35’s behalf to the Distributor was to revise the
release strategy by abandoning the cinema release in some European territories,
which is what the Distributor did.
252.The second of
those occasions was less significant, and concerned the cinema release of
“Enchanted” in France, where there was concern that the agreed Christmas date
for cinema release would coincide with a transport strike (such a strike could
have an adverse effect upon the impact of billboard advertising, the major form
of marketing the release of films in France). Mr Salter discussed the matter
with Buena Vista International, recommending that the release should go ahead
since otherwise major cinema chains in France, having been denied at short
notice the film for their Christmas season, might be reluctant to take it at
all at any other time. That recommendation accorded with the views of Buena
Vista International, and that is how the Distributor proceeded.
Further findings as to the transactions and the nature of Eclipse 35’s
activities
253.We turn now
to the further findings we make as to the nature of Eclipse 35’s activities and
the arrangements it entered into. Following the hearing we received very
extensive written submissions from both parties as to the findings we should
make and the conclusions we should reach in the light of the evidence before
us. As will appear, not all these issues are relevant to the conclusion we
have reached on the question of whether Eclipse 35 was carrying on a trade, but
in view of the submissions made and the cases put to us we set out our findings
on all these matters.
254.We look first
at the question of whether Eclipse 35 acquired any rights from Disney having
regard to the effect of the Licensing Agreement and the Distribution Agreement,
and if so, whether those rights had value and whether Eclipse 35 was engaged in
the distribution of those rights. We then look at the marketing services
arrangements to determine whether Eclipse 35 was engaged in the directing and
supervision of the marketing and release of the Films. Finally, and more
briefly, we look at the borrowing facility, deposit and security arrangements.
The acquisition of rights: the Licensing Agreement and the Distribution
Agreement
255.Eclipse 35’s
case is that, in entering into the Licensing Agreement, it acquired from Disney
the rights, for a term of twenty years, to distribute and exploit the Films
worldwide in a range of entertainment media. It argues that it paid
approximately £503 million for those rights, which accorded with their market
value, together with Variable Royalties (which provided Disney with a share of
the revenues from the Films based on their performance). It argues that it
then proceeded to distribute and exploit those rights by entering into the
Distribution Agreement with the Distributor, granting it a twenty year licence
requiring it to market and distribute the Films world wide. As consideration
it was entitled to receive AODs payable over the twenty year term and totalling
approximately £1,022 million, Variable Distributions (that is, an amount each
year calculated by reference to gross revenues, but only to the extent such
amount exceeded the AOD for that year) and the right to 40 per cent of any
Contingent Receipts. Amounts equal to the Variable Distributions received were
paid out as Variable Royalties.
256.The
Commissioners argue that a proper construction of the Licensing Agreement and
the Distribution Agreement shows that Eclipse 35 was not entitled to receive
any rights (or any meaningful rights), and that such rights as it acquired from
Disney were immediately returned to the Disney group. They argue, further, that
the nature and value of such rights were significantly depreciated by the Prior
Agreements, subject to which they were granted. Their case is that Disney, for
the receipt of the Studio Benefit, was prepared to enter into these
arrangements (and to surrender to Eclipse 35 a share of any Contingent
Receipts) in order to create the cash flows on 3 April 2007 which gave the
financial basis for the Members’ investment, but Disney did so on terms which
ensured it kept full control of the rights in the Films, which it proceeded to
exploit just as it would have done absent any involvement of Eclipse 35. They
argue that the amount paid by Eclipse 35 by way of Licence Fees was not related
to the value of any rights granted by Disney, but was calculated to deliver to
Disney the Studio Benefit of £6 million together with an amount placed in a
defeasance account to secure payment of specified amounts (equating to the
amount of AODs) under the Letter of Credit.
257.The arguments
before us on this issue were principally focused on four issues: the terms of
the Licensing Agreement and of the Distribution Agreement; the effect of the
Prior Agreements; the value and the valuation of the Rights; and the
significance of the Contingent Rights.
(a) The terms
of the Licensing Agreement and the Distribution Agreement
258.Eclipse 35’s
case is that the documentary and other evidence shows that the Rights it
acquired under licence were valuable rights which it then proceeded to
exploit. It points to the fact that the terms of the Licensing Agreement and
of the Distribution Agreement were the subject of extensive and detailed
negotiation between Disney and Future, and the resulting documents comprise a
commercial and detailed licence and sub-licence. A particular concern of
Disney was to secure their ability to recover the Rights in the event of the
insolvency of Eclipse 35, as reflected in the warranties required of Eclipse 35
and the termination provisions in the documents – Disney would not have been so
concerned had Eclipse 35 not had a real and valuable interest in the Films.
Furthermore, the very fact that the Disney group entered into the Distribution
Agreement, and agreed to pay Eclipse 35 the AODs, the Variable Distributions
and a share of the Contingent Rights, evidences the existence of the Rights
granted by the Licensing Agreement and their intrinsic value.
259.The
Commissioners point to the combined effect of the Licensing Agreement and the
Distribution Agreement, which are co-terminous. In their submission that
combined effect shows that Eclipse 35 has no rights as against Disney in
relation to the Films other than the speculative right to a share of Contingent
Receipts: Eclipse 35 acquired nothing of value and in consequence had nothing
capable of being exploited.
260.In support of
this submission the Commissioners note that in the Licensing Agreement Eclipse
35 undertakes to enter into the Distribution Agreement “concurrently with”
entering into the Licensing Agreement, and to grant an exclusive licence of the
Rights to the Distributor in the terms of the Distribution Agreement – to the
extent that Eclipse 35 acquired any rights under the Licensing Agreement it
simultaneously divested itself of them by entering into the Distribution
Agreement. Further, in the Distribution Agreement Eclipse 35 warrants that it
has reserved no rights from the licence granted to the Distributor, and that it
has no entitlement to take any action with respect to the Rights (including by
way of their exploitation) except to the extent provided for in the Distribution
Agreement. Although in the Licensing Agreement Eclipse 35 agrees to perform
all of Disney’s obligations arising in connection with the exploitation of the
Rights, those obligations are immediately assumed by the Distributor in the
Distribution Agreement, where the Distributor agrees to perform all of Eclipse
35’s obligations pursuant to the Licensing Agreement arising in connection with
the exploitation of the Rights (other than the payment by Eclipse 35 of the
Licence Fees and the Variable Royalties).
261.Other terms
in the detail of the Distribution Agreement support the view, according to the
Commissioners, that there was no substance to the Rights. They point out that
Eclipse 35 conferred on the Distributor the possession and custody of the
“Delivery Materials” representing the physical manifestation of the Films, and
that Eclipse 35 is not permitted to appear in the credits for the Films or to
use its name in any publicity for the Films. Further, although certain duties
are imposed on the Distributor to exploit the Rights with due care and
diligence in a manner consistent with the practices of the Disney group, those
duties are subject to the performance by the Distributor of any competing
obligations and duties it may have to other Disney group companies.
262.The
Commissioners also point to Clause 37 of the Licensing Agreement (and the
corresponding provision in the Distribution Agreement) which relates to the
treatment of the transactions for the purposes of United States tax and
financial reporting requirements: for such purposes the Disney group declares
that the transactions are “intended to be treated solely as the purchase by
[Eclipse 35] of its right to participate in proceeds for an amount equal to the
net financial benefit of the Transactions as of Financial Close to [the Disney
Group]”, notwithstanding the legal form of the transactions.
263.The
Commissioners also argue that no commercial significance can be attributed to
the payment by the Distributor of the Variable Distributions – because of the corresponding
obligation on Eclipse 35 to pay the Variable Royalties under the Licensing
Agreement, the result is no more than one Disney entity agreeing to pay a
performance-related sum to another Disney entity, that payment to be made
through the collection agency of another Disney entity, WDMSP Ltd.
(b) The Prior
Agreements
264.As we have
already noted, the Licensing Agreement provides that the grant of the Licence
is “expressly subject to the Prior Agreements”, and there is a corresponding
provision with regard to the grant of the sub-licence in the Distribution
Agreement. The “Prior Agreements” are specified licence agreements between
Disney and its principal group distribution companies (the Buena Vista
companies), dating from 1990 (and amended in the period up to August 2005),
“and any and all other licences or other agreements between [Disney] and any
one or more of its Affiliates relating in whole or in part to the [Films]
and/or any of the Rights existing as at the date of Financial Close”.
265.We have also
referred above (paragraphs 50 to 54) to Mr Molner’s evidence with regard to his
enquiries of Disney as to the significance of the Prior Agreements (and whether
he could have sight of them) and his own understanding of their purpose and
effect. Certain inconsistencies in his evidence on these matters revealed in
cross-examination resulted in his producing a third witness statement in the
course of the hearing to clarify his evidence.
266.The
significance in this case of the Prior Agreements is this: the Commissioners
argue that they possibly grant valuable distribution rights within the Disney
group, and if so the Rights granted by the Licensing Agreement, being expressly
subject to the Prior Agreements, are thereby very significantly depreciated in
their value. At the very least by entering into the Licensing Agreement
without knowing what was the effect of the Prior Agreements, Eclipse 35 clearly
had little regard for the integrity of the arrangements as a genuine commercial
transaction.
267.Eclipse 35
argues that it did, through Mr Molner (during negotiation of the first tranche
of Eclipse transactions), raise the question of the effect of the Prior
Agreements and asked to see them, but this was refused. This was not (based on
his own experience at Paramount and in negotiating with other film studios) a
surprise to Mr Molner since he understood them to deal with confidential
matters. Mr Molner’s evidence is that Disney’s legal team gave oral
confirmation that the Prior Agreements did not convey any rights – they were
not prepared to disclose them (having regard to their confidential nature)
because they were commercially irrelevant, rather than because they reserved
out of the Rights a significant benefit for Disney which Disney wished to hide
from Eclipse 35. In these circumstances Mr Molner concluded that in all
likelihood the Prior Agreements comprised “master agreements” providing for
royalty rates between Disney group companies in the event that distribution
rights to individual films were transferred within the group – this provided a
means of establishing transfer-pricing values for financial reporting and
cross-border tax purposes and for the internal allocation of profit between
different parts of the Disney group.
268.Further, if
the Prior Agreements comprise a network of distribution arrangements within the
Disney group, that, Eclipse 35 says, is to Eclipse 35’s benefit and enhances
the value of the Rights: Eclipse 35 exploited the Rights by sub-licensing them
to the Distributor because it knew that the Disney group had unrivalled
distribution expertise and an unrivalled distribution network of which Eclipse
35 wanted to take advantage. Even if the Prior Agreements provided for a
system of intra-group licences which would apply to the Films, that does not necessarily
preclude Disney from granting the Rights, as valuable rights, to Eclipse 35,
and such licences then become the means by which the Distributor carries out
its obligations under the Distribution Agreement to exploit the Films: at worst
such licences provide some sort of limit or control on how the Distributor
exploits the Films, but that does not render the Rights valueless.
269.In response
to a point made by the Commissioners (who relied on the evidence of Mr Sills)
that the Prior Agreements could provide the Disney group with an opportunity to
“self-deal” (that is, to grant a particular distribution right to a group
company on terms more favourable to that group company than arms-length terms),
Eclipse 35 argues that such an opportunity does not in itself remove all value
from the Rights. It argues that Eclipse 35 was entitled to assume that Disney,
as a reputable and major commercial entity, acted in good faith in granting the
Rights and in agreeing, in the Distribution Agreement, to market and distribute
the Films. From the reports of the Distributor’s activities prepared in
carrying out the marketing services arrangements it is clear that the
Distributor entered into a range of licensing deals in relation to the Films
with third parties in order to obtain the best revenues.
270.Finally,
Eclipse 35 points to the Variable Distributions actually received by Eclipse 35
under the Distribution Agreement and the calculation of those amounts: they
demonstrate that Eclipse 35 was in receipt of substantial amounts by reason of
the exploitation of the Rights and that those amounts were derived from the
totality of the revenues from the exploitation of the Films in the territories
and through the media specified in the Licensing Agreement and the Distribution
Agreement. If there were pre-existing exploitation rights conferred by the
Prior Agreements in relation to the Films some part of the revenues derived
from the exploitation of the Films would flow to satisfy such rights, and that
was not the case. The Rights granted by the Licensing Agreement and
sub-granted by the Distribution Agreement comprised all the rights to the Films
in relation to the specified territories and the specified media.
271.The
Commissioners argue that it is reasonable to infer that the Prior Agreements
confer distribution and exploitation rights on the Buena Vista distribution
companies, and that since the Rights granted to Eclipse 35 are subject to the
Prior Agreements the Rights are of little, if any, significance or value. They
point to Mr Molner’s first witness statement and also to his second witness
statement (prepared in response to the witness statement of Mr Sills), in both
of which it is clear that his assumption was that the Prior Agreements related
to the distribution of films. It is only in his third witness statement that
he states his assumption that they are “master agreements” which related to
royalties or values for intra-group transfer purposes.
272.The Prior
Agreements are expressed to be licence agreements between Disney and the various
Buena Vista companies in the Disney group who variously have the function
within the group of distributing films in different territories and through
different media. The evidence of Mr Sills is that the Disney group is
structured in this integrated way, separating film production from film
distribution, and with different distribution companies organised by territory
and medium, together providing a comprehensive distribution of all film
rights. This structure is entirely consistent with the Prior Agreements
conferring substantive distribution rights to the distribution companies within
the Disney group, calling into question whether the Rights granted by the
Licensing Agreement have any meaningful value.
273.In any event,
the Commissioners argue, Eclipse 35 was prepared to take a licence of the
Rights without knowing what was the effect of the Prior Agreements and hence
without knowing whether or not the Prior Agreements affected the value of the
Rights, and that is not a credible commercial stance – Eclipse 35’s
indifference on this matter shows that it had no concern for the nature or
value of the key asset for its purported trade.
(c) The value
and the valuation of the Rights
274.The issue of
the Prior Agreements, in the case put forward by the Commissioners, goes to the
question of the value of the Rights granted by the Licensing Agreement. The
Commissioners argue, as a separate issue, that Eclipse 35 did not have
available to it a valuation of the Rights to form the basis of its decision to
pay £503 million by way of Licence Fees for the Rights under the Licensing
Agreement. They argue that that figure is simply derived from an arithmetic
calculation to achieve the cash flows which underlie, and form the basis of,
the transactions.
275.We describe above
(see paragraphs 210 to 217) the exercise carried out by SCI and Salter Group to
determine the estimated range of Ultimates for the Films, and Disney’s interest
in that exercise.
276.Eclipse 35’s
case on this issue of valuation is that throughout Future worked on the basis
that film rights acquired were assets which carried a premium value because of
the “franchise” nature of the films, and that the price paid for those rights
had to reflect that value. For this reason the matching of films to be
licensed with the capital raised for each tranche of the Eclipse transactions
was a complex issue, with the further complication that the financial terms
have to result in the investors receiving a minimum specified return which is
the incentive for the contribution of their capital. It was a provision of the
Term Sheet with Disney that each Eclipse partnership should obtain a valuation
of the film rights licensed based on independent advice.
277.Eclipse 35
argues that it used, in Salter Group, recognised experts in forecasting the
amount and timing of gross revenues, which is the principal component in a
valuation exercise. They provided their expertise and applied it to the
financial model (the waterfall) prepared by SCI from the terms of the
documents. When Disney indicated that the likely gross revenues produced
initially by Salter Group for “Enchanted” fell below Disney’s own calculations,
further adjustments were made to reflect the marketing drive which Disney had
indicated they would make for that film and to broaden the scope of comparable
films. This process of determining the Ultimates, across a range of possible
cases, was commercial and carried out by experts. The actual performances of
the films licensed in the various Eclipse tranches show that the Salter Group figures
are accurate.
278.Two
relatively simple exercises were then required to convert those performance
forecast figures into a pounds sterling valuation: discounting for timing in
accordance with the timed Ultimates forecast by Salter Group, and applying a reasonable
exchange rate.
279.The resulting
figure, as the aggregate Licence Fees, had to be commercially acceptable to
Disney in the context of the overall commercial deal negotiated with Disney,
and having regard to the capital raised. Eclipse 35 argued that this was,
overall, a careful and legitimate exercise to arrive at Licence Fees which
reflected a fair value for the Rights licensed.
280.The
Commissioners argue that no actual valuation has been produced by Eclipse 35,
but only the Salter Group Ultimates and an assertion as to how a valuation
could be derived from those numbers. Even the production of the Ultimates was
subject to manipulation by changing the films in the “comparable films”
exercise undertaken by Salter Group, and Salter Group was dependent on the
waterfall supplied by SCI for such matters as distribution costs and the effect
of third party participation rights.
281.In any event,
the true purpose of the Salter Group report was to provide an opinion as to the
possibility of Eclipse 35 receiving Contingent Receipts, and to ensure that the
amount to be paid as AODs (that amount being a consequence of the capital
raised and the investors’ return on that capital) broadly accorded with the
forecast gross revenues from the Films.
(d) Contingent
Receipts
282.The issue
between the parties in relation to Contingent Receipts is whether the
entitlement of Eclipse 35 to Contingent Receipts under the Distribution
Agreement demonstrates both that Eclipse 35 acquired the Rights (on the basis
that the Contingent Receipts are an incident of the Rights) and that the Rights
have value. The matters in dispute relate to the nature of the entitlement to
Contingent Receipts (that is, whether they are derived from the Rights or are
an independent contractual entitlement) and also to their speculative nature.
283.We have
already referred to the provisions in the Distribution Agreement which provide
for the calculation and payment of Contingent Receipts (see paragraph 134) and
to the Salter Group forecast and opinion in relation to their likely payment
(see paragraphs 225 to 228).
284.Eclipse 35
argues that the terms of the Contingent Receipts provisions, and Eclipse 35’s
share, were the subject of real and extensive negotiations between Future and
Disney, and that that indicates their real commercial significance to both
parties. As to the nature of the entitlement to Contingent Receipts, they are
payable under the Distribution Agreement as consideration for the Rights
sub-licensed by Eclipse 35 to the Distributor.
285.Eclipse 35
argues that the Salter Group opinion demonstrates that, at the time the
transactions were entered into, there was a possibility that, over the twenty
year cycle of the Films, Contingent Receipts would become payable. That
opinion was perfectly sustainable, since it required the Films to perform only
27 per cent better than Salter Group’s Base Case in order to generate
Contingent Receipts.
286.Eclipse 35
points to the actual performance of the film “Pirates of the Caribbean: Dead
Man’s Chest”, the subject of the Eclipse first tranche, where the revenues to
date indicate a probability that Contingent Receipts will become payable to the
relevant Eclipse partnerships. It argues that the success of that film
generated interest in film investment in the UK and was a factor in the minds
of those investing in Eclipse 35, who saw the possibility of a share in super
profits: it was a significant part of the marketing of Eclipse 35 to investors
in the Addendum to the Film Partnership Proposal, for which purpose the Salter
Group opinion was obtained. It acknowledges that current performance of the
Films now makes it unlikely – but not impossible – that they will generate
Contingent Receipts.
287.The
Commissioners argue that Eclipse 35’s entitlement to Contingent Receipts is a
mere contractual right which does not flow from, or is not dependent upon, any
holding by Eclipse 35 of the Rights, being a right to contingent future income
from the Distributor’s exploitation of the Films. In its nature it is akin to
the participation rights in the financial performance of a film which may be
negotiated by investors in a film or by the leading actors and production team
who have worked on a film. In the overall financial analysis of the
transaction Disney was prepared to offer this right to contingent income in
exchange for the immediate and certain right to the Studio Benefit.
288.The
Commissioners challenge the reliability of the Salter Group opinion on the
likelihood of the Films generating Contingent Receipts on the grounds that the
waterfall on which the calculation of Contingent Receipts is modelled for the
purposes of that opinion was provided by SCI and was not independently verified
by Salter Group. They argue that Eclipse 35 had shown an indifference to the
likelihood of the Films earning Contingent Receipts in that it agreed to
Disney’s demands for the cross collateralisation of the Films, knowing from the
Salter Group workings that even if “Underdog” performed to the Best Case
standard it would barely earn Contingent Receipts, so its pairing with
“Enchanted” would almost certainly depreciate the likelihood of any Contingent
Receipts being received by Eclipse 35. The financial performance of the Films
to date shows that the accrual of Contingent Receipts, which as a forecast was
always a remote contingency, has in reality turned out to be even more
unlikely.
Discussion
289.Our
conclusion with regard to the issues between the parties relating to the
licensing of the Rights is that Eclipse 35 acquired the Rights under the
Licensing Agreement which it then proceeded to sub-licence by entering into the
Distribution Agreement. The Rights were valuable, and the Licence Fees, whilst
not necessarily exactly equating to the value of the Rights, broadly
represented that value when seen in the overall context of a commercially
negotiated transaction. In substance, therefore, on these issues we accept the
case made by Eclipse 35.
290.Mr Gammie,
for the Commissioners, stressed that the Commissioners were not putting forward
a case that the Licensing Agreement and the Distribution Agreement were sham
documents, that is with an apparent legal effect which does not accord with the
actual transaction agreed between the parties. He said his purpose was to
identify the real effect of those agreements in their entirety by reference to
their terms and the context in which they were entered into. However, his line
of argument that no rights in the Films were acquired by Eclipse 35 is scarcely
a step away from asserting that the agreements were a sham when the whole tenor
of the agreements is that the Rights are licensed by Disney to Eclipse 35 and
sub-licensed by Eclipse 35 to the Distributor.
291.The Licensing
Agreement is a clear and unequivocal licence of the Rights for the term of
twenty years. The licence is exclusive to Eclipse 35. It is made clear that
the grant of such licence is terminable, and that it is not a sale or transfer
of the title to the Rights, which remains with Disney, subject to the licence
granted to Eclipse 35. The Rights so licensed are the distribution and other
exploitation rights in respect of the Films in the media and throughout the
Territory as specified in detail in the relevant Exhibit to the Licensing
Agreement. As consideration for the grant of the licence and its continuation
during the term Eclipse 35 is liable to Studio to pay the (very substantial)
Licence Fees and the Variable Royalties. Extensive further provisions relate
to matters ancillary to, or to give full effect to, the licence of the Rights
(such as dealing with the materials which provide the physical representation
of the Films; protection of copyright; advertising and promotion rights; and
making foreign language versions). There are also extensive provisions dealing
with termination of the licence by expiry of the term or before the end of the
term, with different consequences (in the case of early termination) depending
upon the cause of termination, but in all cases, broadly, ensuring that the
Rights revert to Disney.
292.Viewing the
Licensing Agreement we see no basis for any conclusion other than that, by and
upon its terms, Disney confers on Eclipse 35 the Rights it purports to confer,
which, since they are exclusive exploitation rights in respect of the Films
across the range of entertainment media, and in virtually every country in the
world, are rights potentially of significant value.
293.Two questions
then arise: first, whether the fact that the grant of the licence of the Rights
is “expressly subject to the Prior Agreements” means that no Rights are
licensed to Eclipse 35, or that such Rights as are licensed are of reduced
value; and secondly, whether the terms of the Distribution Agreement, entered
into and having effect contemporaneously with the Licensing Agreement, mean
that no Rights are licensed to Eclipse 35.
294.The Prior
Agreements are defined in the Licensing Agreement as a series of licence
agreements between Disney and various Buena Vista distribution companies (which
we understand are all within the Disney group of companies). In origin they
date back to the early 1990s and earlier and have been amended most recently in
2005.
295.At the time
Eclipse 35 entered into the Licensing Agreement it did not know the purpose and
effect of the Prior Agreements, nor their effect upon, or consequences, if any,
for, the licence it was taking of the Rights in the Films. We have referred to
the confusion in the evidence of Mr Molner on the subject. There is evidence
that Disney told him in the course of negotiating the first tranche of Eclipse
transactions that their content was confidential and would not be disclosed.
There is no evidence that assurances were sought by Future from Disney that the
Prior Agreements did not and would not have a material and adverse impact upon
the licence of the Rights which Disney was proposing to grant to each Eclipse
partnership.
296.Mr Molner’s
assumption that the Prior Agreements are “master agreements” regulating on a
standard form basis the transfer of rights within the Disney group is no more
than surmise. Equally, Mr Sills’s views that they pass valuable exploitation
and distribution rights in respect of every Disney-produced film within what he
described as the vertically integrated group, and that they permit what he
referred to as “self-dealing” by Disney, is no more than surmise.
297.What is clear
is that the Prior Agreements do not expressly relate to the Films, since they
long pre-date them. If they are relevant at all to the Films it must be on
some sort of long-standing “master agreement” basis, either because as a matter
of their terms they engage with all, or certain classes, of Disney film at, for
example, the point when production is complete and distribution is imminent, or
because Disney has taken some prescribed action to bring the Films within their
terms.
298.Eclipse 35
argues that the Prior Agreements are matters of routine “housekeeping” within
the Disney group, and as such without significant consequence for the licence
of the Rights to Eclipse 35. It points to what has actually happened since the
Films have been distributed: for the years in which Variable Distributions were
paid to Eclipse 35 under the Distribution Agreement it is possible to see from
the statements which relate to those Variable Distributions that there has been
no “leakage” of gross revenues. In the calculation of Variable Distributions
all gross revenues earned by the Films can be accounted for. There is no
payment out to a Buena Vista company or any other party such as one would find
if there were some over-riding licence for value which had priority to the
licence of the Rights.
299.That seems to
us a convincing point, and we would only add that we would consider it unlikely
that, in the context of a commercially negotiated transaction, a major
organisation mindful of its reputation and acting in good faith would grant seemingly
highly valuable rights which it knew to be rendered significantly less valuable
by the existence of arrangements whose terms it was not prepared to disclose.
300.We conclude
on balance, therefore, that the Prior Agreements, and the grant of the licence
of the Rights in the Licensing Agreement subject to the Prior Agreements, did
not render the licensed Rights valueless, or materially depreciate their value.
301.A more valid
point made by the Commissioners with regard to the Prior Agreements in our view
is the fact that Eclipse 35 was prepared to take a licence of the Rights
subject to the Prior Agreements without obtaining some level of satisfaction or
comfort from Disney beyond, at best, an un-minuted oral remark, as to their
purpose and effect and possible significance for the Rights granted. That does
speak to a degree of indifference about the value of what was being acquired,
but that does not go to the question of what was acquired, but, rather, to the
significance which Eclipse 35 attributed to this aspect of the transaction and
the question of whether it was really engaged upon a speculative commercial
venture.
302.As to the
Distribution Agreement, this in its terms is an exclusive licence of the Rights
made by Eclipse 35 to the Distributor which is made subject to the licence
which Eclipse 35 has acquired pursuant to the Licensing Agreement. The Rights
licensed are the distribution and exploitation rights exactly corresponding
with the Rights licensed by Disney to Eclipse 35. The period of the licence is
co-terminous with that of the licence held by Eclipse 35. The consideration
given by the Distributor for the Rights licensed comprises the AODs, the
Variable Distributions, and a 40 per cent share in Contingent Receipts. There
are ancillary provisions and termination provisions which correspond to those
in the Licensing Agreement.
303.In its terms
there is nothing in the Distribution Agreement which detracts from or nullifies
the Rights acquired by Eclipse 35 under the Licensing Agreement. If anything
it confirms that they both exist and have high value. Therefore the beginning
and end of the Commissioners’ case is that since the Distribution Agreement was
entered into concurrently with the Licensing Agreement, with both agreements
coming into effect at Financial Close, and since the entirety of the Rights
licensed to Eclipse 35 is licensed to the Distributor for what in all
circumstances (including on early termination) is the exact same term, in the
overall result no rights were acquired by Eclipse 35 and instead Disney
licensed the Rights to the Distributor, its fellow group member.
304.We do not
agree with that proposition. The Licensing Agreement and the Distribution
Agreement must be given effect to in their own terms. The Licensing Agreement,
whilst acknowledging that the Distribution Agreement will be entered into
concurrently with it, grants a licence of valuable Rights to Eclipse 35.
Correspondingly, the Distribution Agreement, whilst acknowledging that it is
entered into concurrently with the Licensing Agreement, is the grant of a
licence which Eclipse 35 is able to grant only if effect has been given to the
Licensing Agreement. Both documents are meaningless if there is no licence of
the Rights to Eclipse 35, and the rights and obligations they create or give
rise to are illusory.
305.In our
judgment the Licensing Agreement and the Distribution Agreement should be
construed and applied so as to give them meaning, and for this objective no
more is required than that they are treated as having effect in the logical
sequence which their respective terms implicitly assume. Thus the Licensing
Agreement should be regarded as having effect momentarily before the
Distribution Agreement, so that Eclipse 35 has a licence of the Rights
immediately before it sub-licences them to the Distributor.
306.The
Commissioners found support in their view in the terms of Clause 37 of the
Licensing Agreement and the corresponding provision in the Distribution
Agreement. This states that for the purposes of applying US GAAP in the
financial reporting of the Disney group and of applying US tax law, the
transactions and arrangements contemplated by the Licensing Agreement and the
Distribution Agreement and related documents “are intended to be treated solely
as the purchase by [Eclipse 35] of its right to participate in proceeds for an
amount equal to the net financial benefit of [those transactions and
arrangements] as of Financial Close to [Disney], the Distributor and their
affiliates”. The parties, including Eclipse 35, are asked to acknowledge that
this is the case, and to agree that for the same US purposes they take a
consistent position.
307.We cannot see
that this provision necessarily assists the Commissioners – indeed, it might
tell against them. First, accounting treatment in accordance with GAAP may
well require that, for those specific purposes, a transaction is reported in a
way which differs from it proper legal form and effect – an obvious example in
the UK, and one not far removed from the transactions entered into by Eclipse
35, is the treatment of UK finance leases. Secondly, Clause 37 specifies that
this particular treatment of the transactions for the specified US tax and
financial reporting purposes is to be afforded by considering the transactions
and arrangements “as a whole rather than only according to their legal form”:
thus the “legal form”, which is our present concern, may, when analysed, result
in a different outcome to that which is to be assumed for US accounting and tax
purposes. Thirdly, if the proper construction of the Licensing Agreement and
the Distribution Agreement were as the Commissioners contend, there would be no
need to have Clause 37 – it is required only because, for those particular
purposes, the treatment of the transactions effected by those documents differs
from their actual legal effect.
308.Eclipse 35
argues that its entitlement to a share of Contingent Receipts payable under the
terms of the Distribution Agreement is further evidence of the reality and
value of the Rights it has acquired by the Licensing Agreement. The
Commissioners argue that the entitlement to Contingent Receipts is not
necessarily dependent upon the Rights, and in any event is an expectation so
speculative and remote as to be of little, if any, value.
309.The right to
Contingent Receipts is a right to a share in the gross revenues earned by the
Films after allowing for a series of deductions, expenses and participations
according to a pre-determined formula or financial model. It would seem that
an entitlement to such a share or participation can be created as a matter of
contract without the beneficiary holding an interest of an intellectual
property nature in the films generating the revenues. Contingent Receipts are
not inherently an attribute or incident of the rights to exploit a film. But
they can be one of the benefits which flow to the holder of such rights because
he is such a holder. That is so in Eclipse 35’s case. Contingent Receipts, if
they accrue, are paid “in consideration of the Rights licensed by [Eclipse 35]
to the Distributor hereunder”, as provided in the Distribution Agreement. That
is so because it is the Rights, and nothing more, which Eclipse 35 has to
contribute. In cases where similar participation rights are agreed with, say,
film investors or actors, that is by way of consideration for the funds or
performance which they contribute. The Commissioners argue that the right to
Contingent Receipts is consideration for Eclipse 35 making available the Studio
Benefit to Disney, but that requires a broader view than we are prepared to
contemplate, at least in the present context of assessing whether Eclipse 35
acquired and sub-licensed valuable rights.
310.As to the
question of the speculative value of Eclipse 35’s entitlement to a share of
Contingent Receipts, we need look no further than the Salter Group opinion on
the matter. The Commissioners attacked this on a number of grounds, but we
accept the evidence of Mr Briggs, its principal author. Salter Group is
experienced in these matters and has a high reputation in the film and
entertainment media industries. They prepared the opinion for the purpose of
informing potential investors in Eclipse 35, with the responsibilities that
that entailed. It is true that they relied on the “waterfall” prepared by SCI,
but that was, as we understand it, no more than a spreadsheet replicating in
the form of a financial model the terms in the Distribution Agreement setting
out how Contingent Receipts are to be calculated.
311.The opinion
was “that a payment of Contingent Proceeds [that is, Contingent Receipts] is
possible”. That opinion was based on the range of forecast Ultimates for both
Films for the three different Cases identified by Salter Group, and taking
account of the cross-collateralisation of the Films.
312.As Mr Molner
expressed it, no-one would be advised to invest in film rights by reference
only to the prospect of what might be delivered by a participation such as the
Contingent Receipts in this case. It is a speculation on the likelihood of a
film proving to be an outstanding success in the earnings it generates
(relative to its costs of production and distribution) over the length of its
life, as it passes through the different cycles of release. One of the films
licensed in an earlier Eclipse tranche looks likely to generate earnings which
will deliver Contingent Receipts for that particular partnership. Although
(due in large measure to the poor performance of “Underdog”) it now looks most
unlikely that Eclipse 35 will receive Contingent Receipts, it was reasonably
expressed as a possibility when Eclipse 35 took a licence of the Rights. This
was so notwithstanding that, as we have already mentioned, the chances of
Eclipse 35 earning Contingent Receipts were reduced (and, even if they became
payable, the amount would likely be reduced) by reason of it agreeing that for
theses purposes the Films should be “cross-collateralised”.
313.In our
judgment that prospect, notwithstanding that it was far from certain, supports
Eclipse 35’s case that its entitlement to Contingent Receipts demonstrates that
it was licensed Rights which were of substance and value.
314.As we mention
below, however, we cannot agree with the further proposition which Eclipse 35
would have us accept with regard to its argument that it is carrying on a
trade, namely that its entitlement to Contingent Receipts demonstrates that the
fortunes of Eclipse 35’s business are related to the performance of the Films.
The prospect of earning Contingent Receipts, although a possibility, is too
remote to qualify as a basis or justification for entering upon a trading
venture on any commercial level, which Mr Molner readily acknowledged.
315.Finally there
is the issue of the value attributed to those Rights. The Commissioners argue
that no valuation was produced and there is nothing to substantiate the Licence
Fees of £503 million paid by Eclipse 35 as consideration for the licence of the
Rights under the Licensing Agreement.
316.Mr Molner
described the process of matching (or perhaps juggling) the various components
in the transaction: a film or films satisfying the “franchise” and other
criteria; the amount of capital likely to be raised; and the return required
for investors in the partnership which would be based on the amounts received
from the Distributor. In that process the consideration given under the
Licensing Agreement (Licence Fees plus the right to Variable Royalties) would
broadly accord with the value of the film or films whose rights were licensed.
317.In the case
of the Films there was no evidence of a valuation produced at the time the
transaction was being negotiated. Mr Molner explained how a valuation was
calculated, applying to the timed Ultimates forecast by Salter Group an
appropriate discount factor to give a present-day value, and an exchange rate
to convert the US dollar figure into pounds sterling. In that process the
crucial element is the forecast of the timed Ultimates – the other two
components of the calculation are purely arithmetical and routine. That
forecast was available to Eclipse 35 in March 2007. The other two components
were, of course, known or capable of being ascertained at that time.
318.Mr Molner’s
evidence was that Disney ran a parallel exercise to the Salter Group Ultimates
forecast, and that their exercise indicated forecast higher gross revenues with
regard to “Enchanted”, causing Salter Group to re-examine the group of films it
was using as comparables in its forecasting exercise. It is reasonable to
assume that Disney were assessing likely gross revenues in order to establish,
for their own purposes, some kind of valuation of the two Films. It is
reasonable to infer that Disney had an interest in the value implicitly placed
on the Films by the Licence Fees (and the prospect of Variable Royalities) in
the context of evidence or justification for the values it placed on them for
its own accounting purposes.
319.Whilst
Eclipse 35 could not produce in evidence an actual valuation of the Rights it
acquired by licence under the Licensing Agreement we are satisfied that it had
the information which enabled it to form a view as to the range of values in
which the value of the Rights was likely to fall. It seems likely – on the
evidence we can put it no higher – that, on their side of the transaction,
Disney were mindful of the need to attribute a justifiable value to the Rights
it licensed. In determining the actual amount of Licence Fees we accept that,
in the negotiation of the transaction, the other factors mentioned by Mr Molner
(accommodating the capital raised to the films to be licensed; ensuring an
acceptable rate of return for Members’ investment) had to be taken into account
in addition to the figure produced by a valuation exercise, but looking at
matters in the round we are able to conclude that Eclipse 35 entered into the
transaction knowing the likely value of the Rights it acquired, and such value
was taken into account in determining the consideration which it gave for the
Rights.
320.Drawing all
these matters together, therefore, we conclude that Eclipse 35 acquired the Rights
by licence pursuant to the Licensing Agreement which it then subsequently
proceeded to sub-licence to the Distributor pursuant to the Distribution
Agreement. Neither the substance of the Rights nor their value was materially
affected or depreciated by reason of the licence being granted subject to the
Prior Agreements. The consideration which Eclipse 35 gave for the Rights
reflected the likely value of the Rights. The Rights gave Eclipse 35, by
reason of the Distribution Agreement, the entitlement to Contingent Receipts,
and at the time the transaction was entered into a payment of Contingent
Receipts, although speculative, was reasonably anticipated to be possible in
the course of the twenty year term of the licence.
The marketing services arrangements and the nature of Eclipse 35’s role
321.The next area
of dispute between the parties concerned the marketing services arrangements:
was Eclipse 35, by means of those arrangements, engaged in directing and
supervising the marketing and release of the Films?
322.Eclipse 35’s
case is that it exploited the Rights it acquired by licence by sub-licensing
those Rights to the Distributor and supervising the Distributor’s marketing of
the Films through the marketing services arrangements. It argues that the
purpose of the marketing services arrangements was not that Eclipse 35 should
carry out the marketing and distribution of the Films (that was the task of the
Distributor), but that it should have a part in directing how those activities
were to be carried out by the Distributor and in monitoring and supervising the
Distributor’s compliance with the agreed marketing and distribution
strategies. In this way Eclipse 35 ensured that its interests were protected
in a situation where there was a broad community of interests between Eclipse
35 and the Disney group in ensuring the success of the Films, but not
necessarily an exact alignment of interests.
323.The
Commissioners argue, first, that by reason of the Distribution Agreement
Eclipse 35 had divested itself of the Rights, so that it could not, in any
sense which is meaningful in the context of Eclipse 35 purportedly carrying on
a trade, play any part in the release or marketing of the Films; secondly, that
WDMSP Ltd was not an agent of Eclipse 35, so that its activities are not to be
attributed to Eclipse 35; and thirdly, that in any event the marketing services
arrangements are no more than administrative or information-providing
activities with little real substance, and that the highly proficient and
experienced Disney marketing and distribution operation had no need for any
input from Eclipse 35 and in any event went about marketing and distributing
the Films without any real regard to the arrangements provided for in the
marketing services documents. They say that these arrangements are aimed at
creating the appearance of a trade and have no real commercial significance.
324.We have set
out in paragraphs 163 to 182 above the terms of the transaction documents
relating to the marketing services arrangements, and in paragraphs 242 to 252
above the further findings as to those arrangements.
325.In support of
its case Eclipse 35 points first to the threshold criteria which it used to
identify films which in its view could benefit from the contribution it could
make to their marketing – essentially, films which were not yet on what Mr
Molner described as the marketing “launch pad” (in his imagery the marketing of
a film is to be compared to the journey of a rocket: all the effort and thrust
is required in preparing the rocket for launch and at the launch itself to set
the film on its course, and thereafter it is only a question of fine tuning the
pre-determined path). There was thus a serious and active process to ensure
that the chosen films had, at the time they were licensed, a potential in terms
of marketing strategy in respect of which Eclipse 35 could apply its influence.
326.Eclipse 35
then points to the master plan – the initial Marketing and Release Plan
relating to all the media in which the Films were to be marketed – which it devised
in advance of the release of each of the Films. A plan of this kind had not
previously been prepared by the Disney group, and it was the strategy benchmark
by reference to which WDMSP Ltd (through SCI and Mr Salter) monitored the
Distributor’s performance (it having agreed in the Distribution Agreement to
undertake the detailed implementation of such plan under WDMSP Ltd’s
oversight).
327.In this
exercise, Eclipse 35 argues, WDMSP Ltd acted as Eclipse 35’s agent in agreeing
to provide to Eclipse 35 the marketing services detailed in the Marketing
Services Agreement, drawing upon the services of senior employees of the Buena Vista distribution companies through the “Designee” arrangements.
328.In pointing
to the commercial reality of these arrangements Eclipse 35 refers to the
evidence of Mr Levy and Mr Molner to the effect that discussions with other
film studios had foundered, at least in part, because of their unwillingness to
accept this level of intrusion into their marketing arrangements, and that the
negotiations with Disney in this area had been difficult, especially in
relation to the question of the duties which WDMSP Ltd owed to Eclipse 35 as
its principal alongside its position and responsibilities as a member of the
Disney group.
329.Eclipse 35
points to the substance of the Marketing and Release Plans, which were tailored
to the respective Films. It points to the arrangements set up between WDMSP
Ltd, SCI and Mr Salter for gathering information and reporting to Eclipse 35 on
the performance of the marketing and release of the Films. In particular it
points to Mr Salter’s experience and close working relationship with his former
Buena Vista colleagues which enabled him to monitor performance knowledgeably
and effectively, and to intervene when circumstances required, as with the
proposal to curtail the cinema release of “Underdog” in Europe after its
disappointing opening box office performance in the United States.
330.In response
to the Commissioners’ charge, based on the evidence of Mr Sills, that the Disney
group did not need any input from WDMSP Ltd in order to market and release the
Films, Eclipse 35 argues that the purpose of the marketing services
arrangements was not to supply some deficiency in the marketing activities of
the Disney group, but to ensure that marketing was a collaborative exercise, to
protect the interests of Eclipse 35.
331.The
Commissioners’ arguments are based on the nature of the relationship which
Eclipse 35 has with WDMSP Ltd and on the reality of what it did. They argue
that, on a proper analysis of the documents, WDMSP Ltd was not an agent of
Eclipse 35 for marketing services or any other purposes (but instead agreed to
provide services to Eclipse 35), and that in any event it played no part in the
distribution or exploitation of the Films: at best it facilitated a reporting
operation.
332.The
Commissioners’ first submission is that, since in their view Eclipse 35 has no
rights which it is capable of exploiting, it is in no position to appoint an
agent to do what it could not possibly do itself. We have already found that
Eclipse 35 did acquire the Rights by licence, and if we are right in that then
this argument falls away.
333.Next the
Commissioners look to the detail of WDMSP Ltd’s responsibilities under the
Marketing Services Agreement. They point to provisions in Clause 2.1 of that
agreement, which require that WDMSP Ltd must provide its services to Eclipse 35
“with due care and diligence in a manner consistent with Distributor’s and
[Disney’s] then prevailing and commercially reasonable practices”. They also
point to provisions in Clause 5.1, which, first, assert WDMSP Ltd’s “fiduciary
duties” to the Disney group (in its capacity as a member of that group) and its
responsibility to act in the best interests of the group in priority to the
interests of Eclipse 35 should there be competing interests; and, secondly,
exclude the standards of care or obligations owed by law by an agent to the
extent that they conflict with WDMSP Ltd’s duty of care to perform its services
consistently with the Disney group practices as required by Clause 2.1. Such
provisions are contrary to the essence of agency and the duties which an agent
owes to its principal.
334.Therefore,
the Commissioners argue, in performing the services defined in the Marketing
Services Agreement WDMSP Ltd is not acting as an agent, and its activities are
not therefore the activities of Eclipse 35. At best it performed the services
for the benefit of (but not on behalf of) Eclipse 35.
335.Next the
Commissioners looked at the extent of WDMSP Ltd’s activities. They point out
that although Clause 4 of the Distribution Agreement speaks of the Distributor
undertaking the detailed implementation of the Marketing and Release Plans
under WDMSP Ltd’s oversight, that is subject to the entitlement of the
Distributor to deviate from or amend such Plans to allow it to exploit the
Rights in a manner consistent with the Disney group’s prevailing and
commercially reasonable practices.
336.As to the
reality of the position the Commissioners submit that Disney group companies
and their employees carried out the marketing and distribution of the Films,
and then notified WDMSP Ltd of what they had done, enabling WDMSP Ltd to pass
that information on to Eclipse 35. WDMSP Ltd’s activities were administrative
only and had no consequence for the way in which the Films were actually
marketed and released. That was only to be expected, given the unrivalled
distribution expertise of the Disney group itself.
337.As to the use
of threshold criteria, the Commissioners point out that implicit in that scheme
was the recognition that significant decisions and activities with regard to
the marketing of the chosen films had been made or undertaken before the films
were brought into the Eclipse structure (and made or undertaken by the persons
who it was contended would thereafter make or undertake subsequent decisions
and activities in their capacity as “Designees”), so that the use of such
criteria was no more than an artificial device designed to give credibility to
the claim that Eclipse 35 had something of value to contribute in these areas.
338.As to the
detail of the arrangements established, Mr Salter’s activities under his
Consultancy Agreement did not require him to take an executive part in the
marketing and distribution of the Films – his role was to receive information
from, or the work product of, others (such as the “Designees”) and to pass that
on to WDMSP Ltd and generally to act as a liaison between WDMSP Ltd, Eclipse 35
and the Buena Vista companies.
339.WDMSP Ltd
itself had no capacity or ability to prepare or monitor marketing plans, and
hence the arrangements with the Designee Providers to procure the Designees to
perform services for WDMSP Ltd. There is no evidence that the individuals (all
employees of the respective Buena Vista companies) agreed to such arrangements,
or were aware that the tasks they would otherwise carry out for those companies
were carried out instead for the benefit of WDMSP Ltd under these
arrangements. It is also questionable whether the Films (which were identified
only after these arrangements were documented) were specifically brought within
the scope of the arrangements.
340.Taking these
points together, the Commissioners argue that the marketing services
arrangements amounted to no more than a structure under which information was
supplied to Eclipse 35 about the performance of its investment in the Films,
and that the entirety of the marketing and distribution activities was carried
out by the Distributor (using the Buena Vista distribution companies in
accordance with normal Disney group practice). Nothing in those arrangements
as they were actually carried out endowed the activities of Eclipse 35 with the
character of trading.
Discussion
341.Mr Peacock
made the point that, in part at least, the Commissioners’ case is not directed
at the case which Eclipse 35 has put forward: Eclipse 35’s case is not that it
was engaged in marketing and distributing the Films – it exploited the Rights
it had acquired by sub-licensing them to the Distributor, and it was for the
Distributor to market and distribute the Films. Eclipse 35 wished to ensure
that its interests in the success of that process were taken into account, and
to that end put itself in the position where it could not only monitor, but
exercise supervisory control over the marketing and distribution activities
carried out by the Distributor. It described its role as that of a
collaborator with the Distributor in the marketing and release of the Films,
and asked us to make a finding to that effect.
342.The issue
therefore is whether Eclipse 35 can establish from the evidence that,
collaboratively with the Distributor, it was engaged in directing and
supervising the marketing and release of the Films.
343.First, we
agree with the Commissioners that WDMSP Ltd cannot be regarded as an agent of
Eclipse 35 despite its apparent appointment as such in Clause 1 of the
Marketing Services Agreement. Mr Molner was candid enough to point out that a
particular point of contention and negotiation between Future and the Disney
group was the question of the responsibilities which WDMSP Ltd should owe to
Eclipse 35 and those which the Disney group considered it should, as a member
of that group, owe to the group, and which should prevail in the event of
conflict. The drafting of the Marketing Services Agreement valiantly attempts
to reconcile that point of strain, but in making that attempt undermines the
fact of the agency it purports to establish.
344.It is, as Mr
Gammie pointed out, the essence of the relationship of agency that the agent,
when engaged on its principal’s business, should, so long as it is acting
within the law, act exclusively and in a fiduciary manner in the interests of
its principal. This is not the case with WDMSP Ltd with respect to Eclipse 35,
since there is express provision in the Marketing Services Agreement that any
duties or obligations which WDMSP Ltd may have in its capacity as a Disney
group member must prevail over the duties it would otherwise owe as agent to
Eclipse 35. The ambivalence of WDMSP Ltd’s position is fatal to the claim that
it is Eclipse 35’s agent, even in respect of matters where there is apparently
no conflict between its actions on behalf of Eclipse 35 and its duties as a
Disney group member (the more so since there is no attempt to specify the
nature and scope of such duties).
345.This in
itself is not fatal to Eclipse 35’s overall case, since WDMSP Ltd can provide
the defined Services for Eclipse 35’s benefit without doing so as agent, and
that is a reasonable construction of the Marketing Services Agreement. There
is certainly a valid legal distinction between the case where WDMSP Ltd acts as
agent (so that, through such agency, Eclipse 35 performs the Services) and the
case where WDMSP Ltd agrees to perform the Services so that their benefit
enures for Eclipse 35, but in the latter case Eclipse 35 may still reasonably
argue that it is engaged in the activities in question in that it has arranged
for them to be undertaken for its own benefit.
346.Our
difficulty lies more with the substance of what happened, even if we limit our
attention to the “collaborative” involvement of Eclipse 35 which we understand
to be its case. Neither Eclipse 35 nor WDMSP Ltd nor SCI had any capability
whatsoever to be a part of any strategic or day-to-day planning for the
marketing or release of the Films, or to monitor or supervise the Distributor’s
performance relative to any agreed plan. Mr Salter, with his long experience,
may have had such capability (although to achieve anything of significance he would
have required substantial support), but as we shall mention his role was more
limited. That capability resided within the Disney group and in particular in
the various Buena Vista distribution companies.
347.Eclipse 35’s
case is that it (or more accurately, WDMSP Ltd for its benefit) secured for
itself a portion of that capability by arranging for the Buena Vista companies,
the Designee Provider, to make available to WDMSP Ltd key executive staff, the
Designees. Eclipse 35 points to the Initial Marketing and Release Plans,
apparently an innovation, as its principal contribution to the marketing
process – a key part of the pre-launch preparation of the marketing rocket, in
Mr Molner’s terms. Those plans, it argues, were prepared by the Designees
acting for WDMSP Ltd as seconded staff. Thereafter the Designees supplied
information about performance, which was packaged and reported upon by a member
of the SCI team and Mr Salter to WDMSP Ltd and to Eclipse 35.
348.Although we
clearly see the contractual arrangements which set up these arrangements, and
had the benefit of helpful diagrams illustrating the chain of responsibilities
and the chain by which information passed back and forth, what we did not have
was convincing evidence that what the documents provided for was matched by
what happened in fact. We saw the theory but not the practice.
349.The
credibility hurdle which Eclipse 35 has to surmount is high, in that, as the
Commissioners were right to point out, the Buena Vista companies would,
regardless of the involvement of Eclipse 35, use their vast resources and
expertise to market and distribute the Films to the best of their considerable
ability. The Disney group had a direct interest in their so doing, to maximise
the Variable Distributions which flowed back as Variable Royalties to Disney,
and to maximise also the likelihood of generating Contingent Receipts (60 per
cent of which went to Disney). In that circumstance clear and convincing
evidence is required that the Designees stepped out of their position as
employees doing for their Buena Vista employer what they did on a daily basis
and performed their duties instead for WDMSP Ltd. Witness evidence from one of
the Buena Vista staff involved in this process would have shed light on the
commercial reality of the arrangements carefully provided for in the network of
documents. Evidence of that kind was not available to us.
350.Absent
evidence of such kind Eclipse 35 points to three things: its initiative to
produce the Initial Marketing and Release Plan for each Film; the activities of
Mr Salter; and the flow of information from the Disney group in relation to the
marketing and release of the Films in the different territories, and in
relation to the performance of the Films.
351.As mentioned,
Eclipse 35 chose films where it considered that the planning of the marketing
strategy was at a stage which was not yet complete – it developed the threshold
criteria to judge how far any film was from the “launch pad”. This, it argued,
enabled it to have a worthwhile contribution to make to that strategy, and
therefore scope to insert into the strategy process an initial overall plan.
Again, though, in the key question of differentiating what the Buena Vista companies did on their own behalf and what their employees did for WDMSP Ltd
evidence was lacking. It was clearly not the case, in relation to each of the
Films, that there had been no preparatory work undertaken by Buena Vista,
before Eclipse 35 came in view, as to how the Films would be marketed to their
respective target audiences – we had no evidence on the point beyond Mr Sills’s
surmise, but common knowledge of the extent and apparent success of Disney’s
marketing effort would suggest that it is most likely to engage in a
sophisticated preparatory process from the earliest moment in the production
life of a film. We do not know whether, in preparing the Initial Marketing and
Release Plans (and we do not question that they were prepared) the Designees
were simply doing, in a different format, what they would in any event do, or,
indeed, were “re-packaging” material which had already been prepared by the
Buena Vista companies. Eclipse 35 simply did not justify its case from the
evidence it produced.
352.As to Mr
Salter, he was not engaged to undertake an executive role: as he puts it in his
witness statement: “My work as a consultant does not require that I participate
in making decisions for the marketing and distribution of the Eclipse Motion
Pictures or that I influence the way in which those activities are carried out by
or on behalf of Disney. Instead, I monitor Disney’s activities in relation to
the Eclipse Motion Pictures and advise WDMSP on whether these are reasonable
and appropriate.” Elsewhere he describes his role as that of liaising between
the Buena Vista companies (and in particular their international distribution
staff based in London, where he himself had previously worked) and WDMSP Ltd.
He was the principal means by which information flowed from those companies to
WDMSP Ltd and Eclipse 35, with an SCI employee assisting him to organise and
present that information. That was how he monitored the Distributor’s
marketing activities and performance.
353.In the course
of his reports Mr Salter made comment upon the information he was delivering.
On one occasion he went beyond comment: in his report to WDMSP Ltd and Eclipse
35 of 7 August 2007 dealing with the box office revenues for “Underdog” in its
first week of cinema release in the United States market, in drawing attention
to its disappointing performance he said: “…it might be wise to reconsider the
size of the international campaign before the film is released worldwide. In
some cases, I feel it may be necessary to just release the film
direct-to-video, however in most countries we should continue to pursue a
theatrical release, utilizing a much smaller campaign. Of course this decision
should be left to the board of directors to consider, however, I feel it is of
the utmost importance that a decision be made in a very timely fashion so we
can instruct the distributor how to move forward.” The subsequent report
speaks of a new release strategy having been laid out, listing territories
where the film is no longer to have a theatrical release and mentioning that in
territories where it is to be released there is to be a reduced marketing
budget.
354.What is not
clear from the evidence before us is whether this was a particular insight on
the part of Mr Salter alone, or whether he was reflecting or enlarging upon the
thinking already being developed by the Buena Vista teams, with whom he was in
regular contact. We mean no disrespect to Mr Salter (who is clearly very
experienced in such matters, and was, in addition, a careful and modest
witness) in saying that what might have occurred to him would no doubt have
occurred to those more closely engaged on a full-time basis in ensuring that
“Underdog” achieved the maximum revenues for the lowest distribution costs.
Indeed, he suggested as much under cross-examination by Mr Gammie: Mr Salter
indicated that he had discussed the matter with the head of Buena Vista in Europe: “I discussed it with him, and we were both in sync. As I say, it’s an automatic
exercise really, when you have a disappointment at this level.” Again, this is
a matter where Eclipse 35 failed to adduce the evidence – perhaps in the form
of witness evidence from a Buena Vista employee – which would have established
the significance, if any, to the Distributor of Mr Salter’s observations and
recommendations in circumstances where the Distributor (through its Buena Vista
distribution arm) was in all likelihood already apprised of both the problem
and the action required to mitigate it.
355.The evidence
of Mr Salter in his cross-examination by Mr Gammie in relation to a second
occasion when he expressed his view (concerning the problems of releasing
“Enchanted” in France at the time of a transport strike) is that he and the
regional chief of Buena Vista International “were pretty much in cahoots as to
what we thought should be done”, and that perhaps gives some further insight
into the reality of the position.
356.Notwithstanding
the incident in relation to the curtailed cinema release of “Underdog” (and,
for the reasons given, without in any event being able to appreciate its
significance) we do not consider that Mr Salter’s activities establish that
Eclipse 35 was, even on a collaborative basis, engaged in directing and
supervising the marketing and release of the Films. Eclipse 35 cannot be said
to be directing and supervising matters in circumstances where the Distributor
had already come to a conclusion as to what it should do.
357.Finally,
although there was undoubtedly a well-planned and well-executed regular flow of
high quality and relevant information gathered by SCI and Mr Salter from the
relevant Disney companies to WDMSP Ltd and Eclipse 35, with pertinent comment
by Mr Salter, and although that information was considered at board meetings of
WDMSP Ltd and by the Designated Members (that is, in effect, the executive
Members) of Eclipse 35, that does not in itself establish the case which
Eclipse 35 is asking us to accept.
358.Whilst we can
conclude that, through WDMSP Ltd, Eclipse 35 monitored the activities of the
Distributor with regard to the marketing and release of the Films, and was kept
fully aware of the activities in that regard which the Distributor undertook
and of the financial performance of the Films, we are unable to conclude that
Eclipse 35 had a part, or at least a meaningful part, in directing and
supervising the marketing and release of the Films by the Distributor.
The borrowing facility, deposit and security arrangements
359.We can deal
with the borrowing, banking and security arrangements more briefly. We have
set out in paragraphs 139 to161 above the terms of the facility, deposit and
security documents. We have set out in paragraphs 183 to 241 above our further
findings as to the financial terms of the transactions and the cash flows which
underlie the transactions.
360.These
arrangements were the subject of extensive argument between the parties, as we
have already recorded.
361.The
Commissioners argue that the venture upon which Eclipse 35 embarked was no more
than an elaborate exercise of structured financial engineering built around a
semblance of acquiring and sub-licensing film rights and all with a view to
creating an interest charge for the Members for which they can claim tax
relief: as such the transactions should be considered as a composite whole.
They point to the cash flows which occurred on Financial Close and to the
twenty year cash flows which, they say, were based on no more than a financial
model driving the financial terms of the transaction over its lifetime. They
argue that these are not related to the inherent value of the Rights nor to the
actual financial performance of the Films, but begin with the amount of capital
(borrowed and own-resource) which Members invest and end with the interest
which the Members pay on their borrowings, both prepaid for years one to ten
and then annually for the remaining ten years.
362.Eclipse 35 does
not deny or dispute the cash flows which underlie the transactions entered into
by the various parties, although it points out that they take no account of the
possibility that Eclipse 35 may receive Contingent Receipts. It says, with
regard to the movement of cash at Financial Close, that the issue is not how
the cash moves, but why it moves as it does – that the real issue is the
different rights and obligations which the parties have created or become
subject to which has resulted in the movement of the cash. As to the twenty
year cash flows, it says that asset-based financing, such as leasing, is
formulated on financial models which fix the financial returns engendered by
the investment made, and the same approach has been adopted in this particular
form of asset-based financing: that this is the case does not detract from the
commercial reality of the transactions entered into. It accepts that tax
relief for the interest paid on the borrowings by the Members is an objective
on their part, and that the financial terms implicit in the transactions
reflect that objective. It argues, first, that the motives and actions of the
Members are not relevant to the issue of whether Eclipse 35 is carrying on a
trade, and, secondly, that it is in any event legitimate for the Members to
seek such tax relief when entering into transactions of this kind where they
have borrowed funds, as that is some kind of “hedge” against the risk of the
venture failing and their being exposed to repaying borrowing when there is an
insufficiency of assets to meet that liability.
363.We have set
out above in our analysis of the financial terms of the transactions and our
analysis of the rights acquired by Eclipse 35 our conclusions on a number of
issues which are aspects of these broader arguments between the parties.
364.With regard
to the movement of cash on Financial Close we have concluded that the rights
and liabilities created by the transaction documents cannot be ignored or in
some way disregarded so as to view cash as simply passing between the various
parties. The transaction documents record the commercial transactions
undertaken by the various parties and their respective rights and liabilities
which result from those transactions. We concluded that Eclipse 35 acquired
the Rights as licensed to it in the Licensing Agreement, and that the Licence
Fees (paid as the Advance on Financial Close, but subject to repayment of part
on early termination) reflected the value of those Rights as agreed between
Disney and Eclipse 35 having regard to the forecast financial performance of
the Films. We concluded that the Members are liable on a personal recourse
basis to Eagle in respect of the advance which it made to them under the
facility arrangements, and that they are at risk in this regard should Barclays
fail to honour the Letter of Credit.
365.These
conclusions lead us to the further conclusion that the transactions should not
be viewed as a composite whole, or, perhaps, viewed in a manner which
disregards the effect of the commercial transactions which the transaction
documents give effect to. The fact that those transactions give rise to a
particular cash flow financial model, both initially and over the twenty year
term of the arrangements, or even that the terms of the transactions have been
negotiated between the parties within the confines of such a financial model,
does not provide a basis for treating the parties – and in the present case,
Eclipse 35 in particular – as though they had not entered into the commercial
transactions in question or had entered into them for a purpose divorced or
different from their commercial effect.
366.As Mr Molner
described it, in any asset-financing transaction of this kind there is, in
reaching a concluded deal, a constant interplay between, on the one hand, the
overall financial shaping of the transaction, which will be governed by a
financial model which, in one way or another, is designed to deliver the
investor a certain return on his investment and, on the other hand, the terms
of the commercial transaction which the parties are prepared to agree having
regard to such matters as the values they attribute to the relevant assets and
income stream, the amount of available capital, the profit margin they require,
the nature and cost of security which is to be provided, and other factors of
that kind, all of which will be a matter of negotiation. That, we are prepared
to accept, is the process which was at work in Eclipse 35’s case, and which
resulted in a transaction which achieved certain consequences by reference to a
financial model whilst meeting the negotiated requirements of the parties in
entering into the commercial arrangements upon which they were intent.
367.Therefore
whilst the cash flows resulting from the transactions can be said to be
fundamental to Eclipse 35’s participation in the arrangements it entered into,
in that Eclipse 35 would not have entered into those arrangements if they did
not result in those cash flows, it does not follow that the arrangements do not
have the commercial purpose or effect which on their face they purport to have.
The parties’ submissions on the law and our analysis of the legal issues
for our decision
368.In this
section we record the parties’ legal submissions in summary and our analysis of
the legal issues for our decision.
369.The following
four propositions were agreed between the parties.
370.First, that
the task of the Tribunal is to form a view on whether what Eclipse 35 actually
did amounted to a trade or adventure or concern in the nature of trade. This
emerges from various authorities, for example per Lord Morris of Borth-y-Gest
in Ransom v Higgs 50 TC 1 at 84 – “it seems to me to be essential to
discover and to examine what exactly it was that the person did”.
371.Secondly,
that our examination of what Eclipse 35 actually did must view the matter in
the context of transactions taken as a whole, or, as Lord Templeman put it in Ensign
Tankers (Leasing) Ltd. v Stokes [1992] STC 226 at 235/6, we must ascertain
the fiscal consequences corresponding to the legal consequences of the scheme
documents read and construed as a whole. We would only add that all the
evidence of what Eclipse 35 actually did, which includes but is not limited to
the licensing, distribution and marketing services documents, is clearly
relevant.
372.Thirdly, that
a tax avoidance motive (or scheme) incorporated within what is otherwise a
trading transaction does not “de-nature” the transaction so that it is for that
reason no longer a trading transaction (see, for example, per Lord Jauncey of
Tullichettle in Ensign Tankers (ibid at 247) where he said that
he did not consider that FA and AB Ltd v Lupton had that result).
373.Fourthly,
that a financial model was produced which reflected the cash flows which were
the product of what the parties had agreed in the documents entered into and
that those cash flows were an important part of the transactions as a whole,
giving a tax advantage to the Members of Eclipse 35 in the earlier years, and
reversing over time.
374.Mr Peacock,
in arguing the case for Eclipse 35, suggested that, at a “fairly high level of
generality”, we should look simply at what Eclipse 35 did, standing back and
asking ourselves “Does that look like a trade?” Anticipating a positive answer
to that threshold question, he suggested that we ought then to go deeper into
the detail to “find good reasons why what at first glance looks like a trade is
not, for some reason, as a matter of law, a trade”.
375.He suggested
this as a convenient approach, rather than one which we were bound by any
authority to take. For the Commissioners, Mr Gammie unsurprisingly did not
endorse that approach and we reject it. It seems to us that it is for Eclipse
35 to persuade us, having regard to all the evidence, and in a “one-step”
process, that what it actually did was trade or engage in an adventure or
concern in the nature of trade.
376.Mr Peacock
submitted that the method(s) adopted by partners in a partnership to raise
money to contribute as capital to the partnership cannot have any bearing on
whether what the partnership actually did amounted to a trade. He referred in
support to a passage in the judgment of Millett J in Ensign Tankers ([1989]
STC 705) at 762-3 as follows:
“In considering the purpose of a transaction, its
component parts must not be regarded separately but the transaction must be
viewed as a whole. That part of the transaction which is alleged to constitute
trading must not be viewed in isolation, but in the context of all the
surrounding circumstances. But this must mean all relevant surrounding
circumstances; that is to say, those which are capable of throwing light on the
true nature of the transaction and of those aspects of it which are alleged to
demonstrate a commercial purpose.
If the purpose or object of a transaction is to make
a profit, it does not cease to be a commercial transaction merely because those
who engage in it have obtained the necessary finance from persons who are more
interested in achieving a fiscal advantage from their investment. Even where
the trader is the creature of the financier, the two activities are distinct
and the object of one is not necessarily the object of the other.
In FA & AB Ltd v Lupton, Lord Morris said
([1972] AC 634 at 647; 47 TC 580 at 620):
‘It is manifest that
some transactions may be so affected or inspired by fiscal considerations that
the shape and character of the transaction is no longer that of a trading
transaction. The result will be not that a trading transaction with unusual
features is revealed but that there is an arrangement or scheme which cannot
fairly be regarded as being a transaction [in the nature of trade].’
In my judgment this is the true significance of a
fiscal motive. Fiscal considerations naturally affect the taxpayer’s
evaluation of the financial risks and rewards of any proposed venture, and are
often the decisive factor in persuading him to enter into it. First-year
allowances, enterprise zones, government grants and the like operate as
financial inducements to businessmen to engage in commercial activities which
would be financially unattractive or unacceptably speculative without them.
Such motivations, even if paramount, do not alter the character of the
activities in question. But while a fiscal motive, even an overriding fiscal
motive, is irrelevant in itself, it becomes highly relevant if it affects, not
just the shape or structure of the transaction, but its commerciality so that,
in Lord Morris’s words, ‘the shape and character of the transaction is no
longer that of a trading transaction’. But nothing less will do.
Accordingly, in my judgment, and adapting the words
of Lord Simon in Thomson v Gurneville ([1972] AC 661 at 679; 47 TC 633
at 679), the question is whether, in the light of all the relevant
circumstances, the transaction is capable of being fairly regarded as a transaction
in the nature of trade, albeit one intended to secure a fiscal advantage or
even conditioned in its form by such intention; or is incapable of being fairly
so regarded but is in truth a mere device to secure a fiscal advantage, albeit
one given the trappings normally associated with trading transactions.”
377.We did not
understand Mr Gammie to disagree with anything in this citation. His response
was that before one gets to the question of whether a tax avoidance motive
“de-natures” a trading transaction (which he accepted it does not) there is a
prior question, namely whether in fact the transaction in issue is a trading
transaction at all and that prior question is addressed by examining the
context in which Eclipse 35 undertook its transactions, which brings in a
consideration of how Eclipse 35, and its Members, raised the funds which
enabled Eclipse 35 to entered into the Licensing Agreement.
378.Mr Gammie’s
submission was that the reality of the transaction (“the transaction viewed
realistically” in the words of Ribeiro PJ in Collector of Stamp Revenue v
Arrowtown Assets Ltd [2003] HKCFA 46 at [35], cited with approval by the
House of Lords in Barclays Mercantile Business Finance Ltd v Mawson (“BMBF”)
[2005] STC 1 at [36]) was that it implemented “a sophisticated financial model
developed by [Future]” which was designed on the assumption that the Members of
Eclipse 35 borrowed a specific portion (94%) of their capital contribution to
Eclipse 35 to enable them to shelter “tax negative reversing sale and leaseback
cash flows”. That is, as we have mentioned, that the tax relief on the
prepayments of interest envisaged under the financial model would shelter the
significant income arising from the working out of earlier and unrelated sale
and leaseback arrangements the Members had individually entered into. This was
the context in which Mr Gammie invited us to examine what Eclipse 35 actually
did.
379. Mr Peacock
accepted that we must look at what Eclipse 35 did in context – with the caveat
that that does not extend to the personal motivations of the Members or
their personal financial positions. He submitted that what Eclipse 35 did
“looks like a trade”’. He summarised what Eclipse 35 did as contracting with
Disney to license in rights, contracting with the Distributor to license out
rights, thereby ensuring that there are going to be streams of income coming in
from the Distributor, swapping Disney credit risk for bank credit risk in
relation to the AODs and employing the marketing services arrangements to
ensure that its interests are best protected.
380.Mr Peacock
referred us to the decision of the House of Lords in Ensign Tankers and
the later decision of the Court of Appeal in New Angel Court Ltd v Adam [2004] STC 779. In New Angel Court at [92] Jonathan Parker LJ (with whom the
other members of the Court agreed) referred to Lord Templeman’s speech in Ensign
Tankers and noted that he had been able to conclude that the composite
transaction in that case was (at least in part) a trading transaction “whatever
its design”. Lord Templeman identified a trading transaction in Ensign
Tankers because the partnerships in that case expended capital in the
making and exploitation of films. Referring to Victory Partnership, he said (ibid.
at 243-4):
“In the present case a trading transaction can
plainly be identified. Victory Partnership expended capital in the making and
exploitation of a film. That was a trading transaction which was not a sham
and could have resulted in either a profit or a loss. The expenditure of
$3,250,000 was a real expenditure. The receipts of $3,000,000 were real
receipts.”
381.Mr Peacock
submitted that objectively judged, what Eclipse 35 entered into was, in the
same way, a series of transactions which constituted a trade. He invited us to
reach this conclusion by four “routes”. The first was the case law route. The
second was the statutory construction route, by which he submitted that section
362 TA 1988, properly construed, provides for relief for interest where money
is borrowed to invest in a partnership carrying on a trade and that it followed
that the mere fact of borrowing money or paying interest could not be
sufficient to support the conclusion that the partnership was not carrying on a
trade. He supported this proposition by reference to Lord Morris’s speech in FA
& AB Ltd where he said (ibid. at 617-618):
“One trading transaction may result in a profit.
Another may result in a loss. If each of these, fairly judged, is undoubtedly
a trading transaction its nature is not altered according to whether from a
financial point of view it works out favourably or unfavourably. Nor is such a
transaction altered in its nature according to how the revenue laws determine
the tax position which results from the financial position.”
382. We note,
however, that Lord Morris, later in his speech, addressed the position where
there was doubt about the trading character of a transaction. He said, with
reference to the earlier case of J P Harrison (Watford) Ltd v Griffiths 40 TC 1 (ibid. at 619-620) that:
“The transactions in the Harrison case not
only had all the characteristics of trading: there was no characteristic which
was not trading. There was nothing equivocal. There was no problem to be
solved as to what acts were done. To the question quid actum est there
could be but one answer. The question quo animo was irrelevant. As
Lord Reid said in giving the judgment of the Board in Iswera v Commissioner
of Inland Revenue [1965] 1 WLR 663 (PC) (at page 668):
‘If, in order to get
what he wants, the taxpayer has to embark on an adventure which has all the
characteristics of trading, his purpose or object alone cannot prevail over
what he in fact does. But if his acts are equivocal his purpose or object may
be a very material factor when weighing the total effects of all the
circumstances.’ “
383.Mr Peacock’s
third route was to recognise that interest is a cost of capital and the fact
that capital has been raised in a particular way and on particular terms,
whether borrowed, not borrowed, at interest, not at interest, at interest in
arrear or at interest in advance or with prepayment of interest cannot have any
bearing on the question of whether the activity conducted with the use of
capital so raised is a trade or not.
384.Mr Peacock’s
fourth route was to recognise that Eclipse 35 was a legal entity separate from
its partners, under the Limited Liability Partnerships Act. By section 863
ITTOIA 2005 there is an imputation of the activities of the partnership to the
partners, but no imputation of the acts of the partners to the partnership.
385.In Mr
Peacock’s submission all these ‘routes’ led to the conclusion that the motives
and acts of the Members of Eclipse 35 can have no bearing on the question at
issue, whether Eclipse 35 itself was trading.
386.Mr Peacock
also placed some reliance on the similarities of the transactions undertaken by
Eclipse 35 to a film sale and leaseback, noting that the Commissioners in the
Business Income Manual (as then in force) at para. 56455 accepted that where a
partnership “of wealthy individuals” purchases a master version of a film from
a film production company and immediately leases all the rights of the film
back to the film production company for a period of 15 years, the partnership
will be carrying on a trade of exploitation of master versions of films.
387.Mr Gammie
however sought to distinguish the transactions in this case from that type of
film sale and leaseback, contending (as we have already discussed) that Eclipse
35 did not acquire any significant rights under the Licensing Agreement, and
that if it did, by the Distribution Agreement, Eclipse 35 had for practical
purposes parted with everything it had so acquired. Instantaneously Eclipse 35
received rights in the Films and gave those rights back. All Eclipse 35
retained was a share of Contingent Receipts, and, rather than trading, Eclipse
35 merely bought into a contingent future possible receipt. Normally, Mr
Gammie said, the lessor in a sale and leaseback transaction is left with
ownership of the leased asset. That is not the position in these
transactions. Further, Eclipse 35 had not claimed that it was carrying on a
financial trade, but instead a trade of exploiting films. In the BMBF
case, although Mr Gammie recognised that “probably quite similar cash flows and
financial modelling could be done in relation to the activity there”,
nevertheless the taxpayer in that case was not a special purpose vehicle set up
for the purpose of implementing a financial model, but one of the largest
finance lessors in the country for whom the transaction in issue, with the
Irish Gas Board, was no more than an everyday incident of its ordinary business
of providing finance by means of leasing.
388.In response
to this point Mr Peacock observed that the Commissioners have not hitherto
contended that a single asset lessor (for example a lessor of an aircraft or a
ship where there is only one asset in a company, for liability reasons and to
avoid sister vessel arrest) is not engaging in a leasing trade. He did not
accept that the combined effect of the Licensing Agreement and the Distribution
Agreement was that Eclipse 35 obtained rights and gave them back. He submitted
that Eclipse 35 was the grantee of rights under the Licensing Agreement and the
grantor of rights under the Distribution Agreement, subject to the rights and
obligations of the respective parties to those two agreements. He also
submitted that it was impermissible in law to assume that there was a single
composite transaction which denied the purpose and effect of each of the agreements,
albeit that they were entered into at about the same time and designed to fit
together
389.Mr Gammie
submitted that Eclipse 35 had engaged in financial modelling to which there had
been an attempt to plug in a film effectively to confer on the activity the
characteristic of trade. Eclipse 35 was buying from Disney in consideration of
the Studio Benefit what was effectively the facade of trade. Disney would
always produce and distribute the Films in “the Disney way” without any
effective interference from Eclipse 35. The profits from the transactions were
not the profits of a trade. They were instead the profits of the financial
modelling arrangement, which could be characterised as profits from property,
akin to an annuity, where a lump sum is paid on day one and in return a stream
of income is received. He recalled that the distinction between the charge to
tax on profits arising from property and profits or gains arising from trade
has been a feature of our taxation system since earliest times.
390.Mr Gammie
also drew our attention to section 609 ITTOIA 2005, which provides for a charge
to income tax on income from a business involving the exploitation of films or
sound recordings where the activities carried on do not amount to a trade (a
“non-trade business”). He also referred to section 687 ITTOIA 2005 under which
income tax is charged on income from any source not otherwise so charged. His
submission was that Parliament contemplated the possibility that income from
the exploitation of films could indeed be income from a “non-trade business”.
391.We have
already referred in some detail above to the submissions of the parties as to
the effect and significance of the marketing services arrangements: it is
sufficient to note here that the tenor of Mr Gammie’s arguments was that the
peripheral type of activity undertaken by WDMSP Ltd in carrying out those
arrangements did not lend any credence to the idea that Eclipse 35 was
trading. Mr Peacock’s response, in summary, was that through those
arrangements Eclipse 35 had a real interest in, and a real ability to
influence, the exploitation of the Films, so that the exploitation of the
Rights by the grant of the sub-licence to the Distributor was thereby a matter
in which Eclipse 35 had an active involvement.
392.Eclipse 35’s
entitlement to Contingent Receipts represented the only income stream which
Eclipse 35 might receive which reflected the success of the Films. As Mr
Peacock put it, the Contingent Receipts entitlement reflected Disney risk and
film risk. Mr Gammie made the point that it could not be said of Contingent
Receipts that they were (or would be, if they materialised) payments received
from customers – which is what one might expect if they were trading receipts.
His submission was that if any Contingent Receipts materialised they would
represent an additional return from the financial model which Eclipse 35 was
implementing – effectively additional investment income. He suggested (as we
have referred to above in some detail) that there was not any significant real
value or content to what was promised in the way of Contingent Receipts.
393.In relation
to the second issue for our decision, whether, if we find that Eclipse 35
carried on a trade, it did so with a view of profit, Mr Gammie pointed out that
Lord Reid in Harrison had said that earlier cases had established that
operations of the same kind as, and carried on in the same way as, those which
characterise ordinary trading should be held to be trading even though there
was no intention to earn a profit (ibid. p.295). It followed from that
that the question of whether Eclipse 35’s trade (if we found there to have been
one) was carried on with a view to profit was a separate question.
394.As regards
the main issue for our decision, in our discovery and examination of what
exactly it was that Eclipse 35 did, the question of law is whether Eclipse 35
can rely on the legal effect of the agreements it entered into in order to
oblige the Tribunal to conclude that it was conducting a trade (construing the
statutory concept of trade purposively), or whether on the contrary we should
accept (in favour of the Commissioners) that that is an unrealistic view on the
facts having regard to the true legal effect of the agreements Eclipse 35
entered into, viewed in their proper context of transactions designed to give
the pre-determined cash flows we have explained above. If we decide that
question of law in favour of Eclipse 35, we must go on to decide what the trade
was and whether Eclipse 35 was carrying it on with a view to profit. If, on
the other hand, we decide that question of law in favour of the Commissioners,
we will (although, it would perhaps not be strictly within our remit to do so)
state our conclusion as to the character of the transactions for tax purposes.
Conclusions on the issue of whether Eclipse 35 was carrying on a trade
395.We consider,
in agreement with Mr Peacock, that the manner in and extent to which the
Members of Eclipse 35 financed themselves to contribute the necessary capital
to Eclipse 35 is extraneous to whatever it was that Eclipse 35 did. Also, we
have concluded that the banking and security arrangements entered into by
Barclays and Eagle involving the Members, Disney and the Distributor are
similarly extraneous to what Eclipse 35 did. We have rejected (see paragraph
364 above) the Commissioners’ contention that Eclipse 35 is to be treated as
not having acquired the Rights or sub-licensed them at all, or that the Rights
had no significant value.
396.What Eclipse
35 did was to enter into the Partnership Consultancy Agreement with Future (on
3 October 2006), the Marketing Services Agreement with WDMSP Ltd (on 9 February
2007) and, most importantly, the Licensing Agreement with Disney and the
Distribution Agreement with the Distributor (both on 3 April 2007). These
transactions had legal effect according to their terms.
397.In
ascertaining whether Eclipse 35 was carrying on a trade, we examine these
transactions. The relevance of the Members’ financing arrangements and the
banking and security arrangements entered into by Barclays and Eagle is that
they are part of the context in which Eclipse 35 entered into the transactions
identified. As we take a realistic view of the facts of this case, these
facts, which (as we have said) are extraneous to “what exactly it was that
Eclipse 35 did”, may, as part of the context, indicate why the transactions
referred to in paragraph 396 above were entered into by Eclipse 35. We will
have to decide whether these extraneous facts affected the commerciality of
what Eclipse 35 did with the consequence that “the shape and character of the
transaction is no longer that of a trading transaction” (see: per Millett J in Ensign
Tankers [1989] STC at 763). We return to this point below (at paragraph
412).
398.A purposive
construction of the concept of “trade” as that word is used in the Corporation
Tax Acts must take account of the definition in section 832(1) TA 1988 – that
it “includes every trade, manufacture, adventure or concern in the nature of
trade”. We note that Lord Templeman in Ensign Tankers stated that the
transaction which Victory Partnership entered into in that case (which he
accepted was a trading transaction) “was not a sham and could have resulted in
either a profit or a loss” ([1992] STC at 243). We also note that Lord Reid in
Iswera used the expression “an adventure which has all the
characteristics of trading” (our emphasis) to describe an activity which comes
within the category of “trade” for relevant purposes ([1965] 1 WLR at 668). We
consider that an element of speculation is a characteristic of the concept of
trade – if a taxpayer is trading, what he does must, normally at any rate, be
speculative in the sense that he takes a risk that the transaction(s) may not
be as profitable as expected (or may indeed give rise to a loss).
399.In Ransom
v Higgs, Lord Wilberforce said (in the context of identifying a trade) that
“there must be something which the trade offers to provide by way of business”
and that, as a norm, “trade ... presupposes a customer” (50 TC at 88). He also
said that “everyone is supposed to know what ‘trade’ means” and that the best
the Court can do is to apply the general characteristics of trade to a novel
set of facts in order to see how near to, or far from, the norm the facts are (ibid.).
400.Eclipse 35’s
case is that the sub-licence to the Distributor of the rights acquired from
Disney in consideration of specified periodic payments over twenty years which
ensured over that period profits for Eclipse 35, together with the possibility
of receiving Contingent Receipts, had the profit-making character necessary for
it to be recognised as a trading transaction. Of course Mr Peacock also prayed
in aid the marketing services arrangements which Eclipse 35 entered into with
WDMSP Ltd, but we have concluded (at paragraph 358 above) that these did not,
as a matter of fact, endow the activities of Eclipse 35 with the character of
trading. In argument, however, Mr Peacock was clear that the acquisition and
sub-licence of the Rights, looked at alone, was sufficient to support, even
compel, the conclusion that Eclipse 35 was trading.
401. There is no
doubt that the sub-licence has produced and can be expected to continue to
produce profits for Eclipse 35 (see for example the audited financial
statements for the periods ended 5 April 2008, 2009 and 2010 referred to at
paragraphs 193 to 195 above). Disregarding for the moment the question of
Contingent Receipts, the profit over a twenty year period, year by year, is
determined at the outset, and is determined without any reference to the
success or otherwise of the exploitation of the Rights sub-licensed. In these
circumstances we cannot realistically regard the profit as the speculative
profit of a trading venture consisting of the exploitation of film rights. We
accept that Eclipse 35 has taken the commercial risk that Barclays may not meet
its liabilities under the Letter of Credit so that payments directly
corresponding to the AODs might not be received (although it should be noted
that the substitution of Barclays was a credit-enhancement arrangement designed
to minimise the risk that Eclipse 35 would not receive the AODs). But the risk
of Barclays not meeting its liabilities under the Letter of Credit (certainly
as viewed as at 3 April 2007 but also as viewed at all times thereafter) is too
remote to cause the pre-determined profit to be speculative in any relevant
sense. In addition, and importantly, that risk is not associated with the
acquisition and exploitation of the rights in the Films (the trade Eclipse 35
claims to be carrying on); it is associated with the solvency of Barclays,
which is a factor as far removed from what Eclipse 35 actually did as the
Members’ financing arrangements.
402.The
Contingent Receipts are the only element of the income streams which Eclipse 35
has bargained for which is affected by the performance of the Films in
consequence of their exploitation. Although obviously the prospect of Eclipse
35 actually receiving any Contingent Receipts, while being possible, was highly
speculative – and made more speculative by the fact that the Films were
“cross-collateralised” as described above – it was in our judgment (as we have
stated at paragraph 314 above) so remote as to make wholly unrealistic a
conclusion that the entitlement to Contingent Receipts under the sub-licence of
the rights in the Films gave the sub-licence the character of a trading
transaction. Mr Molner’s evidence (paragraph 312 above) was that no-one would
be advised to invest in film rights by reference only to the prospect of what
might be delivered by a participation such as the Contingent Receipts in this
case. The truth of that is seen in the financial illustrations which were
given to potential investors when the arrangements were marketed, since those
illustrations disregarded the prospect of Contingent Receipts in presenting an
internal rate of return which was considered by Future to render the investment
attractive even if an investor did not wish to borrow part of the capital
intended to be contributed (see paragraph 112 above). The prospect of Eclipse
35 receiving anything from Contingent Receipts was clearly at all times
considered by everyone involved as a “bonus” rather than as a profit to be
reasonably expected from entering into the acquisition and sub-licence
transactions.
403.For these
reasons we conclude that the transactions entered into by Eclipse 35 did not
have the speculative aspect which we would expect to see in trading
transactions.
404.We now turn
to consider what the transactions offered to provide by way of business, and if
there was any discernible customer (cf Lord Wilberforce’s comments in Ransom
v Higgs referred to at paragraph 399 above).
405.The
acquisition by licence and the sub-licence of the Rights were not sham
transactions and we have concluded (see paragraphs 289 and 320 above) that they
had effect according to their terms and that the Rights were real and
meaningful. The fact remains, however, that the Licensing Agreement and the
Distribution Agreement are co-terminous and were intended to be (and were)
entered into concurrently. They were also interdependent, in the sense that
Eclipse 35 could enter into the Licensing Agreement only if it entered into the
Distribution Agreement: it could acquire a licence of the Rights only if it
sub-licensed them on the specified terms to the Distributor (and it also denied
itself the right to do anything else whatsoever, without Disney consent).
406.Also relevant
to the question of what the transactions offered to provide by way of business
is the provision that Eclipse 35 would never receive actual physical delivery
of the physical manifestation or representation of the Films. By clause 8 of
the Licensing Agreement, Disney contracted to provide physical delivery of the
Films to Eclipse 35 by delivery of the relevant prints and negatives to a
specified laboratory to be held to the account of the Distributor. Also, the
provisions for termination of both agreements effectively dove-tail so that it
is unrealistic to assume that either agreement could have any effective life
beyond the life of the other. In addition, Eclipse 35’s acceptance that the
Distributor may act in the best interests of the Disney group which may not be
in the best interests of Eclipse 35 is relevant to this question.
407.As we have
already concluded in relation to the marketing services arrangements, the
capability of strategic and day-to-day planning for the marketing and release
of the Films was within the Disney group.
408.In these
circumstances it is difficult to see what services Eclipse 35 realistically
offered to provide to the Disney group by way of business. Eclipse 35 did
sub-license the Rights to the Distributor, but it had acquired the self-same
Rights a moment previously from Disney, and had acquired them on terms whereby they
would be so sub-licensed. Eclipse 35’s case is (and has to be) that the
Distributor was its customer, but we consider it is unrealistic to conclude
that this was so on any meaningful basis.
409.The
Commissioners contend that the real effect of the Licensing and Distribution
Agreements is that in consideration of the Studio Benefit of £6 million, Disney
provided to Eclipse 35 the opportunity to participate in the arrangements and
the speculative right to Contingent Receipts. Whilst we accept Mr Gammie’s
submission that the cash flows set up by the transactions were fundamental to
Eclipse 35’s participation in the arrangements, we do not endorse this
submission in the broad sense of characterising the transactions in this way.
It is sufficient for us to conclude that on a realistic view of the facts –
that is, on any commercially meaningful basis – Eclipse 35 had no “customer”
and did not offer to provide any goods or services by way of business. The
acquisition and sub-licence of the Rights by Eclipse 35, although having legal
effect according to their terms, cannot be characterised realistically as the
provision of services by Eclipse 35 to Disney by way of business, any more than
the money paid into the bank account to the credit of Victory Partnership by
LPI in Ensign Tankers could be characterised as a loan (cf ibid.
per Lord Goff at 246).
410.These
considerations plainly point to the conclusion that Eclipse 35 was not
trading. Another factor pointing in the same direction is the conclusion we
have reached that the amount of AODs payable to Eclipse under the Distribution
Agreement was reduced below the level payable under the earlier Eclipse
tranches (which broadly represented interest and principal payable over the
lifetime of the transaction) by reference to the special feature of the Eclipse
35 transaction, which was the prepayment of interest (see above at paragraphs
200 to 205). This demonstrates that the quantum of the putative trading
receipts of Eclipse 35 was affected by the extraneous factor of the financing
arrangements of the Members, which highlights the unreality of regarding them
as trading receipts at all.
411.We have also
to consider whether the Licensing Agreement and the Distribution Agreement can
be regarded as trading transactions on the analogy of a sale and leaseback
transaction. We conclude that they cannot be so regarded. Where the purchase
of an asset by a lessor on terms that it is leased back by a finance lease is
properly to be regarded as a trading transaction, the essence of the trade is
the provision of finance by the lessor. Although sometimes called a leasing
trade, it is in reality a financial trade. In the case of a single asset
lessor (referred to be Mr Peacock – see at paragraph 388 above) we consider
that the usual case is that the financial trading activities of the group,
consortium or other association to which a single asset lessor may belong,
effectively endow the leasing activities of the lessor with the characteristics
of a financial trade. In this case, Eclipse 35 does not claim to be carrying
on a financial trade and in any case did not provide finance. It is
unrealistic to regard the payment of the Studio Benefit as the provision of
finance for a consideration. In addition, a trade of acquiring and exploiting
film rights would, we consider in agreement with Mr Gammie, usually involve the
retention by the trader of some residual film rights having commercial reality
– the example given in para. 56455 of the Commissioners’ Business Income Manual
(cf paragraph 386 above) seems to have that premise. Here, Eclipse 35
effectively and realistically sub-licensed to the Distributor everything it
acquired from Disney. The right to Contingent Receipts can be ignored for this
purpose because it had insufficient commercial significance.
412.We return to
the question of whether the Members’ financing arrangements and the banking and
security arrangements entered into by Barclays and Eagle affected the
commerciality of what Eclipse 35 did with the consequence that “the shape and
character of the transaction is no longer that of a trading transaction” (see:
per Millett J in Ensign [1989] STC at 763). This is the question posed
by Lupton v FA and AB Ltd 47 TC 580. We do not go so far as to conclude
that, even having regard to the context in which Eclipse 35 did what it did,
Eclipse 35’s “paramount object” was to procure a tax advantage for the Members
(cf ibid. at 631, 632 per Lord Donovan). This is not a case where
Eclipse 35 has entered into transactions having “elements of trading” but
which, viewed as a whole, cannot fairly be regarded as a trading transaction (cf
ibid. at 598 per Megarry J, approved by Lord Morris ibid. at 621,
Lord Guest ibid. at 623 and Lord Simon of Glaisdale ibid. at
631). Eclipse 35’s paramount object was to obtain the returns inherent in the
Distribution Agreement. We agree with Mr Gammie that what Eclipse 35 actually
did was not a trading transaction at all. But equally, what Eclipse 35
actually did is not to be characterised, on the authority of Lupton, as
a mere device to secure a fiscal advantage.
413.We conclude
for the reasons given above that Eclipse 35 cannot rely on the legal effect of
the agreements it entered into to show that it was conducting a trade.
414.We regard the
activities of Eclipse 35 viewed realistically as amounting to a business
involving the exploitation of films which does not amount to a trade (a
“non-trade business” within section 609 ITTOIA, giving that concept a purposive
construction).
415.We add that
if we had concluded that Eclipse 35 was trading we would also have concluded,
having regard to the terms of the Licensing Agreement and the Distribution
Agreement, that it was carrying on a trade of the acquisition and exploitation
of film rights and that it was carrying on that trade with a view to profit.
416.The
Commissioners urged us to decide the further question of whether monies
borrowed by the Members were monies used for the purposes of Eclipse 35’s trade
(assuming it were carrying on a trade). In view of our decision that Eclipse
35 was not carrying on a trade this is not a matter we need to decide. In any
event it is not a matter which we consider should be determined in these
particular proceedings. It relates to any claim which the Members might make
for relief for the interest they have paid and as such is a matter which they,
and not Eclipse 35, should argue. We are aware that the same might be said of
the issue as to whether Eclipse 35 is carrying on its trade (assuming that to
be the case) with a view to profit, but in the circumstances of this case we
regard that issue as an adjunct to the issue of whether it is so carrying on a
trade and hence have expressed our conclusion on the point.
417.For the
reasons given we dismiss the appeal.
Right to apply for permission to appeal
This document contains full findings of fact and reasons
for the decision. Any party dissatisfied with this decision has a right to
apply for permission to appeal against it pursuant to Rule 39 of the Tribunal
Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application
must be received by this Tribunal not later than 56 days after this decision is
sent to that party. The parties are referred to “Guidance to accompany a
Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and
forms part of this decision notice.
EDWARD SADLER
TRIBUNAL JUDGE
JOHN WALTERS, QC
TRIBUNAL
JUDGE
RELEASE DATE: 20 April 2012
Authorities referred
to in skeletons or argument and not referred to in the decision:
Ex p White, re Neville (1871) LR
6 Ch App 397
Joachimson v Swiss Bank Corporation [1921] 3KB 110
Snook v London and West Riding Investments Ltd [1967]
2QB 786
Garnac Grain Co v HMF Faure & Fairclough Ltd [1968]
AC 1130
Overseas Containers (Finance) Ltd v Stoker 61 TC 473
Antaios Compania Naviera S.A. v Salen Redierna A.B. [1985]
AC 191
Libyan Arab Bank v Bankers Trust Co. [1989] 1QB 728
Consolidated Goldfields plc v IRC; Gold Fields Mining and
Industrial Ltd v IRC [1990] STC 357
Gold Fields Mining and Industrial Ltd v GKN (United
Kingdom) plc and another [1996] STC 173
Foskett v McKeown [2001] 1 AC 102
Investors Compensation Scheme Ltd v West Bromwich
Building Society [1998] 1 WLR 896
BCCI v Ali [2002] 1 AC 251
Tower MCashback LLP 1 and another v HMRC [2008] STC 3366
Re Sigma Finance Corp (In administration) [2010] 1 All ER 571
HMRC v Halcyon Films LLP [2010] STC 1125
HMRC v Micro Fusion 2004-1 LLP [2010] STC 1541
Icebreaker 1 LLP v HMRC [2011] STC 1078
HMRC v Tower MCashback LLP 1 and another [2011] UKSC 19
