Sullivan Entertainment’s recently initiated public offering could be in jeopardy with the recent public announcements by the heirs of Lucy Maud Montgomery Macdonald’s estate relating to a long-running claim against Sullivan over profits from the Anne of Green Gables movies; and a subsequent rejection of the production company’s proposal for mediation and binding arbitration, which leaves open the possibility of lengthy court litigation.

‘If you were going to invest in Sullivan Entertainment what would you think after this press conference?’ asks the Toronto prodco’s legal counsel Randy Pepper, referring to a July 6 press conference held by the Macdonald family, where they brought the dispute before the national media.

The dispute centres on a 1984 contract in which Kevin Sullivan agreed to pay the Macdonalds ‘10% of 100% of the net profits in perpetuity from all sources based on the use of all rights granted by this agreement after deduction of reasonable distribution fees and expenses and the audited production costs calculated according to accounting practices customarily employed in the motion picture and television industry in Canada. Calculation of time of payment and reporting of the percentage share of revenues shall be as favourable to the Macdonald family as that accorded the most favoured party advancing funds for the production and entitled to a share of revenues.’

The contract also stated that Sullivan would ‘maintain full and complete records of transactions related to such revenues and shall permit the inspection and audit of such records by the Macdonald family or its representatives.’

According to the Macdonald family’s lawyer Marion Hebb, Sullivan Entertainment has insisted it has not made any ‘net profit’ from the Anne movies and, since 1990, refused to allow for a full accounting of profits on the programs.

Meanwhile, in a preliminary prospectus filed in June, the company (which estimates earnings of $6.4 million for its current fiscal year on revenues of $35.7 million) boasts to potential investors that Anne has sold in 230 countries, covering almost every tv market in the world.

‘Basically Sullivan is saying the Anne of Green Gables movies have not recouped – that they have not got any money back on the films so they don’t owe my clients anything,’ says Hebb. ‘But one has to look at the accounts to know if that is the case, and up to now they have not allowed an audit to happen so we can see how they have calculated their net profits.’

Hebb says that since 1990 she has tried on numerous occasions to request reports of revenues and eventually asserted the right to audit.

In July 1997, the Macdonalds filed a motion for an audit with the Ontario Court’s General Division. According to the family, Sullivan offered to settle the audit motion on the basis of an audit of its records for Anne of Green Gables: The Sequel and an accounting of the producers’ gross receipts and profit for Anne of Green Gables. In February 1998, Sullivan provided summarized accounting for the two programs – what Hebb calls a ‘few lines’ – which maintained no money was owed the Macdonalds.

Last November, the family claims that Sullivan agreed to an audit by the Macdonalds’ accountant without a court order, but in December said it would not set a date for the audit until a confidential proposal put forward by Sullivan was addressed. In January, the Macdonalds rejected Sullivan’s proposal and made a counteroffer, upon which Sullivan suggested mediation.

The Macdonalds also contend that an agreement was signed in 1989 for the Road to Avonlea series, and while the company paid them for the first five seasons, they stopped paying in the final two seasons, with an alleged $40,000 in arrears outstanding.

Pepper says the crux of the issue is the definition of net profits – which the two sides cannot agree on – and an audit cannot take place until a decision as to what documents an auditor would be privy to in calculating a determination of profit. For example, should overhead and expense items be accessed by auditors and entered into this net profit calculation?

In March, Sullivan proposed that the matter be resolved through mediation and binding arbitration. In May, the company offered $150,000 to settle the claim, which the Macdonalds rejected. On July 6, the family held a news conference to bring the dispute into the spotlight.

‘We proposed a way to resolve this through mediation and binding arbitration and offered to give them access to all documents, but they pulled the plug on that process,’ says Pepper.

The Macdonalds are asking for an independent audit and a cheque, says Hebb. If the dispute is not resolved, going to court, which would be a lengthy process, is ‘an option,’ she says.

It could also damage Sullivan’s plans to go public. Its prospectus includes ambitious plans to further exploit Anne properties through new film and tv projects and merchandising opportunities.

The Macdonalds are disputing Sullivan’s right to proceed on further sequels without their authorization, and claim that all merchandising requires their approval.

Sullivan says it believes that the literary work Anne of Green Gables is in the public domain in Canada and elsewhere, and has been advised by its legal counsel that it holds all rights necessary for the production of its latest Anne of Green Gables miniseries, set to air next season on cbc; its new $6.5-million animated series based on the live-action production; and the merchandising of the characters from the new animated series. An animated Anne of Green Gables film is also planned.

In its prospectus, Sullivan made note of the dispute with the Macdonald heirs and stated that although it would defend any actions by the heirs, ‘even if amounts are owing to them, such amounts would not be material to Sullivan’s operations.’ The company estimated that if an arbitration proceeding ruled against them, ‘based on the industry definition of net profits which would be the most favourable to these descendants of Lucy Maud Montgomery,’ Sullivan would owe a maximum of $140,000.’

The Macdonald family is taking issue with the Sullivan prospectus, which boasts of high sales on its Anne properties. The prospectus states that ‘Historically, a significant portion of Sullivan’s revenue has been derived from sales of programming to the cbc, including Anne of Green Gables, Anne of Green Gables – The Sequel, Road to Avonlea. . . .’

Sullivan’s prospectus says its success includes ‘the ability to produce with low financial risk and maximize financial benefits by retaining worldwide distribution rights for its productions.’

The Macdonalds contend their agreement with the company stipulates that Sullivan requires their approval for merchandising activities. Meanwhile, the prospectus lays out a growth strategy for investors which includes plans to increase opportunities for merchandising and ancillary products, including characters from the new Anne of Green Gables series.

The prospectus projects more ‘evergreen product’ – which it defines as the successful re-licensing of programs long after original broadcast.’ Anne of Green Gables and Road to Avonlea are cited as examples of successful relicensed projects that ‘provide significant distribution revenue over a prolonged period of time and create ancillary product opportunities.’

The company document also states that ‘the revenue from Sullivan’s productions, combined with low overhead costs, has allowed it to maintain healthy profit margins and enabled it to produce programming without incurring long term debt.’

In 1998, revenue from its program library and home video operations (of which Anne properties and Anne of Avonlea are included) was $5.5 million.

Sullivan reported $30.5 million in revenue for the year ending Sept. 30, 1998 with ebitda of $11.1 million. Forecasts for fiscal 1999 predict a 17% year-over-year increase in revenue to $35.7 million and an increase in ebitda of just over 7% to $12 million.