Alex Du is a lawyer at the Toronto law firm of McMillan Binch and a member of the firm’s KNOWlaw Group.

obtaining enough financing to complete a project is one of the most important tasks a producer will face during a film and television production. Over the years, producers have learned how to be creative and flexible, learning new structures and financing techniques to ensure that whatever sources of funding they do obtain will meet the production budget.

What to do when you

have a ‘gap’

With presales to other countries diminishing and production costs rising (not to mention exchange rate risks), producers will often find a gap in their budget. In the film and television industry, the term ‘gap’ typically refers to the difference between the production budget for a project and the total amount of contingent or anticipated sources of funding obtained to date.

For example, if a producer secures $1 million in presales and other sources of contingent funding for a project with a $2-million budget, the project would have a $1-million gap or deficit. Gaps are typically reduced by future or anticipated sales to distributors in either domestic or foreign markets.

The following is a brief analysis of how gaps arise and how some producers attempt to get around them when financing their projects.

Interim financing

In most cases, funds representing presales, tax credits, deferrals, investments and other sources of funding are not immediately available and are contingent on certain events occurring before a producer can have access to them.

For example, many presale contracts stipulate that amounts due to the production company are not payable until the project is delivered.

Meanwhile, money is needed to pay production costs, virtually all of which are due before delivery. Since producers cannot use these contingent sources of funds to directly finance the production, they turn to banks to lend them the money they need to provide the needed cash flow. Banks will look to the presales and other contingent sources of funding as collateral for a loan. This type of a loan is often referred to as interim financing.

Traditionally, banks will provide production interim financing if they know there are enough presale commitments and other sources of funding to meet the production budget (i.e., there is no gap) and that the producer has obtained a completion guarantee or bond for the benefit of the bank.

If a project can’t be finished on time or on budget, a completion guarantor usually agrees to continue production and undertakes delivery of the project by a certain date. A completion guarantee provides the bank with a certain degree of comfort because they know someone with the proper expertise will complete and deliver the project on time and therefore, trigger presale obligations needed to pay the production loan back to the bank.

Essentially, a completion guarantee or bond permits the bank to accept presales, tax credits or other sources of funding as security for its production loan.

Gap financing

While it is true that some banks in Canada have become more sophisticated and knowledgeable of the film and television production business, as a general rule, most of them will not offer production loans if a gap exists in the budget.

A gap represents insufficient collateral for a bank to lend against, and since banks are generally uncomfortable with unsecured lending, they have traditionally stayed away from lending in this kind of situation. Moreover, with the exception of a few, most banks in Canada do not or have not yet acquired the expertise and experience to assess the risks associated with anticipated or future sales of a film or television project in various unsold markets.

Does this mean that Canadian banks do not provide gap financing? No. Some banks in Canada have already developed an understanding of the film and television production business, formed relationships with, or have learned about the reputations of, certain sales agents and producers and can comfortably take risks that other less experienced banks will not tolerate. These are the banks that are most likely to have, or are willing to provide, gap financing for Canadian productions.

However, as time goes on, more banks will begin to understand and become sophisticated about film and television production. With this increased understanding will come more competition among the banks and they will have to differentiate themselves from each other. As the Canadian film and television industry matures, banks may take a greater interest in gap financing since the risks will be better understood and the fees that a bank can earn for this type of lending can be lucrative.

In deciding whether to provide gap financing, banks will assess their risk by looking at several factors such as:

* the production budget and the size of the gap;

* the production company’s history of completing its projects;

* the producer’s sales forecasts or projections for unsold foreign and domestic markets; and,

* the reputation and past successes of the production company or a sales agent in obtaining sales in unsold markets or territories.

So, while banks in Canada are no longer saying no to gap financing, they are saying yes only to established producers with a proven track record and reputable sales agent.

Those banks that are prepared to provide gap financing will limit the size of the gap they finance. Banks will typically charge higher interest rates and a fee for gap production loans to compensate for the risk they are taking. Also, keep in mind that gap production loans typically have an interest reserve (i.e. the portion of the total loan that a bank will hold back from the production company in order to ensure that enough is available to at least repay the interest on the loan) that is larger than in traditional production loans since the gap loan will not be repaid until some time after the project has been completed and delivered to distributors.

Insurance-backed

guarantees

There’s a form of gap financing that is done by way of an ‘insurance-backed guarantee.’ This works by having an insurance company issue a policy that ‘guarantees’ that the bank will, over a specified period of time, be repaid from sales of the film or television project. The policy is usually issued in an amount equal to the gap. If the bank fails to get repaid over the time set out in the policy, the insurance company would pay the bank the amount insured.

In effect, the insurance policy is borrowed against and acts as the bank’s missing collateral – it fills the gap. Of course, there is still a cost associated with this type of gap financing. These policies are costly, sometimes starting as high as 10% to 12% of the gap amount insured and the bank will still increase the interest reserve because the loan will not be paid back to the bank until some time after the project has been completed and delivered or until the policy is drawn upon.

A producer will have to determine whether such a strategy is more cost-efficient than just a straight gap production loan from a bank with a fee and increased reserve.

In the u.s market, insurance companies have limited these policies to large independents who make a large number of studio-distributed films. The insurance companies have conducted an analysis of the films released by studios and have determined that over a period of time, losses from one film can be offset by gains in another. By looking at a series of films released by a studio, the insurance companies can determine how many films must be produced and distributed to spread the risk to an acceptable level.

According to some industry analysts, insurance companies have not yet been able to ascertain the risks associated with providing a policy to an independent producer who makes only one or two films in a year since they do not fit into the studio distribution analysis. This type of gap financing product is currently uncommon in Canada.

Contingent loss of

revenue policies

There’s yet another variation on this insurance theme. A ‘contingent loss of revenue’ policy allows a bank to tolerate greater gaps in the production budget since the production company usually takes out an insurance policy for the full amount of the production budget with an insurer, rather than just for the missing gap.

Like the insurance-backed guarantee, the beneficiary of the policy is the bank. The bank still takes full security on all of the assets of the production company similar to that of a typical production loan, works with the producer to obtain a completion guarantee, and ensures that it can step into the shoes of the owner of the policy in the event that it has to enforce its security.

With this type of insurance product in place, a bank can get quite comfortable (provided the insurance company is reputable and has a proven track record of paying on its policies) with lending against the policy.

However, similar to the insurance-backed guarantee, there is a steep price to pay for this kind of policy:

* an increase in the interest reserve will be necessary for sales completed after delivery;

* policy fees are quite high, from 10% to 15% of the amount of the policy (i.e. of the total budget); and,

* legal fees for negotiating and drafting all of the documentation necessary for production financing will increase substantially. This is because the insurer is potentially on the hook for the cost of the entire production, so they will want to be deeply involved in the negotiations and the overall structuring of the financing.

This type of gap financing has been used in Canada, albeit infrequently and not always with success.

The bottom line

Canadian producers have always had to be experts in complex financing structures – ones that involve an often bewildering mix of private money, public funds, tax laws, international treaties and banks. For those with the stamina for learning yet another complex way of funding a production, these types of gap and insurance-backed financing are providing a new alternative.

(This article contains general comments only. It is not intended to be exhaustive and should not be considered as advice in any particular situation.)