Disney sued over accounting by film financiers

Maybe you’ve already heard, but Disney’s in hot water—and not just because of the actors and writers strikes happening right now.

Disney is being accused by one of its major financial partners of using “nearly every trick in the Hollywood accounting playbook to deprive” TSG Entertainment, a film financing firm, “out of hundreds of millions of dollars,” according to a lawsuit filed on August 15 in Los Angeles County Superior Court.

In the suit, TSG took aim at both Disney and its subsidiary, 20th Century Studios, formerly 20th Century Fox, which joined Disney in 2019 as part of a multibillion-dollar acquisition.

Since 2012, TSG has been in a revenue participation agreement with 20th Century Studios under its former name, and this agreement was amended nine times throughout its duration, per the lawsuit.

The RPA outlined how TSG would profit from selected films’ revenue in exchange for its financing commitments, including production and marketing costs.

The financier said it has invested “in good faith” over $3.3 billion into “some of Fox’s most successful, beloved, and award-winning films,” including blockbusters like Avatar: The Way of Water, Bohemian Rhapsody, and the Deadpool and X-Men franchises.

Over time, though, the financier noticed that the return on its investments was decreasing “dramatically,” leading the firm to hire an independent auditing firm to conduct an audit “of Fox’s books and records” to see whether or not the terms of the RPA were being upheld.

The independent audit found that Fox underpaid TSG by at least $40 million using “a number of underhanded Hollywood accounting tricks,” according to the lawsuit. It also throws a number of other allegations at the defendants, including the claim that Disney negotiated “sweetheart” deals in which TSG-backed films boosted Disney’s subscriber numbers, while minimizing “the profit payments to stakeholders like TSG.”

As of this writing, Disney has not commented on the lawsuit.

Revenue recognition. At the core, though, is the central allegation that there was around $40 million “that should have been accounted for that wasn’t there,” according to Jason Cherubini, co-founder and CFO of Dawn’s Light Media and chair of the accounting department at Stevenson University. “If that’s actually off, and there were gross receipts that existed that were not paid to investors, that’s a straight breach of contract,” he explained.

Cherubini takes issue “when people throw out ‘Hollywood accounting’ as if it’s this massive gray area, and it’s exclusive to Hollywood,” he said. “It really has a lot to do with revenue recognition and where you match expenses to.”

Ripple effect. But, ironically, the bigger implications of the lawsuit will likely stem from some of the additional allegations against 20th Century Studios and Disney, not the underpayment, Cherubini explained.

“When you get into some of the self-dealing stuff, I think that’s more where this could change things in the industry,” he explained, adding that it aligns with some of the demands regarding streaming brought forth in the WGA and SAG strikes.

“Most of the profit shares—this is profit shares for SAG, for WGA, for investors—often have been lifted off of, ‘Well, what is the film going to earn?’” Cherubuni pointed out. In the past, studios could “directly measure that, through box office ticket sales, through transactional video on demand, and through streaming licenses,” he added.

But now, as media heavyweights become “part of the production company…they’re going to license it to themselves, [to] their streaming service. It benefits them to license it at the minimum amount.”

“This disrupture of payout is going to have to be addressed in this new way of consuming media,” he continued. “Because if you’re investing in a film, and…all of your profit from that film [is] tied to box office dollars and license deal dollars, and there’s a way to skirt that with that self-dealing, you want a way around that.”

Wider repercussions? These issues, though uniquely linked to the intense period of labor upheaval and unrest in entertainment, aren’t siloed to the film and TV industries, Cherubini said, and finance leaders across industries can learn from the Disney lawsuit and the strikes.

“When we look to other [non-media] industries, it really is looking at, ‘How do you structure performance bonuses? And do you go to other KPIs beyond just financial metrics?’” he said. In the film industry, most of these benefits have been purely aligned with financial metrics, and that’s causing conflict in the streaming era. Financial leaders should consider it a lesson.

“Now that we’re…seeing these other benefits, you may have to move more to a balanced, scorecard-type approach, where you’re going to list the benefits or you’re going to measure the profit sharing, or however you make those performance payments, on other things as well,” Cherubini said.