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4 • 2020

How does a Loan-out Company Work?

Loan-out companies may be used primarily in the entertainment industry, but there is nothing exotic about the companies themselves. Just like any other business entities, they are formed for the purpose of allowing their owners to “take advantage of the corporate form.”[1] This advantage accrues, at the most fundamental level, because limited liability companies and corporations (which are the forms taken by most loan-out companies) are considered separate legal entities from their owners, who typically are not personally liable for the companies’ obligations.[2]

Loan-out companies are formed by filing the necessary paperwork with the appropriate state authority. In California, for example, a corporation’s existence begins with the filing of articles of incorporation with the California Secretary of State,[3] while a limited liability company is formed by filing articles of organization with the Secretary of State.[4] There is a filing fee, and there are other costs associated with forming and maintaining a limited liability company or a corporation,[5] including getting competent legal and accounting assistance,[6] so many advisors indicate that an artist should enjoy a certain level of income before opting to form and maintain a loan-out company.[7]

Once a loan-out company is properly formed and up and running, the company’s sole business function is generally to “loan out” the services of its artist-owner to production companies and other third-party employers wanting to use the artist-owner’s personal services.[8] That process usually involves three contractual relationships.[9]

In the first arrangement (the “employment agreement”), the artist-owner essentially contracts with him or herself. That is, the artist-owner’s wholly-owned loan-out company enters into an employment agreement with the artist, who agrees to provide services for the loan-out company.[10] The artist may also assign his or her rights, including intellectual property, to the loan-out company.[11] The employment agreement also establishes the loan-out company’s right to lend the artist’s services, or license his or her rights, to a third party.[12]

In the second arrangement (the “lending agreement” or the “licensing agreement”), the loan-out company then contracts to “loan out” the employee’s personal services, or license the employee’s rights, to a production company or other third party.[13] The third party that “borrows” the artist’s services pays the contract amount to the loan-out company, which in turn pays a salary to the artist,[14] and may also provide other benefits to the artist such as a retirement plan, a medical reimbursement plan, and various types of insurance.[15]

The third arrangement (the “inducement agreement”) is between the artist and the third party directly.[16] In essence, the artist guarantees that he or she will perform the personal services required by the lending agreement between the loan-out company and the third party.[17] While the inducement agreement is not strictly required for the loan-out arrangement to work, it is essential from the third-party employer’s perspective, for reasons that we’ll get into in an upcoming article.

[1]1 Thomas D. Selz, et al., Entertainment Law 3d: Legal Concepts and Business Practices § 8:32 (Westlaw updated through Dec. 2019).

[2]See, e.g., Superior Transcribing Serv., LLC v. Paul, 72 A.D.3d 675, 676, 898 N.Y.S.2d 234, 235 (2010) (“The general rule is that a corporation exists independently of its owners, who are not personally liable for its obligations, and that individuals may incorporate for the express purpose of limiting their liability[.]” (internal quotation marks omitted)); Main Line Pictures, Inc. v. Basinger, No. B077509, 1994 WL 814244, at *6 (Cal. Ct. App. Sept. 22, 1994) (“Performers’ ‘loan-out’ companies are not sham entities. As a general rule, the sole shareholder of a personal service corporation is not liable for the obligations of the corporation.” (citation omitted)).

[3]See Cal. Corp. Code § 200.

[4]See Cal. Corp. Code § 17702.01.

[5]See eMinutes Blog, How Much Does It Really Cost to Incorporate (Nov. 15, 2016); Michael Lovitz, Loan-Out Companies: Unintended Consequences for Creators?, 35 Del. Law. 16, 17 (Fall 2017).

[6]See eMinutes Blog, Why Every Entrepreneur Needs Both a Lawyer and a CPA to Form a Company (Dec. 12, 2015).

[7]See, e.g., Lovitz, supra note 5, at 17 (suggesting that “for an artist earning more than $100,000 annually, a properly organized and operated loan-out company will likely yield measurable benefits for its owner.”).

[8]See Home Box Office, Inc. v. Directors Guild of Am., Inc., 531 F. Supp. 578, 597 (S.D.N.Y. 1982); Aaron J. Moss & Kenneth Basin, Copyright Termination and Loan-Out Corporations: Reconciling Practice and Policy, 3 Harv. J. Sports & Ent. L. 55, 72 (2012); Lovitz, supra note 5, at 17.

[9]See 1 Selz et al., supra note 1, § 8:31.

[10]See id.; Lovitz, supra note 5, at 17; Moss & Basin, supra note 8, at 72.

[11]See, e.g., Great Entm’t Merch., Inc. v. VN Merch., Inc., No. 95 CIV. 9333 (LBS), 1996 WL 355377, at *1 (S.D.N.Y. June 27, 1996) (singer incorporated loan-out company for the sole purpose of holding his trademark and merchandising rights and licensing them to a third party); Roddenberry v. Roddenberry, 44 Cal. App. 4th 634, 641, 51 Cal. Rptr. 2d 907, 910 (1996), review denied (July 31, 1996) (loan-out company formed by creator of “Star Trek” owned a copyright interest and the rerun payment and profit participation rights in “Star Trek”).

[12]See 1 Selz et al., supra note 1, § 8:31; Matthau v. Superior Court, 151 Cal. App. 4th 593, 601, 60 Cal. Rptr. 3d 93, 98 (2007), review denied (Aug. 15, 2007) (a loan-out company has the right to the artist’s personal services, which are performed through loan-outs to third-party employer).

[13]See 1 Selz et al., supra note 1, § 8:31; Moss & Basin, supra note 8, at 72.

[14]See, e.g., Matthau, 151 Cal. App. 4th at 601, 60 Cal. Rptr. 3d at 99 (“When loan out companies are used by actors, the loan out company, rather than the actor, receives the compensation due from the studio or other employer for the actor’s services.”); Basinger, 1994 WL 814244, at *1 (actor “loaned out” her services through her loan-out company, which in turn employed and paid actor after payment for her services was made to the loan-out company); Laughton v. Comm’r, 40 B.T.A. 101, 101 (1939) (actor’s loan-out company realized substantial earnings through amounts paid to company as consideration for actor’s services under loan agreements), remanded, 113 F.2d 103 (9th Cir. 1940).

[15]See Mary LaFrance, The Separate Tax Status of Loan-Out Corporations, 48 Vand. L. Rev. 879, 881 (1995).

[16]See 1 Selz et al., supra note 1, § 8:31.

[17]See id. (the inducement agreement “binds the individual artist to render his or her services to the third party employer directly if the loan-out corporation breaches the lending agreement or becomes dissolved”); Great Entm’t Merch., Inc., 1996 WL 355377, at *1 (the function of an inducement agreement is “to ensure that the performing artist subscribes to the underlying obligations of the loan out company’s contract”); Basinger, 1994 WL 814244, at *3 (“The Inducement is in the nature of a personal guarantee.”).