The Importance of the Inducement Agreement in Dealing with a Loan-out Company
Actors and other creatives often use loan-out companies to offer their services or rights to others. The artist’s wholly-owned company enters into an “employment agreement” with the artist and then “loans out” the artist’s services to a third-party production company or other employer pursuant to what we have referred to as a “lending agreement.” Strictly speaking, those two contracts are the only ones required for the loan-out arrangement to work, but the third-party employer will almost always insist on entering into an “inducement agreement” directly with the artist to protect its interests, for reasons exemplified by two loan-out cases decided in the mid-1990’s.
In the first case, the actor Kim Basinger initially agreed in January 1991 to appear in the film “Boxing Helena.” Based on Basinger’s oral agreement, the production company, Main Line Pictures, Inc. (“Main Line”), had substantial presales for the film and began preproduction activities such as casting, wardrobe, special effects, and model construction. In May 1991, final execution drafts of the lending agreement and the inducement agreement were prepared. The draft lending agreement was between Main Line and Basinger’s loan-out company, Mighty Wind Productions, Inc. (“Mighty Wind”), for the acting services of Basinger. The lending agreement called for Mighty Wind to cause Basinger to report for the rendition of services in connection with “Boxing Helena,” in exchange for which compensation would be paid to Mighty Wind. There was no place for Basinger to sign as an individual, and the agreement was never signed anyway. The inducement agreement was in the nature of a personal guarantee by Basinger and provided that she was familiar with the lending agreement between Mighty Wind and Main Line and consented to its execution. In addition, if Mighty Wind breached the lending agreement, Main Line could join Basinger in the action without first having to exhaust its remedies against Mighty Wind. The inducement agreement called for Basinger’s personal signature, but that agreement, too, was never signed. In the meantime, Basinger changed agents in April 1991, and her new agency advised her not to make the film.
When Basinger pulled out in June 1991, Main Line sued Basinger and Mighty Wind, alleging that they had breached a contract to provide Basinger’s acting services. Importantly, the complaint contained no alter ego allegations, that is, Main Line did not allege that Mighty Wind’s corporate veil should be pierced to hold Basinger personally liable for Main Line’s obligation to provide Basinger’s acting services under the lending agreement. Even though Main Line never asserted an alter ego theory, the judge approved various special verdict questions for the jury asking whether Basinger “and/or” Mighty Wind had breached a contract with Main Line to perform acting services in “Boxing Helena.” The jury concluded that “Basinger and/or Mighty Wind had entered into and breached oral and written contracts with Main Line, causing damages in the amount of almost $7.5 million. Including attorney’s fees of more than $700,000, the trial court entered judgment against Basinger and/or Mighty Wind in the amount of about $8.135 million.
Basinger appealed the judgment. The court of appeal noted the standard rule that corporations are separate legal entities, distinct from their shareholders and officers, that are formed for numerous business reasons, “including as a shield from liability and for tax purposes.” And personal service corporations, such as loan-out companies, are “entitled to the same separability of identity as are other corporations,” such that even sole shareholders of personal service corporations are generally “not liable for the obligations of the corporation.” Because Main Line expressly rejected any reliance on an alter ego theory to hold Basinger liable for Mighty Wind’s obligations under the lending agreement, Mighty Wind and Basinger were “not synonymous” and Basinger could not be liable for Mighty Wind’s corporate obligations under that agreement, as written. While it was possible that Basinger individually may have entered into an oral agreement with Main Line to provide her acting services on the film, the jury made no specific findings on that issue. In addition, the record contained no testimony concerning the separate inducement agreement, which was “in the nature of a personal guarantee” but which was not signed by Basinger. In short, “[a]lthough Basinger’s services were key to the contract, the issue is the party or parties responsible if she fails to perform. If the contract is only with Mighty Wind, then only Mighty Wind can be liable for a breach of the contract.” Because the court of appeal could not tell from the trial record whether the jury found that Basinger, Mighty Wind, or both of them entered into the contract, the court reversed the judgment. However, the jury verdict would have stood had Main Line simply obtained a well-drafted inducement agreement, signed by Basinger individually, guaranteeing Mighty Wind’s obligation to provide Basinger’s acting services on “Boxing Helena.”
This important lesson to be learned from the Basinger case came a little too late for the plaintiff in the second case amply demonstrating the importance of the inducement agreement when contracting with a loan-out company. In that case, Vince Neil, the lead singer of Mötley Crüe, was getting ready to embark on a solo concert tour. In May 1993, Neil entered into negotiations with Great Entertainment Merchandise, Inc. (“GEM”) for the licensing of Neil’s trademark and merchandising rights to manufacture T-shirts for the tour. On June 22, 1993, Neil established his loan-out company, VN Merchandising, Inc. (“VN”), for the sole purpose of holding his rights and licensing them to GEM. The next day, VN licensed its sole asset, Neil’s trademark and merchandising rights, to GEM, for $1 million. The $1 million was structured as an advance on the royalties VN expected to accrue from GEM’s exploitation of those rights. In return, VN agreed to cause Neil to undertake a concert tour before an aggregate of 800,000 paid attendees, which was the number GEM anticipated would be required in order to earn back the advance and turn a profit on the deal. In addition, VN agreed that if Neil failed to perform before 800,000 paid attendees, then GEM could demand that VN repay the full amount of the unrecouped advance paid by GEM.
At the same time, Neil signed an inducement agreement. The court explained the vital importance of the inducement agreement when dealing with a loan-out company:
A routine practice in the entertainment industry, the function of an inducement letter is to ensure that the performing artist subscribes to the underlying obligations of the loan out company’s contract. Since the purchaser of the service enters into a contract with an often under-capitalized company, whose only asset is the underlying right which is to be purchased, the purchaser needs some assurance that the performer is willing to honor the contract of his [loan-out] company[,] lest its only recourse be against a shell corporation. Inducement letters, in effect, allow the loan out company to guarantee the personal services of the individual artist.
Unlike Basinger, Neil actually signed an inducement agreement, in which Neil agreed, in relevant part, to perform and discharge, to the best of his ability, “all of the obligations undertaken by me pursuant to the terms and conditions of my agreement with [VN] so as to fulfill all of the commitments, warranties, and representations contained in the Agreement [between VN and GEM] and in all of the provisions as the same apply to me.
As it turns out, Neil’s tour did not meet expectations and he only performed before an aggregate number of 533,032 paid attendees, about one-third short of the 800,000 guaranteed number. Accordingly, GEM demanded that VN and Neil repay the full amount of the unrecouped $1 million advance paid to VN. When they both refused, GEM sued them both and obtained summary judgment against VN. As to Neil, however, the court noted that he would have to repay the advance only if the inducement agreement could be construed as a guarantee of VN’s obligations under its agreement with GEM. Notably, the court started from the position that the language of a purported guarantee must be strictly construed. The court found that Neil convincingly argued that the quoted language merely promised that Neil would use his best efforts to perform for 800,000 attendees but did not “unequivocally guaranty VN’s financial obligations.” Although it seemed logical that GEM would “never have entered into a contract with a single asset company … without some protection of a financially responsible guarantor,” and would have bargained for some assurance that the $1 million advance “could be recoupable against a financially viable party,” the court was nonetheless “troubled by the apparent lack of wording specifying a financial guarantee” of VN’s obligations under its own agreement with GEM. Therefore, the court concluded that, in light of the New York law that a guarantee must be strictly construed, it was not appropriate to enter summary judgment against Neil on the breach-of-contract issue.
The lessons of the Basinger and Neil cases are clear. When a third party contracts with a loan-out company to obtain the artist-owner’s services or rights, not only must the third party obtain a signed inducement agreement from the artist-owner, but the third party must also ensure that the language of the inducement agreement plainly and sufficiently guarantees that the artist-owner will perform the loan-out company’s obligations to the third party under the lending or licensing agreement, as the case may be.
See id. at *4, 6. We will cover piercing the corporate veil and alter ego liability specifically in the context of loan-out companies in a future article. For now, background information is available in other articles we have written on veil-piercing and alter ego liability. See, e.g., eMinutes Blog, The Benefits of Incorporating (Nov. 5, 2016); eMinutes Blog, Reducing Risk of Alter Ego With Some Simple Things (Apr. 10, 2016).
See Basinger, 1994 WL 814244, at *4.
Id. at *5.
Id. at *6.
Id. at *7 (emphasis added).
Id. at *7. The court refused, however, to order judgment in favor of Basinger and Main Line. Id. at *7-8. Thus, the case could be retried. In fact, the case was scheduled to be retried, but it appears that Basinger eventually settled shortly before the retrial. See Variety, Basinger “Boxing” Suit Settled (Dec. 17, 1995). In the meantime, “Boxing Helena” was filmed with Sherilyn Fenn in the title role and bombed horribly on its release in September 1993. See IMDb, “Boxing Helena” (film’s total gross was only $1,796,389).
Given the report that Basinger settled before the retrial for less than half the amount of the jury verdict, not obtaining a signed inducement agreement was a very costly mistake.
Great Entm’t Merch., Inc. v. VN Merch., Inc., No. 95 CIV. 9333 (LBS), 1996 WL 355377 (S.D.N.Y. June 27, 1996).
Id. at *1 (footnote omitted).
Id. at *2.
Id. at *3.
Id. at *4. Note that in the Neil case, unlike in Basinger, GEM asserted an alter ego claim for relief against Neil. Because that is a highly fact specific inquiry, however, GEM did not ask the court to assess the validity of that claim as part of its motion for summary judgment. Accordingly, the court left “the highly relevant issue of piercing the corporate veil for a later day.” Id. at *3.