Hollywood’s Script in China

Three experts discuss China’s rapidly evolving film industry and opportunities for US entertainment companies

It’s been a busy year for the US film industry in China. During Xi Jinping’s visit to the United States in February, the PRC government announced it would loosen China’s quota on imported films. In April, the Walt Disney Co. announced it would co-produce Iron Man 3 with Chinese company DMG Entertainment. Shortly after, the US Securities and Exchange Commission (SEC) announced an investigation into whether Hollywood movie studios had been paying bribes while working in China, but that hasn’t stopped business deals between the two countries’ film industries. In May, Dalian Wanda Group Co. said it would buy AMC Entertainment Holdings, which operates more than 300 movie theaters in the United States. And this spring, American films have been opening at the top of China’s box office rankings.

To make sense of these developments and the potential of the Chinese film market for US companies, three film industry experts recently spoke to CBR Editor Christina Nelson about trends in producing and distributing films in China.

Mathew Alderson, a Beijing-based partner at Harris & Moure Attorneys, represents individuals and companies in media, entertainment, and intellectual property-intensive industries. He blogs about China’s film industry and legal issues at www.chinalawblog.com. He recently discussed legal troubles companies run into while producing and distributing films, as well as whether China will increase the quota on the number of foreign films it allows into the country.

Why are studios co-producing films in China?

Alderson: China now has the largest foreign box office market in the world, but in China there are effectively no sources of ancillary income, such as income from Internet downloads and home rental. So, Hollywood studios want a piece of the box office action. There is a quota for foreign films that can share in box office revenue. The reason for the interest in co-productions is that they are regarded by the Chinese as domestic films and are therefore not subject to the quota. The share of box office payable on co-productions is higher: a co-production can command around 38 percent of box office as opposed to 13 to 25 percent available for imported films. The Chinese authorities also require that around 55 percent of total box office is taken by domestic films so a certain return on domestic films is guaranteed.

What is the most common legal mistake you see companies make when it comes to producing and distributing films in China?

Alderson: There are several common mistakes. First, companies often fail to undertake proper due diligence on their Chinese co-producers and other Chinese counter-parties. As a result, fundamental matters such as the existence, identity, and domicile of a Chinese person or a Chinese company are not established, and the permits or licenses these parties require under Chinese law are not verified. Second, there is a tendency to assume that US law and jurisdiction should apply to all contracts in all circumstances. US law and jurisdiction are of little value unless the Chinese party has assets in the United States. These days good results can often be obtained by foreigners seeking to enforce contracts in the Chinese courts, particularly in the top-tier cities. Finally, there is a tendency to sign brief memoranda of understanding (MOU) or other short-form documents without taking independent advice. Normally prepared by the Chinese party, such documents tend to lock the foreigners into a particular type of entity or a particular deal structure when these may be inappropriate or even unlawful. Foreigners are often reluctant to subject these types of documents to close scrutiny for fear of insulting their partner and losing some advantage or opportunity, which is usually illusory anyway.

What can you tell us about the SEC investigation into whether Hollywood studios were bribing PRC government officials to film and distribute movies in China?

Alderson: The investigation was announced during the 2nd Beijing International Film Festival. The timing was instructive. Clearly, the SEC is sending Hollywood a message here. The message is that the entertainment business in China is no longer the “Wild West.”

What are a few best practices the movie studios—and companies in general—can implement to avoid violating the Foreign Corrupt Practices Act (FCPA)?

Alderson: At least put FCPA compliance provisions in all contracts made in or in connection with China. The US Association of Corporate Counsel recommends that contracts should specifically mention the importance of FCPA compliance and require partners to represent that they know the elements of the law and will comply with it. You should have a clearly worded audit clause that requires the partner to provide documents and assistance in an investigation. You should also ensure that you are able to terminate a contract if your partner is in violation of the FCPA. Other than that, you should be aware that the SEC tends to regard representatives of state-owned enterprises (SOEs) to be representatives of the Chinese government, and financial dealings with those representatives are in the cross hairs. Any US corporation that has formed a joint venture with an SOE needs to be very careful about the payments made to representatives of that SOE.

What are the implications of the announcement in February during Xi Jinping’s visit to the United States that China would increase the quota of films it allows in the country?

Alderson: Have the Chinese really made such a decision? I am not yet convinced. During Xi Jingping’s recent visit to Hollywood, the US announced the signing of a new film-related agreement with China. The agreement was said to improve the terms on which the US may import films into China for theatrical release. This all took place in the context of the World Trade Organization (WTO) dispute between the two countries over the importation and exhibition of “audiovisual entertainment products” in China.

If the film agreement exists at all, it has not been published at the time of this interview. So far, all we have seen is a draft joint communication from the US and China delegations to the WTO’s dispute settlement body. The communication reports that “progress” has been made in resolving the dispute and that an MOU sets out some “preliminary arrangements” made by the two countries. The MOU has not been published, but the joint communication says that it includes certain “key elements.” Three of these elements in particular are worth mentioning. First, enhanced format films (for example, IMAX) are not subject to the 20-film quota. Second, the distributor of a film imported on a revenue-share basis is entitled to 25 percent of gross box office takings. Third, Chinese entities other than China Film Group [China’s largest state-owned film company] will be entitled to import and distribute films. Clearly, it is impossible to form a view on the situation without reading the MOU. The deal has apparently been put forward in an effort to resolve part of an ongoing WTO dispute. The key elements of the deal are preliminary.

Robert Cain, a partner at film co-production company Pacific Bridge Pictures, has been doing business in China since 1987. He has worked on co-productions in China, including the film Mongol, which was nominated for the 2008 Academy Award for best foreign language film. He writes about China’s film industry on his blog, China Film Biz. Cain says co-productions between US and Chinese film companies offer immense opportunities, but Hollywood studios may have to change their business model to adapt to the China market.

There has been a lot in the news about Hollywood studios doing co-productions in China. Is there actually an uptick in this trend, and why would a film studio decide to pursue a co-production?

Cain: There’s certainly been an uptick in talk and announcements. The reality is there have been very few real US-China co-productions. You can really count on one hand the number that have been done in the last three or four years. What people tend not to know or talk about is that there’s a huge co-production business in China with companies from other places like Hong Kong, Taiwan, and [South] Korea.

The reasons for doing a co-production are pretty clear. There’s still a—and I think there will be one for a while— quota on the import of films into China. Even with the increased number of slots that are expected to open up this year, [the Chinese government is] still restricting the number of films that can get in. So doing a film as a co-production is a way of getting around the quota. If films qualify as approved co-productions then they are treated just like any domestic production with open access to distribution. And the other important reason is the economics are better. You get a better share of the box office.

Are American companies trying to model themselves after companies from Hong Kong and Taiwan that have done co-productions before?

Cain: No, in fact I’m not sure how aware they are of the existing, pretty successful approaches. Particularly in Hong Kong and Taiwan, there’s such a cultural affinity and understanding. They speak the same language, and it’s easier for them to work with each other. They also, in my experience, come with more of an attitude of meeting the Chinese producers at least halfway and making an effort to understand what their needs and the needs of the marketplace are. They really tailor their films and their approach to be successful in China. The Hollywood studios are still trying to figure that out.

Are we going to see more Chinese characters or plotlines that fit with Chinese traditions of storytelling in Hollywood films?

Cain: I think there’s an awareness in Hollywood that they need to figure out how to cater better to the Chinese audience. I wasn’t at the Beijing International Film Festival this year, but what I’ve been reading, what I’ve been hearing is there’s been more activity around US-China co-productions. I don’t know what the result is from those conversations. But generally speaking, I think the studios are at least at the point where they now understand how quickly China is growing, and how important it’s becoming. You can’t ignore the numbers because they’re growing so quickly. How that’s translating into effective action, I’m not sure. I haven’t seen very much of it yet.

Is piracy still a big industry concern? If so, what can you do about it as a foreign company?

Cain: There’s been a huge amount of pressure applied for many years. It is still a concern. It’s interesting that where online piracy is also a big problem at least there is a lot of spending and legitimate acquisition of film titles by online distributors. So where there was no money coming back to the studios from that, at least there’s some revenue stream [from online sources] and it’s one that’s growing from China. So much of the viewing in China has shifted from physical media to online—that change is happening really quickly.

What is it like to work with a Chinese company to make a movie? What are some of the challenges and benefits of doing this?

Cain: I really enjoyed the experiences I’ve had working with the Chinese producers and crews. I can’t really say I’ve had any more problems or challenges than I’ve had elsewhere. The difficulty in working there is the infrastructure for making films is still at an early stage of development, and the talent pool is not very experienced yet. There are great film-makers and great writers, but there just aren’t many of them. It’s hard to find people at the level of skill and professionalism that you’re accustomed to finding here in Los Angeles. And that goes all the way down the line, sourcing cameras and equipment and sound stages. But that’s changing; there’s been a lot of investment in China so it’s getting better. It’s an issue that’s going to go away as they make more films there and get more experience. The opportunity, of course, is just to show a part of the world that people are eager to learn about and understand. There are also phenomenal locations. I made a couple of productions in Beijing and Shanghai, and they are really spectacular locations. Just having access to such a big and growing market is a real plus.

Brent Reynolds has been traveling and doing business in China for almost 30 years. Through a company he founded in 2006, Q Global Entertainment, Reynolds licenses and distributes films in China to television stations and web portals, including China Central Television (CCTV), Sohu.com, and Tudou. Reynolds recently answered questions about distributing films in China and the fast growing market for on-demand video.

What are the steps a company would take to distribute a film in China?

Reynolds: It’s a little bit more convoluted than purchasing the film rights, taking it to another country, and distributing it. We have to authenticate it first. So we take our contracts to a government bureau and they check with wherever we bought the film. The Chinese group actually goes back and verifies within that country from the supplier you bought it from that you actually own the rights you say you do. Once that’s done, and that takes a month or so, then you get your chops and your stamps and you go to the censors with it. The censor will decide whether this film will pass, if it needs to be edited, or if it’s outright rejected. There’s a different censor for TV, theatrical, and new-media or web-based distribution models. It’s fairly convoluted and time consuming. Once you get it through those first couple of steps, should you succeed, then you can take it out and try to show trailers to your different customers or go to one of the film festivals—in Shanghai, Beijing or Hong Kong—and try and show it and market it. Then you can sit down and write contracts, and after you sign the contracts, you get to chase your valued Chinese customers to get them to pay you.

What are some of the challenges associated with chasing down payments?

Reynolds: The only challenges are delays. We get paid by everybody. For instance, I have sold to DVD makers, and they pay me pretty quickly. And some of the other folks pay on time, and others take three to six months depending on the contract. It’s not really bad, you just have to chase a little bit harder.

Is the legitimate market for on-demand, streaming video growing now?

Reynolds: That’s increasing and that’s a fairly robust distribution model in China. The big studios in the United States seemed to fight the idea of web distribution, but now we have Netflix. China didn’t have those legacy businesses that stifled music or film distribution on the web. Initially, China had a lot of pirated films and a lot of pirated music being distributed on the web, but in the last couple of years the government has started to crack down seriously on that and we’re dealing with a lot of extremely large, profitable, legitimate Chinese web portals that buy and verify legitimately licensed entertainment from Western sources. They almost can’t get enough of it. They want so much of that stuff. It’s incredible to see the change in China as far as licensed distribution of legitimate products.

When did this side of the business start to take off?

Reynolds: I would say in the last two years. It’s been very recent. Before that they were buying the films, but there was a lot of pirated product out there and the legitimate companies weren’t paying very much for the films.

Is this something you would recommend to film companies as a way to distribute films?

Reynolds: If you’re a film studio and you have really good quality films and you’re not trying to do something in China, then you ought to find a distributor in China to monetize your films. They’re not doing any good staying at home. And a lot of the Hollywood studios have libraries of hundreds of great films that could readily be distributed profitably in China. I’m not sure which ones are doing very much, but we don’t see a lot of them succeeding at a high level.

What about piracy? How can film studios protect against piracy?

Reynolds: A few years ago the top Hollywood studios got behind in China because their executives were worried about piracy. Well, the fact is that when a movie comes out in America theatrically or even before, the Chinese already have it. So when I get a film to China or a studio gets it to China, if the Chinese want it, they’ve pirated it, but they have a second-quality copy and the distribution is limited. CCTV, new media companies, universities, airlines, hotels, and military installations will still buy [the real versions]. So the legitimate distributors of film that can only use licensed products that are checked by the government will still buy our films.

Piracy is a fight that we should continue to battle, but we shouldn’t put all our resources into it. Our resources should be put into bringing our beautiful American product that we’re the best in the world in producing to China, and we should push the name brand in China.