Film Financing in India

Bank Financing of “Bollywood” Films: Opportunity or Risk?

Stephen W. Workman, Esq.*

The film industry in India is prolific. “Bollywood,” as the industry is typically referred to, is the world’s largest
by volume, producing in excess of 1000 films annually.1 Surprisingly, however, Indian banks and financial
institutions have been slow to enter the film financing arena. Instead, the vast majority of these films have
been funded through corporate or private investment arrangements.2 This stands in contrast with the United
States, where banks have played a prominent role in Hollywood production finance for years.3

There are various means by which a producer can fund a motion picture project, including sale of
partnership interests, or entering into a production funding arrangement with a studio.4 Independent
producers, however, often prefer bank financing because it allows the producer to retain greater control over
the film while also not having to share box office receipts with financial backers.5

Bank financing of independent films can be characterized as pure “asset-based lending” because the
production company has no business history and is not a “going concern.”6 The bank must therefore be
satisfied that it is adequately securitized for repayment of the loan. With regard to film productions, loan
collateral is available in a number of forms.

Domestic Collateral Available to Banks for Production Loans

In the funding of domestic (e.g., Hollywood) films, a bank’s primary collateral is in the form of either a single
distribution agreement, whereby a single entity is acquiring all of the exploitation rights in the film (a so-
called “negative pickup” deal), or in the form of several “pre-sale agreements.”7 These are distribution
agreements, or licenses, the producer has negotiated and entered into for exploitation of the film in various
territories and markets. For example, a producer may have executed pre-sale agreements for “domestic
theatrical rights,” “foreign theatrical rights” and “home video rights” to the film, which serve as the primary
source of repayment of the bank’s loan.8 The problem, of course, is that these receivables do not mature
until the film is completed and delivered.

The bank will also obtain security interests in the assets of the production company through a standard
UCC-1 filing, and in the film itself, through a copyright mortgage and a laboratory agreement.9 The bank will
also insist on assignment of any underlying literary rights, such as the story and script, as well as any prior
grant of motion picture rights from an author or publisher.10 But if the film is not produced, edited and
delivered in a timely manner, the bank’s primary collateral becomes, essentially, worthless. The “accounts
receivable” represented by the pre-sale agreements are not due and payable unless and until the film is
delivered to the licensee in accordance with the delivery schedule and conforms to the agreed upon
specifications.11 If circumstances arise that give a licensee a reason to not accept delivery, or if delivery fails
altogether, the bank is exposed because, by definition, the production company does not have alternate
means of repaying the loan.

The risk of non-delivery of the film, however, is not a “credit risk,” and is not a risk that the bank will
assume.12 Therefore, the producer needs a mechanism to address the contingency of non-delivery of the
film or rejection by a licensee. This mechanism is the “completion bond” or “completion guaranty.” The
completion guarantor guarantees to the bank, via the completion bond, that the film will be completed and
delivered to the licensee(s) in accordance with the delivery schedule.13 In the event film cannot be timely
delivered, whether due to late delivery or abandonment of the project, the completion guarantor pays the
bank an amount that typically equals the producer’s outstanding indebtedness.14 The completion bond will
also grant the guarantor the right to step in and assume control of the production if significant risks arise,
such as the production falling significantly behind schedule or significantly over budget.15 In addition, banks
will typically obtain a “cut through endorsement” from the completion guarantor, which serves to guaranty
performance of the completion bond by the guarantor’s insurance company.16

More specifically, the security obtained by banks in funding U.S. film productions include: Mortgage and
assignment of copyright in the film. Through this instrument, which is filed with the United States Copyright
Office, the producer transfers all right, title and interest in the film’s copyright to the bank.17 UCC-1 financing
statement covering all assets of the production company. This statement is filed with the Secretary of State
of the state in which the production company is organized. Typically, the UCC-1 is also filed in the state(s)
where the film is produced, and also with the Secretary of State of California.18 Laboratory pledgeholder
agreement between the bank and the film processing laboratory. Under this agreement, the bank requests
the laboratory to subordinate its lien in the film negative to the bank. As pledgeholder for the bank, the
laboratory agrees to hold the film for the benefit of the bank in the event of default. The bank might permit
the laboratory to retain its lien in a senior position up to a specified dollar amount, to cover unpaid services.19

Collateral Available under Indian Law

The extent to which security interests are available to financial institutions under the laws of India will
influence the extent of their involvement in funding of production of “Bollywood” films. Absent a predictable
legal framework, lenders will be reluctant to take on the risks associated with a film project.20

India’s legal system has been characterized as “an unreformed derivative common law system,” where
general principles of common law are combined with a fragmentary statutory scheme, causing uncertainty in
the application of law.21 As a result, the rules governing “secured transactions” in India are scattered among
various statutes, none of which is comprehensive even as to its own subject matter.22

Despite reform efforts by such organizations as the Asian Development Bank and the European Bank for
Reconstruction and Development, India has yet to consolidate the law relating to the creation, perfection and
enforcement of security interests.23Depending on the nature of the collateral and manner of creation, any
number of statutes my impact a security interest under Indian law. The Transfer of Property Act of 1882
applies where the security is immovable property or choses in action. The Registration Act controls the
registration of immovable property. Negotiable instruments are governed by the Negotiable Instruments Act
of 1872. Intellectual property is subject to the Copyright Act of 1957, the Design Act of 1911, the Patent Act
of 1970 or the Trade and Merchandise Act of 1958. A pledge of tangible movables is subject to the Contract
Act of 1872. The Companies Act of 1956 may also apply if the debtor is a limited company. The Insurance
Act of 1938 controls rights in insurance policies. 24

In an effort to streamline enforcement of certain types of security interests, India enacted the Securitisation
and Reconstruction of Financial Assets and Enforcement of Security Act (the “Act”) in 2002.25 The Act does
not address issues of priority or perfection, and does not eliminate the application of the above stated
disparate statutes.26 It does, however, establish the power of secured creditors to sell secured assets without
the intervention of the courts and establishes a national office (the Central Registry) for the recording of
certain asset based lending transactions.27

Prior to the Act, a secured creditor could not register its security interest other than in immovable property;
rather, only charges incurred by a limited liability company borrower were registered, and registration was
the obligation of the company borrower.28

Security interest in the “general property” of the debtor

India has a mechanism for a lender to obtain a security interest in the general property of a corporate
borrower, such as a production company. This mechanism, the “floating charge,” is derived from English
common law.29 The accepted definition of this mechanism appears in a judicial opinion of Lord Macnaughten
in 1897:
 A floating security is an equitable charge in the assets for the time being of a going concern. It
attaches to the subject charged in the varying condition in which it happens to be from time to time.
It is of the essence of such a charge that it remains dormant until the undertaking charged ceases
to be a going concern or until the person in whose favour the charge is created intervenes.30

The instrument of debt creating the floating charge (debenture) would contain the rights of “intervention” of
the charge-holder.31Where the debtor company is a going concern, the Companies Act permits and provides
for appointment of receivers by debenture floating charge-holders. Upon appointment of the receiver, the
floating charges crystallize on the debtor’s assets and the debtor can no longer make use of the assets
without the receiver’s consent.32

The Act now permits the holder of a security interest in the form of a floating charge to record the transaction
in the Central Registry.33

Security Interests in Specific Movable Property

India has no law specific to a security interest in moveable property, except in the case of a “pledge.”34 A
pledge is a security interest where possession of the goods, in the form of a bailment, is also granted to the
creditor.35 Section 172 of the Contracts Act defines a pledge as “the bailment of goods as security for
payment of a debt.” A pledge, therefore, covers specific property, and the property must be delivered to the
creditor.36 Delivery need not be actual, it can be constructive, but it must be sufficient to place the creditor in
full legal control of the goods.37 In event of default, the creditor (the “pawnee”), can elect among two
remedies: sue on the debt and retain goods as collateral pending litigation, or sell the goods. If sale of the
goods results in a deficit, the pawnee can sue the debtor for the balance; if the sale results in a surplus (after
interest and expenses), the pawnee is obliged to return the excess amount.38

Pledges are excluded from registration on the Central Registry.39 The presumed reason for this exclusion is
due to the fact that pledges are already well protected by Section 176 of the Contracts Act.40

A second form of security interest recognized under Indian common law is the hypothecation. This form of
transaction establishes a lien over specific moveable property as security for a debt when the debtor
retaining possession of the collateral.41 Hypothecation is the preferred, and sometimes only, method of
obtaining security in property that must remain with the debtor for ongoing business purposes, so that
business operations are not adversely affected.42 In order for a lien under hypothecation to represent a
viable security interest, it follows that the debtor cannot transfer the property to a third person without the
express permission of the creditor.43 However, courts in India have not always consistently applied this
principle.

In one case, the Supreme Court held that in a hypothecation of company stock, the debtor was free to sell
the stock without the permission of the creditor.44 In another case, the Supreme Court held that a bank lost
its security interest in machinery because it did not affix metal plates on the machinery to display that it had
been hypothecated to the bank.45 These cases underscore the uncertain legal rights of creditors, as the
courts seem to have confused hypothecation being a fixed or floating charge.46

Until 2002, banks and financial institutions had to enforce hypothecation security interests in Court, a slow
and time consuming process.47 With the passage of the Act, banks and financial institutions now have a
security interest arising by hypothecation can record the transaction in the Central Registry and its interest
can be enforced without court intervention.48

Copyright as Collateral
One of India’s few modern and comprehensive statutes, the Copyright Act of 1957, as amended, provides
authors with the full range of protections under copyright as is found in the United States.49 In fact, the anti-
piracy provisions and criminal infringement penalties under the Indian Act make it among the most stringent
in the world.50

Section 57 of the Act defines an author’s rights under copyright, and includes the right of
assignment.51 Accordingly, copyright in the script, underlying literary property, film and soundtrack are
available as collateral. By way of example, the Industrial Development Bank of India requires an assignment
of copyright to the film’s music, video and electronic rights.52 However, the assignment of these properties
should specify a term or will be deemed lapsed after five years, by operation of law.53 A “mortgage” of
copyright is not specifically recognized under Indian law. Mortgages are, by definition, limited to “immovable
property.”54

As India is a signatory to the Berne Convention, registration is not a prerequisite to acquiring copyright in a
work; rather, copyright arises upon creation of the creative work.55 However, the Indian Copyright Act does
provide for registration of copyright with the office of the Registrar maintained in the Copyright Office
Department of Education.56 Assignment of copyright may be registered with the Registrar, but registration is
not required to effectuate the assignment.57

Availability of Completion Guarantees

In 2002, the risk shifting mechanism of the completion bond arrived in Bollywood. In that year, Film
Finances, Inc., the Los Angeles based completion bond company that dominates the industry worldwide,
opened an office in India, becoming the first company to offer completion guarantees in India.58 In 2005,
General Insurance Company of India began offering underwriting support to Infinity Film Completion
Services, a newly formed division of an Indian venture capital group, for up to 25 film completion bond
projects.

Assignability of “Pre-Sale” Contracts

Where a producer has entered into a “pre-sale” contract, for distribution rights in the film for one or more
markets, media or territories, may the bank obtain an assignment of the “future receivables” represented by
such contract? Indian law follows English common law on this subject.59 Under common law, the position on
transferability of future debt suffered for a time by the maxim “you cannot transfer what you do not already
have.”60 In the case of Tailby v. Official Receiver, however, English common made the shift to recognize that
“future debts” are properly assignable, so long as upon their coming into existence they can be identified
with certainty.61 Tailby has been followed by the courts of India, and it is now clear that while a future debt
can be transferred only when it arises, a contract of assignment may be entered into now to effect the future
transfer.62

Conclusion
Although India has yet to adopt a comprehensive statutory framework for secured transactions as has been
recommended by international financial reform organizations, Securitisation Asset Reconstruction and
Enforcement of Securities Act of 2002 represents an improvement in enforcement of security interests.
Expanded registration rights of lenders holding non-posessory liens is also a positive development, but
India’s courts need to do a better job of applying common law principles of hypothecation given the absence
of a comprehensive code. The forms of collateral available to banks lending to film productions in India
versus the United States are not dissimilar; a range of collateral is available. Banks can, and do, obtain loan
security in the form of a first hypothecation charge of movable assets, copyright and pre-sale contract
assignments, and laboratory agreements pledging the film negatives. It is the arrival of the completion
guarantee, however, that has finally made bank financing of Indian films commercially attractive to banks.
According to a study conducted by Rabo India Finance Pty Ltd. in 2002, the reluctance of banks to lend to
the motion picture industry was due to the lack of assurance that films would be completed on time and
within budget.63 The arrival of the completion guaranty to India cannot be underestimated. Following Film
Finance’s entry into a strategic alliance with the Industrial Development Bank of India, the Reserve Bank of
India lifted the restriction against banks financing film projects have a production budget in excess of Rs 100
million.64

Another issue identified in the Rabo report was the need for India’s film industry to give better structure and
organization to the production, distribution and exhibition segments.65 As observed by the chairman of the
Bank of India, the film industry must recognize that it is, after all, a business, and the most difficult task for
bankers is “to create an environment where the dreamers understand the numbers, and the accountants
understand the dreams.”66 More and more banks are entering the Indian film finance arena.67 But for bank
financing of films to reach its full potential, Bollywood needs to better understand the powers of collateral
and business organization, and legislators need to adopt a more modern and comprehensive law of secured
transactions.

*Stephen W. Workman is a member of the State Bar of California and the State Bar of Illinois, and is
currently pursuing an LLM degree in the International Business & Trade master of laws program at John
Marshall Law School in Chicago, Illinois, for which this paper is written.