03/2012. Special Ticker - "Crowdfunding"

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1 Newsletter Page 1/6 Special Ticker - "Crowdfunding" 1. The "Crowdfunding" phenomenon 2. Legal issues in connection with film financings by way of Crowdfunding 1. The "Crowdfunding" phenomenon 1.1 What is Crowdfunding? In general, the term, "Crowdfunding", which was coined in 2005/2006, refers to a specific form of financing of projects of an artistic, socio-political or social type by a high number of mostly private supporters, which form developed as a result of the possibilities of the Internet. In Crowdfunding, the initiator of a project outsources the financing process to the Internet community in whole or in part. Since the realisation of the first Crowdfunding project on the Internet platform, "Sellaband.com" (pre-financing of the costs of a music album by the fans) in 2006, a large variety of popular international Crowdfunding platforms emerged. The currently largest platform, "Kickstarter" (USA), states that it has approx. 550 new launches per month and had collected more than $ 32 million in 2011 for film productions alone. Other areas of the media sector such as music and computer games, however, also benefit from that new development. Even though the Crowdfunding platforms in these areas mostly focus on smaller amounts (less than $ 10,000 on average), there are a number of prominent success stories. For example, the developer studio, "Double Fine", recently received approx. $ 3.3 million within five weeks through a Crowdfunding action on "Kickstarter". Also, the US musician, Amanda Palmer, acquired approx. $ 1.2 million through Crowdfunding to finance her new solo album and the related tour. The importance of Crowdfunding is increasing also in Germany, in particular in the music and film sector. For example, the producers of the first film financed through Crowdfunding, "Hotel Desire" (2011), managed to generate the production costs of 170,000 through Crowdfunding within only three months. "Iron Sky", an international co-production with German participation, was, according to their own statements, also co-financed through Crowdfunding. The currently most prominent example in Germany is probably the planned film version of the TV series, "Stromberg", for which a total of 1 million was collected by way of Crowdfunding. 1.2 The stages of the Crowdfunding process Typically, the Crowdfunding process can be divided in three stages: (1) Publication of a project idea by the initiator on a Crowdfunding platform on the Internet: In addition to a transparent presentation of the actual contents of the planned project, the initiator will at the same time also

2 Film & TV-Ticker Newsletter Page 2/6 determine the specific intended use of the collected monies, the envisaged budget objective together with the limit for the collection period, as well as any consideration for the supporters. (2) Waiting for closing of financing: If they are convinced of the project, supporters may provide financial contributions in various amounts, which contributions will initially be held in trust by the Crowdfunding platform. (3) Implementation of the project or repayment according to the "all-or-nothing" principle: If the defined budget objective is not reached in full within the time limit, all financial contributions will normally be returned to the supporters, and the Crowdfunding financing will have failed. If the financing objective is reached, the initiator will start the actual implementation of the project while using the contributions by the supporters. As a general rule, the Internet platform operator will be paid specific commission for its intermediary activities. 1.3 Consideration for the supporters Whether, and to what extent, the supporters will receive from the initiator future consideration for their financial contributions depends on the respective Crowdfunding project and is structured very differently. There is a range from a purely ideational support without any consideration to an actual participation in the proceeds of the (film) project. In other cases, supporters will, alternatively or in addition, also receive consideration depending on the amount of their financial contribution without a profit participation such as merchandising articles, film DVDs, tickets for the opening night, a personal mention in the final credits, private screenings etc. Normally, supporters will, however, not acquire any real shares or rights in the project and will have no say in the realization of the production. 2. Legal issues in connection with film financings by way of Crowdfunding Crowdfunding raises a number of legal issues which have hardly been discussed before, in particular, in relation to the legal qualification of the contractual relationships established between the parties involved, questions regarding copyright law, as well as potential requirements under capital market law. The most important legal issues are set out below: 2.1 Contractual relationship between the initiator and the supporter If the supporter, after the registration on the platform, undertakes to provide financial support to the project, this will create a contractual relationship between the initiator and the supporter, with the platform operator's role normally being limited to that of a mere intermediary. So, the platform operator will normally not act as a legal representative of the initiator but merely as a messenger/agent.

3 Film & TV-Ticker Newsletter Page 3/ Support without consideration If the financial support is rendered without any consideration by the initiator, this will qualify as a donation. To be legally effective, a deed of donation must be notarised, and this will regularly not be the case in relation to Crowdfunding. The resultant formal defect will, however, be remedied by the actual rendering of the performance promised by the supporter. Pending the rendering of the performance, however, the initiator will have no claim against the supporter for payment of the promised amount for lack of an effective contract. If it is provided that the contribution rendered by the supporter will be repaid in the event of the failure of the production (or the failure to close the financing), a support without a consideration by the initiator will qualify as a donation subject to conditions ( 525 German Civil Code). In the event of the failure of the production, the repayment claim will then follow from the statutory provisions ( 527 German Civil Code) Support with a consideration (without profit participation) If the initiator promises to mention the supporter in the final credits of the film as a consideration for the support, unless otherwise agreed, in case of doubt a sponsoring agreement it is to be assumed to exist. Such agreement will not be considered to be a donation due to the lack of gratuitousness. Therefore, the agreement will not come into existence only upon the rendering of the performance but, rather, as early as upon the making of the promise by the supporter to render a contribution. That agreement will then be governed by the provisions of the German Civil Code regarding the law of obligations, in consideration of the practices in the business Support with a profit participation If the initiator promises to the supporter a financial participation resulting from the exploitation of the production (e.g., in the producer's net proceeds, resp. the "back end"), this will not yet constitute the conclusion of a contract under company law (in the form of a partnership under the German Civil Code or a silent partnership), as Crowdfunding normally lacks the typical voting and approval rights and the contribution to maximise the profit, nor will it be a loan in the conventional sense due to a lack of an agreement on interest. Rather, a support with a consideration must be considered to be a legal relationship with a profit participation. Unless agreed otherwise, if no fixed repayment claim of the supporter (and thus indirectly also a share in the loss) is agreed in relation to the contribution rendered, a participating right will exist. On the other hand, if a full repayment claim is agreed, a profitparticipating loan will exist. Therefore, the statutory provisions regarding partnerships under the German Civil Code and silent partnerships will not apply. That legal classification may be a great advantage to

4 Film & TV-Ticker Newsletter Page 4/6 the initiator with a view to a duty to publish a prospectus (if any) (see also below). In the case of a profit participation which applies to proceeds in the first rank, it must also be considered that this will usually not be compatible with distribution agreements regarding the film, which provide for a prior repayment of minimum guarantees furnished. The same applies to repayment claims of film subsidies which stipulate a corridor in front ranks (e.g., Eurimages). From a producer's perspective, it is, therefore, recommendable agreeing a participation in the proceeds which does not apply until the "back end", or at least not until the recoupment of distribution guarantees and senior claims repayable to subsidies. 2.2 Ancillary right of the film producer Capacity as film producer Under 94 German Copyright Act, the film producer has the exclusive right to reproduce, distribute and show the film produced by it. In that context, a "film producer" is the person who, in an overall view, renders the organisational and economic performances for the production. In the case of Crowdfunding, a supporter will not normally be involved in the actual film production, nor will a supporter have any voting and approval rights of or decision-making powers. Against that background, a supporter does not qualify as a film producer within the meaning of the statutory provisions. Under tax law, a supporter does not qualify as a film producer, either, within the meaning of the "Media Decree" by the tax authorities as a result of the absence of the necessary actual ability of the supporter to exert an influence on the production process, as well as a joint ownership of the rights to the film. Therefore, an option of tax depreciation in relation to the contributions rendered by supporters as coentrepreneurs of a co-production does not exist. 2.3 Duty to publish a prospectus Under the provisions of the German Investment Products Act (VermAnlG), providers of publicly offered shares which grant a participation in the results of a business enterprise, as well as providers of profit-sharing rights, are required to publish a prospectus which, in particular, informs investors of the risks relating to the investment. Such prospectus must be approved by the German Federal Financial Supervisory Authority (BaFin) prior to publication. Violations of the duty to publish a prospectus may result in substantial fines. Offers for less than 20 shares, or offers with a sales price not exceeding 100,000 in a year, or offers for shares with an individual price of 200,000 or more, are not, however, covered by the duty to publish a prospectus. In the prevailing view held by legal commentators, profit-participating loans are not covered by the duty to publish a prospectus, either. Therefore, unless the aforementioned exceptions apply, Crowdfunding may be

5 Film & TV-Ticker Newsletter Page 5/6 subject to the duty to publish a prospectus, depending on the structuring of the contractual relationships. To avoid such duty, where possible, it is recommendable using a structure in the form of a profitparticipation loan (repayment duty including a share in the profit). 2.4 BaFin licence of the platform operator If the contribution is paid directly or indirectly (e.g. through Paypal) through the platform operator, the question arises whether a licence by BaFin will be required in accordance with 8, para. 1 German Act on the Supervision of Payment Services (ZAG). If a business enterprise provides payment services on a commercial basis, it will be deemed a payment service provider within the meaning of the ZAG. This will also apply if the payment services must only be regarded as an ancillary service to the principal business (recent judgement by the Regional Court of Cologne regarding an intermediary for online food orders). If amounts of money are received exclusively for the transfer of the relevant amount to the recipient of the payment in the absence of the opening of an account, the Regional Court of Cologne held that a money transmission transaction will exist. Therefore, this could also be assumed in the case that the platform operator receives contributions by supporters, for example, through Paypal, and pays such contributions subsequently to the initiator. Against that background, a relevant licence requirement under 8 ZAG can be considered if the payment of contributions is settled as set out above. The requirement of such licence can be avoided if the payment is made directly in the relation between the initiator and the supporter. Dr. Ulrich Fuchs and Dr. Johann Heyde Internal Dr. Johann Heyde was awarded for his doctoral thesis Cross-boarder Licensing of Online-Music Rights in Europe with the 2011 faculty award of the faculty of law of Ludwig-Maximilians- Universität, Munich. Practice Group Film/TV Dr. Ulrich Fuchs Dr. Christoph Haesner Florian Hensel Dr. Johann Heyde Norbert Klingner Dr. Karolin Nelles LL.M. Dr. Andreas Peschel-Mehner Dr. Ulrich Reber Dr. Gerd Hansen Prof. Dr. Mathias Schwarz Dr. Anne Zoll Hanna Bickel LL.M.

6 Film & TV-Ticker Newsletter Page 6/6 Legal Notice SKW Schwarz Rechtsanwälte Steuerberater Wirtschaftsprüfer The seat of the partnership is in Munich, registered with the Local Court of Munich under PR 884. Authorized representative: Prof. Dr. Mathias Schwarz Chief editor: Dr. Johann Heyde Locations: Berlin Frankfurt/Main Neues Kranzler Eck/Kurfürstendamm 21 Moerfelder Landstraße 117 T +49 (0) T +49 (0) F +49 (0) F +49 (0) Dusseldorf Munich Steinstraße 1/Kö Wittelsbacherplatz 1 T +49 (0) T +49 (0) F +49 (0) F +49 (0) Hamburg Ferdinandstraße 3 T +49 (0) F +49 (0) If you no longer wish to receive the Film & TV-Ticker, please send us an or inform your contact at our firm. We will be happy to inform you of our other tickers and newsletters. Occupational title: Rechtsanwalt/-anwältin der BRD Competent chamber of lawyers: Chambers of lawyers of Berlin, Düsseldorf, Frankfurt a.m., Hamburg und München The professional regulations may be retrieved at under the heading Professional Regulations duties to inform pursuant to 5 German Telemedia Act. SKW Schwarz 2012