# Durkin v. Commissioner

> United States Tax Court · December 22, 1986 · 87 T.C. 1329

URL: https://www.frixlaw.com/law-library/cases/4628587

## Case

- **Full name:** Thomas J. Durkin and Colette A. Durkin v. Commissioner of Internal Revenue, Respondent Jerome A. Grossman and Sybil G. Grossman v. Commissioner of Internal Revenue
- **Court:** United States Tax Court
- **Decided:** December 22, 1986
- **Citations:** 87 T.C. 1329; 87 T.C. No. 79; 1986 U.S. Tax Ct. LEXIS 7
- **Precedential status:** Published
- **Opinion:** Opinion
- **Judges:** Simpson
- **Cited by:** 59 later opinions in the Frix Law Library

## Citator (automated)

- No negative treatment found by the automated citator. That is not the same as a confirmation that the case is good law; read the citing cases.
- Full citator and citing cases: https://www.frixlaw.com/law-library/cases/4628587

## How later opinions describe it (automated extraction)

- concluding that economic reality assured that promissory notes of limited partners to the partnership would be enforced

## Opinion text

Thomas J. Durkin and Colette A. Durkin, Petitioners v. Commissioner of Internal Revenue, Respondent; Jerome A. Grossman and Sybil G. Grossman, Petitioners v. Commissioner of Internal Revenue, Respondent
Durkin v. Commissioner
Docket Nos. 18885-82, 25313-82, 22937-83, 4229-84, 17602-84, 17677-84, 27623-84
United States Tax Court
87 T.C. 1329 ; 1986 U.S. Tax Ct. LEXIS 7 ; 87 T.C. No. 79 ;
December 22, 1986 , Filed
*7 Decisions will be entered under Rule 155 .
D was a limited partner in B, and G was an indirect limited partner in S. PPC, a producer and distributor of major movies, sold all of its rights, except sequel rights, in six movies to FWC. FWC paid PPC cash and short-term recourse notes equal to 25 percent of the negative cost and long-term nonrecourse notes equal to 75 percent of the negative cost of each movie. In 1977, on the same day it purchased two of the six movies, FWC sold them to B. In 1978, on the same day it purchased the remaining four of the six movies, FWC sold them to S. B and S paid cash and short-term recourse notes in excess of 25 percent of the negative cost and long-term recourse notes equal to 75 percent of the negative cost of each movie, but the long-term notes would become nonrecourse on the occurrence of certain specified conditions. D and G guaranteed the long-term notes. On the same days that B and S purportedly purchased their motion pictures, they executed distribution agreements with PPC, wherein they transferred all of their rights, except copyright, in such motion pictures to PPC. PPC distributed the motion pictures. S borrowed money from Delta *8 at 9 1/2 percent interest per annum and with bonus payments based on PPC's nontheatrical gross receipts. Such money was needed because the initial payments for the movies exceeded the capitalization of S. B and S made guaranteed payments to their general partners of both a fixed dollar amount and a percentage of cash-flow. B and S reported various deductions. D and G reported tax losses for every year through 1980, except 1979 for G, and claimed investment credits as a result of the activities of B and S. Numerous subpoenas duces tecum issued on behalf of the Commissioner were quashed. Held :
1. B and S did not acquire a depreciable interest in the motion pictures. They purchased, in substance, only a contractual right to payments contingent on the success of the motion pictures.
2. B and S are entitled to depreciate their bases in each such contract right.
3. B and S erred in using motion picture gross receipts when calculating depreciation under the income-forecast method.
4. B erred in not including an estimate of network television revenue when calculating depreciation under the income-forecast method, where there was an agreement but no signed contract concerning network *9 television exhibition.
5. S could not use the double-declining-balance method of depreciation because its contract rights were intangible assets. The straight-line method must be used; useful life of such assets determined to be 6 years.
6. The long-term notes from B and S to FWC were not bona fide recourse debt and, therefore, were not includable in depreciable bases.
7. The short-term notes from B and S to FWC due prior to 1986 were bona fide recourse debt and, therefore, were includable in depreciable bases.
8. D and G are entitled to investment credit with respect to the motion pictures because B and S acquired an "ownership interest" in each of their respective films within the meaning of sec. 48(k)(1), I.R.C. 1954 .
9. B and S are not entitled to deduct guaranteed payments made to their general partners.
10. B and S are not entitled to current deductions for advertising payments where such payments are found to be part of the purchase price of certain motion pictures.
11. Expenses arising from private screenings of motion pictures by S were ordinary and necessary business expenses.
12. Certain amounts deducted by B and S were for organization costs.
13. Bonus fees paid to Delta *10 were not reasonable in amount.
14. This Court properly quashed the Commissioner's subpoenas duces tecum.
Alan F. Segal , for the petitioners in all dockets.
Calvin Eisenberg , for the petitioners in all dockets except docket No. 22937-83.
Bryan R. Sullivan and Thomas J. Kane , for the respondent.
Simpson , Judge .
SIMPSON
*1331 The Commissioner determined the following deficiencies in, and additions to, the petitioners' Federal income taxes: Addition to tax
sec. 6651(a)(1),
Petitioners Docket Nos. Year Deficiency I.R.C. 1954 1
Thomas J. Durkin and 25313-82 1977 $ 18,642.56
Colette A. Durkin 18885-82 1978 35,162.50
27623-84 1979 33,376.74
4229-84 1980 17,275.58
Jerome A. Grossman and 22937-83 1978 46,196.00 $ 10,513
Sybil G. Grossman 17677-84 1979 53,395.00
17602-84 1980 13,802.00 3,450
After concessions by the parties, the issues for decision are: (1) Whether the petitioner, Thomas Durkin, as a limited partner in a partnership *14 which purportedly owned two motion pictures, and the petitioner, Jerome A. Grossman, as an indirect limited partner in a partnership which purportedly *1332 owned four motion pictures, are entitled to deductions for distributive shares of losses reported by the partnerships, and, if so, what are the appropriate partnership deductions; (2) whether the petitioners are entitled to investment credits for their investments in such motion pictures; and (3) whether this Court erred in quashing the Commissioner's subpoenas duces tecum.
FINDINGS OF FACT
Some of the facts have been stipulated, and those facts are so found.
The petitioners, Thomas J. and Colette A. Durkin, husband and wife, resided in Westchester, Illinois, at the time they filed their petitions. They filed their joint Federal income tax returns for 1977, 1978, 1979, and 1980 with the Internal Revenue Service Center at *15 Kansas City, Missouri. The petitioners, Jerome A. and Sybil G. Grossman, husband and wife, resided in Northbrook, Illinois, at the time they filed their petitions. They filed their joint Federal income tax returns for 1978, 1979, and 1980 with the Office of the District Director of Internal Revenue, Chicago, Illinois.
During all the years at issue, Paramount Pictures Corp. (Paramount) was a subsidiary of Gulf & Western Co. (G & W), a diversified holding company. During such years, Paramount was an industry leader engaged in the production, acquisition, and distribution of feature motion pictures, and in the production and distribution of television movies and series. Paramount's production facilities were located in Los Angeles, and its distribution activities were coordinated in New York. It also had approximately 40 branch offices throughout the country involved in motion picture distribution. It made substantially greater profit from distribution than it did from production. It sought to supply its large distribution network with between 15 and 20 motion pictures per year.
Since 1968, Charles J. Arney, Jr., has held various positions at Paramount and its parent company, G *16 & W. In 1972, he was the assistant controller at Paramount. In 1975 and 1976, he took the position of director of treasury operations. In November 1977, he became the president of Gulf & Western-Canada, Ltd. In January 1979, he went to *1333 the west coast as the tax department representative at Paramount. In October 1979, he started working for Arthur Barron, the executive vice president of finance and administration for Paramount. Mr. Arney was the principal negotiator for Paramount in the transactions at issue in this case.
Calvin Eisenberg is an attorney who worked for the Internal Revenue Service for approximately 4 years. In 1966, he joined the law firm of Levenfeld & Kanter (the law firm), 2 where he has worked ever since. Prior to 1977, he was involved in establishing several motion picture "service company" partnerships. Such a partnership was responsible for all aspects of bringing a motion picture into existence for a fixed price. Paramount was a partner in several of such partnerships.
*17 John Heyman has been involved in the entertainment industry for many years. Upon graduation from Oxford University Graduate School, he began working in the commercial television industry creating, writing, and packaging shows. Packaging a show consists of organizing all the nontechnical aspects of the show, such as the script, the director, and the cast. Later, he became a theatrical agent representing, among others, Elizabeth Taylor, Richard Burton, Richard Harris, Lawrence Harvey, Trevor Howard, and Burt Bacharach. As an agent of highly sought after entertainers, his primary duties were to identify the best jobs and to negotiate the contracts for such jobs. He negotiated his first "negative pick-up" deal with Paramount in 1971 or 1972. Such a deal involves the purchase of the negative of a motion picture after it has been completed; the purchaser picks up the film as a finished product. The purchase can be contracted for at anytime, including before production starts. He successfully negotiated six or seven such deals in 1977, a similar number in 1978, and eight or nine in 1979.
World Film Services, Ltd. (WFS), is a British concern which was formed by Mr. Heyman in the early *18 1960s. Since the inception of WFS, he has owned all but 1 share of its stock and has served as a director. The remaining share is held by a nominee, as required by British law. During the *1334 mid-1970s, WFS usually had between 6 and 20 full-time employees in the London office. During the production of a film, WFS had as many as 300 employees.
In 1973, the Film Writers Co. (FWC), 3 a California corporation, was formed as a subsidiary of WFS through the merger of the West Coast Film Writers Co. and the East Coast Film Writers Co. Such corporation was a signatory to the Writers Guild of America basic agreement, the Producers-Writers Guild of America Pension Plan, and the Motion Picture Health and Welfare Fund. It has been involved in several ventures in the entertainment industry. The corporation had no more than 6 employees when not in production, and up to 200 when in production.
*19 During the years at issue, Bernard M. Filler was the chief operating officer and principal shareholder of Capital B Corp. (Capital B). Prior to graduating from Stanford Law School in 1962, he attended the University of Illinois and passed the Certified Public Accountant's exam. Mr. Filler served on the board of editors of the Stanford Law Review and is a member of The Order of the Coif. For 7 years, while in New York, he practiced law in the areas of corporate securities, investment banking, and finance while an associate at Paul, Weiss, Rifkind, Wharton & Garrison. In 1974, he became partner in charge of corporate development at the Chicago law firm of Holleb, Gerstein & Glass (the Glass firm).
In 1977, Mr. Filler decided to abandon the practice of law and to form an investment banking firm, Capital B. The initial share distribution of Capital B was 40 percent to Mr. Filler, 50 percent to members of the law firm, or trusts or partnerships associated with them, and 10 percent to members of the Glass firm. For the years 1977 through 1980, Mr. Filler was the president of Capital B. At various times during such years, Roger Baskes, Mr. Eisenberg, Steven Felsenthal, Stanford L. *20 Glass, and Milton Levenfeld were the other officers of Capital B. Messrs. Baskes, Eisenberg, Filler, Glass, Kanter, and Levenfeld, together with Robert Gerstein, Michael Friedberg, and Richard K. *1335 Janger served as directors of Capital B during such years; Messrs. Filler, Glass, and Kanter served in such capacity every year. Messrs. Baskes, Eisenberg, Friedberg, Janger, Kanter, and Levenfeld were partners in the law firm, Mr. Felsenthal was an associate of the law firm, and Messrs. Gerstein and Glass were partners in the Glass firm.
During the first months of 1977, Capital B actively sought to participate in a number of bona fide investment banking projects. Because Mr. Filler believed that the presence of partners of the law firm and the Glass firm gave potential customers the impression that Capital B had the resources to meet their needs, he frequently asked such partners to participate in meetings with potential customers. In May 1977, Capital B received its first fee, in the amount of $ 6,000, from the syndication of an oil and gas partnership. Mr. Filler wrote memorandums concerning his activities. Such memorandums were distributed to the Capital B board of directors.
*21 From 1977 through 1980, Capital B served as a general partner in at least 10 motion picture negative pickup partnerships organized with the assistance of the law firm. For each such year, at least 85 percent of Capital B's gross receipts were guaranteed payments from such partnerships. Starting on January 1, 1978, Capital B paid the law firm a monthly retainer of $ 75,000; a few months later, such retainer was increased to $ 100,000 per month.
Prior to the establishment of Capital B, Mr. Eisenberg determined that motion picture service company transactions were not very profitable and were difficult to structure and manage. Additionally, section 280, added to the Code by section 210 of the Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1544, required individuals to capitalize the cost of producing films and to amortize such cost essentially in conformity with the income-forecast method. Such requirement decreased the profitability of motion picture service company partnerships which had previously been allowed to deduct the full costs of production as they were incurred. As a result, Mr. Eisenberg has not been involved in forming any such partnerships since the time of the *22 1976 act.
*1336 In 1977 and 1978, all of the motion pictures purchased by Mr. Heyman through FWC were sold to partnerships organized by Capital B and Mr. Eisenberg. In 1979, FWC again sold films to such partnerships, and FWC sold $ 108 million or $ 109 million worth of films to a British bank. In 1980, FWC effectively stopped doing business in the United States. Such stoppage resulted from the breakup of the law firm and resultant divided loyalties on the part of Mr. Heyman. At the same time, Mr. Heyman did a great deal of business in England.
In 1980, on the advice of its accountant, FWC transferred certain of its assets and liabilities to a wholly owned subsidiary, FWC-Del. Such transfer was made to avoid certain New York State income taxes. FWC-Del. opened an office in Chicago in the same building as the offices of the law firm. Lester Bernstein, president of FWC-Del., accepted the assignment from FWC of certain motion picture acquisition agreements and purchase agreements, including those concerning the transactions at issue. Notification of such assignments was sent to Paramount by FWC. Such notification was prepared by the law firm and signed by Pamela H. Osowski. *23 Paramount acknowledged receipt of such notification in a letter to the law firm. At such time, Mr. Bernstein was involved in other activities concerning the law firm.
In March or April of 1977, Mr. Heyman contacted Mr. Eisenberg and asked if he would be interested in purchasing two motion pictures which FWC was in the process of obtaining. Such films were "The Bad News Bears in Breaking Training" ("Bears 2"), a Paramount picture, and "Greased Lightning," a Warner Brothers picture. Although Mr. Filler was apprehensive about the enterprise, it was decided that Capital B would form a limited partnership to purchase such films. 4 At that time, it was agreed that Mr. Eisenberg, who had known Mr. Filler since 1974 or 1975, would provide the expertise for negotiations and other activities where his knowledge of the film industry would be helpful, and that Mr. Filler would handle the administrative details of such partnership. Shortly thereafter, Capital B *1337 formed Ambassador Associates (Ambassador), a limited partnership. Such partnership, like those involved in the case at hand, was intended to engage in negative pickup transactions.
*24 On July 27, 1977, FWC purchased "Bears 2." Due to the lack of subscriptions, such motion picture was the only one purchased by Ambassador. On the same day, FWC entered into a letter agreement with Paramount under which the parties agreed to the sale and distribution of six other motion pictures under terms substantially the same as those in the acquisition agreement and the distribution agreement pertaining to "Bears 2." The motion pictures included in such letter agreement were: "Saturday Night Fever," "Duellists," "Heaven Can Wait," "Looking For Mr. Goodbar," "First Love," and "The One and Only." Such letter agreement set forth the closing and release dates, and the acquisition agreement and distribution agreement terms for each motion picture. Although not legally committed to do so, in July 1977, limited partnerships formed by Capital B purchased all six pictures.
The acquisition agreement, dated November 2, 1977, by which Paramount sold "First Love" to FWC provided, in pertinent part:
1. SELLER'S REPRESENTATIONS AND WARRANTIES: The SELLER represents and warrants that as of the date hereof:
* * * *
1.8 SELLER has obtained customary Errors and Omissions Insurance from Fireman's *25 Fund pursuant to SELLER's blanket policies, such coverage to be for the benefit of SELLER and PURCHASER as their interest may appear. * * *
* * * *
1.14 Except for the purchase price payable hereunder, and the gross receipts participations and deferments listed in Exhibit "A" annexed hereto, and customary musical performance rights payments and "residual" payments pursuant to applicable collective bargaining agreements, no sums are or will be due or payable by the PURCHASER with respect to the PICTURE or by anyone authorized by the PURCHASER to exercise any of the rights, powers, licensese [sic] and privileges herein granted to the PURCHASER. This warranty shall not be applicable to any sums due or payable by reason of any transactions entered into by PURCHASER with respect to the PICTURE, except insofar as such transaction shall cause any sums to become due and/or payable pursuant *1338 to an agreement and/or commitment made by SELLER or by which SELLER is bound.
1.15 * * * The SELLER is the copyright proprietor of the PICTURE. * * *
1.16 The PICTURE was produced in the United States of America.
* * * *
1.18 The SELLER has obtained all the necessary documentation authorizing *26 the production, exhibition, performance, distribution, marketing and exploitation of the PICTURE and the rights sold hereunder, throughout the world, for any and all purposes, and by every means, method and device now or hereafter known and required for the full, complete and unlimited exercise and enjoyment by the PURCHASER, its grantees and licensees, of each and all of the distribution, exhibition, broadcast and exploitation rights sold to the PURCHASER, and the PURCHASER shall own, possess and enjoy all such rights without any liability or obligation to or hindrance by any person, firm or corporation, except as otherwise specified herein.
* * * *
3. SALE: SELLER hereby sells to PURCHASER and PURCHASER hereby purchases from SELLER all of SELLER'S rights, title and interest of any and every kind and character whatsoever in and to the PICTURE, the copyright therein (and all renewals and extensions thereof), and the original negative thereof. Without limiting the generality of the foregoing, SELLER hereby sells, transfers and assigns to PURCHASER all of those items specified in Exhibit "B" attached hereto, all rights, title and interest in and to the PICTURE and any and all parts *27 thereof and the literary, musical and dramatic material contained therein (but only as embodied therein) throughout the world, and the sole, exclusive and irrevocable right, license and privilege, under copyright and otherwise, to distribute, sub-distribute, reproduce[,] exhibit, project, license, perform, sell, market, broadcast, issue, reissue, and advertise, publicize, dispose of, turn to account, derive revenue from and otherwise exploit and deal in and with the PICTURE and any and [all] parts thereof throughout the world, in any and all media, methods, system and process, whether now known or hereafter devised and in all gauges film and other surfaces, whether in movie theatres, on armed forces bases[,] on ships, on aircraft, on radio, on television (including, without limitation, free, cable, subscription and pay), through cassettes, cartridges, tapes and other audio or video devices, CATV and any other method or means for the exhibition, performance or exploitation of the PICTURE theatrically[,] non-theatrically, and/or by means of television, in any and all gauges, forms, procedures or processes or in any other fashion or through any other medium whatsoever, whether now known *28 or hereafter devised and in all languages. The literary and dramatic material included in the PICTURE shall be deemed sold to PURCHASER only to the extent included in the PICTURE. The music rights sold shall be subject to the conditions contained in the licenses relating thereto.
*1339 4. TERRITORY AND TERM: The Territory covered by this Agreement shall consist of the entire world. The term hereof shall be in perpetuity.
5. DELIVERY:
5.1 The SELLER shall deliver the PICTURE to PURCHASER promptly upon execution hereof by making physical delivery to MGM Laboratory Inc. at 10202 West Washington Boulevard, Culver City, California 90030 (herein the LABORATORY), in the PURCHASER'S name but at the SELLER'S sole cost and expense, of each and all of the film and sound material specified in Exhibit "C" attached hereto and made a part hereof. SELLER shall also cause to be delivered to PURCHASER, at SELLER's expense, a laboratory letter from said LABORATORY, in form and substance like that attached hereto as Exhibit "C", certifying that said LABORATORY holds said materials to the PURCHASER'S account and for the PURCHASER'S sole benefit, and certifying further that the negative of the *29 PICTURE and the other items so delivered are of a grade and quality satisfactory for the reproduction of commercially acceptable 35mm release prints of the PICTURE with synchronized English language dialogue and sound track.
5.2 The pre-printed material pertaining to the PICTURE shall be kept at the LABORATORY in the name of PURCHASER or its designee or the distributor whom PURCHASER or its designee licenses to distribute the PICTURE, PURCHASER being hereby authorized to transfer said materials to the account of said distributor and/or designee, but in all events subject to the provisions of the Security Agreement referred to hereinafter.
5.3 SELLER shall also deliver to PURCHASER in addition to the materials specified on Exhibit "B":
a) A verified statement showing the Negative Cost 5 of the PICTURE, including overheads to SELLER of 25% of the direct costs of production and interest, to be not less than $ 2,496,000.
* * * *
6. DISTRIBUTION AND CONTROL OF PICTURE:
6.1 Subject to the provisions of this Agreement, and all exhibits attached hereto, the PURCHASER shall, at all times, have full control in its absolute discretion over the manner and terms upon which the PICTURE shall be *30 marketed, distributed, exploited, exhibited, sold, licensed or otherwise disposed of, and all matters pertaining thereto. So long as the arrangements for the distribution of the PICTURE are made through a "major" distributor (as that term is understood in the motion picture industry), PURCHASER shall have the right to delegate the authority granted herein to such distributor.
* * * *
*1340 7. PURCHASE PRICE
The purchase price for all rights and property sold, transferred and assigned by SELLER to PURCHASER hereunder shall be the sum of $ 2,496,000.00, payable as follows:
a) The sum of $ 116,000, payable $ 15,000 contemporaneously herewith by delivery to SELLER of a bank check in said amount, subject to collection, receipt whereof is hereby acknowledged and $ 101,000 on December 1, 1977.
b) The sum of $ 208,000 payable by delivery to SELLER upon execution hereof of PURCHASER'S non-interest bearing promissory note in the amount of $ 208,000 payable to the order of SELLER, which note shall have a maturity date of June 30, 1978, and which shall be a recourse note in the form like that set forth in Exhibit "D" attached hereto.
c) The sum of $ 2,172,000 payable by delivery to SELLER *31 upon execution hereof of PURCHASER'S promissory note in the amount of $ 2,172,000 payable to the order of SELLER, which note shall have a maturity date of June 30, 1986, with interest on the unpaid balance at the rate of 8% per annum, which note shall be in form like that set forth in Exhibit "E" annexed hereto and which note shall be a non-recourse note, i.e. SELLER'S rights to payment thereof shall be limited solely to payment thereof out of the percentage payments if any, derived by PURCHASER from the distribution of the PICTURE.
* * * *
10. COLLATERAL SECURITY:
10.1 As collateral for payment of the promissory notes to be executed by the PURCHASER hereunder, the PURCHASER shall execute and deliver to SELLER a security agreement * * * granting SELLER the first and prior security interest and lien upon all the right, title and interest of the PURCHASER in and to the PICTURE, * * * and all other property and rights acquired by PURCHASER hereunder. * * *
* * * *
2. INDEMNITY: SELLER agrees to defend, indemnify and hold harmless the PURCHASER, * * * its * * * successors and assigns, * * * from and against any charges, damages, costs and expenses, * * * which may be sustained or suffered *32 by or secured against them or any of them by reason of, based upon or relating to, a breach of any of the SELLER'S covenants, representations, warranties or agreements contained herein, or in the exercise or attempted exercise of any of the rights, licenses or privileges herein granted * * *
Such agreement was signed by P.B. Powell for Paramount and Ms. Osowski for FWC. The acquisition agreements for all the other films were signed by Walter Joseph, Jr., for Paramount and Ms. Osowski for FWC.
The acquisition agreements for the other films were nearly identical to the "First Love" acquisition agreement. *1341 The acquisition agreements for "The One and Only" and "Heaven *33 Can Wait" were dated December 2, 1977. The total purchase price of "The One and Only" was $ 4,770,000: $ 5,000 payable contemporaneously with execution of the acquisition agreement, $ 207,000 payable on December 20, 1977, a recourse promissory note for $ 53,500 with a maturity date of June 30, 1978, a similar note for $ 477,000 payable on June 30, 1979, and a nonrecourse interest-bearing promissory note for $ 4,027,500 with a maturity date of June 30, 1986. 6 The total purchase price of "Heaven Can Wait" was $ 12,534,500: $ 10,000 payable contemporaneously with execution of the acquisition agreement, a recourse promissory note for $ 914,000 with a maturity date of June 30, 1978, a similar note for $ 1,384,625 payable on June 30, 1979, and a nonrecourse interest bearing note for $ 10,225,875 with a maturity date of June 30, 1986.
*34 The acquisition agreements for "Grease," "Foul Play," and "Bad News Bears Go to Japan" ("Bears 3") were dated May 25, 1978. The total purchase price of "Grease" was $ 8,179,600: $ 25,000 payable contemporaneously with execution of the acquisition agreement, a recourse promissory note for $ 1,201,940 with a maturity date of June 30, 1978, a similar note for $ 817,960 payable on June 30, 1979, and a nonrecourse interest-bearing promissory note for $ 6,134,700 with a maturity date of June 30, 1986. The total purchase price of "Foul Play" was $ 6,695,000: $ 25,000 payable contemporaneously with execution of the acquisition agreement, a recourse promissory note for $ 979,250 with a maturity date of June 30, 1978, a similar note for $ 669,500 payable on June 30, 1979, and a nonrecourse interest-bearing promissory note for $ 5,021,250 with a maturity date of June 30, 1986. The total purchase price of "Bears 3" was $ 5,682,300: $ 25,000 payable contemporaneously with execution of the acquisition agreement, a recourse promissory note for $ 827,345 with a maturity date of June 30, 1978, a similar note for $ 568,230 payable on June 30, 1979, *1342 and a nonrecourse interest bearing promissory *35 note for $ 4,261,725 with a maturity date of June 30, 1986.
Balmoral Associates, Ltd. (Balmoral), is an Illinois limited partnership of which Capital B and Mr. Filler are the general partners. Balmoral purchased "First Love" and "The One and Only" from FWC. The private placement memorandum describes "First Love" as:
a bittersweet, tender love story set on a contemporary college campus and told from a woman's point of view. A young man of a decidedly romantic temperament meets the girl of his dreams, but she turns out to be far more worldly than he anticipates. Played out on campus and in the girl's lavish family mansion, the couple's ensuing love affair eventually dissolves as a result of her persistent attraction to an older, married man.
This motion picture, based upon a short story by Harold Brodkey, was produced by Larry Turman ("The Graduate", "The Great White Hope", "The Best Man" and "The Flim Flam Man") and directed by Joan Darling. "First Love" stars Susan Dey (star of the successful television series "Partridge Family") and William Katt ("Carrie"). * * *
"The One and Only" is described in such memorandum as:
a funny and tender story which gives the audience a *36 glimpse into the life and romance of Gorgeous George as a young man. This motion picture climaxes when George dons a fur-trimmed gold robe and blond wig with a hairnet and enters the Madison Square Garden wrestling arena to thunderous applause.
This motion picture was produced and written by Steve Gordon and directed by Carl Reiner ("Oh, God!" and "Where's Poppa?"). * * * [It] stars Henry Winkler, television's "Fonzie". * * *
For convenience, "First Love" and "The One and Only" will sometimes be referred to as "Balmoral's motion pictures" or "the Balmoral motion pictures."
Shelburne Associates, Ltd. (Shelburne), is an Illinois limited partnership of which Capital B and Mr. Filler are the general partners. The private placement memorandum contained the following descriptions of the four motion pictures purchased by Shelburne from FWC:
(a) " Grease ".
"Grease", the film version of the longrunning show, is a musical celebration of rock and roll in the Fifties with a cast including John Travolta ("Saturday Night Fever"), Olivia Newton-John and Stockard Channing.
This motion picture was produced by Robert Stigwood Organization and was directed by Allen Carr. * * *
*1343 (b) *37 " Heaven Can Wait ".
"Heaven Can Wait", a remake of the 1949 original film starring Gene Tierney and Don Ameche, is a comedy fantasy about a famous football player who dies before his time and is given the ultimate comeback, a chance to return to Earth.
This motion picture was produced by Warren Beatty ("Shampoo" and "Bonnie and Clyde") and directed by Warren Beatty and Buck Henry, with screenplay by Elaine May. "Heaven Can Wait" stars Warren Beatty, Julie Christie, James Mason and several other prominent artists. * * *
(c) " Bad News Bears Go To Japan ".
Following the two preceding popular Bad News Bears pictures, "Bad News Bears Go To Japan" picks up the team of sandlot youngsters on their way from Los Angeles to the Orient, raising havoc with the American pastime.
This motion picture was produced by Michael Ritchie, directed by John Berry and stars Tony Curtis with the Bad News Bears team. * * *
(d) " Foul Play ".
From the creator of "Silver Streak" and "Harold and Maude", "Foul Play" is a comic thriller that brings together on the screen the wacky charms of Goldie Hawn and Chevy Chase.
This motion picture was produced by Thomas L. Miller and Edward K. Milkis and directed *38 by Colin Higgins. * * *
For convenience, "Grease," "Heaven Can Wait," "Bears 3," and "Foul Play" will sometimes be referred to as "Shelburne's motion pictures" or "the Shelburne motion pictures."
The purchase agreements by which the partnerships acquired the films from FWC were signed by Mr. Filler as the representative of the relevant partnership. Each of the purchase agreements was nearly identical to the corresponding agreement by which FWC acquired the film. The only relevant differences were that the purchase agreements did not mention the purchase of errors and omissions insurance and that the financial terms differed. The consideration paid by Balmoral for "First Love" was $ 2,571,000: $ 10,000 payable upon execution of the purchase agreement, $ 130,000 payable on December 1, 1977, $ 259,000 payable on or before June 30, 1978, and a recourse 8-percent interest-bearing promissory note for $ 2,172,000 with a maturity date of June 30, 1986. The purchase agreement provided that such:
note shall become and be without recourse to the extent of fifty percent (50%) of the original principal amount thereof when the distributor's *1344 gross receipts (as defined in the distribution *39 agreement relating to PICTURE to be entered into by PURCHASER and when said distributor accounts to PURCHASER therefore) from the distribution in the United States equals ONE MILLION FIVE HUNDRED THOUSAND ($ 1,500,000) and said distributor's gross receipts from all other territories equals ONE MILLION FIVE HUNDRED THOUSAND DOLLARS ($ 1,500,000), and shall become and be without recourse as to the full extent thereof when said distributor's worldwide gross receipts equals FIVE MILLION DOLLARS ($ 5,000,000). In all events the entire note shall become nonrecourse to the full extent thereof upon a licensing of the syndicated television exhibition rights of the PICTURE and receipt by the said distributor of the sum due to it upon the first syndicated television broadcast of the PICTURE.
The consideration paid by Balmoral for "The One and Only" was $ 4,870,000: $ 212,000 payable on or before December 20, 1977, $ 403,500 payable on or before June 30, 1978, $ 227,000 payable on or before June 30, 1979, and a recourse 8-percent interest-bearing promissory note for $ 4,027,500 with a maturity date of June 30, 1986. The purchase agreement provided that such:
note shall become and be without *40 recourse to the extent of fifty percent (50%) of the original principal amount thereof when the distributor's gross receipts (as defined in the distribution agreement relating to PICTURE to be entered into by PURCHASER and when said distributor accounts to PURCHASER therefore) from the distribution in the United States equals THREE MILLION FIVE HUNDRED THOUSAND DOLLARS ($ 3,500,000) and said distributor's gross receipts from all other territories equals THREE MILLION FIVE HUNDRED THOUSAND ($ 3,500,000), and shall become and be without recourse as to the full extent thereof when said distributor's worldwide gross receipts equals ELEVEN MILLION DOLLARS ($ 11,000,000). In all events the entire note shall become nonrecourse to the full extent thereof upon a licensing of the syndicated television exhibition rights of the PICTURE and receipt by the said distributor of the sum due to it upon the first syndicated television broadcast of the PICTURE.
The consideration paid by Shelburne for "Heaven Can Wait" was $ 12,734,500: $ 10,000 payable on or before December 20, 1977, $ 1,014,000 payable on or before June 30, 1978, $ 1,484,625 payable on or before June 30, 1979, and a recourse 8-percent *41 interest-bearing promissory note for $ 10,225,875 with a maturity date of June 30, 1986. The purchase agreement provided that such:
*1345 note shall become and be without recourse to the extent of fifty percent (50%) of the original principal amount thereof when the distributor's gross receipts (as defined in the distribution agreement relating to PICTURE to be entered into by PURCHASER and when said distributor accounts to PURCHASER therefore) from the distribution in the United States equals TEN MILLION DOLLARS ($ 10,000,000) and said distributor's gross receipts from all other territories equals SEVEN MILLION FIVE HUNDRED THOUSAND DOLLARS ($ 7,500,000), and shall become and be without recourse as to the full extent thereof when said distributor's worldwide gross receipts equals TWENTY FIVE MILLION DOLLARS ($ 25,000,000). In all events the entire note shall become nonrecourse to the full extent thereof upon receipt by the said distributor of more than $ 1,500,000 from the television exhibition of the PICTURE and the exhibition of the PICTURE on free home television.
The consideration paid by Shelburne for "Grease" was $ 8,429,600: $ 25,000 payable upon execution of the *42 purchase agreement, $ 1,352,000 payable on or before June 30, 1978, $ 917,900 payable on or before June 30, 1979, and a recourse 8-percent interest-bearing promissory note for $ 6,134,700 with a maturity date of June 30, 1986. The purchase agreement provided that such:
note shall become and be without recourse to the extent of fifty percent (50%) of the original principal amount thereof when the distributor's gross receipts (as defined in the distribution agreement relating to PICTURE to be entered into by PURCHASER and when said distributor accounts to PURCHASER therefore) from the distribution in the United States equals ELEVEN MILLION DOLLARS ($ 11,000,000) and said distributor's gross receipts from all other territories equals FOUR MILLION DOLLARS ($ 4,000,000), and shall become and be without recourse as to the full extent thereof when said distributor's gross receipts from the United States equals SIXTEEN MILLION DOLLARS ($ 16,000,000) and said distributor's gross receipts from all other territories equals FOUR MILLION DOLLARS ($ 4,000,000). In all events the entire note shall become nonrecourse to the full extent thereof when said distributor's gross receipts from other *43 than theatrical sources equal or exceed SIX MILLION FIVE HUNDRED THOUSAND DOLLARS ($ 6,500,000).
The consideration paid by Shelburne for "Foul Play" was $ 6,845,000: $ 25,000 payable upon execution of the purchase agreement, $ 1,079,250 payable on or before June 30, 1978, $ 719,500 payable on or before June 30, 1979, and a recourse 8-percent interest-bearing promissory note for $ 5,021,250 with a maturity date of June 30, 1986. The purchase agreement provided that such:
*1346 note shall become and be without recourse to the extent of fifty percent (50%) of the original principal amount thereof when the distributor's gross receipts (as defined in the distribution agreement relating to PICTURE to be entered into by PURCHASER and when said distributor accounts to PURCHASER therefore) from the distribution in the United States equals NINE MILLION DOLLARS ($ 9,000,000) and said distributor's gross receipts from all other territories equals TWO MILLION FIVE HUNDRED THOUSAND DOLLARS ($ 2,500,000), and shall become and be without recourse as to the full extent thereof when said distributor's gross receipts from the United States equals TWELVE MILLION DOLLARS ($ 12,000,000) and said *44 distributor's gross receipts from all other territories equals THREE MILLION DOLLARS ($ 3,000,000). In all events the entire note shall become nonrecourse to the full extent thereof when said distributor's gross receipts from other than theatrical sources equal or exceed FOUR MILLION DOLLARS ($ 4,000,000).
The consideration paid by Shelburne for "Bears 3" was $ 5,782,300: $ 25,000 payable upon execution of the purchase agreement, $ 887,345 payable on or before June 30, 1978, $ 608,230 payable on or before June 30, 1979, and a recourse 8-percent interest-bearing promissory note for $ 4,261,725 with a maturity date of June 30, 1986. The purchase agreement provided that such:
note shall become and be without recourse to the extent of fifty percent (50%) of the original principal amount thereof when the distributor's gross receipts (as defined in the distribution agreement relating to PICTURE to be entered into by PURCHASER and when said distributor accounts to PURCHASER therefore) from the distribution in the United States equals SEVEN MILLION FIVE HUNDRED THOUSAND DOLLARS ($ 7,500,000) and said distributor's gross receipts from all other territories equals TWO MILLION FIVE HUNDRED *45 THOUSAND DOLLARS ($ 2,500,000), and shall become and be without recourse as to the full extent thereof when said distributor's gross receipts from the United States equals TEN MILLION DOLLARS ($ 10,000,000) and said distributor's gross receipts from all other territories equals TWO MILLION FIVE HUNDRED THOUSAND DOLLARS ($ 2,500,000). In all events the entire note shall become nonrecourse to the full extent thereof when said distributor's gross receipts from other than theatrical sources equal or exceed SIX MILLION DOLLARS ($ 6,000,000).
Promissory notes and other obligations due before 1986 will sometimes be referred to as short-term notes and will sometimes be identified by payor. Promissory notes due in 1986 will sometimes be referred to as long-term notes and *1347 will sometimes be identified as recourse or nonrecourse and by payor.
The purchase agreements for all the motion pictures had a guaranty paragraph. For "First Love" and "The One and Only," Balmoral had to "secure guarantees of 50% of the principal amount of PURCHASER'S note to SELLER on a prorata basis from each of its limited partners." For "Grease," "Foul Play," and "Bears 3," Shelburne had to secure the guarantee *46 of 97 percent of such principal amount, and for "Heaven Can Wait," 100 percent had to be guaranteed.
The security agreements executed between FWC and the partnerships incorporated the following clause:
12A. Distribution Agreement . The Secured Party acknowledges that Debtor shall be granting certain rights and licenses with respect to the Photoplay pursuant to a distribution agreement including, without limitation, certain distribution rights and fees and the right to recoup certain advances, and that the security interest granted hereby shall be in all respects subordinate and junior to the rights granted in said distribution agreement. Nothing contained herein and no action taken by the Secured Party hereunder shall affect or diminish such rights of the distributor under said distribution agreement.
The distribution agreement, dated November 2, 1977, by which Balmoral granted certain rights in "First Love" to Paramount, provided in pertinent part:
1. DISTRIBUTION RIGHTS AND PERIOD: Partnership does hereby irrevocably grant and license to Paramount its successors and assigns under copyright and all renewal or extended copyrights the exclusive right and privilege, during the *47 term hereof, and for the Paramount Territory to distribute, exhibit, market, re-issue and otherwise exploit, and to license and permit others to distribute, exhibit, market, re-issue and otherwise exploit, the Picture and the literary, and dramatic material contained in the Picture (but only as embodied therein) and all other rights, properties and interests therein and thereto to the extent owned by Partnership * * * and to make any changes, eliminations or additions thereto, as Paramount may determine.
All references herein to the "Paramount Territory" shall be deemed to refer to the entire world.
The distribution rights herein granted to Paramount shall include, without limitation, the right to distribute or exploit the Picture by means of so-called free television and/or pay or subscription television, community antennae television systems, cassettes, cartridges, tape or electronic visual recording systems, and in any other method or means for the exhibition, performance or exploitation of the Picture theatrically, nontheatrically *1348 in any and all gauges, forms and procedures and/or by means of television or any similar process or in any other fashion or through any other *48 medium whatsoever whether now known or hereafter devised and in all languages. The music rights licensed hereunder shall be subject to the conditions contained in the licenses relating thereto.
The term of this Agreement is
(a) a period of twenty-eight (28) years commencing from the date hereof and,
(b) thereafter and in perpetuity for successive additional periods of twenty-eight (28) years,
provided, however, that in the event the proceeds payable to Partnership under subparagraph 3 FOURTH of this Agreement shall have attained the sum of $ 5 million prior to the commencement of any of the additional periods described in (b) hereof, Paramount agrees to pay Partnership upon the date of commencement of any said additional twenty-eight (28) year period, the sum of Five Thousand Dollars ($ 5,000) or the then fair-market value of the Picture, whichever is the greater, which sum shall constitute an advance against any further sums which thereafter may become due and payable to Partnership pursuant to subparagraph 3 FIFTH of this Agreement. Paramount's failure to make such payment shall not divest Paramount of its right to extend and to be deemed to have extended the term hereof for *49 said additional period unless and until Partnership shall have given Paramount, by prior written notice * * * sixty (60) days within which to elect not to extend for said additional period and Paramount shall not have tendered payment to Partnership of said consideration on or before the expiration of the said sixty (60) day period. In the event the proceeds payable to Partnership under subparagraph 3 FOURTH of this agreement shall not have attained the sum of $ 5 million at the time of the commencement of any of the additional periods described in (b) hereof, Paramount shall have extended and shall be deemed to have extended said rights for said additional period and no consideration shall then be due and payable from Paramount to Partnership for the extension of said additional period; however, during any said additional period if and when the proceeds payable to Partnership under subparagraph 3 FOURTH of this Agreement shall have attained the sum of $ 5 million, then the aforesaid advance of $ 5,000 or the then fair-market value of the Picture, whichever is the greater, shall be due and payable in consideration of the extension of the term hereunder and for the remainder of the *50 then additional period but Paramount shall not be in default for failure to pay same until and unless notice thereof shall have been given by Partnership in the manner aforestated.
* * * *
2. * * *
(c) * * *
Paramount * * * may make outright territorial grants covering the distribution of the Picture in any part of the Paramount Territory without limitation, whether or not Paramount * * * shall there maintain *1349 its own exchanges, provided, however, that it shall not make any "outright sale" with respect to the theatrical distribution of the Picture in the United States or Canada. * * *
(e) Paramount agrees to cause the Picture to be released in the countries of the Paramount Territory as soon as reasonably practicable consistent with Paramount's policies regarding release in any such country, * * *
* * * *
3. THEATRICAL AND PAY TELEVISION DISTRIBUTION FEES: U.S.A. AND CANADA 30% UNITED KINGDOM 35% REST OF WORLD 40% TERRITORIAL GRANTS 10% FREE TELEVISION DISTRIBUTION FEES: U.S.A. NETWORK SALES 25% U.S.A. SYNDICATION AND CANADA 35% REST OF WORLD 40%
For all other gross receipts, distribution fees will be the same as theatrical for the applicable territory.
The gross receipts *51 (as defined in Paragraph 2 hereof) shall be apportioned in the following order:
FIRST: (a) Partnership shall receive a sum equal to one and three-quarter (1 3/4%) percent of gross receipts until such time as the Partnership shall have been paid pursuant to subparagraph FOURTH below an amount equal to the sum of $ 2,496,000, plus interest thereon at the rate of 8% per annum commencing on the date hereof when, Partnership thereafter shall receive a sum equal to three (3%) percent of gross receipts derived thereafter. * * * [Union and guild costs are to be deducted prior to computing sums payable to the Partnership.]
(b) Paramount shall retain a sum equal to gross receipts multiplied by appropriate distribution fees as set forth above.
SECOND: Thereafter, Paramount shall recoup and reimburse itself for a sum equal to all of its distribution advances paid or incurred by Paramount * * *
THIRD: Thereafter, there shall be deducted from gross receipts the total of all sums due and owing to such persons, firms and/or corporations other than Partnership and Paramount to whom deferred compensation and/or participations in gross receipts by way of deferred compensation or otherwise are owing *52 by reason of contractual commitments to them in connection with the acquisition of rights and rendition of services for the Picture. * * *
FOURTH: Thereafter, 100% of remaining gross receipts shall be paid to Partnership until Partnership has been paid the sum of $ 2,848,941, together with interest thereon at the rate of 8% per annum commencing on the date hereof.
FIFTH: Thereafter, any gross receipts remaining shall be apportioned as follows: Partnership -- sums equal to 15% thereof, Paramount -- sums equal to 85% thereof. In the event either Paramount or Partnership gives up or assigns to any third party a share of any amounts payable hereunder, such share shall be payable wholly out of said respective party's share if and when such share becomes available in accordance with the terms of this Agreement.
*1350 * * * *
4. On or before December 1, 1977, Partnership will pay Paramount $ 300,000, which sum will be used to pay the advertising costs hereunder, which costs shall be deemed paid by Partnership. Promptly after said sum has been expended Paramount shall provide Partnership with a statement showing the manner in which said sum was so expended.
* * * *
6. * * *
(h) * * *53 * Paramount has obtained customary Errors and Omissions Insurance with Firemans Fund pursuant to Paramount's blanket policies, such coverage to be for the benefit of Paramount and Partnership as their interests may appear. * * *
* * * *
7. (a) Partnership agrees to defend, indemnify and hold harmless Paramount, its assignees and licensees, against any charges, damages, costs, and expense, * * * whatsoever, which may be sustained or suffered by or secured against them by reason of, or based upon or relating to a breach of any of Partnership's representations, warranties or agreements contained herein or in the exercise or attempted exercise of any of the rights, licenses or privileges herein granted * * *
8. Contemporaneously herewith, Partnership shall deliver the Picture to Paramount by delivering the items specified * * * to such laboratory as Paramount may designate. Such laboratory shall have the sole and exclusive right to possession and custody of the material to be delivered hereunder * * * during the entire period of Paramount's exclusive distribution hereunder. Partnership shall furnish Paramount with a Letter of Irrevocable Authority in Paramount's customary form of Laboratory *54 Agreement to the laboratory Paramount designates so that Paramount and/or its subsidiary or affiliates shall be the only ones exclusively entitled to order prints or deal with any of the materials deposited therein with respect to the Picture. Paramount shall pay all storage costs and all costs for material ordered by it and shall hold Partnership harmless with respect thereto. Notwithstanding the above, Partnership will have access to the material deposited therein for the sole purpose of inspecting said material. Partnership shall not remove any of said material from the laboratory.
9. (a) As between Partnership and Paramount, Paramount shall have the right to determine the title under which the Picture shall be released * * *
(b) Partnership shall have the right to advise and consult with Paramount with respect to the opening advertising and publicity campaign and the initial theatrical release of the Picture in the United States and Canada, and Paramount agrees to give good faith consideration to Partnership's suggestions and advice, but [Paramount's] decision in such matters shall be final.
(c) * * * Paramount shall have the right * * * to use and license the use of all material *55 upon which the Picture was based or from which it was adapted, * * * subject, however, to the agreements between the *1351 producer of the Picture and such artists, authors and others appearing in or connected with the Picture.
* * * *
11. If any person, firm or corporation shall do or perform any acts which Paramount believes constitute a copyright infringement of the Picture or of any * * * material contained in the Picture, * * * or violate or infringe any right of Partnership or Paramount therein or if any person, * * * shall do or perform any acts which Paramount believes constitute an unauthorized or unlawful distribution, exhibition, or use thereof, then and in any such event, Paramount may and shall have the right to take such steps and institute such suits or proceedings as Paramount may deem advisable or necessary to prevent such acts and conduct and to secure damages and other relief by reason thereof, * * *. Paramount may take such steps or institute such suits or proceedings in its own name or in the name of Partnership or in the names of the parties jointly, and Paramount is hereby appointed and constituted the lawful attorney-in-fact of Partnership to do all acts *56 and things permitted or contemplated by the terms of this paragraph. * * *
* * * *
13. All the rights in the Picture (including the copyright therein and negative thereof) excluding the rights herein granted to Paramount, are reserved to Partnership.
14. (a) Partnership hereby grants to Paramount for the term hereof, * * * the exclusive worldwide perpetual publication, performing, recording (including without limitation "original soundtrack album"), synchronization and all other rights in all musical compositions written for or used in or in connection with the Picture. Paramount may license any and all of such rights * * * to any other music publishing company of its choice * * *.
(b) * * * If Paramount grants record rights to any record company, Paramount shall endeavor to obtain the best available royalties in good faith negotiation with such record company, and in any event shall obtain not less than the following royalties:
* * * *
15. * * * Paramount shall have, during the term hereof, the sole and exclusive merchandising rights in all stories, characters and objects, things and incidents described or appearing in the Picture, * * *. Without limiting the foregoing, merchandising *57 rights shall include publication rights in novelizations of the screenplay and other publication rights to the extent acquired.
16. (a) Partnership agrees to accept Paramount's usual and normal methods of accounting, which Paramount agrees will be in accordance with generally accepted accounting principals [sic] and practices in the motion picture industry. Partnership shall have the right to inspect and audit in New York, Paramount's home office distribution records relating to the Picture, customarily maintained in New York, but not more frequently than once in any year, nor for any period previously audited or *1352 more than two (2) years prior to the date of any such audit. Any such audit must * * * be completed within thirty (30) days after Paramount shall have made said distribution records available to Partnership or its representative. * * * Partnership agrees to accept, and Paramount agrees to provide statements quarterly for the first two (2) years following general release of the Picture, semi-annually for the third year, and annually thereafter so long as the Picture is in active distribution. Such statements shall be provided within 90 days of the close of the *58 accounting period in question. Such statements may be on a billings or collection basis, and Paramount shall have the right to change the method from time to time. In the event a statement is on a billings basis, Paramount shall have the right in subsequent statements to make adjustments for uncollected bills.
* * * *
(c) In preparing and filing their tax returns, Paramount and Gulf & Western Industries, Inc. and their distributing subsidiaries shall have the sole right to take the full amount of whatever credits, deductions or other benefits that may be available to them throughout the world with respect to, or relating to, taxes and fees paid by them in connection with distribution of the Picture, and Partnership shall not have the right to share or participate in or to take any such credits, deductions or other benefits as aforesaid.
* * * *
18. (a) Partnership may assign its share of the receipts from the Picture provided that written notice of such assignment shall be promptly given to Paramount and that Paramount shall not be required or obligated to make payments or disbursements directly to more than two such assignees at any one time. Except as herein provided, Partnership *59 shall not assign this Agreement without the written consent of Paramount.
(b) * * * Nothing contained herein shall be deemed or construed to limit or prevent Paramount from assigning or hypothecating all or a portion of its share of the revenues derived hereunder, or as prohibiting or preventing Paramount from causing the Picture to be distributed in whole or in part through sub-distributors, selling agents or licensees, * * * except as otherwise specifically provided in this Agreement.
19. Paramount may add titles to the Picture and to any publicity or advertising issued in connection therewith, indicating Paramount's and/or its parent's names, brands or trademarks and containing words, such as, "PARAMOUNT PRESENTS", "A PARAMOUNT PICTURE", "PARAMOUNT PICTURES", etc., as Paramount determines.
* * * *
21. * * * Paramount shall have the right to select from the Picture such material as Paramount may desire for deposit in Paramount's stock film library without any compensation to Partnership for material so selected. Any material so selected shall forever be and remain *1353 Paramount's sole and exclusive property and Paramount shall have the right to use such footage or make such *60 footage available to others in any motion picture photoplays and any considerations received by Paramount from others shall belong to Paramount exclusively.
Such agreement was signed by Mr. Filler on behalf of the partnership and called for theatrical exhibition to commence no later than November 25, 1977.
The distribution agreements for the other films were nearly identical to the "First Love" distribution agreement. The only relevant differences were some variations in dates of execution and exhibition, payment for advertising costs, apportionment of gross receipts, and time limits for financial statements. Such agreements for "The One and Only" and "Heaven Can Wait" were dated December 2, 1977, and theatrical exhibition was to commence on April 15, 1978, and July 1, 1978, respectively. Under the distribution agreement for "The One and Only," Balmoral was to pay Paramount $ 450,000 on or before June 30, 1978, for advertising costs, and the gross receipts were to be apportioned as follows:
FIRST (a) Partnership shall receive a sum equal to one and three-quarter (1 3/4%) percent of gross receipts until such time as the Partnership shall have been paid pursuant to subparagraph *61 FOURTH below an amount equal to the sum of $ 4,770,000 * * *
* * * *
FOURTH: Thereafter, 100% of remaining gross receipts shall be paid to Partnership until Partnership has been paid the sum of $ 5,275,618 * * *
FIFTH: Thereafter, any gross receipts remaining shall be apportioned as follows: Partnership -- sums equal to 25% thereof, Paramount -- sums equal to 75% thereof, provided, however, that in no event shall Partnership's said 25% share be less than such sums as would have been payable to it hereunder if participations in net profits were not deductible * * * and Partnership's share of the remaining gross receipts pursuant to this subparagraph FIFTH were 11% and if Partnership's said 25% share shall be so less, Paramount shall additionally pay to the Partnership on a continuing basis an amount equal to the sums by which it is so less.
The distribution agreement for "Heaven Can Wait" required Shelburne to pay Paramount $ 825,000 on or before June 30, 1978, for advertising costs, and the variations in the apportionment of gross receipts were as follows:
*1354 FIRST: (a) Partnership shall receive a sum equal to one and three-quarter (1 3/4%) percent of gross receipts until *62 such time as the Partnership shall have been paid pursuant to subparagraph FOURTH below an amount equal to the sum of $ 12,534,500 * * *
* * * *
FOURTH: Thereafter, 100% of remaining gross receipts shall be paid to Partnership until Partnership has been paid the sum of $ 13,464,077 * * *
Additionally, apportionment of remaining gross receipts was substantially the same as set forth for "The One and Only."
The distribution agreements for "Grease," "Foul Play," and "Bears 3" were dated May 25, 1978. The initial exhibition date for "Foul Play" was August 1, 1978, one month after such date for the other films. Such agreements contained no advertising advance payment, but contained the following provision concerning accounting statements provided by Paramount:
16. (a) * * * Such statements shall be provided within 90 days of the close of the accounting period in question, provided, that the first said statement hereunder shall be provided 120 days after the close of the relevant period. * * *
Such agreement for "Grease" required variations in the apportionment of gross receipts as follows:
FIRST: (a) Partnership shall receive a sum equal to one and three-quarter (1 3/4%) percent *63 of gross receipts (other than those from free home network and syndicated television distribution) until such time as there shall be payable to the Partnership pursuant to subparagraph FOURTH below an amount equal to the sum of $ 8,179,600 * * *. At such time as the gross receipts are such that the remaining gross receipts payable to the Partnership pursuant to subparagraph FOURTH below and/or to be apportioned pursuant to subparagraph FIFTH below reach the level of $ 8,179,600 plus interest thereon at the rate of 8% per annum commencing on the date hereof, to the extent that gross receipts from free home network and syndicated television distribution are not necessary for such level of remaining gross receipts to be reached, Partnership shall also be entitled to receive a sum equal to four (4%) percent of such gross receipts from free home network and syndicated television distribution as are not so necessary for said level of remaining gross receipts to be reached, whether derived before or after said level of remaining gross receipts is reached. * * *
* * * *
*1355 FOURTH: Thereafter, 100% of remaining gross receipts shall be paid to Partnership until Partnership has been *64 paid the sum of $ 8,179,600 * * *
FIFTH: Thereafter, any gross receipts remaining shall be apportioned as follows: Partnership -- sums equal to 12 1/2% thereof, Paramount -- sums equal to 87 1/2% thereof. * * *
The gross receipts provisions of the "Foul Play" agreement were the same as those in the "Grease" agreement, except that the dollar value in the "FIRST" and "FOURTH" subparagraphs was $ 6,695,000. Similarly, the terms for "Bears 3" were the same except that such dollar value was $ 5,682,300.
Payments due Balmoral and Shelburne were due with the relevant distribution statement. This timing was standard in the industry and was specifically set forth in the distribution agreements for "Grease," "Foul Play," and "Bears 3".
Pursuant to the distribution agreements, the partnerships sent letters to the movie laboratories directing them to hold for the benefit of Paramount or transfer "any part" of the film and sound material for which Paramount was the distributor. However, the entire film and sound material could only be transferred with the prior written consent of the partnership. All charges for services performed on behalf of Paramount were to be paid by Paramount. Additionally, *65 no one, except the partnership, was to have access to the film and sound material without Paramount's written consent, and no one, including the partnership, could remove such material without Paramount's written consent.
On November 2, 1977, FWC signed two documents, concerning "First Love" and "The One and Only," entitled "Notice of Irrevocable Authority," and Balmoral signed two such notices. The effect of such documents was to allow Paramount to retain the funds due it under the acquisition agreement and thereby to avoid an unnecessary circular flow of money from Paramount to Balmoral, under the distribution agreement, then from Balmoral to FWC, pursuant to the purchase agreement, and finally, according to the terms of the acquisition agreement, from FWC back to Paramount. FWC and Shelburne signed similar documents *1356 for "Heaven Can Wait" on December 2, 1977, and for the other Shelburne motion pictures on May 25, 1978.
On November 2, 1977, Paramount assigned all of its interest in and the copyright of "First Love" to FWC. At the same time, FWC assigned a security interest in "First Love" to Paramount, including:
1. All motion picture rights as more fully set forth *66 in the Acquisition Agreement * * *
2. All common law and/or statutory copyright, domestic and foreign, to be obtained by * * * [FWC] in the Photoplay together with all rights to renew or extend such copyright and the right to sue in either or both Assignor's or Assignee's name for past, present or future infringements of copyright.
On the same day, FWC assigned all of its rights in, and the copyright to, "First Love," subject to the Paramount security interest, to Balmoral. A similar series of documents were executed for each of the films involved herein. Such documents for "The One and Only" and "Heaven Can Wait" were executed on December 2, 1977, and for "Bears 3," "Foul Play," and "Grease" on May 25, 1978. All other relevant ancillary agreements, letters, and promissory notes referred to in the acquisition agreements, the purchase agreements, and the distribution agreements were properly executed.
On June 15, 1978, Paramount agreed to the following modification to the acquisition agreements for the motion pictures acquired by Balmoral and Shelburne:
Paramount hereby acknowledges and agrees that the failure of * * * [FWC] to make due and punctual payment of the Note as a result *67 of any delay by the distributor of the Picture in rendering distribution statements for the first calendar quarter of 1978 and all prior periods, and remitting payments required to be made concurrently therewith, shall not be deemed to constitute a breach of the Sale Agreement or a default under the Security Agreement. Further, Paramount hereby extends the due date of the Note until such time as said statements are rendered and said payments are remitted by the distributor of the Picture, reserving all other of its rights under the Sale Agreement and Security Agreement.
On June 21, 1979, paragraph 1 of each of the distribution agreements was amended by deleting the $ 5,000 or then fair market value language and inserting in its place a flat $ 25,000 payment. Such amendments were recommended by *1357 Paramount's counsel as a means of avoiding potential litigation.
The provisions in the purchase agreements between FWC and the partnerships dealing with the partnerships' long-term notes and the conditions under which they would convert from recourse to nonrecourse were the result of the "at-risk" rules contained in the Tax Reform Act of 1976. The guarantees executed by the limited *68 partners were designed to insure maximum tax benefits for the limited partners.
The acquisition and purchase agreements were negotiated with Mr. Heyman representing FWC, and the distribution agreements were negotiated and enforced with him representing Balmoral and Shelburne. He continued to act as the primary negotiator for the partnerships when problems arose concerning Paramount's distribution activities. The major economic and financial reporting terms were negotiated; most other points were the standard terms Paramount employed in such agreements. During the negotiations, Mr. Heyman consulted with Mr. Eisenberg very frequently.
The acquisition, purchase, and distribution agreements for each motion picture were intended to be a package; it was always planned that Paramount would be the distributor of the motion pictures. Indeed, Paramount would not have sold the pictures without receiving the distribution rights. By entering into such packages, Paramount was achieving three objectives: it reduced its financial risk associated with each film, increased its ability to make more films by improved cash-flow, and utilized its distribution organization closer to its capacity.
Mr. *69 Heyman wanted FWC to be perceived in the film community as an important company doing business involving major motion pictures. By acting as the "middleman" between Paramount and the partnerships, FWC was developing an on-going relationship with Paramount and creating the image of a company associated with major motion pictures.
On November 14, 1977, the date appearing on the Balmoral private placement memorandum, there were agreements in principle for network television sales for "First Love," in the amount of $ 2,000,000, and "The One and *1358 Only," in the amount of $ 3,800,000. The network television license agreement for "First Love" was finalized in February 1978, and such agreement for "The One and Only" was finalized in June 1978. Network television agreements for "Bears 3" in the amount of $ 5,500,000, "Grease" in the amount of $ 6,190,000, and "Foul Play" in the amount of $ 3,500,000 were agreed to in principle by April 1978. License agreements for syndicated (non-network) television had not been agreed upon prior to the execution of the transaction documents involved herein. In January 1983, Paramount licensed domestic syndication rights to "The One and Only," *70 "Foul Play," and "Grease." By September 1984, Paramount had licensed foreign syndication rights to all the films.
"First Love" was released on November 4, 1977, and "The One and Only" was released on February 3, 1978. The Shelburne motion pictures were released during the summer months of 1978 -- "Bears 3" on June 2, "Grease" on June 16, "Heaven Can Wait" on June 28, and "Foul Play" on July 19.
The Balmoral private placement memorandum stated that the purchase price of a unit in the partnership was $ 70,000, payable $ 30,000 upon subscription, $ 33,000 payable on June 1, 1978, and $ 7,000 payable on June 1, 1979. The two post-subscription payments were evidenced by promissory notes. Total capitalization was stated as $ 2,450,000. Under paragraph 6.5 of article VI of the articles of limited partnership, each limited partner agreed to guarantee partnership obligations up to a value equal to 130 percent of his interest in Balmoral. Pursuant to such paragraph, Mr. Durkin executed a guarantee for "First Love" in the amount of $ 15,514.50 and a guarantee for "The One and Only" in the amount of $ 28,768. Such guarantees were delivered by Mr. Filler to FWC. The guarantees included *71 the provisions that:
1. The Guarantor unconditionally and irrevocably guarantees the due and punctual payment of the principal of the [long-term] promissory Note, * * *
2. The Guarantor agrees that this constitutes a guaranty of payment and waives any right to require that any action be brought by the Seller for payment of any amounts due and owing to Seller from the Purchaser with respect to the Picture.
*1359 The private placement memorandum for Shelburne was not issued until April 12, 1978. The purchase price of a unit in Shelburne was $ 316,000, payable $ 130,000 at the time of execution of the subscription agreement, $ 125,000 on June 1, 1979, and $ 61,000 on June 1, 1980. The two post-subscription payments were evidenced by promissory notes. Total capitalization was stated as $ 11,060,000. Pursuant to paragraph 6.5 of article VI of the articles of limited partnership, each limited partner had to guarantee partnership obligations up to a value equal to 225 percent of such interest.
The Balmoral private placement memorandum contained the following passage:
COMPENSATION OF GENERAL PARTNERS
The following table itemizes all of the types and estimated amounts of compensation *72 payable to the General Partners. All such items were fixed solely by the General Partners and have not been determined by arm's length negotiations:
Guaranteed Payments The General Partners will receive fees in 1977, 1978 and 1979 from the Partnership for their services and expenses in creating the Partnership and this private placement. The General Partners, in turn, will utilize a portion of these fees to pay legal, accounting and other expenses in connection with the organization of the Partnership and this Offering, estimated at $ 158,500, and the fees of offeree and other representatives, if any. The balance, approximately $ 300,000, will be divided between the General Partners as follows: $ 275,000 to Capital B Corporation, and $ 25,000 to Bernard M. Filler.
$ 458,500
Annual Overhead, Administrative and Service Fee The General Partners will be entitled to receive an annual overhead, administrative and service fee equal to 2% of the Partnership's cash flow after satisfaction of Partnership obligations for which they will provide the Partnership with office facilities, administrative services and all other indirect expenses not relating to the acquisition *73 of the Pictures and the investment in CC-PE.
No estimate
[Fn. refs. omitted.]
The Shelburne private placement memorandum contained similar provisions. The Shelburne guaranteed payments totaled $ 2,087,050. Approximately $ 755,000 would be spent on expenses incurred in connection with establishing the *1360 partnership, negotiating contracts, and preparing the private placement memorandum. Of the remaining payments, $ 1,332,050, Capital B was to receive $ 1,282,050 and Mr. Filler was to receive $ 50,000. These payments were compensation "for their services and expenses relating to this private placement." The annual overhead provision was the same in both private placement memorandums.
Both such private placement memorandums stated that the general partners would sell units only to a person who made a written representation that, inter alia, he had a net worth, exclusive of home, furnishings, and automobiles, in excess of $ 1 million if he was purchasing one unit, or 50 percent thereof if he was purchasing one-half unit.
The private placement memorandum for Shelburne contained the following statement:
The General Partners have been advised that an agreement has been entered *74 into licensing the network television exhibition of "Foul Play" for two showings in return for a fee of $ 3,500,000. This picture will be available for telecast three years after theatrical release and payment will be made two-thirds upon the first telecast and one-third upon the second telecast. Network television sales for "Grease" and "Bad News Bears Go To Japan" are currently being negotiated, however, no agreements have been reached.
The Shelburne motion picture purchase agreements required substantial cash outlays by Shelburne before the partnership was fully capitalized. The necessary cash was provided by a loan from the Delta Partnership (Delta). Under the terms of such loan, dated April 5, 1978, Shelburne received $ 2,135,000: $ 2,084,000 on or before June 30, 1978, and $ 54,500 on or before June 30, 1979. Such loan was secured by Shelburne's rights in its four motion pictures and was evidenced by two promissory notes, due June 30, 1986, and bearing 9 1/2 percent interest per year. Additionally, under the loan agreement, Delta received a "bonus payment" in the amount of 10 percent of all worldwide nontheatrical 7 gross receipts received by the distributor of the films. *75 The terms were negotiated by Mr. Eisenberg and Mr. Filler; they were not negotiated at arm's length.
*1361 Delta was a partnership composed of CMS Investors (CMS), with a 95 1/2 percent interest, and Megaventure, with a 4 1/2 percent interest. CMS was owned by partnerships and trusts associated with or for the benefit of members of the law firm or members of their immediate families; persons owning at least a 90-percent interest in CMS also had an interest in Capital B, and partnerships or trusts for the benefit of members of the law firm or their immediate families held 50 percent of the interests in Capital B. Mr. Eisenberg was a member of the law firm for whom several such partnerships or trusts were established. In June 1978, 8 CMS borrowed $ 2,100,000 from four Netherlands Antilles corporations. The loans carried an interest rate of 9 percent until the due dates in 1980, when the rate *76 increased to 13 percent. Such funds were used by CMS for its capital contribution to Delta. Delta then loaned nearly all of such funds to Shelburne.
Zeeuwse Maatschappij N.V. (Zeeuwse), a Netherlands Antilles corporation, loaned CMS $ 1,100,000 of the funds which it contributed to Delta. In April 1981, Delta sold Zeeuwse a portion of its interest in its bonus payment for $ 1,400,000; Delta assigned all its rights in the four films except "its interest in free home network and pay or subscription television, CATV or music royalties."
In the spring of 1978, Mr. Heyman sent Mr. Arney a letter stating that the final cost statement for "The One and Only" indicated a direct cost of $ 3,096,000, which, with overhead and interest, brought the total cost substantially below the cost warranted by Paramount in the acquisition agreement. In such letter, Mr. Heyman requested *77 the return of the appropriate amount of FWC's initial payment and the appropriate reduction in the purchase price. Paramount agreed, resulting in a $ 119,250 rebate to FWC and new purchase terms: purchase price of $ 4,293,000, a recourse promissory note for $ 87,750 due on December 20, 1977, and a nonrecourse interest-bearing note for $ 3,669,750 with a maturity date of June 30, 1986. Balmoral received a cash rebate, and corresponding changes were made in the purchase agreement: the consideration was $ 4,393,000, $ 92,750 *1362 payable on or before June 30, 1978, and a recourse 8-percent interest-bearing note for $ 3,669,750 with a maturity date of June 30, 1986.
In 1977, Balmoral made a guaranteed payment of $ 25,000 to Mr. Filler. From 1977 to 1980, Balmoral made $ 281,219.06 in guaranteed payments to Capital B: $ 232,500 in 1977, $ 34,788.19 in 1978, $ 7,692.97 in 1979, and $ 6,237.90 in 1980. Balmoral reported a current deduction for all such payments on its returns for such years, except for $ 20,000 to Capital B in 1977 which was a syndication cost. Of the guaranteed payments, $ 4,787.92 of the amount paid in 1978, and all of the amounts paid in 1979 and 1980, were *78 for the annual overhead, administrative, and service fee equal to 2 percent of Balmoral's cash-flow.
Shelburne paid Mr. Filler the $ 50,000 in guaranteed payments referred to in its private placement memorandum; in 1978, he received $ 34,000, and in 1979, he received $ 16,000. Capital B received $ 1,647,953.31 in guaranteed payments: $ 855,500 in 1978, $ 758,392.85 in 1979, and $ 34,060.46 in 1980. Shelburne reported a current deduction for all such payments, except $ 58,250 to Capital B in 1978 which was a syndication cost, on its returns. Of the guaranteed payments, $ 324,342.85 of the amount paid in 1979, and all of the amount paid in 1980, were for the annual overhead, administrative, and service fee equal to 2 percent of Shelburne's cash-flow.
Balmoral paid $ 160,523.68 in legal fees from 1977 through 1980. The law firm was paid $ 147,927.98 as follows: $ 116,576.57 in 1977, $ 22,554.33 in 1978, $ 5,377.31 in 1979, and $ 3,419.77 in 1980. In 1977, $ 8,040 was paid to Taft & Kaminsky, and $ 4,555.70 was paid to Friedman & Koven. During the same time period, Balmoral paid $ 35,806.42 in fees to accountants. Weiss & Co. received $ 24,759.42 as follows: $ 12,350 in 1977, $ *79 2,250 in 1978, $ 5,534.42 in 1979, and $ 4,625 in 1980. Solomon, Finger & Newman was paid $ 11,047 in 1980. Balmoral deducted all of the payments as professional fees, except for $ 28,132.27 for 1977. Of such amount, $ 22,500 was capitalized as organization cost, $ 4,550 was classified as syndication cost, and $ 1,082.27 was reported as miscellaneous expenses. Balmoral elected to amortize such organization cost over a period of 60 months *1363 and claimed deductions for amortization expense of $ 750 for 1977 and $ 4,500 for each of the years 1978, 1979, and 1980.
Shelburne paid $ 727,592.67 in legal fees from 1978 through 1980. The law firm was paid $ 699,171.45 as follows: $ 451,498.88 in 1978, $ 239,650.52 in 1979, and $ 8,022.05 in 1980. In 1978, $ 20,910 was paid to Taft & Kaminsky, and $ 7,511.22 was paid to Friedman & Koven. During the same time period, Shelburne paid $ 74,078 in fees to accountants. Weiss & Co. received $ 51,448 as follows: $ 23,500 in 1978, $ 13,998 in 1979, and $ 13,950 in 1980. Solomon, Finger & Newman was paid $ 22,630 in 1980. Shelburne deducted all of the payments as professional fees on its returns for the appropriate year, except for *80 $ 62,500 paid in 1978. Of such amount, $ 55,000 was capitalized as organization cost, and $ 7,500 was recorded as syndication cost. Shelburne elected to amortize such organization cost over a period of 60 months and claimed deductions for amortization expense of $ 8,250.00 for 1978 and $ 11,000 for each of the years 1979 and 1980.
Balmoral reported gross receipts of $ 12,500 for 1977, $ 1,761,432.95 for 1978, $ 943,108 for 1979, and $ 1,336,372 for 1980. Balmoral reported a loss of $ 2,589,074.12 for 1977, a loss of $ 2,810,978.90 for 1978, a loss of $ 22,136.76 for 1979, and ordinary income of $ 526,380.35 for 1980. Shelburne reported no gross receipts for 1978, and gross receipts of $ 43,023,941 for 1979 and $ 3,385,580 for 1980. Shelburne reported a loss of $ 14,871,963.80 for 1978, ordinary income of $ 34,247,881 for 1979, and a loss of $ 3,653,249 for 1980.
For purposes of the investment credit, Balmoral claimed qualified investment of $ 2,571,000 for "First Love" on its return for 1977, and $ 4,393,000 for "The One and Only" on its 1978 return. On its return for 1978, Shelburne claimed qualified investment of $ 12,734,500 for "Heaven Can Wait," $ 8,429,600 for "Grease," *81 $ 6,845,000 for "Foul Play," and $ 4,369,630 for "Bears 3." The amount of qualified investment claimed for each film equaled the stated purchase price of the film by the partnership, except in the case of "Bears 3" where the qualified investment was reduced by the amount of foreign costs incurred to produce the film.
*1364 In the "First Love" distribution report for the period ended September 23, 1978, the cost of domestic prints is listed as $ 274,855 and deferments are stated as $ 45,000. The distribution report for "The One and Only" for the period ended September 23, 1978, listed additional print costs of $ 604,011 and deferments of $ 362,500. Such print costs and deferments were reflected on Balmoral's amended return for 1978. On such return, an increased qualified investment of $ 1,286,366 was reported. Similar information was reflected on Balmoral's amended return for 1980. On such return, an additional qualified investment of $ 124,258 for additional prints and deferments was reported, $ 6,798 of which related to "First Love," and $ 117,460 of which related to "The One and Only."
Shelburne filed amended returns for 1979 and 1980. The amended return for 1979 reported *82 an additional qualified investment of $ 6,568,464. This amount included print costs, union and guild payments, deferments, and participations reported in the distribution statements for all of the Shelburne films. The amended return for 1980 reported an additional qualified investment of $ 591,417.
Balmoral reported depreciation expenses of $ 1,948,686.88 for 1977, $ 3,835,819.08 for 1978, $ 529,614.06 for 1979, and $ 510,599.98 for 1980 on the appropriate partnership return. These amounts were calculated by applying the income-forecast method using Paramount's gross receipts from the Balmoral motion pictures without including network television rentals. Shelburne reported depreciation expenses of $ 12,760,822.22 for 1978, $ 6,123,491 for 1979, and $ 6,123,491 for 1980 on the appropriate partnership return. On its return for 1978, Shelburne used the double-declining balance method for computing depreciation. For years after 1978, Shelburne used the straight-line method of depreciation with a 4-year useful life.
Capital B engaged a New York accounting firm with expertise in motion picture auditing, Solomon, Finger & Newman, to perform audits of Paramount's distribution records *83 relating to the pictures owned by Balmoral and Shelburne. Review of such audits and followup negotiations with Paramount by Mr. Heyman resulted in the recovery of money, which they would not otherwise have received, by *1365 the partnerships. Additionally, Messrs. Eisenberg and Filler reviewed the distribution statements from Paramount. Such review and the resultant negotiations with Paramount, usually by Mr. Heyman, resulted in the recovery of money by the partnerships.
During 1979, the long-term notes for "Foul Play," "Grease," "The One and Only," and "Heaven Can Wait" converted from recourse to nonrecourse and, consequently, the limited partners' guarantees associated with such motion pictures were canceled and returned to them. On August 19, 1982, Mr. Filler, on behalf of Capital B, informed FWC that the long-term note for "First Love" had converted from recourse to nonrecourse. At such time, the limited partners' guarantees associated with such film were canceled. As of September 1984, despite the fact that such notes converted 2 years before, such notes had not been paid in full. Similarly, the long-term notes associated with "The One and Only" had not been paid *84 in full by September 1984. By such time, the long-term notes for "Grease," "Foul Play," and "Heaven Can Wait" had been paid in full. As of such date, the long-term notes for "Bears 3" had not converted.
After the investors had become partners in Shelburne and the four Shelburne motion pictures had been released, some of such motion pictures were shown privately to the partners and their families by Shelburne at the Edens Theaters in Northbrook, Illinois. Such showings were catered and were held in recognition of the substantial investments made to Shelburne by the investors. Shelburne incurred various expenses in connection with the screenings, including costs for rental of the theaters and catering. Such costs were reported to be $ 4,859.40 and were deducted as "rent" on Shelburne's 1978 return.
Mr. Grossman has been an accountant for over 24 years. He formed a partnership named Good News Boys (GNB), which invested in the motion picture "Bears 2" by becoming a limited partner in Ambassador Associates. In May 1978, GNB acquired one unit in Shelburne; Mr. Grossman executed all relevant documents on behalf of GNB. GNB received distribution checks from Shelburne in the amounts *85 of $ 349,156.88 in 1979, $ 46,254.10 in 1980, $ 5,690 in 1981, *1366 and $ 2,220 in 1983. In addition, GNB was relieved of its obligations to pay capital contributions due in June 1979 and June 1980, resulting in constructive dividends of $ 186,000.
Prior to his receipt of information concerning Balmoral or Shelburne, Mr. Durkin had known Mr. Eisenberg for some time and had been an investor in other partnerships organized by him or the law firm. On December 16, 1977, after reviewing the private placement memorandum, Mr. Durkin subscribed to a one-half unit interest in Balmoral. The purchase price of such one-half unit was $ 35,000 and was payable in three installments: $ 15,000 at the time of subscription, $ 16,500 on June 1, 1978, and $ 3,500 on June 1, 1979. Promissory notes were executed for the 1978 and 1979 payments. Pursuant to instructions from Balmoral, Mr. Durkin dated documents December 14, 1977. Mr. Durkin received distribution checks from Balmoral in the amount of $ 4,783.12 in 1978, $ 5,223.65 in 1979, and $ 4,235.47 in 1980. He continues to receive such checks. Additionally, he was relieved of his obligation to pay the promissory notes due on June 1, 1979. *86 Such relief resulted in a constructive dividend of $ 3,500.
Mr. and Mrs. Durkin reported Balmoral partnership losses of $ 35,877 for 1977, $ 28,483 for 1978, $ 307 for 1979, and $ 0, due to loss carryover, for 1980. They claimed an investment credit for the motion pictures with a cost or basis of $ 60,874.24 for 1978. 9 Mr. and Mrs. Grossman reported GNB partnership loss of $ 101 for 1978, income of $ 38,854 for 1979, and loss of $ 75,032 for 1980. They claimed an investment credit for qualified investments by GNB with a cost or basis of $ 89,735 in 1978, $ 73,560 in 1979, and $ 14,689 in 1980. In his notices of deficiency, the Commissioner disallowed in full the losses and investment credits claimed by the Durkins and Grossmans.
OPINION
Many persons have invested in partnerships like Balmoral and Shelburne that purchased interests in the negatives of motion pictures. This case has been selected as a test case *1367 with the *87 hope that it will resolve all the issues involved in the similar cases.
The first issue for decision is whether Balmoral and Shelburne became the owners of their respective motion pictures for purposes of computing allowable depreciation. For the years 1977 and 1978, the Commissioner raised such issue after issuing the notices of deficiency. For the years 1979 and 1980, such issue was raised in the notices of deficiency. Therefore, the Commissioner bears the burden of proof with respect to this issue for the years 1977 and 1978, and the petitioners bear such burden for 1979 and 1980. Rule 142(a), Tax Court Rules of Practice and Procedure. 10
The Commissioner argues that by virtue of the distribution agreements, Paramount acquired the irrevocable right to exploit the films, throughout the world, for their entire economic lives, if not in perpetuity. As a result of such agreements, the partnerships conveyed *88 to Paramount all substantial rights in the motion pictures, and retained no interest upon which a deduction for depreciation can be based. Therefore, the amount received by the partnerships as a result of Paramount's exploitation of the films was a return of basis, and the excess, if any, was ordinary income. The petitioners contend that the partnerships owned the six motion pictures involved in this case. Such ownership arose through the purchase and acquisition agreements and was retained by the partnerships because the distribution agreements reserved certain critical substantial rights for the partnerships.
Whether the partnerships became the owners of the motion pictures for tax purposes as a result of the transactions involved herein is a question of fact to be determined by reference to the written agreements read in light of the attending facts and circumstances. Grodt & McKay Realty, Inc. v. Commissioner , 77 T.C. 1221 , 1237 (1981) ; Miller v. Commissioner , 68 T.C. 767 , 776 (1977) ; see Fields v. Commissioner , 14 T.C. 1202 , 1210-1213 (1950) , affd. 189 F.2d 950 (2d Cir. 1951) . *89 It is well established that the economic substance of a transaction rather than the form in which it is cast is determinative of its tax *1368 consequences. See Golsen v. Commissioner , 54 T.C. 742 , 754 (1970) , affd. 445 F.2d 985 (10th Cir. 1971) , and the cases cited therein. Thus, in a number of cases, courts have refused to permit the transfer of formal legal title to shift the incidence of taxation attributable to ownership of the property where the transferor continues to retain significant control over the property transferred. E.g., Helvering v. Clifford , 309 U.S. 331 (1940) ; Helvering v. F. & R. Lazarus Co ., 308 U.S. 252 (1939) ; Law v. Commissioner , 86 T.C. 1065 (1986) ; Hilton v. Commissioner , 74 T.C. 305 (1980) , affd. 671 F.2d 316 (9th Cir. 1982) ; Miller v. Commissioner, supra at 767 . "[Taxation] is not so much concerned with the refinements of title as it is with actual command over the property taxed -- the actual benefit for which *90 the tax is paid." Corliss v. Bowers , 281 U.S. 376 , 378 (1930) . It is therefore fundamental that the availability of a depreciation deduction is not predicated on the mere holding of legal title to property but rather upon a capital investment in the property. Gladding Dry Goods Co. v. Commissioner , 2 B.T.A. 336 (1925) .
Ownership of a motion picture negative is distinct from ownership of the copyright thereto ( 17 U.S.C. sec. 27 (1976) ; 17 U.S.C. sec. 202 (1982) (effective Jan. 1, 1978); Michael Todd Co. v. Los Angeles County , 57 Cal. 2d 684 , 371 P.2d 340 , 21 Cal. Rptr. 604 (1962) , and cases cited therein), and ownership of the former without possession of at least certain of the rights encompassed by the latter is commercially valueless (see Misbourne Pictures Ltd. v. Johnson , 189 F.2d 774 , 776 (2d Cir. 1951)) . Copyrights are monopolies; "they entitle the owner to prohibit various kinds of reproduction, and to relieve individuals of these prohibitions by licenses." *91 Goldsmith v. Commissioner , 143 F.2d 466 , 467 (2d Cir. 1944) (Hand, J., concurring), affg. on other grounds 1 T.C. 711 (1943) . With respect to a motion picture, the exclusive rights that comprise the so-called "bundle of rights" that is a copyright are the rights to: produce copies of the motion picture, prepare derivative works based upon the motion picture, distribute copies of the motion picture to the public by sale or rental, exhibit the motion picture to the public, and display still photographs taken from the *1369 motion picture to the public. 11 17 U.S.C. sec. 1 (1976) ; 17 U.S.C. sec. 106 (1982) (effective Jan. 1, 1978). Such rights may be subdivided indefinitely and may be owned and enforced separately. 17 U.S.C. sec. 201 (d) (1982) (effective Jan. 1, 1978). The copyright for "First Love" has a 28-year term, and the copyright for each of the other motion pictures has a 50-year term. 17 U.S.C. sec. 24 (1976) ; 17 U.S.C. secs. 302 , 303 *92 (1982) .
For tax purposes, a sale of a motion picture occurs when there is a transfer of all substantial rights of value in the motion picture copyright. Tolwinsky v. Commissioner , 86 T.C. 1009 , 1042-1043 (1986) , and the cases cited therein. No sale occurs if the transferor retains substantial proprietary rights in the motion picture. See Carnegie Productions, Inc. v. Commissioner , 59 T.C. 642 , 653 (1973) ; Cory v. Commissioner , 23 T.C. 775 (1955) , affd. 230 F.2d 941 (2d Cir. 1956) .
An examination of the various written agreements reveals that the partnerships acquired and retained no substantial ownership rights in the motion pictures. Under the acquisition agreements, FWC purportedly obtained from *93 Paramount a copyright, without sequel rights, for each motion picture. FWC purportedly transferred all such rights to the partnerships. The partnerships, according to the distribution agreements, then transferred back to Paramount all of the basic rights associated with a copyright, while retaining a "bare" copyright. For each motion picture, all the documents evidencing such transactions were executed at the same time. This series of transfers resulted in Paramount's having the rights to make copies of the motion pictures, to distribute copies of the motion pictures to the public, to show the motion pictures to the public, and to otherwise exploit any dramatic material contained in the motion pictures. Such rights applied to theatrical exploitation, pay television, video cassettes, and commercial television throughout the world. Such enumerated rights combined with Paramount's retention of motion picture sequel rights provided Paramount with the entire bundle of rights that is a copyright.
*1370 The transactions also resulted in Paramount's retaining rights and liabilities commonly associated with ownership. Paramount had the right to designate the laboratory that made *94 copies of the motion pictures, and it was to pay all the costs related to storage and the making of copies. It had the right to determine the title of each film and the opening advertising and initial theatrical release of the motion pictures in the United States and Canada. Paramount could sue in its own name for copyright infringement. It was given exclusive worldwide rights to the soundtrack of the films and could license such rights. Paramount could add its name to the picture and related advertising in such phrases as "A PARAMOUNT PICTURE." Paramount could select such material as it desired from the motion pictures for deposit in its stock film library without compensation to the partnership, and such material was to remain Paramount's property in perpetuity. Finally, there is no credible evidence that the partnerships had any control over exploitation of the motion pictures.
Our conclusion that Paramount retained all substantial rights in the motion pictures is further supported by the fact that Paramount retained a significant financial interest in and control over the motion pictures and their proceeds. Paramount held $ 31,843,050 of FWC's long-term nonrecourse notes *95 from FWC's acquisition of the motion pictures. By virtue of the notices of irrevocable authority, Paramount was able to retain the funds that it would otherwise have paid to the partnerships, that the partnerships would then have paid to FWC, and that FWC would then have paid to Paramount. There was no limit placed on the amount of profit Paramount could receive from its distribution efforts. Additionally, all relevant witnesses agreed that Paramount would not have sold the motion pictures if it could not distribute them. Paramount's financial interest combined with its tremendous control over exploitation of the films clearly indicates that it had all the rights and responsibilities of ownership.
The petitioners argue that the potential payment to be made by Paramount to the partnership at the end of every 28-year period in order to extend the distribution agreement is a "renewal price" indicative of the partnership's ownership *1371 of its respective motion picture because Paramount had to make a payment every 28 years for the privilege of distributing such motion picture. We conclude that the payments are of little value and thus we disagree. According to the terms of *96 the distribution agreement, Paramount's distribution rights for each motion picture are to last in perpetuity, and at the beginning of each successive 28-year period, if the proceeds payable to the partnership under subparagraph "3 FOURTH" reach $ 5,000,000, Paramount is to pay the partnership the greater of $ 5,000 or the fair market value of the motion picture. The payment amount was later amended to a fixed amount of $ 25,000. Such payments are to be mere advances against further sums payable to the partnership pursuant to subparagraph "3 FIFTH" of the distribution agreement and are only payable upon 60 days' written notice by the partnership. These advances are not, as the petitioners argue, the renewal price for successive 28-year periods of film distribution. Such advances are only a change in the timing of payments and are small when compared to the multimillion dollar cost of each motion picture.
The petitioners contend that several other provisions in the distribution agreements indicate that the partnerships owned more than bare legal title and copyright to each of the motion pictures. The partnerships did not limit their contract remedy to default; the distribution *97 agreements did not preclude a remedy whereby the partnerships could gain physical control over the motion pictures. In prior cases, such a limitation of remedies has been cited by this Court as support for the proposition that a taxpayer did not own a film. E.g., Carnegie Productions, Inc. v. Commissioner , 59 T.C. at 645 . Additionally, Paramount cannot make an "outright sale" of its rights with respect to theatrical distribution in the United States and Canada. We observe, that while Paramount may not make such outright sale, it may make "outright territorial grants" anywhere in the world, and therefore, the restriction is one of form and not substance. Both of these provisions, under a different set of facts and circumstances, might support a taxpayer's claim of ownership for tax purposes of a film; however, under the facts and circumstances at hand, we conclude that such *1372 provisions, while protecting the petitioners' economic interests created by the transactions under review, simply do not constitute a legitimate claim of ownership.
A deduction for exhaustion and wear and tear is granted to a person who uses property in his trade or *98 business and incurs a "loss resulting from depreciation of capital he had invested." Helvering v. F. & R. Lazarus Co ., 308 U.S. at 254 . Depreciation "is not predicated upon ownership of the property, but rather upon an investment in property which is thereafter used. * * * The material elements are, the person who makes the investment, use of the property, and the period over which that investment is to be recovered out of income." Gladding Dry Goods Co. v. Commissioner , 2 B.T.A. at 338 -339 . An income interest dependent on the success of a motion picture may be subject to exhaustion over time in the same way that an investment in the motion picture itself would. Law v. Commissioner , 86 T.C. at 1100-1101 ; Tolwinsky v. Commissioner , 86 T.C. at 1053-1054 .
The series of transactions between Paramount, FWC, and the partnerships resulted in the partnerships' obtaining a gross receipts participation and a net profits interest in the proceeds of Paramount's distribution efforts. The partnerships' gross participation was 1 3/4 percent until break-even, and 3 percent *99 thereafter, with some variation for receipts from network and syndicated television for "Grease," "Foul Play," and "Bears 3." The partnerships' net profits interests are set forth in subparagraph "3 FIFTH" of each distribution agreement and range from a minimum of 11 percent to a maximum of 25 percent. As we did in Law and Tolwinsky , we conclude that such interests will exhaust over time and that, therefore, the partnerships are entitled to an allowance for depreciation.
On its returns for 1977, 1978, 1979, and 1980, Balmoral computed depreciation expense under the income-forecast method by using Paramount's gross receipts, excluding network television rentals, for "First Love" and "The One and Only" in the numerator and denominator. On its return for 1978, Shelburne computed depreciation expense using the double-declining-balance method of depreciation with 3-year useful lives for the motion pictures. For 1979 and *1373 1980, Shelburne used the straight-line method of depreciation with 4-year useful lives. The Commissioner contends that Balmoral must use its own net income in the fraction appearing in the income-forecast method and should include estimates for network *100 television rentals. Concerning the computation of depreciation expense for Shelburne, the Commissioner argues that it was not entitled to use the double-declining-balance method of depreciation for 1978 and that it made unreasonable estimates of the useful lives of the motion pictures in the computations for 1978, 1979, and 1980. The Commissioner contends that a reasonable useful life for the films, given the facts as we have found them, is 8 years. As we are clearly convinced of our conclusions, the burden of proof with respect to the method of computing depreciation is not material.
A contractual right to participate in a motion picture's gross receipts or net profits is an intangible asset. Law v. Commissioner , 86 T.C. at 1098-1101 ; Tolwinsky v. Commissioner , 86 T.C. at 1046-1053 . Section 167 prohibits use of the double-declining-balance method to compute the allowable depreciation expense for intangible property, but allows the use of the straight-line method for such property. Generally, a change in a taxpayer's method of computing depreciation requires the consent of the Commissioner. Sec. 1.167(e)-1(a), Income *101 Tax Regs. ; see sec. 446(e) . However, subject to certain limitations not applicable to this case, a taxpayer may change without the consent of the Commissioner from the declining-balance method of depreciation to the straight-line method at anytime during the useful life of the asset. Sec. 1.167(e)-1(b), Income Tax Regs. Additionally, the straight-line method of depreciation is to be used in all cases where the taxpayer has not adopted a different acceptable method of computing the depreciation expense of a depreciable asset. Sec. 1.167(b)-1(a), Income Tax Regs.
The income-forecast method requires the application of a fraction, the numerator of which is income from the motion picture for the taxable period, and the denominator of which is the estimated total income from the motion picture during its useful life. The cost of the motion picture is multiplied by such fraction to calculate the depreciation *1374 allowed for such taxable period. 12 Rev. Rul. 60-358 , 1960- 2 C.B. 68 (pertaining to television films), amplified to include motion pictures, Rev. Rul. 64-273 , 1964- 2 C.B. 62 . For such *102 method, the term "income" means the taxpayer's net, rather than gross, income. Gordon v. Commissioner , 766 F.2d 293 (7th Cir. 1985) , affg. a Memorandum Opinion of this Court; Fife v. Commissioner , 82 T.C. 1 , 9 (1984) ; Greene v. Commissioner , 81 T.C. 132 (1983) ; Siegel v. Commissioner , 78 T.C. 659 , 693 (1982) . When the taxpayer elects to compute depreciation by use of the income-forecast method, he must use the method as prescribed by the Commissioner. Greene v. Commissioner , 81 T.C. at 139 .
*103 The petitioners call upon the Court to overrule a series of recently decided cases which clearly hold that when computing depreciation expense under the income-forecast method, the taxpayer must use his net income. They claim that consistent use of Paramount's gross receipts more accurately reflects the stream of income to the partnerships. However, the petitioners then go on to say:
As the record shows, in order to calculate the net income from a film considerable information and analysis is required. In accordance with various agreements, there are numerous expenses and deductions from distributor's gross receipts, including participations, deferments, union and guild payments, prints, advertising expenses, etc., which must be taken into account to calculate net receipts. Accordingly, in order to determine net receipts, Weiss needed all such other expense and deduction information which information simply was not available at that time. * * * [Emphasis in original; fn. refs. omitted.]
Additionally, they argue that the use of gross receipts is more directly related to the actual depreciation of a motion picture.
During the years in question, Balmoral owned contract *104 rights to funds derived from the commercial exploitation of two motion pictures. The actual depreciation of such motion pictures is not directly related to the appropriate depreciation expense of such contract rights. This proposition is clearly stated by the petitioners when they point out the *1375 numerous adjustments to gross receipts which must be made to calculate net receipts. Moreover, the petitioners failed to present any credible evidence that the relevant net receipts information could not be obtained prior to the filing deadlines for the partnership's returns. Therefore, Balmoral's net income should be used in the income-forecast computation.
Balmoral did not include network television rentals in the denominator of the income-forecast fraction. Rev. Proc. 71-29 , 1971- 2 C.B. 568 , states that when using the income-forecast method of depreciation for motion pictures, such as those in question, the taxpayer need not estimate the income from future television exhibition. "However, if an arrangement for domestic TV exhibition is entered into prior to the time the cost of the motion picture has been depreciated to a reasonable *105 salvage value, the Service will require an estimate of income from TV exhibition of such films to be made at that time." Rev. Proc. 71-29, 1971-2 C.B. at 569 . The Commissioner contends that estimates for income anticipated from the agreements in principle for network television exhibition of the motion pictures should be included from the time of such agreements in 1977. At a minimum, the Commissioner argues that income estimates from network broadcasting should be included from the time such agreements were formalized by execution of contracts -- February 1978 for "First Love," and June 1978 for "The One and Only." The petitioners contend that no estimate need be made until some payment is actually received by Balmoral from the networks because until that time, the amount is too speculative to be included in the denominator. We observe that the petitioners' argument conveniently allows greater early-year depreciation than is allowed by the plain language of the revenue procedure. Further, we observe that the logic of the petitioners' argument would render the income-forecast method useless because all future revenue, including box office *106 receipts, would be considered too speculative. The agreements were with network television stations for motion pictures to be distributed by Paramount, a well known motion picture distributor, and were signed within 6 months of the transactions in question. Therefore, on the facts of this *1376 case, we must agree with the Commissioner that an estimate of income from network broadcasts should be included in Balmoral's income estimate for 1977 and thereafter.
Shelburne could not use the double-declining-balance method of depreciation for 1978, because the contract rights it owned in the motion pictures were intangible. Because it chose an unacceptable method of depreciation, the straight-line method will be used to compute depreciation expense for 1978. Testimony at trial indicates that syndication usually occurs 5 1/2 years after the initial release. The Commissioner's 8-year useful life was based upon the maturity of the long-term notes in 1986; we find such maturity date of no relevance to the useful life of Shelburne's contract rights. Based upon the record as a whole, our best judgment is that 6 years is a reasonable useful life for Shelburne's contract rights.
The *107 next question for our determination concerns the basis of depreciation of Balmoral's and Shelburne's contract rights. In general, the basis of property is the cost of such property. Detroit Edison Co. v. Commissioner , 319 U.S. 98 (1943) ; secs. 167(g) , 1012 . When debt principal is payable solely out of exploitation proceeds, nonrecourse loans are contingent obligations and are not treated as true debt. Estate of Baron v. Commissioner , 83 T.C. 542 , 550-553 (1984) , affd. 798 F.2d 65 (2d Cir. 1986) ; Fox v. Commissioner , 80 T.C. 972 , 1022-1023 (1983) , affd. without published opinion 742 F.2d 1441 (2d Cir. 1984) , affd. without published opinion sub nom. Hook v. Commissioner, Kratsa v. Commissioner, Leffel v. Commissioner, Rosenblatt v. Commissioner, Zemel v. Commissioner , 734 F.2d 5 -7, 9 (3d Cir. 1984), affd. sub nom. Barnard v. Commissioner , 731 F.2d 230 (4th Cir. 1984) ; Saviano v. Commissioner , 80 T.C. 955 (1983) , affd. 765 F.2d 643 (7th Cir. 1985) . *108 When a transaction is structured in such a manner, that payment by the taxpayer is not probable, either because of the length or the terms of the debt, the source of the payments, or any other arrangement which does not provide an economic incentive for the taxpayer to pay the debt, then such debt is not genuine indebtedness to be taken into account for purposes of determining a taxpayer's investment in property. See Tolwinsky v. Commissioner , 86 T.C. *1377 at 1048-1050 . Such a debt does not reflect an actual investment in property and cannot be included in the taxpayer's depreciable basis. Siegel v. Commissioner , 78 T.C. at 684 -691 ; Brannen v. Commissioner , 78 T.C. 471 (1982) , affd. 722 F.2d 695 (11th Cir. 1984) ; Estate of Franklin v. Commissioner , 64 T.C. 752 (1975) , affd. 544 F.2d 1045 (9th Cir. 1976) .
The Commissioner contends that the bases of depreciation in the motion pictures do not exceed $ 699,000 for "First Love," $ 1,173,250 for "The One and Only," $ 3,333,625 for "Heaven Can Wait," $ 2,294,900 *109 for "Grease," $ 1,823,750 for "Foul Play," and $ 1,520,575 for "Bears 3." The Commissioner argues that the long-term notes from the partnerships are not includable in Balmoral's and Shelburne's bases because such notes represent contingent, illusory liabilities and because the purchase price of each motion picture unreasonably exceeded its fair market value. The petitioners state that such notes represent genuine indebtedness and that the purchase price of each motion picture, including the related promissory notes, was not substantially in excess of its fair market value.
The Commissioner contends that the petitioners were not "at risk" for the amount of the purportedly recourse promissory notes maturing in 1986 for which they executed guarantees. He argues that while Mr. Heyman rendered services in negotiating the transactions herein and resolving subsequent disputes, FWC was interjected into such transactions solely to create the appearance of "risk" with respect to such promissory notes. The Commissioner also claims that the events set forth in each purchase agreement whereby the partnership's long-term notes converted from recourse to nonrecourse were certain to occur. Finally, *110 he submits that any amounts payable by virtue of the limited partners' guarantees was too contingent for the at risk rules, and that the possibility of indemnification from the general partner, Capital B, violates the at risk requirements.
The petitioners contend that they were at risk for the entire amount recited in the purchase agreement, including the amount of the notes maturing in 1986. They argue that Mr. Heyman is an independent party to the transactions herein and, on behalf of FWC, stands ready to enforce the guarantees and reap substantial additional profits for FWC. *1378 In support of this position, the petitioners observe that Mr. Barron did not like Mr. Eisenberg, Paramount was very cautious in its business dealings because of a Securities and Exchange Commission investigation, and FWC assumed a large risk even before the partnerships were formed. The petitioners state that the conversion events set forth in the purchase agreements were carefully negotiated by Messrs. Eisenberg and Heyman and were events with a substantial economic relationship to the motion pictures and which demonstrated the requisite degree of economic viability to satisfy the at risk requirements *111 for conversion events. As such, they state that conversion events are similar to examples of bona fide conversion events which appear in the legislative history of section 465. S. Rept. 94-938 (1976), 1976-3 C.B. (Vol. 3) 49, 86 n. 1; H. Rept. 94-658 (1976), 1976-3 C.B. (Vol. 2) 695, 802 n. 10. The Commissioner concedes that he has the burden of proof on this issue for all years except for 1979 for Mr. and Mrs. Durkin.
Given the history of motion picture deals wherein Mr. Heyman and the law firm have worked together, the structure of the transactions in question, the lack of any services by FWC, and the tremendous increase in recourse debt which occurred in the transactions from FWC to the partnerships, this Court concludes that the partnerships' long-term notes and the guarantees of the limited partners were without business purpose and executed solely to gain tax benefits. Therefore, the long-term notes from the partnerships to FWC which mature in 1986 are disregarded for tax purposes. See Goldstein v. Commissioner , 364 F.2d 734 , 740 (2d Cir. 1966) , affg. 44 T.C. 284 (1965) ; *112 see also Knetsch v. United States , 364 U.S. 361 (1960) . However, we are persuaded that the amount of the short-term notes from FWC to Paramount is bona fide debt and that the short-term notes from the partnerships to FWC are bona fide, as are the promissory notes of the limited partners to the partnerships.
In support of our conclusion regarding the partnerships' short-term notes, we conclude on the record as a whole that Paramount entered into the transactions in question to receive an early return on its investment in the motion pictures, and it sought to insure this return by the use of recourse notes from FWC and similar notes from the *1379 partnerships to FWC. The existence of the nonrecourse long-term notes from FWC to Paramount underscores Paramount's desire to receive such early return. We are convinced that Paramount would have enforced FWC's short-term notes if the motion pictures had been unsuccessful. In the event of enforcement by Paramount, economic reality would have dictated that FWC would have to enforce the partnerships' short-term notes. Additionally, although the partnerships' short-term notes are for a larger amount than *113 those of FWC, reflecting a markup for Mr. Heyman's services, we conclude that the full amount of the partnerships' short-term notes would have been enforced. By virtue of their promissory notes, the capital contributions of the limited partners would have provided the necessary funds. Compare Pritchett v. Commissioner , 85 T.C. 580 (1985) (Court-reviewed) with Abramson v. Commissioner , 86 T.C. 360 (1986) (Court-reviewed).
Our conclusion concerning the long-term notes is based in part upon the expectation of the law firm and the petitioners, at the time the parties executed the various relevant agreements, that such notes would convert regardless of the success of the motion pictures. Each of the Balmoral long-term notes convert to nonrecourse upon Paramount's receipt of sums due it upon the first syndicated (nonnetwork) television broadcast of the relevant motion picture. In effect, the conversion to nonrecourse occurs upon the payment of any money from any local television station. Mr. Heyman stated, as a rule of thumb, that syndication occurs 5 1/2 years after theatrical release of a motion picture. One of *114 the conversion events for "Heaven Can Wait" is the receipt by Paramount of more than $ 1,500,000 from cable and free home television. Mr. Heyman stated that the cable exhibition of a motion picture will usually commence 18 months after theatrical release. Mr. Arney testified that even a "fairly mediocre" motion picture will generate syndicated television revenues of $ 1,500,000. "Grease" has gross receipts from other than theatrical sources of $ 6,500,000 or more as a conversion event. Prior to execution of the FWC-Shelburne purchase agreement for "Grease," there was an agreement in principle to exhibit it on network television for $ 6,190,000. The motion picture "Foul Play" has Paramount's gross receipts from other than theatrical *1380 sources of at least $ 4 million as a conversion event. Prior to execution of it

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/4628587. Public record. Not legal advice.