The Gala Film Partners, LLP v The Commissioners for HMRC

An appeal by Gala Film Partners, LLP (“Gala”) against amendments made by HMRC to its partnership tax return for the 2003/04 tax year. In a closure notice dated 28 August 2015, HMRC concluded that Gala did not, as it had claimed, incur a loss in that tax year of £110,755,060.68 in the course of carrying on a trade of film distribution (“the loss”) and that it had taxable profits of £552,570.52.

A referral made by HMRC and the individual members of Gala listed above (“the Referrers”) (under s 28ZA Taxes Management Act 1970) for the tribunal to determine whether they are, as they have claimed, entitled to relief by set-off against their other income for (a) their allocated share of the loss, under ss 380 and 381 of the Income and Corporation Taxes Act 1988 (“ICTA”), and (b) the interest paid on the bank loans made to them to finance their contributions to Gala, under ss 353 and 362 ICTA.

Distribution rights in selected films would pass from one studio entity to another via Gala on the basis that:

Gala would grant a studio entity a call option to enable it to acquire Gala’s “business”, which it could exercise on specified dates, the first of which would fall in the third year of the arrangements.

Gala would pay the Initial Expenditure, licence fees and other costs and expenses of putting the structure in place using (a) the contributions, as financed in part by a bank loan, and (b) a bank loan obtained by Gala:

The “minimum royalties” would comprise (a) sums due annually, and (b) a large “minimum amount” due at the end of the term of the distribution agreement, which would be calculated to be sufficient to enable Gala/the members to repay interest on, and the total principal, of the bank loans respectively and, over the term, for Gala to realise a small profit from their receipt. These sums would be due when the corresponding payment of interest or principal was due. If the studio exercised the call option, the option price would be at least equal to the “minimum amount”.

The studio would (a) arrange for a bank to issue a letter of credit to Gala, in effect, to guarantee the payment of the “minimum royalties”/option price and (b) deposit an amount equal to the Initial Expenditure/total principal of the loans with the issuer in an interest bearing account for the issuer to use to meet its obligations under the letter of credit.

Therefore, the arrangements would be such that from the outset:

On Gala’s analysis, the arrangements would generate a substantial loss in the 2003/04 tax year, broadly, of a sum equal to the Initial Expenditure and costs of putting the arrangements in place, for which the members of Gala would seek relief under ss 380 and 381 ICTA. The loss would arise on the basis that, so Gala says (a) its activities, as conducted in accordance with and pursuant to the distribution agreement, would constitute a trade of the exploitation of distribution rights in respect of the selected films, and (b) Gala would incur the Initial Expenditure, as its full agreed contribution to the studio’s costs of distribution of the films, in 2003/04, before the films were likely to generate any significant “gross receipts”, which may generate income for Gala.

The members claimed loss relief on a sum equal to their total contributions of £10 million, of which only £2.24 million was provided from their own resources as cash contributions.

The members obtained a total tax repayment in the first year of the arrangements of £4 million, £1.754 million more than their cash contributions (“the tax relief”). As the summary states this meant that their position in the first year after tax relief was received at 40% (the highest rate of income tax at the time) was “17.54% cash positive”.

The members were liable to capital gains tax (“CGT”) on the price paid by Sony on the exercise of the call option of only £798,000 due to taper relief. A member’s charge could be reduced or eliminated if the member had capital losses.

Therefore, even though Gala did not receive any sums from the arrangements in excess of the “minimum royalties” and the option price (as calculated to ensure the repayment of all sums due under the bank loans), the members received a net benefit purely from tax relief of approximately £1 million. We refer to this as “the tax benefit”.

(a) During that tax year, Gala was carrying on a trade the profits of which are taxable under Case I of schedule D (see s 18 ICTA), and (b) the Initial Expenditure (and related costs and expenses) can be deducted in computing the profits of that trade for tax purposes on the basis that they constitute “money wholly and exclusively laid out or expended for the purposes of the trade…” (under s 74 ICTA).

The loss was computed in accordance with generally accepted accounting practice in the United Kingdom (“GAAP”), as required by ss 42(1) and 46(2) Finance Act 1998 which, at the relevant time, provided as follows:

“42 Computation of profits of trade, profession or vocation

(1)

For the purposes of Case I or II of Schedule D the profits of a trade, profession or vocation must be computed in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law in computing profits for those purposes”.

“46 Minor and consequential provisions about computations

(2)

Except where otherwise expressly provided, the same rules apply in computing losses of a trade, profession or vocation for any purposes of the Tax Acts as apply in computing profits.”

As set out at [121] and [156] of that decision, the words used import a wholly subjective test which, as regards an LLP, is to be assessed by reference to the subjective views of its “controlling mind”.

As set out at [123] of that decision, the term “profit” has “the basic meaning of an excess of income over costs over a possibly indefinite period”. That is the sense in which we use the term “profit” when in this decision we refer to Gala’s prospects of receiving a profit.

(a) There is no difference in meaning between “laid out or expended”, the wording in s 74 ICTA as it applied at the time, and “incurred”, the term used in the later version of s 74 to which much of the relevant case law relates, and (b) the question whether Gala “laid out or expended” or “incurred” expenditure depends on the obligations it incurred and discharged under the relevant agreements and whether Gala bore “the economic burden of an expense”. This was the approach taken by the tribunal in Ingenious Games LLP and ors v HMRC [2017] SFTD 1158 (“Ingenious FTT”) (see [864]) as endorsed by the decision of the Upper Tribunal (“UT”) in that case (see [2019] UKUT 0226 (TCC) (“Ingenious UT”) at [434]).

The relevant legal principles applicable in determining whether expenditure is incurred “wholly and exclusively for the purposes of a trade” are succinctly summarised in Ingenious FTT at [839] as follows:

“… it is well known, and there was no dispute that:

(1)

by “for the purposes of the trade” is meant for the purposes of enabling a person to carry on the trade and earn profits in it;

(2)

a dual purpose, where not saved by section 34(2),was not exclusively a trading purpose; as a result an expense incurred both for the purposes of trade and another purpose is not deductible;

(3)

the purpose referred to is that of the taxpayer subjectively determined;

(4)

the purpose of the taxpayer must be distinguished from the effect of the expense. Thus a private benefit which is merely a consequence or an incidental effect does not give rise to a dual purpose;

(5)

although the purpose is to be subjectively determined this does not limit the investigation to the taxpayer’s conscious motives; a pinch of salt is necessary – some consequences are so inevitably and inextricably involved in a payment that unless merely incidental they must be taken to be a purpose for which the payment is made.”

He remarked, at [110], that there is no special rule for interpreting tax legislation and the decision in Ramsay “marked the end of an unduly literal interpretative approach to tax statutes and a formalistic insistence on examining steps in a composite scheme separately”. He noted that, as Lord Nicholls, giving the judgment of the Judicial Committee, said in Barclays Mercantile Business Finance Ltd v Mawson [2004] UKHL, [2005] 1 AC 684 (“BMBF”) at [32]:

“the essence of the new approach was to give the statutory provision a purposive interpretation in order to determine the nature of the transaction to which it was intended to apply and then to decide whether the actual transaction (which might involve considering the overall effect of a number of elements intended to operate together) answered to the statutory description. This brought the interpretation of tax statutes into line with general principles of statutory interpretation and required notice to be taken of the reality of the transaction in issue….”

He added that the effect of the Ramsay case and the modern approach was elegantly summarised by Ribeiro PJ in the following statement (approved by the Appellate Committee in BMBF) in Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46 (“Arrowtown”), at [35]:

“the driving principle in the Ramsay line of cases continues to involve a general rule of statutory construction and an unblinkered approach to the analysis of the facts. The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically.”

At [108], the UT said that (a) where a number of contracts are entered into together, at the very least the existence of the other contracts is part of the factual background known to the parties at or before the date of the contract, as referred to by Lord Neuberger, at [10] of Wood v Capita Insurance Services Ltd [2017] UKSC 24 and commonly referred to as the “factual matrix”. The existence of the other contracts is therefore a relevant part of the factual matrix when construing any one of them, and (b) where the contracts specifically cross-refer or there are other indications that they are intended to operate only as a package, then that fact will be relevant.

At [109], they cited Lewison on the Interpretation of Contracts, 6th edition, paragraph 3.03 where it is said:

“Many transactions take place by the entry into a series of contracts…In such cases, where the transaction is in truth one transaction all the contracts may be read together for the purpose of determining their legal effect. This principle is a more specific example of the general principle that background is admissible in interpreting a written contract. It applies to other documents executed as part of the same transaction, whether they happen to be executed before, at the same time as, or after the document requiring to be interpreted.”

At [110], the UT continued that, therefore, “where there is in truth one transaction, the tribunal is entitled to read the contracts together for the purpose of determining their legal effect”. In their view, that is not the same as saying that “where there is a series of contracts to implement a transaction there is a single composite agreement”; the “composite agreement” approach is not correct as a matter of contractual construction. However, “what must not be done is to adopt blinkers in looking at each agreement”.

In determining the legal rights and obligations acquired by the LLPs pursuant to the contractual arrangements, the tribunal was entitled and correct to look at the entirety of each set of transaction documents, which it found (at [91]) were entered into at the same time and as a single package:

“That set of documents…reflected what was undeniably a single, albeit multi-party, transaction as a commercial matter. Even though it was common ground that none of the documents in question could be regarded as a sham, the absence of any allegation of sham does not prevent the tribunal following the approach outlined above or, for example, examining critically whether the written provisions of the documents had the effect when read together that the LLPs maintained that they did. This is consistent with the principle, illustrated in Antoniades v Villiers as discussed above, that the tribunal is not bound by labels that the parties have chosen to apply if those labels do not reflect the true nature of the legal rights and obligations created pursuant to the contractual arrangements.”

As regards the Ramsay approach, at [111], the UT rejected the view that, at the first stage of contractual construction, the Ramsay approach is to be ignored provided its scope is properly understood and the principles are correctly applied. There is no reason why the tribunal should not come to a conclusion as to the overall effect of the arrangements through a process of construing the relevant contracts alongside a consideration of the extent to which the application of the Ramsay principle affects the position. Nevertheless, in their view, it is equally permissible to take the approach of first construing the relevant contracts conventionally, and then considering whether and to what extent the Ramsay principle applies. Whichever process is followed, “the facts must be analysed in the light of the particular statutory provision being applied and taking account of the need (depending on the relevant question) to view the transaction realistically”.

Under the transaction documents, the distribution rights in relation to the selected films were held by Sony, Gala was not entitled to exploit rights to distribute the selected films in any meaningful sense and Gala had no realistic prospect of receiving any income in addition to the “minimum royalties”. The rights licensed back and forth between the various studio entities simply went around in a circle, passing through Gala en route.

Those who controlled Gala knew that there was no real prospect of Gala making a profit and that it was inevitable that Sony would exercise the call option at the earliest opportunity. It was an inherent feature of the scheme that it would be wound up in a manner which attracted a CGT charge, on the price paid on the exercise of the call option, rather than an income tax charge (as would apply to the final “minimum amount”) thereby ensuring that the individual investors would (if the scheme worked as intended) be able to make a profit on their cash contributions purely from tax relief.

In effect, the bank borrowings were placed on deposit in a blocked account in year 1 and, as was intended and inevitable from the outset, were returned in year 3 with guaranteed “minimum royalties” paid in the interim. The bank borrowings were never truly at Gala’s disposal given that (a) they were paid into a blocked bank account over which Sony exercised a substantial degree of control, (b) an equal amount was simultaneously deposited by Sony with the bank which issued the letter of credit, and (c) that amount was and could only be used, in effect, to meet interest and capital payments on the bank loans. The loaned monies essentially went in a circle from the lending bank and back to it (via Gala, the members, Sony and the bank which issued the letter of credit) and were only included in the structure to inflate Gala’s loss, as a necessary ingredient in the attempted raid on the Treasury. The only monies genuinely at Gala’s disposal were the cash contributions which was used to pay fees for putting the scheme in place.

For all the reasons set out in Parts B and D, our view is that (a) Gala “laid out or expended” the Initial Expenditure but (b) neither that sum nor the relevant costs and expenses of setting up and operating the arrangements were “laid out or expended” by Gala “wholly and exclusively” for the purposes of any trade relating to film distribution which Gala carried on, (c) if our view in (b) is not correct, contrary to HMRC’s stance, Gala has established that the majority of the relevant sums were “laid out or expended” in the tax year 2003/04, but (d) in any event, all of the relevant sums are capital in nature.

For all the reasons set out in Part F, Gala’s asserted loss for the 2003/04 tax year was not computed in accordance with GAAP.

under s 380(1) unless for the year of assessment in which the loss is claimed to have been sustained, “the trade was being carried on on a commercial basis and with a view to the realisation of profits in the trade….” (under s 381(1)). A trade is treated as being carried on “with a view to the realisation of profits” where at any time it is “carried on so as to afford a reasonable expectation of profit” (under s 384(9)), or

under s 381 unless the trade was carried on throughout the period in which the loss was sustained “on a commercial basis and in such a way that profits in the trade...could reasonably be expected to be realised in that period or within a reasonable time thereafter.”

It was stated that the sole object of Gala:

“shall be to carry on the Business and any business activity relating thereto or arising therefrom including without limitation:

(a)

entering into the Transaction Documents and any agreements pursuant thereto;

(b)

engaging in the acquisition of distribution rights and sequel and remake rights in theatrical films and arranging for the distribution of those theatrical films and entering into and performing and exercising the LLP’s obligations and rights under the Transaction Documents relating thereto and other agreements entered into pursuant thereto or in connection therewith;

(c)

lending money, giving credit or providing any other form of credit on such terms as the Ordinary Members determine;

(d)

carrying out the duties of the LLP in relation to the rights and obligations of a rights holder and film distributor; and/or

(e)

acting as distributor of theatrical films.”

The Ordinary Members are defined as the members other than the designated members and we refer to them as “the members”. Gala’s “Business” is defined as:

“the acquisition of a portfolio or portfolios of distribution rights and remake and sequel rights in theatrical films, such portfolio or portfolios to be acquired in the course of trading with a view to gain, and the exploitation of the distribution rights by means of the Distribution Agreements in consideration of a share of the distribution receipts arising therefrom all as more particularly described in the IM.”

Each of the members agreed to use “all its reasonable and prudent endeavours to perform the Business at all times in such a way so as to maximise the profitability of the Business”.

It was stated that (a) the agreement was conditional upon Gala receiving duly completed applications for admissions by prospective members whose prospective “Contributions” (defined as “any money or assets paid into the accounts of or transferred into the ownership of [Gala] by [a member]..”) committed unconditionally to Gala were in aggregate not less than £50 million, (b) if that condition was not met by 28 February 2004, any monies received from the members would be reimbursed with any interest earned thereon, (c) no new members would be admitted to Gala after 5 April 2004, and (d) admission of a member would be effective on Gala receiving his Contribution in cleared funds and the counter-signature and dating of his admission form by or on behalf of Gala.

It was stated that (a) a member would acquire a “Member’s Share”, defined as a share of and interest in Gala’s capital (its excess of assets over liabilities as shown in its accounts) equal to the amount of his “Contribution”, plus or minus a share of the profit or loss of Gala to be attributed to him, and (b) members would share any profits and bear any losses relating to “the Slate” (defined as “a set of distribution rights and sequel and remake rights in theatrical films acquired by” Gala), as shown in the profit and loss account for “the Slate” drawn up each year, pro rata to their “Individual Slate Contributions”. Such contributions were, broadly, computed by attributing the distribution expenses Gala agreed to pay in respect of “the Slate” between the members in the proportions that their cash contributions bore to the aggregate of their contributions.

The members agreed that (a) the working capital, capital expenditure and other funding requirements would be met out of (i) the proceeds of the subscription for “Members’ Shares”, and (ii) the loan from “the LLP Lender” (the bank which provided a loan to Gala (on terms negotiated by Invicta in accordance with the MSA) “for the purpose of augmenting the LLP’s working capital” and, (b) subject to the provisions relating to winding-up, no member would be required to make any further funding available to Gala.

It was provided that (a) members could appoint any person to provide administrative or other services to Gala and entrust to and confer upon any such person so appointed any of the powers, duties and/or functions exercisable by them as members, upon such terms and conditions, including the right to remuneration payable by Gala, and with such restrictions, as they thought fit, (b) an operators agreement (“the OA”) and a media services agreement (“the MSA”) would be duly executed on that day, (c) subject to certain exceptions which are not in point, any matters which were not entrusted to any person pursuant to these provisions would be determined by the members by their votes by simple majority at a duly convened meeting (on the basis that each member would have one vote for each £1 of capital contributed to Gala), and (d) no member could “exercise any of the powers exercisable by them which have been entrusted to and conferred upon the Operator pursuant to the [OA] or [Invicta] pursuant to the [MSA]”.

It was provided that members would not be permitted to (a) sell or otherwise deal with their interests in Gala in any way, other than by way of security assignment to “the Lender”, (being “an entity that provides a loan to a member for the purpose of financing their Contribution”) and save as otherwise stated in the MA, or (b) withdraw their capital without the consent of the members given by way of a simple majority vote. Members could be expelled in certain limited circumstances and, depending on the trigger event, may receive their “Member’s Share”.

It was provided that, if Gala was wound-up each member (a) would be liable to contribute to its assets an amount equal to his aggregate contributions (which was not to be treated, for this purpose, as reduced by any withdrawal of capital or drawings), and (b) any surplus of assets of Gala over its liabilities remaining at the conclusion of the winding up, after payment of all creditors and all expenses of the winding up, would be paid by the liquidator to the members in such proportions as their respective “Member’s Shares” bore to each other on the day of the commencement of the winding up.

to establish, operate and, if required by Gala, to wind-up Gala (as those terms are defined in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001),

to report to Gala on all matters pertaining to its interests in the Slates acquired in order to enable Gala to meet its obligations under the MA,

to approve and control all withdrawals from any bank account of Gala,

to ensure that the members were provided every 6 months with adequate information about Gala’s proceeds from film distribution receipts, as broken down by member,

to provide such other services as may be necessary in pursuing the purpose of the Business, and

to provide such other services as may be agreed from time to time between the parties.

Invicta reserved the right “to delegate such of the Services as it considers appropriate to a third party, provided always that [Invicta], shall retain responsibility and liability for the performance of all the Services.”

It was provided that, without further consent of Gala, Invicta was entitled “to carry out any business of the same nature as and competing with the Business without accounting for and paying over profits made by [Invicta] in such business”.

Invicta was to receive a fee for its services calculated under a formula (see Part D).

It is not unusual for such agreements “to be drawn as widely as possible…to avoid the possibility that the document has to be revisited in the future”. The OA was drafted before the transaction was entered into and:

“certainly our understanding was that the operator simply was there to service the obligations and the needs of…the LLP, in terms of compliance. It was a compliance mechanism and compliance requirement.”

Whilst there is a general catch-all clause in the OA, Chiltern’s role was in fact “very limited and to the point” and was akin to that of a company secretary. There is:

“no way in which - at no time did they get involved in the actual business, which is to identify assets, negotiate, acquire the assets, and do all of the other things that are within the confines of the services that were rendered by [Invicta]. Chiltern is a non-entity, from the point of view of the business.”

So the catch-all provision does not “properly describe or accurately reflect the function of Chiltern in those circumstances”; rather the proper analysis is to look at what Invicta did in the MSA given this is “after all a media business. Chiltern were not equipped to perform that role and they were not asked to perform that role”. Nor does the provision which required Chiltern to report to Gala (see [33(2)] reflect what Chiltern were asked to do. It came from a sort of standard form arrangement. At no time did Chiltern, and they were not in a position to, report to Gala on matters referred to in that clause and they were not asked to do so: “They were not qualified or competent to report to the LLP, and those functions are expressly reported and undertaken by Invicta in the [MSA].” In his view, therefore, the OA should not be looked at in isolation but together with the MSA:

“The real bread and butter operation, media operation as opposed to corporate operation of the business was undertaken by Invicta at all relevant times, before and after the execution of the documents…At no time was Chiltern involved in any of these activities…They were not competent to do that. The members were not looking for them…we have to look at the actual operation as it actually happened. Operationally, Chilterns were nothing more than a…Company Secretary.”

There is a contradiction inherent in the documents. It is provided that the operator has exclusive operational capacity but the MA contemplates that a third party could be engaged to do other things in relation to Gala’s business. So the situation is “at very best unclear…and ambiguous”. As it happens Gala engaged a third party, Invicta, which actually reported to Gala and did all of the things that needed to be done on behalf of Gala, as far as the business was concerned and:

“I draw a distinction between operating the LLP and conducting the business….Chilterns were at all times responsible for operating the LLP, in much the same way that a company secretarial company is engaged to provide company secretarial services. That’s the distinction that was made at the time and that’s the distinction which is the reality….The agreement makes this quite clear that it contemplates the possibility that the LLP would engage others. It’s quite clear that Chilterns didn’t have the competence to do the services that are at the heart of this transaction. Organising the Company Secretarial aspects of the enterprise, though important, it was important for everybody, including the members that the LLP was run in a compliant way, and that was Chiltern’s function, the guts of the transaction in terms of the trade was at all times undertaken by Invicta….We were always clear in our minds that we needed Chiltern for the operational aspects and not for the business trading aspects of the business.”

Chiltern had no competence in the film business and neither Invicta nor the members looked to them, for an understanding of the film industry:

“They had no connection with Sony, wouldn’t know how to get involved with Sony, and...the true relationship and the business mind of the partnership...is embodied in the [MSA]...When one takes the full menu of services, you see that that’s where the proper brains, business brains...or business mind of the partnership resides…”

Gala’s secondary argument as regards its stance that Gala carried on a trade is that, for the purposes of the required multi-factorial assessment, all the acts of Invicta carried out under the MSA must be attributed to Gala (as, so it says, must the acts of both those appointed by Invicta to assist it and of the Sony sub-licensee). Gala submitted that Invicta was appointed as Gala’s agent under the terms of the MSA as regards the activities specified in the MSA but considered that this attribution should be made regardless of whether Gala was strictly an agent.

HMRC disputed that Invicta was appointed to act as Gala’s agent under the MSA and submitted that no such attribution should be made whatever its precise role was. This issue is dealt with in Part C.

HMRC said that (a) who are the “controlling minds” of an LLP is generally to be determined according to the contracts governing its operation, and (b) in Ingenious FTT, at [493], the tribunal decided the controlling mind was the operator of the relevant LLPs as follows:

“To the extent a subjective determination of the view of the LLP has to be made the parties were agreed that it would be that of the controlling minds of the LLPs: the LLPs delegated their running to the Operator, so if one asks about the conduct of the business it is the Operator’s conduct of it which is relevant, and that in turn is that of its directing minds.”

In their view, the controlling mind was Chiltern/those controlling it, given that, pursuant to the MA, it was appointed as operator and was “exclusively responsible” for the provision to Gala of the very broadly framed services listed in the OA. HMRC noted that this accords with the view expressed by solicitors in Instructions to Counsel dated 23 January 2004 produced on behalf of Gala (for a conference which Mr Yusef attended) that: “Day-to-day operation of the LLP would seem to vest in [Chiltern] under the [OA]”. HMRC also noted that the provisions in the MSA highlighted above demonstrate that (a) Invicta did not act as Gala’s agent but rather was appointed to provide services to Gala, and (b) overall, its role was confined to giving advice only without any ability to bind Gala, and (c) by contrast, under the OA, Chiltern could bind Gala, to the extent necessary, in relation to its services.

Brooke LJ in Wisniewski v Central Manchester Health Authority [1998] PIQR P324, that:

“From this line of authority I derive the following principles in the context of the present case:

(1)

In certain circumstances a court may be entitled to draw adverse inferences from the absence or silence of a witness who might be expected to have material evidence to give on an issue in an action.

(2)

If a court is willing to draw such inferences they may go to strengthen the evidence adduced on that issue by the other party or to weaken the evidence, if any, adduced by the party who might reasonably have been expected to call the witness.

(3)

There must, however, have been some evidence, however weak, adduced by the former on the matter in question before the court is entitled to draw the desired inference: in other words, there must be a case to answer on that issue.

(4)

If the reason for the witness’s absence or silence satisfies the court then no such adverse inference may be drawn. If, on the other hand, there is some credible explanation given, even if it is not wholly satisfactory, the potentially detrimental effect of his/her absence or silence may be reduced or nullified.”

Lord Hodge in Royal Mail Group Ltd v Efobi [2021] 1 WLR 3863 (“Efobi”) at [41], that:

“The question whether an adverse inference may be drawn from the absence of a witness is sometimes treated as a matter governed by legal criteria, for which the decision of the Court of Appeal in Wisniewski v Central Manchester Health Authority [1998] PIQR P324 is often cited as authority. Without intending to disparage the sensible statements made in that case, I think there is a risk of making overly legal and technical what really is or ought to be just a matter of ordinary rationality. So far as possible, tribunals should be free to draw, or to decline to draw, inferences from the facts of the case before them using their common sense without the need to consult law books when doing so. Whether any positive significance should be attached to the fact that a person has not given evidence depends entirely on the context and particular circumstances. Relevant considerations will naturally include such matters as whether the witness was available to give evidence, what relevant evidence it is reasonable to expect that the witness would have been able to give, what other relevant evidence there was bearing on the point(s) on which the witness could potentially have given relevant evidence, and the significance of those points in the context of the case as a whole. All these matters are inter-related and how these and any other relevant considerations should be assessed cannot be encapsulated in a set of legal rules.”

contributions made to Gala by its 35 members on or around 2 December 2003, of which (i) a sum of £62,695,394.25 (comprising 77.54% of the total) was funded by loans from Société Général (“SG”) and (ii) a sum of £18,160,156.92 (comprising 22.46% of the total), was provided as cash contributions, and

a loan of £10,915,499.38 obtained by Gala from SG equal to 13.5% of the total contributions.

We refer to these

loans together with those obtained in respect of the second transactions as “the SG loans” or “SG borrowings”. The sums borrowed from SG of a total of £73,610,898.64 were paid into Gala’s “transaction” bank account on 2 December 2003 and simultaneously an equal amount was paid into the expenditure account.

Gala and Sony Pictures Entertainment Inc (“SPE”) entered into an option agreement (“the Option”) which provided that (a) during the period from 2 December 2003 to 27 January 2004 Gala could opt to require SPE to grant licences to it in respect of the right to distribute specified “Pictures”, and (ii) Gala had certain rights in relation to “Sequels”. The Option also included provisions for Gala:

Pursuant to the Option:

We refer to these licence agreements and those entered into under the second transaction as “the LAs” and to the rights granted to Gala under those agreements as “the Rights”.

Gala entered into a distribution agreement with Sony Pictures Releasing Corporation (“SPR”), an affiliate of Columbia, (“the DA”) whereby:

Hence, pursuant to the DA, on closing, Gala paid £73,610,898.64 into the expenditure account plus £572,616.62, as funded by the cash contributions (a total of £74,183,510.26). The additional sum was paid because the amount Sony had to deposit in support of the letter of credit it was required to procure was issued in Gala’s favour (see [61]) was larger than the Initial Expenditure/principal of the SG loans; interest was due on the SG loans at a slightly higher rate than that payable on the deposit.

Gala and SPE entered into a call option agreement (“the Call Option”) whereby, in return for £1, Gala granted SPE an option to require Gala to sell its “Business” to SPE on specified exercise dates for the higher of (a) the Rights’ market value at the exercise date, as calculated under a schedule, and (b) a sum equal to the amount that would have been payable to Gala as the Minimum Amount, if the exercise date for the option were the last day of the term of the DA (“the option price”). The pricing was designed to ensure that, if this option was exercised, Gala would receive at least a sum equal to that required to repay the principal of the SG loans. The exercise dates fell 25, 60, 84, 120 and 180 months after the date that Gala acquired the Rights. The first exercise date was initially 31 December 2005 but this was extended to 28 February 2006 (“the first exercise date”) and later additional exercise dates were added (see [67] and section 15). Further details of the main terms of the Option, LAs and DA are set out in section 9 together with our analysis of the legal effect of the main contractual terms in the documents and the overall effects of the composite transactions embodied in them.

SG “will take security over the assets of [Gala]…in respect of the Loan. Any security taken by [SG] does not affect your personal liability as borrower under this Agreement. You are and will remain fully liable for all amounts which are or may become payable under this Agreement.”

The proceeds “of your capital contribution will be used by [Gala] to pay expenditure in relation to the printing, advertising and other promotional expenditure arising from [Gala’s] exploitation of the distribution, sequel and remake rights…in relation to various films…acquired by [Gala] from major film studios…or such other purposes as [SG] may from time to time agree with [Gala]…”.

The borrower irrevocably authorised SG to make the loan available for the benefit of Gala and payment was to be made into a designated account held with SG, in the name of Gala, and the loan was to be applied exclusively in accordance with the provisions set out in (2).

The borrower undertook to repay the principal on or before the eighth anniversary of drawdown and the dates for payment of interest and principal were to be agreed by SG with Gala acting on the borrowers’ behalf under a power of attorney which SG required the borrower to sign.

The interest rate was to be such that “the aggregate amount of the minimum income receivable annually by [Gala] from any entity to which [Gala] grants distribution rights…in respect of the films on any date is sufficient to make all payments of interest and the repayment of principal” in relevant loans.

“The [Minimum Sums] received by [Gala] and assigned to [SG] in respect of the Films on any date will be used by [SG] to reduce or pay off the amount due from [Gala] on that date”.

Gala was to be required to sign various security documents in SG’s form, and to comply with various other conditions before SG would provide the relevant loan. Details of the security arrangements are set out in [61].

SG made (a) no warranty or representation as to the commercial viability of the investment for which the loan may be advanced, (b) no assessment of the commercial viability or likely success of any films purchased, or other investments made by Gala, and (c) no recommendation or advice as to suitability of the investment or the likely returns or tax or other financial benefits which may be derived by Gala from it.

As arranged by SPR and, as was required for Gala’s obligations under the DA to take effect, Barclays Bank Plc (“Barclays”) issued a letter of credit under which:

We refer to this and the letter of credit issued in respect of the second transaction as “the LC”.

The initial LC was funded by SPR placing funds of £74,183,510.26 in an account with Barclays pursuant to a deposit agreement and charge. Under this agreement, it was provided that (a) in order to induce Barclays to issue the LC, SPR would deposit a sum equal to the Initial Expenditure in an interest bearing account with Barclays on closing of the first transaction, and (b) Barclays would pay amounts equal to the Minimum Sums/“Annual Amounts” to Gala, provided that the sums placed on deposit with it by SPR were equal to Barclays’ actual and contingent liabilities under the LC and SPR irrevocably directed Barclays to pay such sums to Gala’s account, and (c) SPR would charge the account in favour of Barclays as security for its obligations in respect of the LC whether under the reimbursement agreement or otherwise. We refer to this sum and that provided in relation to the second transaction as “the Deposit”. SPR also entered into a reimbursement agreement with Barclays under which it agreed to reimburse Barclays for sums paid by Barclays pursuant to the LC, broadly, on the basis that this obligation would be satisfied from the Deposit.

Gala entered into a debenture with each of SG, SPE, SPR, Screen Gems and Columbia and a deed of priority and subordination to regulate the priority of the debentures:

Further to the debentures, 3 notices of assignment and irrevocable payment instructions were given by Gala and SG to SPR, SPE and Barclays. In each case the relevant party was notified of Gala’s absolute assignment to SG of various rights pursuant to the debenture and irrevocably instructed to pay to Gala’s account with SG (a) in SPR’s case, sums due under the DA, (b) in SPE’s case, sums due under the Call Option, and (c) in Barclays case, sums due under the LC.

Under these arrangements, therefore, in practice, sums due from Gala and the members under the SG loans were to be satisfied by payments made by Barclays under the LC using the funds in the Deposit, and those payments were to be paid direct to SG.

We refer to the arrangements set out in this para, [61], together with those put in place in respect of the second transaction as “the security arrangements”.

The minutes of the meetings record that, on 2 February 2004, (a) at 12pm, a meeting of Chiltern and Gala’s designated members took place at which the admission of 30 additional members was approved, and (b) at 12.15pm, a meeting of Gala’s members took place at which the documents entered into on closing of the first transaction were ratified and draft documentation for the second transaction was approved.

On 3 February 2004, Gala’s additional 30 members made cash contributions of £7,008,097.53 and contributions of £24,194,473.82 funded by SG loans and Gala borrowed a further £4,212,347.13 from SG. The loan agreements made with SG contained the same provisions as set out above in relation to the first transaction.

Gala and SPE entered into an agreement to amend the Option (among other things) by extending the option period to 3 February 2004 so that Gala could opt to acquire a licence of Rights in respect of Breakin’ All The Rules (previously known as Break-Up Handbook) and Secret Window (“the second transaction films”).

Pursuant to the amended Option, Gala entered into 2 further LAs with Columbia and Screen Gems, whereby (a) Gala was granted exclusive licences, each for 21 years, to distribute the second transaction films, and (b) in return for the grant of the licences, Gala was required to pay SPE licence fees of a total of £4,212,347.13. Hence, SPE received total licence fees in respect of the first and second transactions of £15,127,846.51.

Gala and SPR entered into agreements under which they agreed amendments to the DA and Call Option, which were necessary to ensure the inclusion of the second transaction films in the arrangements and to increase the Minimum Sums to cover the repayment of the principal of, and interest on, the additional SG loans taken out on the second closing.

The funds obtained under the SG loans of £28,406,820.95 in total were paid into Gala’s “transaction” account and an equal sum plus an additional amount of £217,461.03 (a total of £28,624,281.98) was simultaneously paid into the expenditure account. £217,461.03 was deposited in the account from the cash contributions to cover the small increased difference in the interest due on the SG loans and on the Deposit. We refer to this amount plus the £572,616.62, referred to in [56(3)(b)] as “the Interest Margin”.

Three side letters were entered into with SG by Invicta (two letters) and GDL (one letter), pursuant to which Invicta and GDL agreed to pay various fees and breakage costs to SG in relation to the further SG loans.

A further LC was issued by Barclays in favour of Gala at the request of SPR, in effect to guarantee payment of the increased Minimum Sums. SPR entered into (a) a further reimbursement agreement with Barclays under which it agreed to reimburse Barclays for sums paid by Barclays pursuant to the LC and (b) a further deposit with Barclays under which it placed the sum of £28,624,281.98 into a deposit account at Barclays.

Gala and SG entered into a supplemental deed of debenture which provided or confirmed that the obligations owed to SG by Gala and its members under the new SG loan, and the new LC, were within the scope of the obligations secured by the earlier debenture. Pursuant to this deed, 3 notices of assignment and irrevocable payment instructions were given by Gala and SG to SPR, SPE and Barclays (respectively) on the same basis as those entered into under the first transaction.

Of the funds it received by way of contributions and SG loans, Gala deposited into the expenditure account, £102,017,714.59 of Initial Expenditure, plus the Interest Margin of an additional £790,077.65, a total of £102,807,792.24.

Sony placed £102,807,792.24 on deposit at Barclays, pursuant to the Deposit. That deposited sum was used (and could only be used) to repay the interest and principal on the SG loans under the security arrangements.

The sum of £25,168,254.45.26, which equals the amount of the cash contributions, corresponds to:

Invicta involved Mr Ackerman and his company, Little Big Picture Company (“LBPC”), in activities which it asserts were relevant to Gala’s trade. Mr Yusef said in his witness statement that he considered it “essential for Gala to have a US operation to assist both with the setting up of the arrangement and in the day-to-day running” of the film distribution business. To that end, he introduced Mr Ackerman to the venture who he had known for around 30 years, having been introduced to him through mutual friends and connections in the industry. He said that he “knew him to be honest, diligent and well connected in Hollywood”, over the years, he had “built up a considerable expertise in film production, distribution, film-financing and film industry technologies” and given he was well connected, he may be able to open certain doors that Mr Yusef could not.

LBPC was formally appointed to provide services under an administration agreement dated 1 December 2003 (“the LBPC agreement”) initially for a period of 1 year which was extended for a further year (as confirmed by an exchange of letters between LBPC on 28 March 2005 and 7 April 2005). However, Mr Yusef involved Mr Ackerman in discussions on the proposal from around May 2003 onwards. Mr Ackerman/LBPC leased premises in Los Angeles from which to conduct work for Invicta from 1 March 2004 to 28 February 2006.

Initially Mr Ackerman envisaged that he would have a substantial team in Los Angeles to work on Gala matters. On 26 June 2003 in a letter to Mr Bamford he set out that (a) the office would “maintain daily interface with the major Hollywood studios whose “A” list product we will be distributing”, (b) this activity would be overseen and managed by 3 “highly qualified motion picture industry executives” and 2 or 3 executive assistants who he would oversee, and (c) he had only just begun the search for skilled staff, but was already talking to a potential recruit. In fact, only 2 office assistants were employed who were responsible for paralegal and administrative tasks including filing, reviewing documents, note taking at meetings, communications, record keeping and reporting to Invicta. Invicta was invoiced by LBPC for services and expenses on a monthly basis. Mr Ackerman said that Invicta put the brakes on his proposal for a larger team as they did not want such high overheads in LA.

Mr Ackerman/LBPC sent Invicta a number of letters relating to the transaction films and the Plans:

Invicta instructed HL, a specialist media financing firm, to provide an opinion on the expectation of profit from the transactions. HL sent Invicta 2 letters dated 21 November 2003 and 30 January 2004, in which HL stated that the films listed in the letter had “a reasonable expectation of profit” (“the 2003 HL letter” and “the 2004 HL letter” respectively and together “the HL letters”).

On 27 April 2006, SG gave two notices to Barclays under the LC which required Barclays to pay the “Net Balance” of £103,910,434.41 to SPR’s account with SG. This constituted the total Deposit, plus interest accrued on the Deposit, less sums equal to the Minimum Sums which, under the DA, fell due prior to the Call Option exercise date.

On 28 April 2006, SPR instructed SG to pay the sum of £103,910,434.41 into Gala’s SG “transaction” account and Gala instructed SG to repay the SG loans in the sum of £103,334,645.57 from that account.

The difference between these two sums of £575,788.84 is essentially what remained of the Interest Margin.

The parties also entered into various other documents in relation to ending the transactions whereby the DA was terminated, and the various security documents were released.

The studios were coming under increasing pressure to come up with innovative financial models to mitigate their cost exposure due to a number of factors including: (a) a decline in video/DVD sales revenues as a result of the increase in media streaming; (b) the costs of development, production and P&A significantly increasing due to technological advances; and (c) a change in the US accounting treatment of the way in which costs were booked and depreciated, meaning that the major studios had to account for P&A immediately.

This meant (a) the studios, who had previously sought to keep all of the funding, and therefore the “upside” (potential profit), of their films in-house, were looking elsewhere for assistance, and (b) they needed to find innovative ways to mitigate costs and risk and might potentially be more open to joint venture-type arrangements with third parties, or outside financial assistance, than they had been in the past.

“The tax relief was attractive in as far as it would entice or "hook" participants, and therefore encourage them to learn about the business. I hoped that, over time, as they became more comfortable with participating in the film industry, the need for tax relief would gradually diminish and eventually disappear...”

As the film industry is speculative in its nature and, given that Invicta were intending to attract HNWIs as participants, “tax mitigation, necessarily, was to be an initial feature of the structure, although only as a form of downside protection in the event that Gala was not a commercial success”. In his experience HNWIs are not generally willing to part with their money on such a speculative, and therefore high-risk venture, if they could not mitigate that risk. He thought that part of the reason that certain legislation had been implemented (for example ss 42 and 48 of the Finance Act 1992) was to offer “downside protection” to incentivise people to participate in the UK film industry.

He wanted to create an environment and a structure that would enable Gala to participate in “Major Studio quality deals” on a model used by “Silver Screen”. “Silver Screen” initially had a tax component, but the pursuit of profit was the primary aim. Once it had done the first couple of deals with the studio, it got to a point of eminence and dominance where it had an almost equal negotiating position with the studio and could increase its profit share whilst at the same time removing the tax aspect to it. He also had in mind that German investors continued to invest in the shipping industry and investors continued to invest in UK windfarms long after the relevant tax incentives to encourage participation in that industry were withdrawn. He attributed that to the fact that the investors had become comfortable with how the relevant industry worked whilst the incentives were in place.

The ultimate aim, therefore, was to provide a low risk yet profitable transaction that participants understood and were comfortable with, which had the capacity to grow organically into a major player in the sector, so that investors would continue to contribute funds even without “downside protection”. He calculated that, by around years 4 or 5, “we would have done a number of successful transactions” that made a return for the participants and “the amount of tax relief they required would shrink because, backed by the historic successes, they would be comfortable putting on risk the entire investment to make a profit”. He thought that by that time the bargaining position with the major studios would be so good that the amount of return a participant could make would be correlated to the amount of equity and risk at any time.

Invicta was not looking to create a string of LLPs but to do several transactions within the original Gala structure, either through admitting additional members or by incorporating another vehicle owned by Gala. At one stage, Invicta was in advanced negotiations with both Sony and Paramount Pictures Inc (“Paramount”) but that deal was never concluded.

To place Gala and, therefore, the members in a position whereby they could participate in “gross receipts” from the relevant films, as “adjusted for the recoupment of transparent costs” on the same (or similar) basis as the studio (higher up the “food chain”) on the basis that gave a better prospect of securing a return.

Hence, to arrange for Gala to enter into an arrangement in which “we would be involved in the distribution of films released by one of the Major Studios” and would “play an active part in that process...on terms which ensured that [Gala] would have a realistic opportunity to enjoy the benefit of the potentially significant returns that films can make”.

The thinking was that the studio’s ability “to charge unnecessary distribution costs would be reduced by Gala’s active participation in the distribution process and “real time” understanding and approval of the distribution plans”. Hence, Mr Yusef wanted Gala “to be actively involved in reviewing and approving” the marketing plans for the relevant films and suggesting changes to them and in “the overall distribution process...with appropriate approval rights over the process”:

“we wanted to have an input on final decisions that were made in relation to the P&A marketing strategy...we wanted to be sure that we had some sort of oversight and control as to what was being spent. We knew that if we simply funded the P&A, and the distributing studio knew that money was available regardless, they would spend it, and they knew that if they spent it, the fee would come from a higher level in the food chain....In short, were we not to be involved in the distribution process, they would spend our money and make more money (by virtue of increased Distribution Expenses) at our expense – i.e. the more P&A that was spent, the lower the pot at the end. We wanted to be able to control that to some extent so that we could ensure there was a greater eventual return for us.”

However, “we very much had in mind the advantages to be gained by deploying the infrastructure already in place with the studio” and were seeking “to engage with a studio to enjoy all of the groundwork that they have put in and contacts that they have established over many years” so that “by forming a joint venture-type arrangement with one of the Major Studios, Gala would immediately obtain the advantages of scale and market share enjoyed by that studio”.

In determining the amount of Gala’s share of profit from the film:

“the studio’s recoupment of production cost would be limited to 60% (rather than 100%) of adjusted Distributor’s Gross, therefore increasing the potential pot available for distribution and, since the studio would not provide all of the funds for Distribution Expenditure, the members have the chance to reach profitability sooner...by participating in distribution so that the distributing studio does not take 100% of the Distribution Expenditure, the lower the deduction that is made at that stage, the higher the balance that would potentially be available as a profit share.”

Gala would participate in the distribution of a range of films to give investors the maximum chance to invest in a project that is likely to succeed at the Box Office, and would be able to choose the films from the studio’s entire slate of films for the year; it was important to avoid the studio “cherry picking” only those films they considered potentially less likely to be a commercial success:

Under licence agreements, Gala would acquire the rights in the films for 21 years, to take into account, as was industry-standard at the time, the 3 “cycles” or “broad windows of exploitation” of films of around 7 years each:

In reality, the purpose of the second cycle (and to a lesser extent the third cycle) is that “you want the ability to be able to exploit a film for a longer period of time in case something happens which results in a film having some commercial value again, and new technology is what typically drives that. His “understanding was that 3 cycles of 7 years was standard at the time”.

Under LAs (a) Gala would have distribution rights in the United States, Canada, and the UK, as these are the 3 key territories for western-society made films which would likely bring in the most revenue and as it was proposed to employ Mr Ackerman whose main expertise was in these territories (together with Germany), (b) Gala would have first-refusal or matching rights on sequels and remakes as, in Mr Yusef’s experience, if a film is commercially successful, sequels are often made so as to “ride on the coattails” of the original’s success, and (c) Gala would be obliged to incur a maximum of 91.5% of the value of the amount raised on distribution expenditure on the films selected, but Gala could incur more if desired.

As regards the distribution agreement:

Mr Yusef considered that, assuming that “tax mitigation for participating” was available to members “we could, realistically, obtain a total raise of between approximately £150 million and £250 million”. He said:

“we knew that, for any Major Studio to be interested in what we were proposing, it had to be large enough to make it worth their while getting into something with us. Accordingly, we were always looking at trying to get to an amount in the hundreds of millions, with a prospect of further raises over subsequent transactions...”

Initially they decided that the participants would each be required to contribute a minimum of £1 million. They saw this as the first of a series of transactions and wanted “people in the partnership that would have the capacity to be involved in further raises down the line; people with substantial income and who were sophisticated, the kind of HNWI who has some experience in evaluating and dealing with these kind of opportunities”. As it turned out, they did not strictly enforce this, usually as a favour or a gesture of goodwill, either for an important existing client, or to an introducer they expected further work from as a result. The smallest sum raised was £454,141.00, although there were not many people that fell at the lower end of the spectrum and very many raised considerably more than the lowest sum.

The participants would be required to contribute around 20% from their own capital, with the balance made up from a full recourse loan. At the time, Mr Yusef was dealing with all of the banks in the media space on a daily basis and had a fairly clear idea before he discussed the proposal with them. He could not now recall why they landed on the 22.46%/77.54% ratio but the amount of equity was determined following a combination of: (a) discussions with the bank on the cost of the loan; typically, the lower the equity, the higher the cost of the loan. Invicta had to ensure that the cost of the loan would ensure that the prospective returns would work; and (b) what Invicta could achieve with the investors; the less equity that investors would have to put in, the more likely it would be attractive to them.

He estimated that the cost of acquiring the rights to distribute the films would be around 10% to 15% of what Invicta hoped to raise and Invicta intended that Gala would fund this by borrowing such a sum pursuant to a non-recourse loan. It was also a function of what Gala would be able to afford and “whether a studio came up with a number that we could not afford. Commercial realities were brought to bear on that situation.” We note that there is no evidence that the price paid by Gala to acquire the Rights was based on negotiation or commercial valuation.

(a) Invicta would conduct an exercise to analyse which films from the slate had the best prospects of being commercially successful and making a return, (b) Gala would acquire the rights to the selected films once funds had been raised, and (c) the films would be placed with the studio for theatrical exhibition, and exhibition in all other forms of media.

Gala would incur distribution expenditure in the form of “release print acquisition and media buys” which would serve to promote the films to the paying public (as a necessary and customary part of the exploitation process). The trade of Gala would be the distribution and commercial exploitation of the films in all media known or thereafter invented.

We do not accept that, under the deal agreed with Sony, Gala had meaningful contractual rights in relation to the distribution process or that, in practice, any activities were carried out by it or on its behalf which had any material import or consequence as regards that process whether from Gala’s or Sony’s perspective. As set out in full in section 9, we consider that, under the terms of the DA, (a) Sony had the right to conduct the distribution process as it chose and was not appointed as, and did not act as, Gala’s agent in doing so, and (b) Gala did not have any right to “input on final decisions that were made in relation to the P&A marketing strategy” in respect of the transaction films or “control as to what was being spent” by Sony in distributing the transaction films and, in practice, Gala simply monitored what Sony spent (see section 14).

As set out in section 11, we do not accept that Gala had a realistic prospect of receiving a share of Gross Receipts under the waterfall of anywhere near a sufficient sum for it to recoup from such receipts a sum equal to the full contributions/Gala’s full outlay under the transactions. In that context, we note, in particular, that (a) Gala did not have a right to a share of 30% of the Gross Receipts from the transaction films (after deductions), or anything approaching such a proportion, (b) nowhere in his lengthy witness statement did Mr Yusef explain what the actual profit sharing ratio was or why, given what was actually obtained, he thought 30% was achievable or, as he put it, “tempting for the studio” and that that ratio would increase over time, and (c) whilst under the waterfall, Sony’s ability to recoup Production Costs was limited to 60% (less a sum equal to the licence fees), any benefit to Gala is illusory given the rest of the terms of the waterfall.

Moreover, Mr Yusef’s claim that the aim was for Gala to participate on an equal footing with Sony, to provide valuable input and to prevent Sony spending unnecessary costs is inherently implausible given (a) the discrepancy in the resources Gala chose to devote to its activities (essentially, Mr Ackerman/LBPC who reported to Invicta) and those already available to Sony, as Mr Ackerman essentially accepted (see section 14), and (b) contrary to Mr Yusef’s suggestion, Sony had every interest in avoiding “unnecessary costs” on the transaction films on its own account, whether it paid for distribution costs with funds provided by Gala into the expenditure account or otherwise; under the terms of the waterfall, all distribution costs incurred on the transaction films would reduce ultimately the Gross Receipts otherwise available to be divided between Gala and Sony.

Overall, the substantial discrepancy between what Mr Yusef said he sought to achieve and what was actually achieved under the contractual terms agreed with Sony, of itself renders implausible Mr Yusef’s statements that the intention was to realise returns from involvement in the distribution of films as part of a long-term vision. Mr Yusef’s comments on other projects and scenarios (such as transactions in relation to the production of films and “Silver Screen”) do not add any weight to his evidence in this regard given that (a) the tribunal is not in a position to judge the nature and effect of those transactions and what the aims and intentions were of those involved in them, and (b) the tribunal’s task is essentially to assess the nature of these transactions on their own terms taking account of all relevant facts and circumstances pertaining to them. We have commented on Mr Yusef’s assertions as regards Sony’s motivations for entering into these transactions in section 2.

We also do not accept that, as was a theme of both Mr Yusef’s and the Referrer’s evidence, generating the loss and associated tax relief can be described as a form of “downside protection” or “mitigation” in the event that the Gala transactions were not a commercial success and that obtaining that benefit was not the driver for the transaction. As set out in section 4, this is an inaccurate description and our view is that, given how the Gala arrangements were designed and operated, obtaining the tax benefit must have been the driver for the transaction, at least as far as those who devised and operated the scheme were concerned (see, in particular, sections 11 and 15).

The minimum fund size would be £150 million and the maximum £250 million. The investment objective was to acquire and commercially exploit all media distribution rights to a portfolio of up to 7 films pursuant to an option.

The IM would state that the studio did not endorse the Gala fund or make any representations or warranties as to income/expense or the tax treatment of the fund’s business and every member would be required to indemnify the studio against withholding tax and from any claim relating to any matter in the IM.

The studio would provide Gala with a range of unexploited films which must be available for release prior to 1 August 2004 and all distribution expenditure in respect of those films to be incurred by Gala must be capable of being incurred prior to 5 April 2004. Gala later provided a draft term sheet to Paramount in which it also referred to this requirement. The films were to be evaluated by Gala and it must be clear from the documents that the studio would not have the right to put films to Gala.

The precise price was to be negotiated but may not exceed 13.5% of the “Fund Capital” (the gross funds raised from members), Gala would be obliged to incur a maximum of 91.5% of the “Fund Capital” exclusively to directly meet marketing costs of the selected films, profits were to be allocated as to 30/70 in favour of the studio and Gala was to enter into a distribution agreement with an affiliate of the studio.

The studio would have a call option and a charge/security interest to protect reversionary rights/share of profits and approval rights over sub-distribution arrangements.

The terms of the distribution agreement would include that it would be for 8 years, Gala would not enter into the agreement unless it approved the marketing plans, Gala’s representatives must have an active role in monitoring the line item expenditure to be paid from the expenditure account in accordance with the approved plan, and Gross Receipts were to be allocated as follows (and in this order of priority (a) 35% distribution fee to Sony, (b) talent participations to Sony, (c) recoupment of any distributor spending on distribution expenses to Sony, (d) recoupment of expenses paid for from the expenditure account to Gala, and (e) 30% to Gala and 70% to the studio.

Gala would require a “shortfall guarantee” and a letter of credit which the studio must fund from its own resources.

He/Invicta knew that Invicta had to come up with a scale of deal that would be of interest to the studios; mostly they are interested in deals of half a billion or a billion dollars. However, he thought this “would never be achieved by Gala on its own, certainly not in the short term anyway”. So, he suggested to the studios that asking for this in the marketplace right from the outset would not be very feasible but that if “we had experience with one successful deal with a moderate fund value, further deals would follow” which would lead to the levels of investment the studios were looking for. He noted again that “we were looking to emulate Silver Screen” and that is how he/Invicta presented their position to the studios as part of the negotiations.

He thought that, “what we were asking for...as a complete set of terms, was challenging to say the least” given, in particular, that they were seeking (a) full access to a studio’s slate of films, and (b) a degree of control and participation over their marketing plans, which he thought none of the studios had ever given before. He added that the process was helped by the fact that, in most instances, his discussions were “at the decision influencer level (“influencer” only, since no one person has the sole right to green-light projects in the studio system)”.

Invicta had “extensive relationships” with executives at all of the studios who all showed “an initial interest in transacting with us to defray their [distribution] expenditure”. He thought that (a) there was an initial conversation with the studios before they were sent term sheets, and (b), if there was interest, there was a subsequent meeting or meetings which were all lined to take place within the space of a few days in May 2003. He and Mr Bamford took turns to deliver a presentation at these meetings and Mr Ackerman attended some of them.

Disney, Fox and Universal baulked at the idea: they did not want Gala to be involved in the distribution process, to have access to their slate of films (they preferred only to make 1 or 2 films available), or to provide rights to sequels. There were similar issues with Paramount although some progress was made with them, and they were sent an initial draft version of a term sheet. Disney offered a deal on those terms but:

“as we were only interested in a deal which would maximise the prospect of a successful commercial exploitation of the rights we acquired, we declined the deal as we did not consider it would meet the needs of our intended participants (who we knew would want a genuine prospect of making a return on their investment).”

All of the studios, except Sony, said that they would be willing to transact but only with the effect of giving Gala the right to reimburse the studio for the cost of the Gala Expenses, without any say as to which films Gala would acquire. Sony were prepared at least to consider “what we regarded as a proper “joint venture” type arrangement” where “we would be fully involved in the process and could choose films from their slate that we considered would give us the best possible prospect of making a return”.

(a) In 2002 Columbia had broken the record for biggest “domestic theatrical gross”, with a tally of $1.575 billion, (b) however, in 2003 Columbia was “entirely dependent” on its ultimate parent for finance which was “suffering in its key markets and in its stock valuation following an aggressive expansion into new businesses which had proved unrewarding and unprofitable. SPE was, therefore, under increased pressure from Sony Corporation to reduce its dependency on financing from Tokyo, at a time when the cost of making and distributing films was escalating at an alarming rate.

Mr Yusef’s contact at Sony was Mr Ken Lemberger who he had known for a long time. He became executive vice chairman of SPE in 1997 and its president in 2001. At the time of the initial contact with Sony, he was working as a consultant (and he retired from SPE in 2003) but he was still there and “put us in front of the right people” (for which he was paid an introducer’s fee). Mr Lemberger “saw that it was worth Sony looking at doing a deal with us if we could work up to the scale talked about. He used what little power he had left at the time to suggest to Sony, that they ought to meet with me”.

Although Mr Lemberger and his colleague Mr Stefan Litt, “came across as being much more receptive to exploring innovative financing channels than the other major studios” and “were willing to consider” the Gala proposal, it was “still a hard sell”:

“Gala’s participation at the distribution level of a Major Studio’s key assets was, at the time, a unique proposition and one which Sony had to be convinced would be suitable for them and was just the beginning of a joint venture with Gala that was capable of operating in the future at scale.”

He recalled that the initial meetings with Sony were attended by officers who had direct responsibility for the distribution side of things and:

“they really bought into the idea that this was not a one-off deal. In fact, I recall having a conversation with one of the executives who said to me that, were this to be a one-off deal, they would not have considered agreeing to it as it necessitated bringing in external lawyers, accountants, and internal professional advisory to sign everything off and so would not be worthwhile for them.”

There were detailed discussions in meetings as to the nature of Gala’s participation in the distribution process, the type of films which would fall into the Gala portfolio and the profit ratio that each entity would be entitled to, and “it certainly remained a challenge to convince Sony that our desired key heads of terms would be in their interests (as well as, of course, our own)”.

There was initially great resistance at Sony to Gala being actively involved in the distribution process at all. Mr Yusef sought to overcome this by meeting with the senior marketing people who control that process to explain the proposal. He brought Mr Ackerman along with him, who was able to add his experience. As the discussions progressed:

“we were able to convince Sony that our objective was not to obstruct the distribution process, rather, that Gala would be able to add value to the process by being involved in it with the common goal of maximising the potential for returns”.

It was agreed that “we would use SPR, the distribution arm of SPE, to distribute the films”. Invicta did not have an issue with this as (a) it is inconceivable” that a studio would agree to allow a licensee to distribute its films through another studio, as a direct competitor, and (b) “we were looking to tap into the established infrastructure that Sony had”.

Sony was initially reluctant to agree to Gala being able to pick which films to acquire rights to from its whole slate but Invicta explained that:

“we were only looking to set up an arrangement which maximised our chances of successfully exploiting the films and making a return, and therefore that this was a critical aspect for the deal to go through.”

Sony saw it was in their interests for Gala to have access to the slate to ensure the deal would not fall through.

There was an initial suggestion from Sony that Gala would acquire films where the expenditure had already been incurred. However, Invicta explained that this was not acceptable as, if Gala just reimbursed Sony in that way:

“we would have no control over what had been spent...it was vital that Gala was able to participate in new projects across the slate because we were not interested in acting simply as a financing party, analogous to a bank. We wanted to be a business partner, acting alongside the studios.”

It was agreed that such films would not be the subject of the transactions.

Invicta were keen to secure rights in any sequels to the films purchased as “we wanted the ability to ride on the coattails of any successes/profit that we made from the original”. Sony were quite relaxed about this although they would not allow Gala to have access to sequels of any films that they had already released for similar commercial reasons.

Invicta wanted terms that would create an acceptable risk versus reward ratio for the members whereby Sony would provide a letter of credit to guarantee “minimum royalties” to cover the loan payments. It is not uncommon for a distributor to pay such sums to secure the distribution rights to a film and it was entirely commercial for Gala to insist on a cash backed letter of credit to secure SPR’s obligations. Notwithstanding the prudent down-side protection that Gala negotiated, there was banking risk if, for example, the bank became insolvent and called in their full-recourse loans from the prospective members which, as subsequent events showed (the global financial crisis which resulted in major banks like Lloyds almost failing) was not fanciful.

Detailed discussions took place on the waterfall. As set out above, Invicta were keen “to place ourselves as high up the food chain as possible”. Sony wanted to ensure that the deal ensured that their existing obligations were met in that they could pay out those that they had already contracted with and that there was an acceptable profit share. There were a lot of negotiations about this but:

“we were eventually able to reach an agreement on the basis that would be acceptable to both parties, and which gave us confidence that we would be able to make a return if we selected the right films and they were a commercial hit.”

As negotiations progressed, Sony “really seemed to buy into” the proposal because they thought that there would be “a conveyor belt of funds” and “that promise helped us to convince them to give us the favourable terms we were after.” Invicta also had to convince them that without those favourable terms, they would not be able to seal the deal with investors and, unless Gala had access to the full slate of films, Invicta would not be able to proceed. It was:

“very much a two-way conversation, with Sony looking to achieve what they wanted (access to regular and large sums of money to outsource their financial outlay) and with us wanting to achieve terms that would maximise the prospect of us making a return on our involvement.”

After weeks of discussions the parties agreed heads of terms on 5 November 2003, which encapsulated the outcome of the discussions. Invicta were “extremely pleased to have secured an agreement with Sony because of the success that Columbia had had in the previous year” and felt they had “stolen a march on” competitors, as “the only way that they could overcome barriers to entry was to accept terms or deal structures that were not as favourable as ours and that we had already rejected”. For example, the deal rejected with Paramount was later taken up in substantially that form by a UK competitor and:

“we genuinely considered that we had something better than our competitors could offer, which maximised the prospect of making genuine returns, and which would likely be of real interest to individuals who wanted to participate in the film distribution industry.”

Invicta then had meetings with the officers involved with business affairs and who had the responsibility to structure the deals and engaged professionals to document and complete the transactions.

(a) Sony was convinced that Gala would be able to add value to the process by being involved in it, (b) Invicta wanted to maximise “our chances of successfully exploiting the films and making a return”, (c) Sony saw it was in their interests for Gala to have access to the slate, (d) Sony acknowledged that Gala would have some control over what was spent on the distribution of the selected films, and (e) detailed discussions took place on the waterfall and Invicta reached a deal on this which gave them confidence they would be able to make a return if they selected the right films and “genuinely considered” that they had something “which maximised the prospect of making genuine returns”.

The contractual terms which Gala concluded with Sony speak for themselves and do not provide a basis for the assertions made in these comments (see sections 9 and 11 and our comments in section 1). Moreover, we consider that Mr Yusef/Invicta must have been aware from the outset that Sony was highly unlikely to agree to Gala having meaningful rights in respect of the distribution process and to receive a share of Gross Receipts given that (a) as explained below, in economic terms, all that Sony was offered in return for its participation in the arrangements was £15 million (as structured as licence fees paid on day 1), and (b) all Gala had to bring to the table in terms of contributing to the distribution process was a one man company which, as Mr Ackerman himself agreed, was a resource which was not in the same league as those which were already available to Sony (both internally and through the agents it contracted with) (see section 14).

Invicta’s desire to secure rights in any sequels to the selected films was as it envisaged being able to ride on the coattails of any successes/profit that were made from the original. It seems highly unlikely that any sequel or remake would be in prospect before the first exercise date and, as noted, we consider that Mr Yusef/Invicta fully expected SPE to exercise that option as soon as it could, as in fact happened (subject to the short extension to the exercise date made at SPE’s request). As set out in Part C, in our view, in reality, Invicta/Gala sought such rights so that Invicta/Gala could point to them as demonstrating the commerciality of the arrangements, but they had no real interest in them.

A repeated feature of Mr Yusef’s evidence is his insistence that (a) Sony did not enter into the transactions to receive the “measly” £15 million of licence fees which he asserted Sony would regard as an insignificant sum or “chump change” and, (b) rather, Sony wanted funding for their distribution expenses on an on-going basis under a lasting relationship and had hoped to gain much larger sums from Gala. He said that Sony were “hungry for money” and wanted to find third parties who would fund its distribution expenses, (i) as he said in his statement and at the hearing, due to a change in the accounting treatment of distribution expenses in the US, and (ii) as he said at the hearing, as the Sony group had made a substantial loss in the previous year. He presented this on a number of occasions, as here, in support for his view that Sony were prepared to give Gala meaningful rights in relation to the distribution of the films, and/or that SPE would not have exercised the Call Option when it did had Gala been able to demonstrate that it could provide further substantial funds to meet further distribution expenses.

We do not accept that Gala has demonstrated that, (a) in fact, a desire for funds to meet Sony’s distribution costs was Sony’s motivation for entering into the transactions for any of the reasons Mr Yusef gave, whether as a result of a change in US accounting treatment or otherwise, (b) Sony were not interested in the £15 million of licence fees, and/or (c) Sony wanted to have a longer term relationship with Gala for the reasons Mr Yusef gave.

The nature of the transaction speaks for itself. As set out in section 10, there was plainly no economic benefit to Sony in funding terms as a result of Gala paying the Initial Expenditure into the expenditure account under the terms of the DA. As part of the design of the structure, on closing, SPR had to place a sum equal to the Initial Expenditure on deposit with Barclays to fund its obligations under the LC, in order to induce Barclays to issue the LC. Under the terms of the DA, SPR had to procure that the LC was issued to Gala as a condition for Gala’s obligations under the DA to take effect. Mr Yusef made no suggestion that, if Gala had obtained more bank funding and put a larger sum into the expenditure account, the structure of the arrangements would have been any different. Indeed, he stressed that such shortfall guarantee and security arrangements to enable the repayment of bank finance are entirely normal and what is to be expected in transactions of this kind. It is reasonable to suppose, therefore, that had Gala/the members obtained more bank funding, the Minimum Sums/amounts due under the LC would have been increased correspondingly and SPR would have been required to make a commensurately larger Deposit to fund them. Hence, however large the sums in the expenditure account, Sony’s cash return from the transactions would remain confined to its “benefit” in the form of the licence fees.

Moreover, Sony did not obtain any other material benefit from the involvement of Gala/Invicta/LBPC/Mr Ackerman in the distribution process for which it was prepared to give Gala a realistic entitlement to profit from Gross Receipts (and Gala did not have any such entitlement) (see, in particular, sections 9, 10, 11 and 14).

We note that the Referrers also referred to their understanding that changes in US accounting meant that Sony had a commercial reason for its participation in these transactions although their evidence is not clear or consistent as to what the relevant changes were or what impact they had (see sections 5, 7 and 13). We accept that, at the relevant time, the Referrers had such an understanding; there is evidence that some investors were told this by Mr Yusef/Invicta and some were told it by UBS or Ms Challons (as explained in section 4, both of whom were involved in promoting this structure to potential investors).

However, in light of the lack of credibility of much of Mr Yusef’s evidence, we make no finding that this was Mr Yusef’s understanding. Moreover, in any event, we do not accept that the fact that the Referrers had this understanding from persons other than Sony combined with Mr Yusef’s assertions on this topic suffice for us to conclude that Sony in fact had any such motivation. We consider that, as HMRC submitted, having regard to the case law set out in section 2 of Part A, it is reasonable to expect Gala to produce evidence from Sony if Gala considers that it is important to demonstrate that Sony had the commercial reasons Mr Yusef asserts it had for entering into these arrangements:

Mr Yusef said that it is unrealistic to expect Sony to give evidence to this tribunal but it is speculation as to whether or not Sony would have agreed to do so given that Gala did not in fact ask Sony to do so and apparently Mr Yusef did not think to do so.

Therefore, (a) we reject Mr Yusef’s assertion that Sony was not interested in £15 million paid in the form of licence fees; Sony must have been interested in that sum as that was all it gained from these arrangements, and (b) we conclude that this sum was, in effect, Sony’s fee for participating in these arrangements and, any interest Sony had in a long lasting relationship with Gala, is likely to be due to the prospect of Sony receiving further such fees.

An essential part of the process was for Gala to decide which films of the available slate provided “the best opportunity of commercially exploiting them to provide a return”, and the overall size of the deal would be determined by the likely expenditure on the selected films:

“In short, once we knew what films were available in the slate, we would determine the likely expenditure, and then work out whether or not we would be able to entice prospective members to participate to an amount that equal or exceeds that amount, otherwise we would be wasting everyone’s time having discussions with the studios.”

We note that it is apparent from the proposals sent to the studios and the terms of the documents entered into with Sony (see section 9) that, as was a feature of the design of the arrangements from the outset, (a) the overall size of the deal was determined by the funds Gala raised from investors, and (b) the Initial Expenditure was simply a specified proportion of the total contributions.

Gala “relied heavily” on Mr Ackerman (and, later, film valuers HL) to analyse the slate of films available and to advise as to their suitability. He felt that Mr Ackerman was, “being in LA, at the coal-face, and was better placed to carry out that analysis”.

Once Invicta knew that Sony was willing to make their entire “slate” for the year available, Mr Ackerman was asked to review the films that were to be released by Sony over the summer of 2003 as against those that were to be released during the winter of 2003.

He thought one could expect very strong worldwide market performance for one of SPE’s films for summer release but was “less bullish about SPE’s other mainframe summer releases, notably Bad Boys 2, S.W.A.T. and Once Upon A Time In Mexico”. Having also assessed the other Hollywood studios’ summer releases, he believed the market was very crowded with a significant number of big budget, high-profile releases and “competition will be cutthroat for all but the very strongest contenders”. For “this and other reasons”, he believed it was in Invicta’s and Gala’s best interests to reject any financing for the 3 films he had doubts about.

He also recommended that Invicta did not consider certain “Revolution pictures” as: “The SPE-Revolution deal would complicate P&A financing from Invicta and Gala’s point of view”.

His research caused him to be concerned about the commercial viability of SPE’s “sub-label Screen Gems’ films, whose genres and small budgets will make market profile difficult”. However:

“Screen Gems’ You Got Served and Breakin’ All The Rules are both commercially oriented low budget films targeting the under-served African-American and youth audiences. These films should be tracked for audience awareness as the summer and fall progress and, if SPE can promote effectively to these niche markets, then both could have some commercial success proportionate to their respective budgets.”

He thought it best for Invicta to focus on SPE’s Christmas and winter mainframe releases - Something’s Gotta Give, Big Fish, 50 First Dates, and Secret Window as:

“Word of mouth in the local creative community is strong on all these four films, and I believe SPE will have an excellent Christmas 03-04 season heading off with Something’s Gotta Give.”

In light of the June 2003 letter, Invicta decided to focus on the films Mr Ackerman had recommended and began taking steps to obtain further information about them. It was a key part of Invicta’s strategy to obtain files from Sony to enable them to analyse the films. They wanted to ensure that Gala, with Mr Ackerman’s help, chose only those films which gave it the best possible prospect of making a return and to send those files to the potential investors so that they could assess the Gala opportunity, and make sure that they understood what they would be getting into. However, acquiring the film files was “a major source of discussion and a point of contention that we had to resolve with Sony”.

Invicta’s aim was to be in the same or at least a very similar position as Sony as regards the documentation available and Invicta had to convince Sony that, for the deal to work, they would have to give Invicta access to their confidential materials: “the fact that our not having the materials could scupper the deal meant they were keen to complete put us in a good position”. Invicta advised Sony that Mr Ackerman would analyse the film files on Gala’s behalf, and Sony were able to do background checks on him and sound out their connections in LA to obtain an impression of him. Mr Yusef thought that this is “where Mr Ackerman came into his own. Mr Ackerman was a respected figure in the industry” and Mr Yusef is convinced that “only through Mr Ackerman’s involvement were Sony willing to send us their film files”.

Initially he worked for Gala on a “good-faith basis” on the basis that he would be compensated for time incurred once an agreement was in place with a studio.

He and Mr Yusef had some very preliminary discussions with studio representatives at some of the film events they went to such as the Cannes film festival. Around May or June 2003, Mr Yusef approached him with a draft term sheet that he proposed to take to the studios for him to comment on. Mr Yusef wanted him to use his contacts to get Invicta in front of key decision makers at the studios. Mr Yusef also had his own important contacts; Mr Ackerman thought his own involvement was intended to add gravitas.

In May and June 2003, he attended meetings with the studios. Invicta were looking for “fairly hands on involvement”. Mr Yusef generally introduced him as someone who would be locally available in Los Angeles which some studios, like Sony, welcomed and others did not. It was very important to Mr Yusef to have this active involvement, so it was a deal breaker if a studio was unwilling. Discussions did not lead to deals with the other studios (and Mr Ackerman gave essentially the same reasons for that as Mr Yusef gave).

As regards Sony, he said:

As Gala had engaged Mr Ackerman, they were already in a strong position in terms of negotiating deals and executing P&A budgets despite the business itself being relatively junior, due to the experience he brought and the contacts he had.

From around May 2003, Mr Yusef regularly started to visit the US for meetings which were broadly bi-monthly until late 2003/early 2004 when he came more regularly to discuss proposed marketing budgets and plans that were being developed – they met almost daily when he was in LA and otherwise had frequent phone calls.

Following a meeting with Sony at Cannes in May 2003, he advised Gala as to which slate of films to acquire:

In order properly to review the films in “the winter slate” he needed access to the documents relating to them, such as the screenplays.

He agreed that he referred to 23 films in his letter and said initially that he “would have had the screenplays and there would have been maybe some initial conceptual marketing plans...but the detail of the marketing plans would not have been extensive at that point”. When it was put to him that he did not have 23 screenplays in late May, he initially said that he did not recall but he thought (a) “we would certainly have looked at this material”, (b) his office “probably has several thousand screenplays” and “it would be not uncommon in the least for that volume of screenplays to be sent to my office....we had a large bank of screenplays in the offices”, and (c) “in terms of my other business the flow of reviewing and looking at screenplays in considerable volume is part of Hollywood business”. He then said that he did not recall the exact number of screenplays he saw but agreed that he did not see them all and whilst he did not recall the details:

“I would be looking at quite a lot of films given my profession in any given week...but I know I went through a lot of this material with a sense of certain professional diligence and given my reputation I would not be making a recommendation without having done some thorough research on these materials…I do not remember the full list of all the elements, as I said, that I may have or certainly would have seen.”

When questioned as to why he said he “would have” done things as opposed that he did do them, he said he thought this is perhaps a difference between British English and American English, but certainly he was implying in his statement that these things did indeed happen and he believed he did these things albeit he could not fully remember in exact detail 19 years later.

When it was put to him that he recommended rejecting Sony Revolution films not on the basis of how he thought the films would do at the cinema but because he thought the producer involved would block Gala’s involvement, he said that the two “are not mutually separable actually”: (a) the producer’s relationship with a studio would have an impact on the commercial terms of the film (in addition to many other factors) and, (b) from knowing him, he thought the producer may block Gala’s active involvement. The producer was a former chairman of Disney, who had taken up a producing role for “Revolution” a relatively new company which had a distribution deal through Sony. He added:

“I probably in this case would not have read all of these screenplays. However, I certainly would have looked at the synopses and the cast. I would also have had a discussion with Sony about the situation. My research and intel at the time led me to believe that Sony was more committed to its own movies than to Revolution’s movies, even though it was a distributor of those movies....[and that] [the producer] would not welcome the level of involvement that we were looking for....in terms of development of the release plans, marketing assessments and again the dynamic day-to-day business of distribution.”

He said that his comment about tracking You Got Served and Breakin’ All the Rules was made on the basis of his research and intel. He explained that, at the time (a) Screen Gems was a relatively new division of Sony, (b) Sony had had some fairly poor performance in terms of its overall corporate revenue, and (c) the first place that a studio would look to generally shift its activities would be in its more commercial and more expensive productions. The Screen Gems movies he was concerned about initially were those that he thought might not have the full level of support from the studio that he/Invicta were looking for. However, Screen Gems did have some good traction in terms of word of mouth and there was a positive opinion at the studio on the other films; that is why he recommended that they should be tracked.

He said that in his reference to “tracking” he meant his discussions on a very frequent basis with the Sony marketing team and with various agencies and producers, maybe even other distributors, and his “word of mouth” research as to what people were saying about these films, packages and talent. This included tracking “the star rating of the lead talent involved” as “part of assessing commercial potential is to look carefully at the ups and downs of that particular talent and there is a star rating for that”. He added that in his recommendations he had “accurately selected in each case stars, although already famous, who were starting a new ascendancy in terms of commercial appeal” such as Diane Keaton and Jack Nicholson, and that was also the case with certain directors like Tim Burton in the case of Big Fish. He continued that while the tracking data may not be in the bundle, the process and exercise involves “many, many factors that you might call a soft science” which “definitely in terms of reputation” it was necessary to take into account before he would recommend these things to the UK.

It was put to him that even if his diary was 100% clear on returning to the US from Cannes, he had a maximum of a week or 10 days before he sent the June letter and, if he worked 5 days a week for 8 hours a day, he would have only 90 minutes to review each of the 23 films. He said:

“...I would have seen some of these elements probably already in Cannes. Somebody would be marketing certain aspects of these films and would have scripts and promotional material with them already in Cannes...I do not recall the exact details, but we would have gone through a significant amount of material to make this assessment on June 6th…I have in my career watched hundreds of movies in the space of several months’ time. So to try to divide that all into 90 minutes is something of a curious task.”

When pressed again on the point he said again that he did not recall “exactly which elements” but he “would certainly have looked at a great deal of material on titles that are mentioned in this letter”.

He did not agree that it is not a surprise that the letter is as thin as it is, because LBPC still had no contract at this time and the thinness of the letter reflects the fact that there was no contractual obligation to produce it.

He confirmed that there was no written contractual relationship between him/LBPC and Invicta before the LBPC Agreement was entered into. He thought that agreement was under negotiation from mid-October 2003 until it was signed. He agreed that it is clear that LBPC’s legal relationship was with Invicta not Gala; he was asked by Invicta to assist them in their trade with Sony in connection with their Gala fund and there was no contract with Gala.

He said that the fact that Invicta paid him an advance of $10,000 in July 2003 created “an unwritten contractual relationship, fiduciary responsibility” whereby he assisted Invicta “on an informal basis as we were leading towards a more formal and contractual relationship” in the procedural affairs as they developed with Sony. He added that it was “very customary in Hollywood and in the motion picture industry for quite a lot of work”, whatever area it is in, to be undertaken by both executives and talent prior to a final contract being signed, but with the understanding that a contract is being negotiated and completed. He thought that this was not referred to in his statement “may be an omission” but said that certainly proof of payment could be provided (from a bank statement).

He described the “fiduciary obligation” as “an unspoken obligation” and said that, under US law, there is certainly an obligation to return such a payment if no services are provided. He said it “is a moral obligation” and that the payment was made “on an honourable basis by Invicta trusting” him to assist them in that initial period and he therefore had a “moral responsibility” to do so.

It was put to him that in his statement he referred to acting “in good faith” and he was asked whether that or fiduciary responsibility was the correct description. He said both were involved and summarised the position as being: (a) He did a great deal of work from the middle of July until the contract was signed which he thought provided value “well in excess of the initial token payment of $10,000”. Had he not done any work whatsoever, he would have felt a moral obligation to return that money and, if he had not done so, he would have been liable under US law to be sued by Invicta for not rendering services on an informal basis, and (b) there was a clear verbal understanding between him and Mr Yusef that during the autumn of 2003 he would be compensated with a contract prior to the end of the year as soon “as we could get to it and as things were shaping up for both [Invicta] and Gala with the Sony studio negotiations…”

In the detailed description of the structure it was stated that:

“The Partnership will provide the opportunity for Partners to acquire the Distribution Rights to Films from the Studio and through the Partnership to trade in the exploitation of those Distribution Rights with a view to profit.”

The proposed transactions were described in broad terms that accord with the actual terms of the deal with Sony and details were given of the financing arrangements, the shortfall guarantee and related LC and the Call Option. However, no studio was named and it was made clear that the terms of a deal were still to be negotiated and no details were given of the waterfall. It was stated that “the Agent Distributor will receive a distribution fee from profits to be negotiated at arm’s length” and “thereafter all profits after the deduction of participations, for example actor’s profit share and third party expenses, will be shared between the Partnership and the Agent Distributor in a ratio to be negotiated with the studio on an arm’s length basis”. Mr Yusef said that, at this point, Invicta were in advanced negotiations with Sony but had yet to finalise all of the details with them so that Sony was not mentioned in the IM.

The description included that (a) Gala “may determine (such decision requiring a 75% majority of Partners) to acquire further Portfolios in the future” and Gala “will be entitled to “cherry pick” those Films to be included within the Portfolio from the Studio’s production slate of Films for the year in question and to choose the Films based on advice received from Invicta under the [MSA]”, (b) the licence fees would be funded by Gala’s borrowings and the members’ contributions would be used to fund “the P&A Expenditure and to pay the advisory and administration fees of the Placing Agent, the Operator and Invicta”, and (iii) all income from the distribution of the relevant films “(after deduction of costs and expenses as set out above) will be apportioned among the Partners pro rata to their respective capital contributions applied to the P&A Expenditure” for the relevant films, and (iv) the Minimum Sums would be applied, in the first instance, towards the repayment of a member’s loan and the interest accrued thereon.

In the detailed description of the structure there was also reference to the fact that the incurring of “the P&A Expenditure may result in the accounts of the Partnership for the first accounting period showing a loss” which may be mitigated by each member claiming loss relief under s 380 or s 381. It was noted, that Gala “should expect however to show taxable profits in subsequent accounting years” in relation to the relevant films and that those taxable profits in the hands of the individual members may be offset against interest payable on any loan taken out to fund his capital contribution.

It was stated that:

“…the Partnership will trade in the acquisition and exploitation of Distribution Rights in a number of Films. The Minimum Royalty Payments over the term of the Distribution Agreement should ensure that the Partnership is trading profitably over its lifetime but, given the amount of the Partnership’s capital that it is anticipated will be spent on P&A Expenditure…the Partnership is expected to incur a trading loss in its first accounting period to 5th April 2004.”

As explained below, the financial illustrations included in the IM make it clear that (a) the Minimum Sums were calculated to produce a small profit for Gala over the 8 year term of the DA, but (b) (i) if Gala received only those sums, a member would make a substantial loss in terms of his own return, and (ii) otherwise, a member would make a positive cash return only if the Call Option was exercised and/or Gala received very substantial Gross Receipts of a level which, as set out in section 11, we consider Gala had no realistic prospect of receiving under the terms of the waterfall.

There was then a detailed description of how any such loss could be relieved by members. It was noted that (a) “After the first accounting period, the Partnership should be making a profit (on a Schedule D/I basis), due to its share of net profits from the exploitation of the Films or from the Minimum Royalty Payments that are due. Partners will be subject to income tax on the profits arising within the Partnership” and a description was given of the tax position, and (b) the price paid by the Studio on exercise of its Call Option would constitute a capital receipt in the hands of the members and would be taxed at an effective rate of 10%.

Scenario 1: This illustrates the position on the basis that the arrangements run their 8-year course and Gala receives only the Minimum Sums. Gala makes a small profit of £42,913 from the guaranteed payments alone (computed as the total distribution income less the total expenditure including interest costs), whereas the member makes a loss of £188,760:

Gala’s position 2004 2005 2006 to 2011 2012 2013

Balance b/f 0 0 0 0 0

Capital received 1,000,000

Bank Loan received 135,000

Distribution Income 41,764 251,385 931,339

Repayment of SG Loan -135,000

Interest on loan -6,193 -37,277 -3,105

Acquisition of [Rights] -135,000

[Initial Expenditure] - 917,522

Other expenses - 82,478

Distribution to Partner -35,571 -214,108 -793,234

Net cash c/f 0 0 0 0 0

Partner’s Cash flow 2004 2005 2006 to 2011 2012 2013

Balance b/f 0 -224,600 175,400 175,400 175,400

Capital subscribed -1,000,000

Partner’s Loan 775,400

Distribution from Gala 35,571 214,108 793,234

Repayment of Loan -775,400

Interest on Partner’s Loan -35,571 -214,108 -17,834

Tax Relief (payable) 400,000 364,160

Net cash c/f -224,600 175,400 175,400 175,400 -188,760

Scenario 2: This illustrates the position if (i) the Call Option is exercised on 30 November 2005 and (ii) Gala receives the Minimum Sums payable prior to that date and an option price of the same amount as the Minimum Amount. Gala makes a loss in cash terms of £144,863 and the member makes a cash profit of £102,388.

Gala’s position 2004 2005 2006 2007

Balance brought forward 0 0 0 0

Capital received 1,000,000

Bank Loan received 135,000

Distribution Income 41,764 42,108

Capital receipt 919,212

Repayment of SG Loan -135,000

Interest on loan -6,193 -6,754

Acquisition of [Rights] -135,000

[Initial Expenditure] -917,522

Other expenses -82,478

Distribution to Partner -35,571 - 819,566

Net cash carried forward 0 0 0 0

Partner's Cash flow 2004 2005 2006 2007

Balance brought forward 0 -224,600 175,400 180,771

Capital subscribed -1,000,000

Partner’s Loan 775,400

Repayment of Loan -775,400

Distribution from Gala 35,571 819,566

Interest on Partner's Loan -35,571 - 38,795

Tax Relief(payable) 400,000 1,377

CGT payable -79,760

Net cash c/f -224,600 175,400 180,771 102,388

Scenario 3: This illustrates the position to 5 April 2007 if Gala receives a Minimum Sum in the year 2004/05 and royalty income of £1.5 million in 2005/06 (32.16% more that the total capital contribution of £1 million and loan to Gala of £135,000). In that case the member makes a cash profit of £139,735.

Gala’s position 2004 2005 2006 2007

Balance b/f 0 0 0 0

Capital received 1,000,000

Bank Loan received 135,000

Distribution Income 41,764 1,500,000

Repayment of SG Loan -135,000

Interest on loan -6,193 -6,244

Acquisition of [Rights] -135,000

[Initial Expenditure] -917,522

Other expenses -82,478

Distribution to Partner -35,571 - 1,358,756

Net cash c/f 0 0 0 0

Partner’s Cash flow 2004 2005 2006 2007

Balance b/f 0 -224,600 175,400 722,892

Capital subscribed -1,000,000

Partner’s Loan 775,400

Repayment of Loan -775,400

Distribution from Gala 35,571 1,358,756

Interest on Partner's Loan -35,571 -35,864

Tax Relief (payable) 400,000 - 583,157

Net cash carried forward -224,600 175,400 722,892 139,735

A member who makes a capital contribution to Gala of £1 million, comprising an SG loan of £775,400 and a cash contribution of £224,600, receives a tax repayment of £400,000 roughly within a year of making his investment.

This cash tax repayment arises, so Gala says and as shown in the scenarios, because (a) in the tax year 2003/04 a loss of £1 million arises to Gala comprising £917,522 of Initial Expenditure and £82,478 of other expenses, which it is asserted were incurred by Gala in the course of a trade, and (ii) that loss can be shared amongst the members.

The member is shown as being in a positive cash position from the outset as (a) the amount of the tax refund of £400,000 exceeds the amount of the member’s cash contribution of £224,6000 by £175,400, and (b) in effect, as the scenarios go on to illustrate, arrangements were in place to secure (so far as possible) that both the member’s SG loan of £775,400 and Gala’s loan of £135,000 and interest on them would be repaid.

The distributions the member receives from Gala during the term (of an amount equal to the Minimum Sums less interest payable by Gala on its SG loan) match the interest due on the member’s SG loan.

The distribution the member receives at the end of the term of £793, 234 (an amount equal to the Minimum Amount less the amount retained by Gala to meet interest and the principal due on its SG loan) matches interest and principal due on the member’s SG loan. However, this distribution is subject to income tax of £364,160. The member, therefore, makes an overall loss of £188,760 (£364,160 less £175,400 remaining of the tax refund carried forward).

In effect, therefore, the benefit of the initial tax refund of £175,400 remaining after set-off against the member’s cash contribution is wiped out in full and, in fact, there is an excess tax charge for the member of £188,760.

The distribution the member receives from Gala prior to the exercise of the Call Option (of an amount equal to the Minimum Sums paid to Gala less interest payable by Gala on its SG loan) matches the interest due on the member’s SG loan.

The distribution of £819,566 which Gala makes to the member when the Call Option is exercised (the price paid on exercise of £919,212 less the amount retained by Gala to meet interest and the principal due on its Gala loan) is more than sufficient to meet the interest and principal due on the member’s SG loan.

In this case, this final distribution is subject to a much lower CGT charge than the income tax charge due on the distribution made from the Minimum Amount under scenario 1. The much lower tax charge means that the member retains the benefit of a large portion of the initial tax refund; a sum of £102,388.

The position is essentially the same as regards the distributions the member receives from the Minimum Sums.

However, due to the receipts under the waterfall, the member receives a distribution from Gala of £1,358,756 (£1.5 million less the sum required to repay Gala’s SG loan and interest).

The tax due on the distribution is £583,157 and the member receives an overall cash benefit of £139,735 – around £37,000 more than the return the member receives in scenario 2.

The aim was to demonstrate that it was possible to make money from film distribution, while at the same providing “downside protection in the form of tax mitigation”. It was clear from the market research that “there was appetite in the market for a proper trading opportunity, as opposed to those structures that simply offered a tax advantage such as sale and leaseback”.

Invicta pulled together the IM “to provide as much of the high-level information that prospective members (or their financial advisors) would need to consider the proposal and its suitability for them”. Invicta looked for HNWIs that could “assess the opportunity on its merits and raise significant sums of money” and who “we thought might be able to take part in more than one transaction in the years that followed, once they were comfortable with what we were seeking to achieve”.

Invicta placed the proposal to investors primarily through its own extensive network of contacts in the financial advisory sector but also through SFP who also had such a network. Invicta “went through an extensive due diligence process meeting with the professional advisors to ensure that they understood the product and were only offering it to the right type of individual” and throughout June, July and into August 2003 met with individuals from, amongst others, HSBC, Coutts, UBS and Barclays and with numerous independent financial advisers (“IFAs”). Following the meetings, UBS prepared a power point presentation for potential investors based on the IM.

Mr Yusef was very keen “to personally interview prospective members to satisfy myself that they understood the difference between the Gala transaction, which was an active trade taking place with Sony” that “could be profitable within a 2-to-5-year timespan, and the sale and leaseback arrangements that Invicta had promoted in order for clients to achieve a tax deferral”. He probably met around 75% of them before they participated, to ascertain their financial objectives and their understanding of the trade. A representative or representatives from SFP was typically in attendance and supported the pitch at these meetings, and at the earlier meetings with IFAs.

Prospective members were asked: (a) to sign and to return to Gala a number of preliminary documents to indicate their intention to participate, and (b) to send a cheque for the level of capital that they wished to invest. The intention was (i) for Gala to hold the forms and funds whilst the finer details of the arrangement were finalised and the film documentation and advice on the likelihood of commercial success was received, and (ii) for this information to be sent to prospective members before closing for them to make an informed final decision on whether to participate.

One of the main reasons he believes that securing a tax advantage was not the only or main motivation of the prospective members of Gala is that they could have achieved this by joining the numerous sale and leaseback LLPs that were promoted by Invicta since 2001. In Mr Yusef’s view, from discussions with a significant number of them:

“the members (including myself), wanted to make money from their participation in Gala, and it is my firm belief that they weren’t solely interested in deferring tax. Certainly, that was not my intention with my participation....”

Mr Iain Thacker, Mr Alan Laing and Mr William Cadogan, with their financial advisor Mr Doug Pritchard, “took a very keen interest in wanting to understand the arrangement and to be very much involved in the operation of Gala and guiding its course (which of course we were pleased with as that was precisely the type of individual we wanted on board)”:

In the section on “background”, it is stated that until recently studios were able to write off distribution expenses over an extended period but accounting standards have changed so that all of these costs are now to be recognised immediately, and as a consequence, studios have been considering ways of outsourcing these costs.

The “key features” are stated in bullet point form to be: opportunity to participate in the acquisition and distribution of major Hollywood films from Sony, ability to shelter current and earlier year’s liabilities, not dependent on existing tax breaks offered to filmmakers, predicated on general accounting principles, no 15 year reversal of the tax relief generated on any losses that may be made, and minimum gross investment of £1 million.

Under a heading “structure”, the “key” features set out include (a) reference to (i) the split between cash contributions and SG loans, (ii) the fact that profits were to be shared 30/70 between Gala and the studio respectively, (iii) details of the option, (iv) the 91.5 and 13.5 figures, and (v) the shortfall guarantee and LC, and (b) statements that (i) gains arising on the studio exercising its call option would be liable to CGT and should benefit from business asset taper relief, (ii) the distribution spend would generate an initial loss to the LLP, and (iii) the LLP would engage a distribution company and make the films acquired from the studio available for distribution and only those films judged to be commercially viable by the LLP would be included.

UBS also set out (a) the tax planning opportunities as regards ss 380 and 381 ICTA, (b) a member’s cashflow, which shows an immediate cash repayment to a member due to tax relief, with a note that cash flows thereafter are dependent upon the studio exercising its call option and the profits generated from the distribution of the films, (c) risks, which are largely tax risks, and (d) under a heading “suitability”, reference to clients with significant UK income or gains taxable at 40%, clients with sufficient cash to invest or ability to borrow and non-domiciled clients who do not want to commit to 15 year term of sale and leaseback structures, and (e) scenarios 1 to 3.

She gave an overview of the Gala proposal as follows:

“Under this arrangement print and advertising expenditure and film distribution are combined to generate trading profits over the medium term whilst allowing individual partners to benefit from the same loss reliefs as those afforded by vanilla sale and leaseback arrangements.

When a major studio film is made the costs of production are often matched or exceeded by the costs of distribution which includes printing and advertising costs.

Until recently the major US studios were able-to write these costs off over an extended period. The accounting Standards have now been changed to the extent that all of these costs are now to be recognised immediately. As a consequence US studios have been considering ways of outsourcing these P&A costs in order to remove the Profit & Loss Account hit on their balance sheet.”

She set out details of the structure including of (a) the Call Option, which she described as giving Sony “an unfettered right that has no performance criteria or trigger”, and (b) the Minimum Sums and security arrangements. She noted the following:

“…Not all films offered to the LLP will be accepted or necessarily passed on for distribution. Only those films judged to be commercially viable will be included. This decision will be made by a team of analysts employed by the LLP, based in Los Angeles.

As part of the agreement to distribute the films on behalf of the LLP the LLP will make approximately 90% of its working capital available to the distribution company to undertake the printing and advertising of the films that have been chosen. In return for making these funds available the LLP will receive 30% of any profits generated from the distribution of the films and 70% will be paid to the distributor…

The L/C is a bank guarantee, with embedded triggers - so in effect you are relying on a bank guarantee from a bank with an external Credit rating of AA- or better…

The risk therefore of the loans remaining unpaid is that the bank(s) issuing the standby Letter of Credit is unable to meet its obligations….”

She noted that Gala would have the option to select the films to acquire and the intention was to acquire 5 to 7 films amongst which are 2 major blockbusters subject to release dates: Spider Man II and Terminator III.

Under a heading “Taxation” she made the following main points:

Under a heading “Loss Relief Claim”, she set out the following:

Under a heading “Risks” she said that the main area of risks are described in the IM and then summarised them as follows:

HSBC Republic Bank (UK) Ltd will be remunerated by an introducer’s fee and Mr Mallett will therefore not be asked to pay any fees.

A loss arising from The Gala Film Fund could be set against Mr Mallett’s income from 2000/01 to 2002/03 but his income in 2001/02 “has been largely utilised by the losses arising from your participation in the Castle Film Partnership” and given the level of his income in 2000/01 “it would be more beneficial for any loss claim to be offset against your income in 2002/03 as we could relieve the income which is subject to higher rate tax”. She asked for confirmation of his earnings in 2002/3 and estimated earnings for 2003/04. Based on a partnership contribution of £1,000,0.00 which would be relievable at 40%:

“Estimated initial refund £400,000

Initial cash or loan contribution at 22:46% £224,600

Estimated cash advantage in year £175,400”

She concluded that:

“The Gala Fund is a tax efficient product that offers additional benefits over and above: those provided by sale and leaseback film partnerships. Unlike other products in the market it carries no production risk.”

She enclosed an IM, the MA, an Instruction and Application pack, a loan agreement, an admission form, a copy of the “robust” counsel’s opinion, a letter from SG regarding the standby letter of credit and the CV of Mr Bold, tax adviser to Gala.

Mr Yusef did not agree that this shows that it was inevitable that the Call Option would be exercised. He thought that UBS were setting out the tax position if the option was exercised and noted that “we were never in position to call for the option to be exercised”.

He agreed that in fact there was no 30/70 split of profits and said that he explained to UBS at the time, “that was a structure that we were aiming for but it turned out that in the negotiations that’s not what we got”. We note that it appears that Mr Yusef/Invicta did not expressly inform investors of the actual ratio for sharing Gross Receipts. They were provided with the means to find that out at most only 2 to 2.5 days before the transactions were approved, when they received the transaction documents.

He said:

“we were not looking for someone with significant income or gains, taxable at 40%, who wished to have the ability to shelter current and earlier year tax liabilities. This is UBS’ targeting of people who they thought would find the downside protection that we were offering useful. What we were looking for were people who had the wealth and the appetite to get involved with the film trade, other than something that they were probably used to, which is sale and leaseback…UBS has been approached to invite their customer base to look at our structure. I didn’t prepare this [presentation]. Nobody in our office prepared this document. They then went out there and harvested their database, and then in many instances we then met with these people to explain what was happening in terms of the actual trade, the actual business of Gala. This doesn’t even deal with the business of Gala.”

He added that this was a client gathering exercise, but it would not begin and end with this presentation. After this process was finished, Invicta would meet with the vast majority of suitable individuals (at Invicta’s or UBS’s offices) and would explain:

“not just this is all about tax and downside protection. There is more to this structure...as is reflected in my witness statement, and that would be what we would be looking to ensure that the prospective members understood.”

It was put to him that UBS put tax at the centre of their marketing material. He said they had to do that, because they had to explain to their customers what the tax consequences of the transactions would be. However:

“At the presentations I was certainly involved in UBS and other institutions, my emphasis was more on what the transactions involved and what we would be doing in terms of participating in the film trade. Obviously, it did in turn also involve me having to explain the tax consequences, but I did in every single instance explain to people that the tax treatment was not the driver. They obviously had to qualify for that in order to get the downside protection, but that shouldn’t be the driver. There were other ways for these people to get involved in tax mitigation or tax deferral…as I say their objective was to explain to their clients what the consequences of the transaction would be. It wasn’t their job, nor were they qualified to talk about the film side of the business, which was the trade that these people were entered into. That was my job.”

In re-examination, he emphasised that the UBS analysis was not prepared by Invicta and did not represent “the way in which we pitch or try to explain the way the transaction worked”. Invicta would talk about the tax element of it, but in terms of downside protection rather than “this is the reason why you should do this deal”. He was quite certain Invicta would not have pitched it in that way:

“We would have explained in detail how, because it was relevant to the concern that some people would have at the time. It was important to distinguish what we were trying to do here from what they were used to, which is sale and leaseback type of transactions. It was, therefore, important to explain to them that this was intended as a trade. There was a profit motive. There was an element of risk but that the risk would be mitigated in this way.”

It was put to him that scenario 2 demonstrates that a member makes a significant positive return (and Invicta, Sony and SG, also all get all of their fees) without the need for a single cinema ticket to be sold and for Gala to receive anything under the waterfall. He agreed that everybody would have been paid and that an inherent and significant element of the model from the outset was that a member would receive a guaranteed positive return come what may. He said that he did not believe the members went into this transaction for that purpose as they “could have achieved that a different way without as much bother”:

“…they could have achieved somewhere close to that by doing a deferred tax arrangement, for example, or some other tax things that were available at the time. They didn’t need to do this to achieve that. That wasn’t the sole driver. That was a mitigant to what they would otherwise consider to be a high-risk transaction.”

When it was put it to him that this just sounds too good to be true, he said that he thought that:

“if it was too good to be true in terms of the overall…objective, I don’t think 65 people would put their money into it…If this was credible, the objective of entering into the film business at a high level was also credible and I think this set of people were minded to enter into the film business in a sensible way. I have already said what my motivations or what everybody else’s motivations were in the witness statement. It wasn’t simply to make tax work. That wasn’t the primary objective. We achieved that differently.”

It was put to him that this is an absolutely whopping return and it was all about the tax. He said:

“I intended to participate in this so that we could be involved, as I say, in a sensible position, in a sensible way in film distribution. I had visions that...this phase would be one of many phases. Each time the phases would be slightly different, but essentially the idea is to be involved in film distribution for quite some time. That’s why I did it…No, it wasn’t all about the tax. We could have achieved that without going through all the bits and pieces at various stages in the transaction…if it was just all about tax, we could have achieved that without doing this.”

We do not accord any weight or significance to Mr Yusef’s repeated asserted belief that investors were not motivated solely by tax considerations because they could have achieved essentially the same, or close to the same, tax effects in other ways such as by investing in a sale and leaseback transaction. On his own evidence, it is not correct that a sale and leaseback transaction offered the same tax advantage as investors could obtain (if Gala’s analysis is correct) under the Gala arrangements. He said that such sale and leaseback transactions involve only a deferral of tax. We take him to mean that any initial tax advantage would be clawed back in its entirety over time. However, under the Gala arrangements, members could achieve a return solely due to tax relief, if the Call Option was exercised, as in fact happened (albeit that they would achieve only a tax deferral in other scenarios). The fact that members could achieve this result was spelt out in scenario 2 in the IM, in the UBS document, which also highlighted that there would be no reversal of the tax relief, and in the letters from Ms Challons.

We also do not accept Mr Yusef’s suggestion at times in his evidence that (a) Mr Yusef/Invicta were somehow at a distance from the approach taken by UBS in its presentation, and (b) he/Invicta were not looking to find investors with significant income/gains taxable at 40% who wanted to shelter income. UBS based their presentation on the IM and so, in effect, on information provided by Invicta. Moreover, Mr Yusef was plainly fully aware of how UBS was presenting the structure to investors on a repeated basis given he spoke of attending presentations to investors at UBS. Mr Yusef’s assertion in (b) conflicts with his other evidence that clearly investors had to have a use for their share of the loss (albeit he said that was “downside protection”).

Mr Yusef also initially sought to distance himself and Invicta from the comments in the instructions to Mr Thornhill but (a), it transpired, as he later accepted, that he in fact attended one of the conferences which followed these instructions, and (b) he accepted that it was essential to obtain the loss/tax relief although he maintained that “it had to be there to entice people to deal with the risk that otherwise would be there” rather than that it was a goal in itself.

In our view, Mr Yusef’s evidence in this section on his/the members concern with Gala’s prospects of receiving a share of Gross Receipts is undermined by (a) the terms of the waterfall, which gave Gala a share of Gross Receipts very far removed from the 30/70 split which Mr Yusef said he sought and which UBS and Ms Challons told investors would be the split (see section 11), (b) the fact that no-one involved in these transactions obtained a meaningful appraisal of Gala’s and/or the members prospects of realising a profit (see, in particular, sections 5, 6, 7 and 13), and (c) he/Invicta did not provide the term sheet agreed with Sony to investors and left it until at the very most 2 to 2.5 days before the closing of the transactions, to provide investors with information from which they could find out what films had been selected and what the terms of the waterfall were and, at that time, did not provide any overview of the terms of the waterfall. The question arises as to why persons who it is claimed were seriously concerned with Gala’s and/or the members’ prospects of making a profit from Gross Receipts left it to such a late stage to provide the investors with the information they would need in order to be able to engage with and, if they wished, evaluate or obtain further advice on that issue.

He was introduced to Gala in 2003 by his financial adviser, Mr Pritchard, who knew that he was looking for “something exciting and interesting which could give a substantial return”. Initially Mr Pritchard provided a number of documents which they discussed in detail, in particular, the IM and counsel’s opinion and he “explained this was an opportunity to potentially earn decent returns on the investment in the medium term and that it was tax efficient” as supported by counsel’s opinion.

This was the first film investment he made and he was very engaged with assessing the opportunity on its merits and trying to judge the likelihood of making a return on his investment. He took the documents away with him to consider in his own time. As regards the IM:

Having considered the documentation and after attending various meetings with the team behind Gala, where he critically reviewed the opportunity, he concluded that Gala was a good investment opportunity for him and that there was a reasonable prospect of making a profit from it within a reasonable period of time.

His understanding was that:

He agreed that (a) what came through the waterfall was not guaranteed and drepended on what was agreed, (b) when the IM was published, no terms for a profit share had been agreed, and in contrast to scenarios 1 and 2, scenario 3 is entirely hypothetical, in that it deals with income from a source that was still to be negotiated.

He said that his reference to earning a return in the medium term was not to months but years and, subsequently, it became clear to him that “there was a very great possibility of making a significant return within 2 years”. As set out in section 7, he later said this view was due in part to the Call Option.

He said that he spent a great deal of time talking to Mr Yusef and Mr Bamford and he became satisfied that, whilst the scenarios in the IM are illustrations, they do not represent the likely outcome, “once we knew what we were investing in, in terms of films”.

He agreed his focus in 2003 was on the likelihood of him making a return on his investment, as distinct from Gala making a return, and said that is “as it would be with any investment”.

He was asked whether his reference to “positive tax treatment” is to the almost immediate substantial tax refund shown in the scenarios. He said that the IM suggested that “the statute allowed us to mitigate our losses”, and he had also had discussions about that and the fact that “the tax regime as set out by the statute and to encourage investment in the film trade suggested that this would be favourable…to mitigate our losses”. He was not sure whether he relied totally on the IM but there was a positive tax treatment explained in the IM and he was aware of it. He then confirmed that he did mean the tax refund. It was put to him that this is not just mitigation. He said that the purpose was to invest in films which would deliver a significant profit and there is no doubt that the way that the legislation had been formed creates that situation. When this was put again, he agreed.

It was put to him that his view that the arrangements were quite positive in case there was a loss does not make sense as the scenarios show that (i) if Gala made a loss, a member would make a profit (as in scenario 2), and (ii) if Gala made a small profit, a member would make a loss (as in scenario 1). He did not answer this but said that the main driving force of the investment was “are we going to be able to make substantial returns from the distribution of films which are successful” and the tax aspect was not the driving force or the focus of the discussions with Gala; it was “much more important to be sure that the films we were investing in were likely to be very, very successful.” When pressed, he said he looked upon the scenarios as being the worst case and did not look at it in the way that counsel did until now. There is no doubt the tax arrangements surrounding film investments were very favourable to the investor and that the intention of Parliament was to encourage the injection of capital into the film industry. He agreed that he was saying that scenario 2 is the worst case even though it shows a member making a very significant profit from tax relief alone after a period of around 2 years, without Gala receiving any income from the distribution of the films.

In giving the evidence set out above, Mr Cadogan seemed more focused on giving a view in support of his/Gala’s case than on answering the questions put to him. This undermines the credibility of his evidence. Moreover, we do not accept that he thought that scenario 2 is the worst case given that (a) he plainly considered the availability of “tax mitigation” to be important, (b) he accepted that the prospect that the Call Option would be exercised at year 2 had some bearing on his expectation of making a return on his investment, and (c) it is plain from the scenarios, which he was taken through, that the so called “tax mitigation” would not produce a positive return for a member in the longer term unless the Call Option was exercised and/or Gala received very substantial sums as its share of Gross Receipts.

He agreed that (a) the success of his investment did not stand or fall based on Gala’s own profit position (in terms of whether its revenue exceeded its expenditure) because a member could make a profit if Gala made a loss, and (b) the IM did not give him anything to go on in terms of assessing the chances of Gala making a profit, because it contains no detail of the studio or of the films involved, and as nothing had been agreed with the studio as regards the terms of the waterfall.

He said that it is probably right that there is nothing in the IM about a change in accounting policy but there were other conversations at the same time with Mr Yusef and Mr Bamford who he met several times. He also met with Mr Thacker and Mr Laing, who he worked with at Oracle and who were also advised by Mr Pritchard. He thought he became aware of the US accounting issue quite early on and he did some research on it and so did Mr Thacker. So he did not depend upon just the information provided by Gala. He did not consider it curious that what he considered to be key is not mentioned in the IM.

He agreed that by “profits arising from the film” essentially he meant whatever is left after the studio has recouped its expenditure and that he did not specify what sort of share of profit because at this time he only had the IM and it did not have any deal terms.

It was put to him there is nothing in the IM or in counsel’s opinion about Gala taking advantage of any tax relief specific to film investments and, in fact, the arrangements did not rely on any such relief but on accounting principles. He said he did not remember all of counsel’s opinion, but at the time he did a lot of personal research and that was not his understanding. When it was put to him that it makes no sense that the UK Government wished to incentivise investment in relation to US film studios, he said he had no way of knowing, that is speculation and: “My understanding at the time was the statute allowed for favourable tax treatment of investments in films, period. I did not have an understanding, nor did I ever come across anything which said otherwise”. When pressed he said he was only interested in the statute as it stood (and was not aware of the processes leading to it) and there are large parts of the tax law which do not make sense. Counsel’s point did not occur to him at the time.

It appears from this that Mr Cadogan had no understanding of what tax rules were relied on to produce the loss he considered was “tax mitigation” albeit that he knew it was important that there was a “trade” carried on “with a view to profit”.

As well as research on the change in accounting standards (whereby he satisfied himself that what he had been told in that regard was accurate) he did some internet research on film profitability which partly influenced his early considerations. This research suggested that, because of the enormous appetite of satellite television for films, very few films would fail to make money over 5 years.

In discussions with Mr Thacker and Mr Laing, they quickly came to realise the proposal was relatively complex and wanted to understand the law and to be sure that Gala was conducting a trade that had a prospect of making a profit. They decided it would be sensible to meet the team behind Gala.

Mr Prichard arranged a meeting with Mr Yusef and Mr Bamford in late summer 2003 to get some clarification on the information presented and to gain some comfort that there really was a substantial reason to believe that this could be a profitable investment that was not simply a made-up tax evasion scheme. He recalled being very impressed with what was being proposed and with the team, particularly Mr Yusef. Mr Yusef said that:

As regards “the tax mitigation aspect”, he recalled discussions that, for the tax planning to succeed, Gala had to be trading but he found the tax side of things to be a bit difficult to follow and so had to consider that aspect in more detail.

Although he was impressed by what he heard at the meeting and thought that, if they could secure the deal as described, there was a real opportunity to make some money, he still wanted to satisfy himself that the tax arrangements were genuine in case the investment did not make the returns anticipated. He mentioned this to his colleagues, who expressed similar uncertainties, and they agreed to press Gala for a second counsel’s opinion to verify the tax mitigation aspect of the arrangements. They asked to be involved in instructing counsel and to attend the conference with him. The conference with counsel went on for 2 to 3 hours during which Mr Thacker and he led a lot of the discussion to clarify their doubts and concerns. The conference identified some issues, and 2 further conferences were then held to iron these out. He did not attend these; they were content to leave it to Gala to deal with.

At the end of this process, he was very confident with the Gala opportunity especially after seeing the note of conference dated September 2003 which supported the earlier opinion and felt satisfied that Gala would be trading within the meaning of the legislation such that “if a return was not made we could at least mitigate the tax position” and:

“I considered that profitability would be dependent upon the films that were going to be made available to us. Given that the intention was to be able to choose the films, not just take any slate that the studio wanted to dump on us, I viewed our chances of making profit to be decent. It was a major advantage to be able to select the films we wanted to buy. It seemed to me that we just needed to pick the right films. Accordingly, I reached a firm decision that, assuming that I was satisfied that the films that were being offered had a reasonable prospect of being successful, I would invest in Gala.”

There were meetings in the summer and into the autumn of 2003 with a mixture of Invicta and his colleagues and Mr Pritchard; he was keen to understand the Gala opportunity to be notified of developments as they occurred and to have a genuine involvement in guiding the business. He recalled (a) Gala rejected a deal with Paramount because they would not let Gala pick the films to acquire and that Gala concluded a deal with Sony which enabled selection of films from their entire slate, and (b) Gala rejected an earlier slate of films offered by Sony and, when the next slate was presented, he was pretty confident in the films made available. Something’s Gotta Give featuring Jack Nicholson, a film starring Adam Sandler, and Big Fish starring Ewan McGregor and Albert Finney, stood out to him. At some stage during this period, he became aware that Gala was setting up an office in LA and employing Mr Ackerman and thought he saw his CV and credentials, all of which emphasised to him that considerable due diligence was being put in place by Gala to maximise the prospect of Gala making a profit.

He agreed that his concern was to do with the fact that in all of the scenarios an investor could get back a substantial repayment of tax almost immediately. When it was put to him that presumably this sounded too good to be true, he said his focus was on whether this was a commercially viable business that would provide a substantial return due to the success of the films, but he did not want to be involved in a business which was purely arranged to provide a tax advantage. He agreed it was very favourable, and said he just wanted to check it out.

He thought that the meeting with Invicta took place no earlier than late August 2003 and agreed that, by then, no specific studio had signed up and no terms were agreed. He said, in effect, that he felt very positive about Mr Yusef and Mr Bamford when he met them, but he certainly wanted to check this was not some sort of made-up tax evasion scheme and his colleagues had similar uncertainties. He said 90% of the issues were dealt with at the initial conference but there were 1 or 2 small issues, which he did not recall and, when counsel’s opinion was published, he was quite happy with that as an affirmation of the positive nature of “what we were doing, that we would be trading, it was a commercial prospect and we had a good chance of making a profit”.

He said he and his colleagues did not attend the further conferences because, having discussed the remaining issues, with Mr Yusef and Mr Bamford they were “perfectly satisfied” that they would deal with them because “we had great faith in them, as experts in their field”. He could not recall the issues, but they were not major - only minor issues of verification - which it was subsequently confirmed were resolved. He confirmed that by early September neither he nor counsel had seen the transaction documents and deal terms were not agreed.

Mr Cadogan initially suggested that this depended solely upon the films being successful and generating a substantial amount of revenue. He then agreed, however, that it also depended on what terms were agreed with the studio and, in September 2003, he did not know the terms but added that “we did have a general idea about what we were going to try to negotiate from the discussions”.

When it was put to him that he was not in a position to assess Gala’s prospect of making a profit given he did not know the deal terms, he said he trusted Mr Bamford and Mr Yusef particularly, who was leading negotiations “to have met his objectives of providing a favourable environment”, which in his view Mr Yusef subsequently did. In other words, he had confidence in Mr Yusef and expected Gala to get favourable terms from the studio and he noted that “we had been given an outline of the potential bargain we were going to get” and of what Invicta were trying to achieve, although he did not know the outcome.

It was put to him that he made a firm decision to invest at a time when he could not know Gala’s chances of making a profit. He said:

“Except that I had already…formed the view that Mr Yusef would be successful in negotiating terms which would provide us with a favourable environment…The terms of the agreement he would get from the studio would provide us with a strong basis for making a substantial profit, over a reasonable period of time.”

He did not agree it was a case of having blind faith in Mr Yusef but said it is a judgment. He said, in effect, that he should have added in his statement that his decision was subject to agreeing reasonable terms with the studio and confirmed that he knew, at that time, that Gala’s prospects of profitability depended on all on the agreed terms and they had not been agreed yet.

In general, his decisions to invest are centred on his “motivation to make money out of that investment when everything is taken into account”. He views “tax efficiency” as just part and parcel of the evaluation of each investment.

In 2003 his accountant introduced him to Mr Andrew Straszewski, of the John Lamb Partnership, who recommended Gala to him. He had no particular interest in films and considered this as he would any other investment opportunity on a cost-benefit analysis. Although he did not have much knowledge of the film industry, especially in relation to distribution, he was interested and willing to learn.

He was informed that film-related investments initially arose out of a government incentive to build up the UK film industry. Such investments struck him as “something that was generally accepted and widespread as being a smart investment where you can potentially generate great returns if things go really well and get a sort of “tax break” if they did not go well. This provided a degree of certainty to the investment and cushioned the risk somewhat. He recalled that “smart tax efficient types of investments such as film investments were common currency at the time” and Mr Straszewski’s advice on Gala was that “it was a non-aggressive type of film investment that had the potential to make a decent profit” and, “in his eyes, the entire opportunity had been very thoroughly thought through”.

Mr Straszewski summarised the IM and the risks involved. He advised that Gala was very much at the safer end of the spectrum and that the Gala documents were very well put together by a smart team. Mr Summers’ understanding was that:

All in all, he thought that the Gala scheme seemed cleverly put together, however, the attraction was not just the bit of clever financial engineering, but the relative excitement of being involved in the film industry.

On-going through the IM:

He did not recall in detail looking at the scenarios in the IM but is able to understand them and expected that he could do so at the time. Looking at them now:

He decided to invest in Gala because he saw that the net cash flows over the life of the investment could be “quite positive” even allowing for some of the risks that the structure might not work. He, therefore, wanted to invest to make an overall profit within what he considered to be a reasonable period of time given the illiquidity of the investment. He understood this to be a relatively safe investment, owing largely to the up-front tax relief, but with the potential to make a relatively decent return if it were to succeed. He spent enough time on Gala to understand the outline elements, but not dozens of hours working through all the intricate details.

He gave consideration to the tax mitigation because that formed an inherent part of the investment and was one of the upsides to it, but it was all part and parcel of the opportunity. The tax consequences formed part of the entire investment package which he evaluated all together as part of the projections prior to entering into the investment. Ultimately, if he were back in 2003/2004 (when there was no negative press surrounding film investments) he would invest in Gala again because “it is a reasonable and credible opportunity. It did not at the time at all feel like this was later going to be stigmatised and challenged” and:

“Essentially, I understood that if things go particularly badly I would lose money, just like any normal investment scenario, and if it goes well, I would make a return and it would be something fun to do.”

He said he had heard the term waterfall but he did not know what it was. He was aware that there were guaranteed Minimum Sums and a possible further share of film revenues depending on how well the films performed but that is as far as his knowledge goes. He understood that there is a distinction between Gala’s profit position and whether he made a return on his cash contribution and he would honestly genuinely say then and now his interest was much more concerned around his financial outcome.

It was put to him that in scenario 3 there is no certainty that Gala would receive £1.5 million and that scenario had no practical utility for a serious investor. He said such illustrations are only ever financial projections and there is obviously no certainty. He confirmed that he personally did not know (a) what level of Gross Receipts would be needed for Gala to receive £1.5 million and would not have sought to know that as he was much more concerned about his personal cashflow, or (b) how likely it was that Gala would receive £1.5 million. He said he made his decision much more on what he might potentially receive from this process and here he was presented with a range of projections. He did not presume to understand waterfalls and he thought, in all such situations, probably an investor is always looking at a scenario somewhere in the middle as the most likely. At the time he did not spend a huge amount of time debating whether scenario 2 or 3 was the most likely, he had not re-read the IM in exorbitant detail in recent times and his recollection of exactly what it said is not perfect. When he invested he assumed that “the people that manage the process will be able to be competent enough, given their experience, to be able to generate something similar to the projections”.

He said if the member expected to be in the cashflow position shown in scenario 1, he should not invest and obviously that scenario is an illustration of a bad outcome which a member would hope would not happen. Hence, why he had said he thought the most likely outcome was scenario 2 or 3.

He agreed that now he could see that the IM does not state how likely the outcome in scenario 3 is and could not do so, as the split of Gross Receipts was still under negotiation, but he genuinely could not say whether that is what he thought at the time. He thought he did not spend an inordinate amount of time going through and trying to prove all of the financial projections.

It was put to him that in scenario 2 a member makes a 45% return even if the films were flops and Gala received nothing under the waterfall and, as a serious investor, he expected that those setting up the structure would arrange for that to occur. He said that looking at the figures in scenario 2 now, a “large portion” of the return is made up of tax relief and, when pressed, agreed the return is entirely due to tax relief.

He agreed that from the IM he could not understand with any precision what film income would come to Gala. He thought he did not want to know that at the time, as he was hiring people to do this for him. It was put to him that given this lack of information and that the IM did not contain details of the films involved and how much money they may make, he could not have known there was the potential to make considerably more based on the IM. He said that he could see the point, but “there was an expectation that there would be films chosen by experts in their field that would be attractive economic propositions” and that was “the whole basis of the procedure” albeit that he was not in a position to estimate the exact nature of the waterfall himself.

He agreed that, in principle, whether Gala and Sony each made a profit depended on the expenditure they each incurred and the receipts they each obtained, and their positions may be different and he had no idea what that split was.

He did not recall any familiarity in depth at the time with what the expectations were as regards the exercise of the Call Option. He noted that the scenarios are merely projections and, whilst it was impossible to check the validity of scenario 3, he imagined all the scenarios were feasible. With his “banker hat” on, any IM has scenarios in it and he did not think an investor would view scenario 3 as impossible; it would be taken as an example of what could happen which is not designed to be concrete and the investor would not think he needed to understand every single financial movement.

He was certainly hoping scenario 1 would not come about. Scenario 3 or something similar would be very pleasant and the best outcome, which an investor always hopes for, but these projections in the IM came before some of the information provided on the people who were setting up the vehicle, who have the expertise in the films. He thought scenario 3 is not impossible to understand as an illustration, albeit it is impossible to understand in terms of exactly how you arrive at the projection, but inherently by investing in the structure and the experts that were hired there is an implication that they would try to achieve scenario 3 or something similar.

It was put to him that (a) it would be reasonable to assume those setting up the structure were driving at scenario 2 if they had agreed a deal under which scenario 3 is impossible or fanciful, and (b) it is fanciful to suggest £1.5 million would come to Gala under the waterfall given that, on the illustrative figures after roughly £2,000 comes in, receipts are split in the ratio of 1 to Gala for every 334 to Sony. He said:

He said that all he was concerned with was his overall outcome and agreed that, looking at scenario 2 now, it appeared that his return came entirely from tax relief. He said, in effect, that his expectation at the time was to make a profit. He seemed to agree his expectation was to obtain a tax refund and said:

“but by the process of having the tax as part of the structure that you invested in, you are part of an LLP, which is carrying on a business which exists as an entity...there is a lifetime to this business when it’s carrying on a trade, it is carrying on an activity. It wasn’t I put my money in. There’s my tax. There is no involvement. There’s a business and there’s a process. The fact that we are here representing [Gala] should illustrate that I am still fully involved as a minor partner.”

It was put to him that in his statement he said he did not think he would have an active role. He said he was still a member of an LLP and whilst he was not claiming to be actively involved, his point is “you don’t cease to be a member of the LLP when you achieve the tax”.

He agreed that (a) he hoped personally to make a return on his money, (b) he was not familiar with the terms of the waterfall and so could not have known, when he went into this, how much income, if any, was going to come into Gala but thought that “whenever you invest in any business you never know the outcome”, and (c) he did know about the projected tax relief and he noted that tax relief is part of very many IMs. He said the tax relief was a key part of what this was about, but he thought there was a suggestion that it would have to occur as part of something generally credible and it was not as if there was an immediate repayment although he was certainly hoping for it within a year. He added that tax efficient investing is certainly not unusual and more recently he had invested in EIS and SEIS related business and a “very large part of my willingness to do that is for the associated tax benefits, because they insulate me from the fact that it’s a very risky process”. When pressed, he said he thought that the tax relief is “a key part of what this was about”.

He seemed to agree that the wording in the IM relating to SFP is a candid recognition that the arrangements constitute a tax shelter. He said that he thought that is an incredibly sensible point to have, because “as an investor... at least part of your process is to try to achieve some tax relief..” and he imagined that is in pretty much everything a tax adviser would write.

It was put to him that given that the sums Gala put into the expenditure account were guaranteed to come back to Gala, in economic terms, Sony still bore the relevant expenditure on distribution costs. He said that this was not an element of the structure he would have considered at the time; he would not have spent “50 hours reading the [IM] and trying to understand every single metric” and he had not subsequently made himself incredibly familiar with the IM. He agreed that the fact that, as he understood it, the studio entered into the arrangement for accounting reasons is not incompatible with Gala and its investors entering into them for the tax relief. He noted that a lot of corporations “do a lot of different things to achieve tax benefits” and “look to do things which are part of the tax code” and this did not strike him as in any way unusual or out of the ordinary.

He agreed that, as in scenario 2 tax relief alone would result in a return for a member, fundamentally it did not matter whether Gala generated any revenues from the films. He added that he thought his comment in his statement summed up his beliefs “in terms of the benefits that would accrue to taking the risk of investing in what was a volatile industry” in that it may potentially generate great returns if things go really well and provide a tax break if they do not go well. He just felt a little bit nervous about committing to specific questions about payments here and there to certain groups or banks when this was not part of the diligence he did on the structure.

He confirmed that he did not look at the waterfall at the time and still had not but said he thought that, as by the time he was involved other people had already done the transaction, he had the security of knowing that other people had proceeded with it. He agreed that at the time he was not in a position to know what Gala’s share of revenues under the waterfall would be or how likely it was to receive anything.

He confirmed that in referring to him making a decent profit he meant a return on his cash and a profit for him and also that is what his financial adviser would have been concerned about.

He seemed to agree that, in this case, the tax relief was not simply mitigation of a loss in the sense that it reduced the economic burden of a loss but gave a positive return and the tax relief was a given or the expected outcome.

He seemed to agree that the films could be flops but that tax still gives a member a return. He said, in effect, that was only in scenario 2 and his witness statement correctly reflected his perhaps naive thoughts about this opportunity at the time and even now. He said it would be disingenuous for him to say that the associated tax benefits of the Gala investment did not cross his mind or were not part of his investment process. Any investor who goes into this would be aware of the potential tax benefits, and obviously he was aware and it was part of his thought process. However, he absolutely did not sit there and rationalise to himself that the only way he would make money out of this is because of the tax because he was investing in a partnership and:

“If you are investing in a partnership, you are part a partnership that can have a business that carries on for many years...investing in a partnership potentially has a long tail of consequences and it’s not something that you go into lightly.”

It was put to him that, subject to the tax analysis being correct, the scheme would succeed due to the tax relief and anything else would be a bonus. He noted that under scenario 1, which he hoped would not occur, a partner’s cashflow is a negative number, even though the tax relief is factored in. He added that this was not viewed by him as a riskless investment; nothing in life is riskless. He then agreed it is true that, if the Call Option was exercised and he obtained the tax relief (as he would, if the tax analysis is correct), that would suffice for him to view these arrangements as successful and anything else would be a bonus. He noted there is a lot of “ifs” involved (although that is what in fact happened.)

He did not accept that the fact that a number of the risks in the IM were all to do with the availability of tax relief demonstrates that tax relief was central or of key importance. He said that he did not spend a huge amount of time on these factors; he probably read or skimmed through them and:

He confirmed that where in his statement he spoke of making a return, he meant him personally making a return on his cash contribution.

It was put to him that whilst the exercise of the Call Option generated a gain for tax purposes there is no economic, real world commercial gain. He said that all he was looking at was his net cash carried forward.

He seemed to agree that when he spoke in his statement of making a return over 3 to 4 years he had in mind the sort of time frame in scenario 2. He said obviously he was saying he did not expect scenario 1 to come about or he hoped it would not come about.

It was put to him that, in reality, he would lose money only if the tax analysis turned out to be wrong. He said that is not true because in scenario 1 that was not the case and whilst that is correct in scenarios 2 (and 3) that was only one of several scenarios. Essentially, his thinking was driven by what he said in his statement; if things went badly, he would lose money just like in any normal investment scenario, and if they went well, he would make a return. He agreed that scenario 2 is not really a normal investment scenario but said that he had no way of knowing for certain that scenario 2 would come about and he noted again the outcome in scenario 1. He said scenario 1 is a normal investment scenario, “because you can lose money... this was never presented to me as riskless... any investment has a worst case, average case”.

Around 2002 Ms Challons advised him (a) that a popular investment opportunity related to films, (b) the government was looking to promote such investment, and (c) whilst investing in films was more speculative than “safer” investments, the legislation in place at the time provided an element of “downside protection” of tax mitigation should the investment be unsuccessful.

He then invested in 2 film sale and leaseback structures, which Ms Challons explained had the sole benefit of providing an effective means of deferring tax. She later referred him to a number of different types of film investment opportunities and explained the mechanics of film partnerships. In summary:

He had an initial meeting with Ms Challons at which she provided him with various papers relating to Gala, which he took away to review. He then met with Ms Challons a couple of times and she explained that:

He did not know for certain whether he would make a return on his investment but, as long as his risk was spread, he considered there to be a reasonable prospect that he might do so and, given that Gala was intending to invest in several films, the prospect might be enhanced.

He received a letter from Ms Challons dated 4 July 2003 (“the July letter”) (see section 4 as regards the content of the letter). He carried out an initial review of the letter and the IM with Ms Challons but thought he needed to read into the proposal in more detail. The IM was the primary document that he reviewed parts of which stick in his mind:

The July letter also made reference (unlike the IM) to Sony. He was encouraged by the fact that Gala intended to transact with a major studio and this added weight to his view that there was a reasonable prospect that he might be able to make a return on his investment.

On reviewing the IM and the July letter and based on his own (albeit limited) understanding of the film industry, it seemed to him that (a) there was a genuine commercial rationale behind Gala, (b) the potential upsides of investing in Gala could be significant, and (c) by purchasing the rights to several films rather than one, his risk was spread. The amount of his personal contribution in Gala was relatively low. He knew there was an element of “downside protection” in that if his investment was unsuccessful, he would be able to offset any losses against his income tax liability - that was simply part of the package offered, which he took into account in deciding whether to invest. Accordingly, when considering all of the factors, he decided to invest as he thought that he could earn some decent profits from his investment if the right films were purchased.

Having decided that he probably would invest in Gala, on 17 July 2003, he signed the various documents for Ms Challons to send to Gala for them to retain on file for completion when appropriate. He understood that he would hear further from Gala in due course with further information regarding the choice of films and studio.

Ms Challons suggested the amount he ought to invest in the various film schemes as based on capital available to him, investment requirements and his income tax liabilities for earlier years.

He initially said that this was part of the wider agreement which was a “commercial agreement which had a genuine and compelling purpose” as a result of the change in US accounting principles:

“So we were looking at what the upside would be from this arrangement. Part of the transaction was that there would be some interim coverage of borrowings....because it might take some time for the royalty payments to come through….[it] seemed to me to be a perfectly sensible commercial arrangement, and part of it was that there was some certainty in respect of the repayment of certain borrowings. It did not deal with the remainder, what we would expect to earn in the event of a successful slate.”

When pressed, he said that the LC provided a sort of floor for the arrangement, and was a “standby” facility, in that it only applied if there was insufficient income from the distribution rights (as he thought was supported by Ms Challons description in her letter). He agreed that if A borrows £1,000 from a bank and pays it to B who agrees to cover A’s interest costs and repay the £1,000, that is an artificial and circular arrangement but did not seem to accept that is what happened here. He said the LC is a “a standby, and it is only on the basis that there is insufficient income coming from the distribution rights…Which I would say is a slightly different point.”

It was put to him that if the bank borrowing was not taken out in the first place, the need for the LC would not have arisen. He said he was doubtful and would like to reflect on and verify that as he was obviously not fully au fait with everything that was agreed in relation to the transaction. He only has what he was given to read.

He initially said he did not regard it as important because he looked at it in a different way: There was a 21-year agreement and a Call Option with its last exercise date 15 years later and he obviously did not know whether or when it would be exercised. That was entirely a matter for Sony who would only do what is in their best interests.

When pressed, he said that it was not important or rather definitive for him, and Sony had negotiated different dates for exercise, and he assumed that Sony would not have gone into this sort of detail if they had not thought that they might exercise. He said that the significance of the fact that, as set out in the July letter, there would be a substantial income tax liability if the option was not exercised, is partly dependent on what revenues came from the distribution rights. He agreed that the possible revenues were entirely speculative but said that counsel was missing a trick:

“That’s the tax treatment. What we were anticipating was income which would go on for many years if the option was not exercised. So whether it was exercised or not was, as I say, entirely a matter for Sony and not for us, but we went into this on the basis that there would be profits - we had a reasonable expectation of profit and that’s what would have come out of that.”

In the letter it was stated that:

“At the time our client believed he had Mansworth v Jelley losses and subscribed to participate in the LLP in August 2003, anticipating that Sony would exercise its option, which it did. The availability of capital losses were the factor that influenced our client’s decision to invest. Our client accepts that it was not the only factor that was taken into account, but considers this was a key factor and one that tipped the balance in favour of proceeding” (Emphasis added.)

He agreed that this letter was written on his behalf and the firm would have taken instructions from him before writing it. He said (a) he viewed the comment as dealing with “a due diligence point,” as to what would happen if the option was exercised, (b) that is what anybody going into this should have looked at, to do so is perfectly sensible; it is the sort of question that any taxpayer and any professional would ask themselves, and (c) and that is why he talked about the commercial sense of the transaction. It was intended to be “a win-win” for both the studio and for Gala and, therefore, the Call Option may or may not have been exercised and, as he had no influence or no knowledge whether Sony would exercise it or not, he had to assess what would happen in each case.

He added that he was told there was potential for Mansworth v Jelley losses to be applied and that ticked his final due diligence point and settled it for him that he would proceed:

“It was a question of that’s the last...sort of stone that tips in favour of proceeding, because I had already felt through my reading of the information and a number of items...that there was…a reasonable prospect of profit out of this in both - initially and in the longer term, to quote the [HL] analysis. So I was already convinced that there was a compelling commercial reason for Sony to do this, and it would have delivered us a stream of revenues over many years, or…What happens if it is capitalised? That is my tax situation. That’s what I expect my tax adviser would write. I thought "In that case I will go into this". That is the sort of due diligence point as opposed to looking at the arrangement as a commercial prospect.”

He said that he would not have used the word “anticipate” but he thought it was used in the sense of looking at what would happen if Sony did exercise the Call Option and “anticipating” the consequence of that. His belief was Sony:

“probably would exercise at some point, but since they had 4 possible dates to do so, I didn’t know when and necessarily what the implications would be. It rather depended on how the films performed. That’s what we went in for.”

When pressed by reference to the wording of the letter, he initially said that the point is that, if Sony exercised, then the issue arises as to what the consequences are, and the letter is about the consequences. He then said that he had a belief that Sony would exercise the Call Option because otherwise they would not have negotiated the option terms. However, he did not know that as it was a call option.

Success depends on the films over essentially a 21-year period unless cut short by the exercise of the Call Option. Part of the proposition is that there “will be money thrown off through the distribution of profits and the profits shared through the distribution of these films” which cannot be calculated, in that all one can do is show illustrations as in scenario 3, but “one can do considerably better than that” and, if so, at the end of the day, the members would pay more tax and HMRC would benefit.

He accepted that in fact Gala’s “business” was phenomenally unsuccessful, but his investment in Gala was successful through tax relief alone. However, he said that was not the intention of those going into the arrangement. Rather the intention was that:

“we would be earning significantly greater sums from being in a slate of successful films owned by - produced by Sony and distributed by them with our investment going towards the P&A. That was what the whole purpose of the arrangement...”

When pressed he said again that the members went into this for a very different reason - “the arrangement was to put us in a position whereby we could earn significant amounts of money from it” as supported by the expert opinion of HL and one could have put a series of other illustrations of how much would come out of it. That is why they went into this transaction and at that point it is quite clear that the members, HMRC and Gala would have benefited. He said counsel was looking at the position with hindsight and when “we entered into this the proposition was very different....the option might not have been exercised on the first or any of the 4 anniversaries. It might not have been exercised at all.”

He agreed that a return was guaranteed due to tax relief in scenario 2 but added that there was no certainty that the Call Option would be exercised. He agreed that, in each scenario, the member obtains upfront tax relief. He said the expectation was that in that first-year money would be invested and that it would come back over a period of years. There was the potential for the transaction to go on for many years. He agreed that the upfront tax repayment was not wiped out by tax due on the gain arising on exercise of the Call Option, so that a member made money overall through tax relief alone. He said this is 20/20 hindsight by looking at what happened:

“When we went into this the expectation was that we would be earning a significant amount of money either because the call was exercised at some point during that period or not. The first year that is the correct accounting treatment but over the period we would have made…considerably more.”

He said, in effect, that, at that time, the Gala concept had been explained to him and finding out the identity of the studio out gave him additional comfort, because clearly Sony and Columbia were the leading studios with a well-known track record. He agreed, however, that, at that time, Sony had not been signed up, the films were not known, and no deal terms were agreed. He said (a) there was a clear statement of intent that Sony would be the type of studio or the studio that would be signed up, and (b) he clearly was not deeply in the negotiation of the terms, because that was for Gala itself to do and he relied on them. They are very experienced.

When it was put to him that without that information he could not form a view on his or Gala’s prospects of receiving money from the films, he said, as far as he understood, and he was relatively amateur, the nature of the film business is that negotiations go on behind the scenes and Gala would negotiate the best terms it could get. That is entirely consistent with trying to put together an answer to the issue that studios had, namely, that a change in accounting treatment meant that they had to take all of the distribution costs in year one rather than spreading them out:

“So it was a statement of intent backed by an organisation which was putting it together, and a team in Los Angeles, and on that basis you would anticipate that there would be an attractive slate which would lead to profits being generated.....in the medium term.”

When pressed, he said that clearly he could not individually calculate exactly what the numbers were going to be but a framework was being put in place whereby “we would enter into a sensible commercial agreement which should be a win-win for both ourselves and the studio”. So on that basis he would not have expected there to be the absolute detail to be able to do a detailed calculation, but this was “a framework for what was... going to be offered to us and clearly was going to be rolled out and put in place”. He was presented with what was being put together and asked if he was interested (and he was) but clearly, he could not actually calculate exactly how much investors would get out of it - but no-one could. That is what he expected then to happen as the first part of putting this transaction together:

“You have to take a view that it is going to be a commercially sensible transaction and on that basis no, you can’t come up with the precise numbers, but can you answer to your own satisfaction the key question, which is given a studio such as this one with a slate of films, including two blockbusters, is there a decent prospect that you are going to make some money out of this arrangement, which is for the benefit of both the studio and ourselves? Yes, is the answer.”

When pressed on the point that his view was based on the tax relief alone, he said (a) this was a commercial transaction and was entirely typical of a commercial transaction, and (b) the taxation is very secondary here. The point is that in these circumstances there was a very strong reason for a studio to have some of their cashflow effectively provided by a third party for reasons of their accounting treatment. He said, in effect, he believed Sony would not do this without believing that they would make a profit, and in turn that Gala would not do so without terms and analysis that was to come, as it did in November.

He agreed that his expectation was that the Call Option would be exercised but said he we did not know when it would be or whether. He did not agree that his view was that the only risk associated with this transaction was the Call Option not being exercised. He seemed to agree that given the lack of information on the films and deal terms, there was no basis for committing to the transaction in July 2003. He said, however, that he did not commit then and noted that, from the July letter, he had the names of 2 films which were sequels and, as he had already said, they may not have been signed up, but the indication in the letter was that they would be on the slate and the previous success of the earlier films suggested that there were significant amounts of money that could be made.

He agreed that whether Sony and Gala made a profit from the films depended on the deal terms and the fact that a film might be successful and might make a lot of money does not necessarily tell you anything about their prospect of making money from the films, because it all depends on their position in the waterfall and the deal terms that have been negotiated. We note that, as set out in section 7, Mr Mallett did not know the terms of the deal when he signed his acknowledgement and so became committed to the Gala transactions.

Albeit with some reluctance, Mr Mallett accepted that in fact he obtained a return from the Gala arrangements purely from the tax benefit. He maintained that this was the position with hindsight, this was not what investors went into the arrangements for and that he did not know that the Call Option would be exercised, in effect, in support of his stated view that obtaining the tax benefit was secondary.

However, whilst he plainly could not know definitively that the Call Option would be exercised at the earliest opportunity, his asserted view that the tax benefit was a secondary consideration lacks credibility in light of the facts that (a) he said in his witness statement that he believed it was likely but not definitive that the studio would probably exercise the option, ultimately he accepted that he believed and expected the Call Option to be exercised, and this accords with the plain statement in the Smith & Williamson letter that he anticipated that it would be exercised, (b) he signed the admission documents only 2 weeks after receipt of the July letter, when he only had the IM and the information Ms Challons set out in that letter and related documents, and (c) at that time, he had no basis for his view that there could be a profit from Gross Receipts and that is why investors went into this, other than his reliance on Invicta/Gala (whom he did not meet with) negotiating a good deal, the mention of the 2 blockbusters (which ultimately were not part of the transaction) and that Sony would not do this without thinking they could make a profit. He accepted, that whether Gala would make a profit depended on the terms of the deal and he did not know what those terms would actually be. He showed no concern with the actual terms; he made no mention of the waterfall as an important aspect of the transaction in his witness statement or of any discussion with Ms Challons on that. He was prepared to sign up to the arrangements (albeit he was not committed at this point) on the basis of Gala possibly investing in 2 blockbusters and in the apparent belief that Gala/Invicta would negotiate a good deal, and (d) moreover, the evidence set out in section 7, demonstrates further Mr Mallett’s lack of interest in the terms of the waterfall and what share of Gross Receipts Gala was likely to receive.

He was informed of the Gala proposal by Ms Challons who he was introduced to in 2003 by a contact at HSBC. His initial response was that he was not interested in investing in films, given he had previously invested in sale and leasebacks, which he had clearly understood to be a legitimate and accepted way to defer tax, only for HMRC to open investigations into them. Ms Challons explained that, although there were some “dodgy” film investments that he may have unwittingly been exposed to, there were other better options. He asked her for further information and she sent him the letter of 12 September 2003 (see section 4).

At the hearing he said he did not at the time realise the sale and lease backs he invested in were tax avoidance schemes; he was advised by his local financial adviser that they were encouraged as schemes to help mitigate tax. When he then found out that that was not the case, he paid everything back to HMRC and suggested that he would never invest in anything that sounds like it is not completely legitimate again. He confirmed that Ms Challons introduced him to Ingenious Film Partners 2 LLP which he invested in and that he has settled his liabilities to HMRC on that.

Mr Lewis highlighted that Ms Challons set out in the letter that: (a) Gala was different from “vanilla sale and leaseback arrangements”, in that it intended to generate trading profits from distribution in the medium term, (b) Gala intended to acquire the rights to 3 to 7 films from Sony, and to fund part of the distribution expenditure of only those films it judged to be commercially viable, (c) the opportunity had arisen due to a change in US accounting standards, (d) details of the structure and risks, which centred around trading, commerciality and security provided by SG and Sony (although Mr Lewis understood that these risks were relatively low) together with a worked example, (e) details of the taxation of the investment, and (f) the financial outcome for him.

Following this, he started to reconsider investments in films on the basis that (a) the Gala proposal came from HSBC, whose reputation and expertise he had no reason to doubt, (b) he realised that his 2000 film investment had originated from a local financial advisor, who was clearly not as sophisticated as HSBC, (c) the Gala proposal sounded commercial and stemmed from what appeared to be a genuine need for studios to source funding as a solution to the change in accounting standards, and (d) it was backed by a major US film studio (unlike his earlier investments which were in small, independent film producers and studios).

He did not have a background in film and, in order to evaluate the commercial case for Gala, he tried to rely on common sense and logic. Given his initial reservations, he met with Ms Challons on 2 further occasions, and they discussed most, if not all, of the contents of the letter. They also discussed the IM but focussed mainly on her letter, which summarised its contents. Ms Challons seemed to be well connected in the media industry and was very persuasive in explaining how it functioned.

Ms Challons explained (a) how distribution costs compare to a film’s production budget, and how the different parts of the film “food chain” can be separately funded, and (b) the US accounting standards changes in more detail. Given his experience with balance sheets, he could understand why a film studio would want to outsource distribution and give up some of their profits in return for doing so.

They discussed the suggested 30/70 split with the studio of the profit generated by the distribution as described in the letter. That certainly pricked his interest as it seemed to him to be a decent split, bearing in mind the fact that the films were backed by a major US studio.

Ms Challons walked him through the scenarios in some detail and it seemed to him that, if the films did well, there was a reasonable prospect for him to make some money on any investment in Gala. He thought he understood that this was irrespective of whether Sony exercised their option or not. His understanding was that the intention was that Gala would endeavour to make commercial gains and returns for the members over the years that followed the initial investment, from exploiting the films.

They discussed the fact that the Gala opportunity was different to his earlier film investments because Gala would be able to be proactively involved in selecting the relevant films, through a team of analysts based in Los Angeles employed by Gala, and there would be an involvement in the distribution:

“This really impressed me as it wasn’t a case of Gala simply signing a document and letting the studio do what it wanted - there seemed to be genuine participation in trying to pick the right films and being involved in how they were distributed. Even the example films provided on the third page of the 12 September 2003 Letter were Spider Man II and Terminator III, which demonstrated to me the high standard of films that would be involved, and led me to believe that the films Gala would purchase would have every opportunity of being successful and, hopefully, turning a profit.”

A significant part of their discussion centred on the “tax mitigation” side of the investment, and he understood that, due to the large up-front costs, Gala would incur significant losses which the members would be allowed to offset against their income pursuant to existing tax and accounting rules.

All in all, he left his second meeting with Ms Challons thinking that the Gala opportunity was an attractive opportunity which might make a return, but which was tax efficient even if it did not. With that in mind, he went away to consider the papers further and to discuss matters with his wife before reaching a final decision. As regards the risks:

Although he understood that it was by no means guaranteed, he expected a return of 10-20%, which was higher than the interest rates available and that it would be realised within 3 to 5 years if the option was not triggered earlier and in addition to this, the investment was tax-efficient, which meant that it was even more financially attractive. He reached the conclusion that the whole Gala package was attractive; there was a sound commercial rationale for Gala, it was recommended by one of the largest financial institutions in the world, it could provide him with a return on his investment and it was tax-efficient.

The amount he invested was the amount that Ms Challons recommended he invest and was based on his taxable income in the 3 prior tax years. As he perceived this to be a good investment in the round, and he could afford the contribution, he was comfortable investing that amount.

As it was important to him that he gained a real understanding of this particular film investment given his earlier film investments, he believes that he read all the documents enclosed with Ms Challons’ letter.

He signed the loan agreement with SG and the other documents on 1 October 2003, he thought at the end of his third meeting with Ms Challons. He has noted now that there is wording to the effect that SG makes no warranty or representation as regards the structure and the likely returns (see section 3 of Part A). With hindsight, he thought he probably should have asked more questions about this, but he gained comfort from the recommendation of HSBC.

He only dealt with Ms Challons and did not meet with any of the people involved in Gala. He thought that Ms Challons offered the opportunity for him to meet the individuals involved, but he trusted her and did not take up the offer.

He confirmed that he was aware of the waterfall and there is a distinction between (a) whether Gala made a profit and whether he made a return on his cash contribution, and (b) whether Gala and Sony made a profit.

He confirmed that he was aware of the Call Option but noted that (a) there is also scenario 3 and scenario 2 was not expected in the beginning, (b) scenario 2 would be the expected outcome rather than scenario 1 if the only conversation was about those two examples but, when he was convinced to go into this transaction, it was not simply based on the Call Option but on the performance of the films.

He agreed that in scenario 3, £1.5 million was not a guaranteed amount and he did not know from the IM what level of Gross Receipts would be needed for Gala to receive £1.5 million or how likely their receipt was or what films were involved. He said, however, that he based his decision on the quality of the films under discussion and the fact that there was a notification from some external experts that they thought these films should deliver those sorts of margins. It was put to him that, in light of this lack of information, scenario 3 is of no practical utility to a serious investor; a serious investor’s intention and hope would be that scenario 2 would happen as it provided a guaranteed return based on the tax benefit and any other cash return would be a bonus. He said he found scenario 3 as beneficial as the other 2 scenarios after listening to Ms Challons, who seemed to be well versed in media positions and the opportunities that should be available.

He said that scenario 2 was not his expectation.:

“I saw these as 3 scenarios. There could have been 53 scenarios. I saw the first one would result in a loss. That could have just been as likely to happen if Sony decided not to exercise their option. It was their call option. I saw.. scenario 2 as being a way of almost putting a footing on to the conversation, but the reason I was interested in this opportunity was the quality of the films and therefore the likes of 1.5 million would be achievable.”

When it was put to him there was no information on the films in the IM, he said when he saw the IM he said he was interested and it was only later when he saw the quality of the films that he was ready to sign up.

It was put to him that Ms Challons set out an illustration of the outcome for him of investing in Gala based only on scenario 2 and specifically drew his attention only to that, because that was what was expected to happen. He said: “That’s not the way I recall the conversation or my expectation.”

He agreed that (a) in year 1 he recovered his cash contribution plus £376,593.20, and (b) the tax relief of around £893,000 does not simply reduce the burden of a loss but resulted in him making a positive return, and (c) he was still in a positive position, even taking account of the tax on the capital gain which arose on exercise of the Call Option. He added, however, that in each of the scenarios, any of which could have happened, there would be a subsequent tax liability, which offset the year 1 positive cashflow.

It was put to him that a serious investor would view the tax benefit as the fundamental and real attraction, because there is no risk involved other than the risk of the tax analysis being faulty and anything else is simply a bonus. He said: The tax relief was part of it but there was also the profitability part of it which he was happy with. He emphasised again that there would be subsequent tax liabilities that would reduce the initial benefit of the tax relief and that if the option was not exercised, then under scenario 1 he would make a loss. He accepted, however, it is correct that the tax relief alone would result in a profit for a member even after CGT. When pressed he emphasised that he had no control over whether Sony exercised the option and, if it did not, he did not get the tax benefit.

It was put to him that the only risk of not making a huge return just based on the tax relief arose if Sony did not exercise the Call Option. He said in that case, there is a capital gain and that would then return in a profit and if Sony did not exercise the option, there is scenario 1 or 3. When pressed, he said: “Subject to what I said before in terms of the option, correct, the figures shown, that’s correct.”

He agreed that the vast majority of the risk factors Ms Challons set out in her letter relate to tax and said that there is “no doubt that tax is an important part of this transaction”. He took issue with counsel describing as one of the tax risks Ms Challons’ statement regarding the income tax liability that would arise if the option was not exercised before the end of the term of the DA. He did not consider that she was putting the non-exercise of the option as a risk in the sense of something that might go wrong; she was alerting him to be aware that Sony may not exercise it but not necessarily saying that, if that occurred, something had gone wrong. It was put to him that Ms Challons highlighted Sony not exercising the option as a risk as it is an example of matters not going to plan. He said that is not the way he reads it even now. In our view, it is plain from the terms of the letter that Ms Challons viewed the situation where Sony did not exercise the option as a disadvantageous circumstance (see section 4).

It was put to him that the statements in the IM regarding the role of SFP constitutes a candid recognition that Gala was a tax shelter product. He did not seem to dispute this but said that he was not sure that tax shelter means tax avoidance and, recognising his previous investment in films, he took comfort from the fact that SFP were involved. He said he could understand the translation that the IM was saying that investing in Gala is less attractive for those who have done other tax shelter products, because they would not then need this tax shelter product.

He agreed that when he considered this in 2003, he did not have the documents and did not know the terms of the waterfall. He said that he meant in his statement that Gala sounded like a commercial proposition after he had heard from Ms Challons about the change in tax laws in the US and that Sony would need to either write off all their distribution costs upfront or find an alternative way.

He confirmed that he was aware that an amount equal to the sums put in the expenditure account was transferred by Sony to Barclays to back up the LCs. When it was put to him that at least in economic terms, in the real world, the funds in the expenditure account were not genuinely available to Sony he said that:

“Economically yes, but the reality is from my background in banking operations with structural transactions you expect cash to flow through different entities for different reasons. So economically the cash ends up in the same place I guess, but that doesn’t mean it hasn’t happened.”

He seemed to agree that, as a matter of principle, there is no inconsistency between Sony entering into the arrangements because of a change in accounting standards, and Gala and its investors doing so for tax reasons. He said that is the way the world works and: “There’s a need and there’s sources of financing, and if those sources of financing could be done in a legitimate, tax-optimised way, I think that’s what is happening all the time.”

He agreed that he did not have the DA when he had his discussions with Ms Challons. He said that his understanding about film selection was based upon the IM which suggested there would be a team of experts employed by Gala in Los Angeles who would work with the studios. He did not have any more facts than that. He agreed that Sony is a major well-known film studio and it is reasonable to think that they would be better placed than Gala or any experts hired by Gala to work out how to exploit and distribute its films but he thought Sony were not necessarily looking for Gala to help with their distribution: “They were looking to Gala to help them finance their films - the printing and distribution.” We note that Mr Lewis was given this impression by Ms Challons in her July letter.

He agreed that in scenario 2, as the tax relief alone gives a profit for a member, it would not matter to a member whether Gala generates any profits itself.

It was put to him that based on the IM he was not in a position to know what Gala’s share of any film revenues would be or how likely those revenues were to arise. He said that he certainly was not aware of the details of the expenses and the “expectation again after the input from Ms Challons was that that would still result in figures such as scenario 3” although he agreed that there were unknowns as regards the expenses and matters such as the level of distribution fee and the split of revenues between Gala and Sony.

He agreed that, when he discussed this with Ms Challons he could not verify the 30/70 split as he did not have the details of the waterfall “but again I trusted my adviser and it sounded appropriate”. He accepted what she said on this as a fact and did not ask her for any evidence to support it. It was put to him that he did not ask her for evidence because he knew that he would make a return based on the tax relief so that the split did not matter. He said that was not his assumption at the time. He confirmed that he was not aware that there is not a single step in the waterfall where revenues are divided 30:70. He assumed from what Ms Challons said that that was an agreed split, and as a member, he would expect therefore to be able to generate profits and that was why he was interested in the transaction. He added that he expected there would be profits because of the quality of the films, which are mentioned in her letter, such as Spiderman and Terminator and with a 30% profit distribution of those films, that sounded like a reasonable transaction to him. When it was put to him that Gala did not acquire rights in relation to those films, he noted that the letter says “the likes of” and that he did not know is the honest answer. He did not appear to know, therefore, what films were subject to the Gala arrangements.

It was put to him that he could not know what would come out of a 30:70 split until he knew what came out of the Gross Receipts under the earlier steps in the waterfall. He said that, in hindsight that is obvious but he was focused on the assurance that he was getting from the quality of the films that were discussed at the time and the quality of transaction compared to what he had invested in before and therefore his expectation that a 30% profit would be a significant return figure for him.

It was put to him that if he really expected to make a profit based on a 30:70 split, given that he invested half a million pounds of his own money, he would have done something to verify if that was correct and, he did not do so, as it did not matter as he would make money just from the tax relief. He said:

“I trusted my financial adviser to give me the right guidance. I didn’t think she would come and tell me lies…my concern was that I would end up having the same situation as I had previously. I would enter into a transaction that I was perfectly happy with, but then HMRC would come after me. I didn’t want that to happen at all and hence my questions were much more around how legitimate is this…I trusted she wouldn’t be coming and telling me untruths.”

He was asked if, in his references in his statement to making money on the investment in Gala, he meant he would make money on his cash contribution, he said that he saw it as making money on his whole investment as he regarded the loan as his obligation as well. He confirmed that he was aware that there were arrangements in place for his SG loan to be guaranteed to be repaid but said that:

“as we have subsequently seen over the last decade or so, nothing is really guaranteed. Banks do fold. So there was still some liability, some potential risk there…I just saw the total amount as the amount I was putting in, even though some of it was funded and some of it guaranteed, but rather than go through that loop again, yes, I expected to make a return on the amount I put in.”

He agreed that, in scenario 2, a member makes money irrespective of how the films perform but noted that he had understood that there was a reasonable prospect of making money irrespective of whether Sony exercised their option or not. He agreed, in effect, that the difference in outcome in scenarios 1 and 2 results from Sony exercising the Call Option but noted that scenario 1 applies if the films did not do well whereas scenario 3 applies if they did do well. He agreed that he did not know how well the films would have to do for anything to come to Gala under the waterfall:

“but reading the [IM] which had the 3 scenarios, my assumption was that if the films did well there was a reasonable prospect for me to make some money, irrespective of Sony exercising their option. That was my statement, because that was the fact. That was how I felt at the time.”

It was put to him that his comment that Gala would endeavour to make commercial gains and returns for members over the coming years cannot be right, because the intention was that the structure would be wound up after a couple of years when Sony exercised its option. He said that was never his intention or expectation.

When it was put to him that he was not in a position to evaluate whether realistically Gala could generate any revenues, as he did not know its position in the waterfall or how the waterfall worked or how likely it was that revenues would arise, he said the quality of the films led him to believe that there was a likelihood that there was a profit to be made in the exploitation of these films and he therefore expected, particularly based on the 30:70 split, that there would be a positive commercial outcome for the members. It was put to him that a 30:70 split was not agreed but, in any event, he was not in a position to know how many Gross Receipts would be needed before that split kicked in or how likely that level of receipts was. He said that he did not have the detail, but he based his understanding on the conversations he had with Ms Challons, who convinced him that the detail and expectation of the return on these films would be commercially attractive.

He was asked if he was surprised to hear that under the waterfall there is a split of 334:1 and was taken through the transcript where Mr Yusef agreed with that. He said: “Of course but without understanding the context of what all the figures mean, they are just a list of numbers, but “I was surprised if I thought it was 30:70 and you are suggesting it is 99.7 to 0.30”. He agreed that on the basis of that split of revenues, is it fair to say that, in fact, those running Gala cannot have been aiming to make a return from exploitation of the films, because the revenue position under the waterfall was so weak. He added that, accepting the 30:70 and the scenarios, he was under the clear impression that this should be a profitable investment. If the figures were more like as was just described to him, then he struggled to understand how it can be profitable.

He said that when he prepared his statement, he was thinking of a return of 10 to 20% per annum but he certainly did not tie it back to the scenarios and it was based on his understanding that there would be a 30:70 split.

He initially said that the important point was that these documents were received prior to the point at which Gala committed to the films; “these were the projects that we wanted, we selected, and then we had to go through a verification process”. So it made sense to him that the film files “dealing with the production schedules, the detailed budgets and everything else would follow in order for us to then take....to our friends at [HL], who then provided us with the final decision as to whether or not to move forward” and noted that was presented to the members at the meetings when the transactions were approved. He pointed out that Mr Ackerman said he had reviewed the scripts before he sent the letters. His recollection was that “we got a whole bundle of documents, which we then sent out to each of the members who had...provisionally committed money”.

When pressed, he said he did not know what information came prior to Mr Litt’s letter and he thought Mr Ackerman is the proper person to answer. He agreed that there are no further letters from Mr Ackerman updating his advice once he had received the files and that the November letters were sent before there was a contractual relationship with LBPC (although he pointed out there was an understanding with Mr Ackerman).

Before sending the November letters, he would have reviewed the screenplays for the films and would have discussed the results of his reviews in the build-up to writing them with Mr Yusef and Mr Bamford. They:

“would ask about the storyline, strength of the dialogue, proposed cast etc and were keen to get my opinions on whether I thought the film would be a success in light of my experience in the industry.”

He would have tailored his review to the requirement of the film but did not include this granular level of detail in the letters as ultimately all they needed to know was whether he considered the screenplay could result in a commercially successful film.

Whilst Mr Litt did not formally send the film files until after he sent these letters, he recalled that some of the documents, such as the screenplays for the relevant films had already been provided to him at meetings with Sony. He thought Mr Litt sent his letter to ensure that Mr Yusef had a complete record of documents.

Mr Ackerman was asked to amplify what documents he received before Mr Litt’s letter was received. He said he had had several meetings on his own with Sony and they had begun to share some initial documents on some of the films with him, and:

“that would have been very, very initial documents in terms of what we ultimately received, but notably a screenplay. It may have been in certain cases a production budget recording the cost or anticipated final cost of the movie and very possibly some initial campaign release information…of the most general kind to begin with.”

When also asked, in effect to expand on what happened at this stage he said, “we simply commented in initial form on the screenplays and the general release concept that Sony had”. He explained that a unit that involves production, finance and distribution makes the decision about whether to make a film and the head of distribution is always consulted on whether “this subject matter is something you can make money with and you can release” and his opinion is taken into account in the studio’s final decision.

He also explained that in negotiations with studios other than Sony he and Mr Yusef felt it would be difficult to convince the studio to share the critical information they sought and they went forward ultimately with Sony because Sony became comfortable with Mr Ackerman, with the relationships he had in Hollywood and with the concept of sharing the data and involving them in the process.

When asked if he had any insight into Sony’s approach to Gala’s position in the deal, he said this that Sony was very concerned that “this deal transaction come together in the right way” and:

“It was not a matter simply of our reaching agreement with their studio attorneys and head of business affairs, notably Mr Stefan Litt, but the deal went all the way to headquarters in New York and to Tokyo…because there was a tax component in the structure of the investment with the UK, they were concerned that the deal not be done in any improper way that would impact Sony’s overall business in the UK…and for that reason they were instructed by New York, the people in Los Angeles, to ensure that the relationship with us was built on a fully transactional basis and that our needs were met to the best of their ability.”

He agreed that LBPC still did not have a contractual relationship with Invicta when he sent the November letters and any money received from Mr Yusef would have long since been used up, so that he was not getting paid for sending any of these letters at that time. When it was put to him that the absence of remuneration is reflected in the thinness of the letters, he said

“You could infer that, yes, but again I would add that a great deal of work was occurring here on the strength of my relationship with Mr Yusef, which went back quite a few years, and also on the strength of my own reputation. Again, it is quite common in the industry in the preparation of various different stages of business in the film industry is that people will undertake work before being remunerated or before being formally engaged by a contract.”

He said he “had already received quite a lot of documentation from Sony” before he wrote the letters and he suggested its provision began very shortly after the initial meetings with Sony, where it appeared that “we should certainly explore the possibility of concluding an agreement for Gala” and “part of that general consensus was that Mr Litt authorised the release of certain elements involving these films”. He described Mr Litt’s letter as a “bureaucratic and formal approval formalising a document which we would have filed showing that we were now in formal receipt as opposed to informal receipt of elements”. However, he did not appear to recall what documents he actually had when he issued the letters and his evidence on this is unclear.

When it was put to him that Mr Litt’s letter contained relevant documentation which he did not have when he wrote the November letters, he said that was not necessarily the case and whilst he did not recall, he thought the letter looks “like a formalisation and recording of elements that we needed and had either already received or were receiving”.

When his comments in examination in chief were put to him, he said that he stood by what he said in his witness statement but:

“When I speak about the most general elements and so forth, I am speaking also with a knowledge of the massive amount of material that my office received as these films went into distribution. So a screenplay and number of preliminary marketing plans and different expenditure strategies, production budgets would definitely have been already with me. However, I would consider that, while critical in making a commercial assessment and offering an opinion, essential elements, I would also consider that a small amount of material in comparison to the voluminous amount of data that we would receive on a weekly basis as the movies went into commercial release. Again because of the dynamic nature of the trade or trading, this was coming from Sony. It was being double checked with data coming from McCann Erickson and there is a tremendous amount of data in that process. So that for me is the full body of data from Sony over the lifetime of my involvement advising Invicta on behalf of Gala”.

He then seemed to accept that he had received only some of the relevant documents before he sent the earlier November letters but could not recall which particular documents he received. He said that, however, he would have had all the information he needed to make the assessment he made: “Otherwise I would not have issued the letter, however brief it is. I would not have issued the letter”. He said again that Mr Litt’s letter looks like part of a formal procedure on behalf of Mr Litt’s office in papering whatever internal needs Sony had, but:

“we had already received a lot of the elements that are referred to in this letter...I had spoken to the elements that I was assessing to make an opinion. That is different from the elements I would receive subsequently leading up to commercial release, again because of the dynamic nature of the market and the voluminous amount of data coming from multiple sources, both Mr Litt’s office, Paul Smith’s office and the McCann Erickson team and other people as well. So this was material that would be added in as part of a process. This process that we are discussing here is a very fluid one, and information is flowing in, not just one documented legal definition of that flow. It is flowing sometimes on an informal basis, certainly leading up to the relationship, as the relationship with Sony was being built, developed and managed, both by Sony personnel, not just Mr Litt. In fact, other people were quite more involved than Mr Litt once the relationship proceeded.”

He did not agree that he advised in the November letters without having some of the relevant documents: “I am advising on documents needed to provide a commercial opinion at that time”. He seemed to agree that he did not send any further letters once he had all the documents but added:

“However, there are many further letters and written exchanges between myself, Mr Yusef and Mr Bamford in which I am updating them on changes that Sony is wanting to make in distribution plans, and as being discussed between myself, Paul Smith and the distribution teams. Those meetings were happening 2…3 times a week...and I would very frequently update by phone both Mr Bamford and Mr Yusef immediately after meetings or the day following as well as provide written analysis of some of the changes which would often be based on changes within a given city according to how a film was performing in its opening week or two, and the changes that we agreed in consultation with the Sony team should be made in order to increase or endeavour to enhance the commercial performance”.

We accept that (a) Mr Ackerman was prepared to do work in anticipation of LBPC’s formal appointment and that he was mindful of his professional reputation, and (b) therefore, that he is unlikely to have issued letters which explicitly state that he reviewed the screenplays without having done so.

The opinion he gave in the November letters is very limited in that (a) on the terms of the letter, he based his view solely on a review of the draft screenplay for the relevant film and the talent involved; he mentions no other documents or analysis so it seems unlikely he took anything else into account even if he had other materials, and (b) he stated that the relevant film had excellent chances of commercial success but did not provide any quantification of what sums the film may generate. He did not produce any updated letters once the film files were received to take into account the fuller information he would then have had.

We consider that a reasonable business/investor who is seriously interested in conducting a film distribution trade, or investing in it, with a view to receiving a profit/return from Gross Receipts from the selected films would not be satisfied with such cursory letters, written in such limited terms, as the sole basis of the recommendation of which films the business should acquire distribution rights in. Mr Ackerman said he would have discussed the results of his reviews in the build-up to writing them with Mr Yusef and Mr Bamford but any such discussions, on his own evidence, were only about “the storyline, strength of the dialogue, proposed cast etc” and whether he thought the film would be a success in light of his experience in the industry. Whilst no doubt these are important and relevant matters, they are only part of the picture in assessing what Gala may actually receive under the waterfall. Mr Ackerman produced nothing further in writing until he produced the December letters in which he described the Plans then in place in respect of the transaction films as “optimal”.

As set out below, Mr Yusef emphasised that Invicta/Gala and the members relied on the HL letters for the further analysis required to demonstrate that Gala had a reasonable prospect of making a profit from the transactions. However, as explained in section 13, we do not consider that a reasonable business/investor would place this degree of reliance on the HL letters. Mr Yusef also suggested in his witness statement that Mr Ackerman provided input into assessing the likely outcome for Gala under the waterfall but, as set out in this section below and in section 13, Mr Ackerman was clear that this was not his role and Mr Yusef eventually accepted that.

HL stated that the purpose of this analysis was:

“to express an opinion on the likelihood of the Slate, as of 21st November 2003, to achieve profitability by virtue of economic performance in the Slate, along with the guaranteed loan payments due under the Term Sheet [the term sheet dated 5 November 2003]. It is our understanding that the minimum partners' capital will be 85 million sterling and the maximum partners' capital will be 250 million in the partnership.”

They said that they had made “such reviews, analyses and enquiries as we have deemed necessary and appropriate” and “among other things” (a) reviewed the Licence Agreement and the Term Sheet and met with certain senior members of the management of Gala to discuss those documents, (b) discussed those documents with certain employees of SPE, (c) reviewed the “Schedule of Theatrical Films to Be Released between 24 October 2003 and 15 February 2004” and the “Schedule of Films Post Theatrical Release Pre Video/DVD Release” and (d) conducted such “other studies, analysis and enquiries as we have deemed appropriate”.

They summarised their process as follows:

“We have relied upon and assumed, without independent verification, that the information provided to us had been reasonably prepared and reflected the best currently available estimates of such information.

In conducting our analysis we utilised data regarding the financial performance over time from a number of feature films, all produced and distributed by a major studio. In addition, each motion picture we examined was a significant major studio release, with similar cost structures and talent.

We have not independently verified the accuracy of bits of information supplied to us with respect to the Slate and don’t assume any responsibility with respect to it.”

They set out that they understood that the films which “may be included in the Slate” (a) that have yet to be released theatrically include but are not limited to: Something’s Gotta Give, Mona Lisa Smile, You Got Served, Fifty First Kisses, and (b) that are post theatrical release but pre video and DVD release include but are not limited to: Bad Boys II, S.W.A.T., The Medallion, Once Upon A Time in Mexico and Underworld.

They concluded that:

“It is the assessment of [HL] that in order to determine the profitability of studio released feature films, the appropriate time-frame to which reference should be made is typically the first cycle of exploitation of the feature film in question.

Based upon the investigation, premises, provisos and analyses outlined above it is our opinion there is a reasonable expectation of profit from the capital introduced by Gala by virtue of economic performance of the Slate, along with the guaranteed payments due under the Term Sheet, during the first cycle of exploitation of the Slate and the reasonable expectation of further profits during the first cycle of exploitation of the Slate and a reasonable expectation of further profits after the expiration of the term under the Term Sheet.”

As regards the decision to instruct HL:

HL’s conclusion, coupled with the very positive analysis that the films had an excellent prospect of being a commercial success provided by Mr Ackerman 2 weeks earlier, gave Mr Yusef “all the more reason to think that the Gala opportunity did have every chance of being a financial success for its investors”.

Mr Yusef noted that Big Fish was not referred to in the 2003 HL letter, and instead reference is made to Mona Lisa Smile. He did not know why that happened but recalls that (a) Big Fish was considered a stronger asset than Mona Lisa Smile in any event and so was acquired notwithstanding that it had not been referred to in the HL letter, and (b) Invicta explained to members at the adherence meeting on 28 November 2003 that the view formed was that Big Fish enhanced the profit profile when compared with Mona Lisa Smile and the members agreed to proceed on that basis.

The conclusion that:

“[HL] (and Mr Ackerman) reached in relation to Gala, namely that there was a reasonable prospect that a profit could be achieved, was based on the extensive set of data that it received from Sony and its own propriety methodology. I can confidently say that none of the members of Gala would have proceeded with the transaction had [HL] concluded that a profit in that transaction was not achievable in light of the terms and waterfall that were agreed after negotiating with…Sony.” (Emphasis added.)

We note that Mr Yusef eventually accepted that Mr Ackerman did not have the role Mr Yusef attributes to him in this extract from his witness statement.

It was put to him that HL had the term sheet which did not refer to the films and a LA which does not contain substantive information about the film. He seemed to agree but said that was not the end of the point and he hoped to have a chance to explain.

It was put to him that HL did not even have the film files. He said that the film files would have also gone to them much earlier and they would, by this stage, have had the same information Invicta had. When it was put to him that HL do not refer to the files, he said they did not need to, because they have got all the details of the films and HL is not a fly-by-night company who would not have gone into this without getting the kind of information you would expect to have at this point prior to entering into this document.

It was put to him that HL did not carry out some rigorous third party stress test as they state they had not verified the information they had. He seemed to agree.

It was put to him that HL referred to 9 films none of which at that stage had been signed up and only some of them were signed up eventually. He said that this was the entire slate of films that Sony had at the time and:

“it was an essential part of the transaction that we had the right to pick which ones. It was never the intention that we would take all of them. It was only those that we wanted. We cherry-picked..”

He then accepted that it was not the entire slate as it did not include Big Fish and in fact only 3 films of those listed were signed up.

It was put to him that HL does not even say how much profit is going to be generated and how much might be expected from the waterfall, as opposed to as the Minimum Sums. He said that they did not need to:

“The waterfall is actually reviewed by them. It is important that people understand that. They have looked at the waterfall. We had discussions at the time about what it would mean to get to profitability under that specific waterfall…I am sure there were discussions that took place between me, Sony, [HL], Justin Ackerman. There was a flurry of activity at the relevant time.”

It was put to him that the likelihood of profitability of the slate was simply not a concern given that, despite the resources devoted to these arrangements, the only formal appraisal regarding slate profitability is a single sentence which it seems was obtained as an afterthought at the last minute, only a few days before the closing of the first transaction, on the basis that HL did not independently verify matters. He did not agree:

It was put to him at length that HL was not in a position to say whether Gala would be able to make a profit from the slate as it did not have knowledge of expenditure, deductions and of receipts and that he knew HL was not in a position to opine on profitability. He said that was absolutely not the case and he strongly rejected that.

He agreed that HL could not have known what the Initial Expenditure would be when they sent the letter because by then not all members who participated in the first transaction had joined Gala and no licences had been signed. He said, however, that (a) the amount needed in order for Gala to take up the licences was known and HL would have known that from the information that they had from Sony, and (b) the extent to which “Gala actually did put into the thing was not necessary in order to arrive at a profitability figure....it is not necessary for [HL] to know how much actually the partners would have spent”; rather HL just needed to know “what the total amount of distribution expenditure would be”. This is the case because “the level at which the distribution expenditure comes out [under the waterfall] is the same whether it is for Sony [or Gala] - we are pari passu except for the shortfall amount” so HL “did know the amount that would be needed in gross revenue to get to that point”.

He agreed HL did not know the exact amount of the contributions. He accepted that, in principle, to work out what Gala would receive under the waterfall, HL needed to know what comes out of Gross Receipts in priority to payments to Gala. He agreed that HL did not know this as they did not have all the required information. However, he believed that they were in a position to arrive at a figure with the information that they did have “in terms of production cost, budget, shooting schedules, release dates” and “more importantly the amount of distribution expenditure that was projected to be spent”. He thought they would have been able to say from that what needed to flow through the waterfall for a profit to occur for Gala, in addition to a sum equal to the Initial Expenditure, which would have to be recouped, and they came to a figure of just under a billion:

“Those were the kind of figures that we were talking about with Justin Ackerman and [HL] and the question was would the waterfall achieve that. I know that you said yesterday that it was fanciful, but it wasn’t. As things turned out, we were not that far off.”

He said that HL almost certainly would have known matters such as actors’ salaries because:

“we would have told them at that stage which of those films we were interested in, and the information was readily available to them via Sony. So they would have known things like the participations”.

It was put to him that HL did not know the likely level of receipts because they refer to 9 films only 3 of which were the subject of the transactions. He said:

“HL and we would have known which films we are interested in. That’s the slate that they would have known. Out of the 9 - we were never going to take 9 - that was the availability…We considered all films including some that are not on that list.”

When pressed he said there were 9 films included in the list of films Gala were considering at the time. There were 2 or 3 other films that were also put to HL. He could not recall now, 19 years later, the exact process, but he knows that “every one of the films that was eventually acquired by the partnership formed part of the slate, and that was what we took information on” and that:

“at the relevant time we talked about what would be required, in terms of Gross Receipts, and [HL] would have known the aggregate amount of distribution expense that was planned to be spent on each of the films in that list and the films we eventually acquired….”

He agreed that HL did not know the 3 things counsel referred to but that was subject to the qualification he hoped somebody would put to him and he added that:

“we and [HL] were in a position to have that information, and they did come to a conclusion on the specific films that we actually acquired, and they would have known the aggregate amount that we and Sony, in aggregate, would have put in, and could therefore have analysed whether or not we could have exceeded the minimum amount that we thought it would require under that waterfall for Gala to make a profit.”

It was put to him that HL did not know how much the Initial Expenditure would be because it was based on the SG loans and HL did not have the full final figures:

He then agreed that HL did not have a figure for Gala's expenditure but said they did not need that figure in order to be able to assess whether the waterfall would chuck out a profit, and that is what matters.

By that stage HL were in a position to assess and appraise whether Gala could reasonably look to a profit, as they were instructed to do as (a) HL would have known (i) the films that Gala were interested in, and (ii) by deduction, the amount of the Initial Expenditure given that they would have had the material in relation to all of those films, including how much the overall minimum expenses would be, which would include the amounts payable by Sony; and (b) HL would have had access to the term sheet, which includes the waterfall.

There was resistance to HL having access to materials relating to the relevant films but he knew from discussions with Mr Davis that they did “because we won that point, they got themselves comfortable with HL as the appraiser, as against going to somebody else that they had no prior dealings with”.

HL went to the studio and had meetings there and had access in relation to each of the films, the detailed information, marketing information and projections that they were looking for. They were happy with that. They didn’t feel that there were any obstacles that they met in relation to that. They did their own independent appraisal in relation to the documentation they had. They had their own proprietary database so that they could make adequate comparisons both in relation to the cast, in relation to the director and in relation to the genre of each of the films in the slate:

“So I was left satisfied that sufficient information, including information regarding the waterfall, that they would be in a position to provide us with what we needed, which was to determine whether or not this slate had the potential to make a profit to Gala…They did know what the aggregate of the print and advertising budget for each of the films would be. Therefore, from the waterfall that they had in front of them, they could determine where we were likely to end up, should the films perform in the way that was projected.”

He confirmed that he stood by the following comment in his witness statement as regards their different roles:

“our roles and the remit of our advice was completely independent. I provided very detailed analysis of the marketing plans from my meetings with Sony and considered the merits of the specific films comprising the slate whereas [HL] were providing an opinion on the broader parameters of the overall deal and financial implications of the investment in Sony’s slate to Gala.”

He agreed that this comment is consistent with the fact that, under the contract, his services did not include the provision of financial analysis. He added, however, that should not be construed as him not providing the financial analysis that he did to Invicta, there is no language in the contract that forbids him from providing financial services or advice and recommendations to Invicta in connection with the Gala business and it is common in the film industry for “often services to exceed a narrowly defined scope in a specific contract”. He added that he “certainly provided financial analysis”, the level of that is borne out by the nature of his meetings with Sony over many months “in the dynamic moment of the marketplace” and those commercial assessments and tracking of data and financial matters were “certainly fulfilled over and beyond the narrower functions of the contract”.

It was apparent that Mr Ackerman did not mean that he provided a financial analysis of the type HL was asked to provide as regards Gala’s prospect of profit but rather that he provided solely an analysis of Sony’s data on the slate of films. He said:

“at the time the relationship both with [LBPC] and Invicta was evolving. Not every single detail could be foreseen in terms of the contract that was written...since I was not involved in Invicta’s negotiations with [Gala], nor was I involved in anything to do with the UK side of things - I was structurally forward facing to the studio partner - that relationship with the studio partner evolved, and as the information flowed it became necessary and it was obvious that I was the person to help Invicta digest and understand and make decisions on the financial data as we received it from Sony. Again, because of the dynamic nature of trading and distribution in the entertainment industry, this was a live event on a many, many months, several year basis in terms of tracking the films and looking and seeing where Sony was wanting to spend and where we agreed that Gala and Sony would spend together, what changes were being made to try to increase the commercial performance of the films in question, where expenditure had been incurred where it had not produced such good results and where artwork needed to be changed...McCann Erickson...an independent company, would be somebody I would speak with frequently to ensure that the data that I was looking at from Sony was indeed the data that they were in turn trading in the buying of radio ads or printing and advertising expenditures in other areas.”

When it was put to him that he was purely talking about Sony’s data and not about Gala’s profit and loss position, he said he was talking about the data he received from Sony and specifically the analysis of that data on his side, which he sent on to Invicta. He agreed that Mr Yusef knew and understood that difference between his role and that of HL. He said that it was correct that, as set out in his witness statement, he recalled attending a further meeting with HL but did not recall attending any further meetings and:

“Mr Yusef wanted to keep [HL’s] advisory role separate from my opinions and advice in order to I think have a number of different independent perspectives one from the other, and I was instructed not to continue with additional meetings with [HL]. [HL] had its direct relationship with Sony and received all of the elements upon which they were making their independent assessment, which they in turn forwarded directly to London without my involvement.”

He agreed that he did not have any knowledge of what documentation HL looked at in providing their reports. Comments he made in his witness statement on this were based on his previous experience of working with similar firms and:

“I am speculating on the basis of my opinion, which I believe I have some expertise in the matter, and at the time I certainly knew of [HL]. They are an extremely reputable firm…Mr Yusef maintained a direct relationship with them, and the documents that I would have received would have been after they had been agreed to and after [HL] would have performed services, but I was not part of that - other than attending one initial meeting, I was then not part of subsequent meetings, phone calls and exchanges of documentation except for the end documents that would have been sent to me to be put in our filing system.”

He agreed that his further comments are not first-hand evidence of things that he personally experienced.

Mr Yusef said in his witness statement that:

“It was important for us that the prospective members learnt about the films that Gala would be acquiring. Our thinking was, the more information we gave each of the prospective members, the more likely it was that they would participate, and the more experienced and sophisticated they would become as members of a partnership involved in the film industry. This would in turn increase the likelihood that in subsequent rounds, they would form our bedrock round of people and our thinking was that, if we had a large number of experienced individuals willing to be involved in a further raise, it would be an amazing asset.”

The bundles contained letters dated 25 November 2003, which Mr Yusef sent by fax and post, to all of the prospective members to give them notice of the meetings scheduled for 28 November 2003. The letter states that (a) enclosed with it were (i) the 2003 HL letter (ii) a pro forma acknowledgement letter, with the date of 25 November 2003 inserted (“the acknowledgement”), which investors were asked to return prior to the meetings, and (iii) a waiver letter, and (b) investors would also receive by post over the following 2 days the film files and transaction documents. The acknowledgement included the following:

“I write to confirm receipt of the transaction documents, film files and the [2003 HL letter] referred to in your letter dated 25th November 2003.

I have formed an intention to participate in the Partnership’s trade having reviewed the documents referred to above. Accordingly, please consider my application to be a member of the Partnership on an unconditional basis. In the event that I am admitted to the Partnership, please accept this letter as confirmation of my approval and ratification of the Partnership’s acquisition of the films specified in the film files. I am also enclosing my signed Distributor Members’ Waiver Letter, to be utilised in the event that I am admitted into the Partnership.”

In signing the acknowledgement, therefore, an investor agreed to become a member of Gala on an unconditional basis and, on admission, the letter was to be taken as the investor’s confirmation of approval of the transaction. We note that (a) investors were required to return the acknowledgement prior to the meetings, before they had an opportunity to question any aspect of the transactions at those meetings, (b) they were provided with the transaction documents and film files at the most only 2 to 2.5 days before the meetings, and (c) they would only have had the means of knowing the films involved and the terms of the deal with Sony when they received those documents; the 2003 HL letter refers to a broader slate of films, and (d) the letter sent to members on 25 November 2003 did not include a written explanation or summary of the key, significant commercial terms, such as the waterfall; there was no explanation that a 30/70 profit share had not been agreed. In effect, therefore, members were required to commit themselves to the transactions with little time to review the full information which was only provided at this late stage and before they had had an opportunity to raise questions on the information provided at the meetings on 28 November 2003.

The investors did not commit their money until certain steps took place. He agreed they had nothing to go on as to how the business would make a profit at that point but emphasised this was before the money was committed. There was a juggling act that had to take place: “There were negotiations going on…so we had to get the money in, but not committed.”

The members were very interested in Gala’s activities, as he thought can be seen from material that they received and the work that they did to ascertain whether they wanted to vote in the partners’ meeting. It is at that point that the commitment takes place.

Mr Yusef said that he doubted that investors would have read all the legal documents but he recollected from talking to people after the event that many people read the screenplays:

“Everybody looked at the production schedules. Everybody looked - commented on the titles we were proposing to acquire. These were serious people about to embark on this endeavour, and yes, they were focused. They had put a lot of money into this or potentially were going to commit to this. So…a 48-hour turnaround before the meeting is not in the circumstances unreasonable….”

He added that “it was quite clear from the way that they were behaving that they were focused. We believed that they were focused because they had actually parted with money to be held on deposit. It was something that we had a right to expect, that they would be focused...I think if you talk to the Referrers, that will be substantiated”. He expected the investors to read the 2003 HL letter, the production budgets, the screenplays of the films and he thought they did as “during the meetings and afterwards they were commenting on the quality of the films and all of that”. So, in his view, they did not just sign up without looking into matters.

He said he found the waterfall “simple, probably because I dealt with it” but for those not involved in the film business, “they would have looked at that waterfall and they would have said: "What does the [HL 2003 letter] say? What does Gala say? What do the people in Gala believe?" That’s the analysis I think they would have made…”

He thought that many of the investors returned the acknowledgement on the morning of the meeting, and if somebody had said they needed more time to review the documents, the meeting could have been put back. It was “important for us to know and to confirm that they had received and read and dealt with the film files before we accepted them into the partnership as a partner”. He said this was not a nonsense, as counsel put to him, but a fact; they did have time to give proper consideration and they did so, at least in terms of the 2003 HL letter, the screenplays, the production budgets, the choice of films, as the things that would have been relevant to their decision. He accepted they would not have had the time to look into things like the legal documents, but principals very often do not get into those. He thought it perfectly possible and feasible for an intelligent person to look at the documents he had mentioned and the screenplays within a day. They had been talking about this for some time so when they needed to make the decision, to part with a lot of cash unconditionally, they would have been focused. It is not unreasonable to assume that that would have been the case.

It was put to him that there was no chance of the investors getting into the detail of the waterfall the day before the meeting, without an explanation in a covering letter. He said they were concerned with being involved in a project that their advisers and their experts advised there was a reasonable prospect would make a profit for them. Hence, the 2003 HL letter was relevant to them given that HL studied the waterfall, and it is based on that that HL say that the slate is or can be profitable.

He read through the transaction documents thoroughly but could not recall his thoughts.

Mr Yusef said HL were selected as the leading guys in the field and he was impressed by Mr Yusef’s knowledge and understanding of the industry and trusted his judgement. The positive conclusion reached by HL:

“further validated for me that the films referred to there had a high chance of making a profit. I was satisfied with HL’s valuation, as anything more in depth, going into the figures etc would have been too speculative. Ultimately, it was a judgement call and I trusted their judgement.”

He recalled reading through the film scripts at home but could not remember if that was before or after he was admitted to Gala. He remembered going through the script for Something’s Gotta Give and thinking Jack Nicholson and Diane Keaton could pull that off and he was definitely influenced by the fact that they were well known stars. Overall, he did not consider that his opinion on those film scripts would affect the decision on which films to choose as he had no way of evaluating the films. He understood that Gala sought advice from Mr Ackerman and HL, and he was confident to leave it to them to make the decision on which films to invest in. He thought he did go to a preview of Somethings Gotta Give (although he could not remember when) and thought it was going to make millions.

He assessed all the factors which he understood to be essential to a successful business including the people involved, the advice from legal, financial and tax advisors, the structure of Gala and the fact that Gala could choose the films invested in. All these factors confirmed that it was the right investment opportunity for him and maximised the likelihood that Gala would make a profit:

He thought he attended all Gala board meetings except 2 and that the resolutions were discussed and debated between members. At the closing meeting (a) there was a long introduction by Mr Yusef in which he provided a final explanation of the Gala proposal, (b) the 2003 HL letter was discussed at some length as Big Fish was not mentioned in it. After a long conversation it was agreed that this omission should not prevent Gala proceeding given that Mr Ackerman had recommended Big Fish, the big-name actors involved and the fact HL referred to the other 3 films. He understood that the members could vote to reject the slate or any film but, after all the due diligence, “we considered the films chosen had the greatest prospect of securing a return on our investment after a reasonable amount of time” and so a resolution was passed to invest in the selected films. Mr Cadogan did not specify in his statement that Mr Yusef covered the terms of the waterfall in his “long introduction” or that the members asked any questions about it.

Mr Cadogan accepted that knowledge of the films invested in by Gala is crucial to HL’s analysis but HL plainly did not know the films. It was put to him he could not possibly have been satisfied with this as a “valuation” as HL did not know what they were supposed to be valuing and, if he was genuinely interested in the prospects of Gala making money from the films, he would have wanted to see an opinion regarding the specific films. He said that (a) the 3 major films Gala invested in are mentioned by HL, (b) their letter combined with “discussions with Niall and with Mohammed gave me the confidence that we were going to make a substantial profit” and he was perfectly happy that those films would be substantial hits. When pressed he maintained that “we felt confident these will be profitable films” and said this was a matter of considerable discussion at the meeting, and “we were satisfied with the responses given by Mohammed to those questions regarding the slate as it was finally agreed, and we were happy with the terms that had been agreed with the studio”.

He agreed that (a) the film files were substantial and there was a considerable amount of documentation, (b) it was only when he got this information that he found out what was actually involved in the arrangements and that Gala was to be involved with 4 films, of which only 3 were referred to in the HL letter, (c) he did not get any further letter from HL and he did not ask for one, and (d) there was no covering letter or other document sent to him which provided a simple explanation of what the deal terms boil down to; he did not ask for that but read the documents.

It was put to him that, as he did not mention the waterfall in his statement, presumably he did not pull out a spreadsheet and model the waterfall. He initially said he sat down with Mr Thacker and spent hours going through this and he did do some analysis along those lines. He thought they spent the whole day together going through this but could not remember exactly. When asked what he put in the analysis for items such as Sony’s expenditure and participations of the actors, he said he honestly could not recall. When it was put to him he did not and could not have had that information, he said he did not recall. When pressed, he agreed that on the basis that that information is not in the transaction documents, he could not have known it. He seemed to agree that unless he knew the various elements that feed into the waterfall (such as actors’ participations, Sony’s expenditure and fees), he could not begin to work through how the waterfall works and what was likely to come through it. He said “but we did discuss that with Mr Yusef when we met before finally agreeing to go ahead with that slate”. He accepted that even if good films were chosen, Gala did not stand a chance of making a profit if the terms were such that Gala would only receive 1p from a billion.

In our view, (a) it is unlikely that any review of the waterfall he undertook, gave Mr Cadogan any meaningful insight into its operation prior to the meeting, given he did not have the information needed to evaluate it, and (b) whatever information he was given at the meetings on 28 November is unlikely to have been sufficient to have given him any meaningful insight, given (i) the brevity of the meetings (of a total of 30 minutes) as recorded in the minutes, (ii) his lack of mention of the waterfall in his statement and at the hearing unless questioned on it, and (iii) his lack of any recollection of what the deal was under the waterfall.

It was put to him that he did not and could not take a view on prospects of the film scripts. He said film is an image, and not a word, media, so how it is filmed decides much of the success. He agreed that he had no way of evaluating Big Fish. He thought he might have got the film files on 26 November 2003 because he and his colleague got together and he thought they had 2 days to evaluate it before the meeting. It was put to him that he signed the acknowledgement and so agreed to invest in films, including Big Fish, and approved the documents before he had asked anyone a single question. He said that his agreement was dependent upon him being admitted to Gala as a member; it was conditional upon his approval and ratification of Gala’s acquisition of the films in the film files. He agreed that was not correct when he was taken to the wording of the acknowledgement and that, in effect, he approved the files before the meeting.

It was put to him that the low attendance at the meeting is far from what one would expect if members are genuinely interested in the prospects of the investment vehicle being successful particularly, as this was their only opportunity to ask Mr Yusef about the agreed profit share and why Big Fish was not mentioned by HL. He said he was determined to be as closely involved as possible, as were Mr Thacker and Ms Livsey. He cannot speak for anybody else on that list. He believed Mr Laing was abroad at the time and thought that Mr Pritchard, who represented other members, was there to represent Mr Laing and suggested that other members may have had representatives attend on their behalf. When pressed, he said he could not answer for the other partners.

It was put to him that he and the other members had no basis at all to form any view on the prospects of the first transaction films making any money for Gala. He said it is a judgment call as in any business and: “We were relying on a whole series of months of investigation, spending time with Mr Yusef and discussing the approach and how we were going about it. We had looked at the films and we were satisfied that there is always risk in any business transaction...[of] not achieving your goals...My belief was that we had a reasonable chance of making a profit for Gala” and the basis for that belief was principally the confidence he had in the principals involved and the films chosen.

He seemed to be aware that Gala’s entitlement to money from these films depended on the performance of all of the films as a whole. He said that his view was that 3 of the films had a great prospect of being profitable, so that even if the fourth film dragged it down, it would not have made a substantial difference. He thought that Something’s Gotta Give was going to be very, very profitable and the money “we would earn as a partnership from it would be substantial”. It is apparent that this view was not based on any knowledge of the deal terms or what was to be deducted before Gala received a share of Gross Receipts. When it was put to him again that he did not know these things he said:

“I relied on the fact that I had great faith in Mohammed Yusef and his judgment and his experience that...we would be successful. I mean, in the end you are only as good as the team you have around you, in any business.”

He agreed that Gala had not received a penny from the films by 2006. When it was put to him that his expectation and hope was that Sony would exercise the Call Option after 2 years, he initially said “my expectation was that we would have been in a very high revenue situation at this time. It would have changed the profile completely”. When pressed, he said that he had no expectation of what Sony were going to do. However, when it was put to him that when he said earlier (see section 5) that he thought there was a very good prospect of making a return after 2 years, that was a reference to the Call Option being exercised, he said “Yes, in part”. He accepted, therefore, in effect, that he expected to obtain the tax benefit but suggested that he thought that he may obtain an additional return from Gross Receipts.

It was put to him that he said earlier that Gala provided a way to potentially earn decent returns in the medium return, but there is a whopping return in the short-term. He said “Assuming we didn’t make losses, of course, yes” and clarified that he means if the partners made losses. When asked if his focus was just on the partner’ positions, he said: “Of course, yes. I’m focused on us making a profit and having to pay tax on that, which I am perfectly happy to do”. He agreed that his focus was not on the profit and loss position at the LLP level but on members and whether they made money.

He said that he did not recall if he knew that Gala entered into the second transactions. When shown the minutes of the relevant meetings he said he would expect that Mr Pritchard was his proxy at them.

He could not say if he was sent the film files for the second transaction films or the 2004 HL letter. He thought he must have been aware of this and Mr Pritchard must have represented him but he could not remember. He said he would have been abroad at this time, otherwise he would definitely have attended the meeting - he would not have missed this meeting deliberately and he would have made sure he was represented.

He was aware of HL and he “gained further comfort as to the Gala arrangement given that there was a tier 1 financial advisory firm opining on the arrangement”. He read the opinion in full, and in particular HL’s conclusion and recalls thinking that this was as strong an assurance as he could possibly get from experts who knew what they were talking about. He was not concerned that the opinion was not more detailed as regards the research it was based on because of the standing of HL and, as a non-expert investor, he would not have expected to receive and wade through lots of detail.

He reviewed the box containing the final transaction documents and various film files. He was “really impressed by the detail of this documentation and the amount that we were being shown, including details of the budget and copies of the scripts”. He noted the famous producers, directors and actors involved and thought that “whilst you can still get flops, you could get a good idea that a film might be successful if it contained star names”. He discussed each of the films with his wife, who is more interested in cinema than he is, and she reacted positively. Had she questioned the quality of the cast or the synopsis, this probably would have influenced him. However, the film files only fortified his interest in Gala and gave him comfort that this was a sound commercial investment and, if the films were successful, he might make a return on his investment.

He expected, as based on his discussions with Ms Challons and going over the documentation, that (a) he would be involved in the film selection to a limited extent; the members would have to vote to purchase specific rights on the recommendation of the Los Angeles experts Gala had appointed, but (b) otherwise he was going to be a relatively passive investor attending meetings on an infrequent basis and getting updates from Ms Challons.

He could not recall why he did not attend the first members’ meeting on 28 November 2003 but assumed he was busy with his job at Credit Suisse. He did not recall attending any meetings before 2005 when he moved to Singapore. He exhibited a notice of members’ meeting dated 7 November 2005, his proxy form and the meeting minutes and said this is how he would have mostly dealt with such matters, but his records are incomplete and he cannot recall if his approach was consistent.

He recalls that he received a lot of documentation relating to Sony wishing to extend the option exercise date, and a recommendation from Gala’s advisors, relating to that and details of how compensation was to be received. He was content to follow the professional advice received that the option should be extended, and did not think much more of it at the time. He was aware that Sony exercised the option shortly thereafter.

When it was put to him that the 2003 HL letter does not deal only with the transaction films, he said that he assumed it included those films.

He agreed that HL do not state for precisely whom there is a reasonable expectation of profit. He thought that HL meant there was a good likelihood of the films invested in making a profit (from monies from box office receipts and DVD sales) and, therefore, that the members would get the return that they were looking for as: “Therefore the 30:70 distribution would work and the 30% would go to Gala and the members would therefore make the return”. We note that Mr Lewis appears to have been unconcerned with checking there was such a ratio in the waterfall and when this profit-sharing ratio would apply under it.

He accepted that the HL letter is a “pretty high-level” letter of only a couple of pages but said he could not believe that someone of HL’s standing would make that statement if they did not believe it was correct. He said, in effect, that he took comfort from the letter as he read it as saying, “the films will be successful and Gala will make a profit because of that”. He said he did not know whether he actually read the letter as meaning that members would make a profit but his assumption was that if the film made a profit, Gala would make a return/profit and, therefore, the members would make their return.

It was put to him that the letter does not state anywhere what would happen if the Call Option was exercised. He said that he did not think HL were asked to opine on that. The opinion was on the quality of, and likelihood of profit on, the films. He agreed that Gala’s profit position would be impacted by whether or not the Call Option was exercised but said he sees that as a side conversation as this is “an expert’s opinion on the quality of the earnings on a slate of films…The funds from that would then flow through to Gala and therefore to members”. He said he thought HL were referring to the reasonable expectation of the films performing well, in particular, as they referred to the period after the expiration of the term. He noted that he was investing for a period when the films would be exploited. He agreed that it does not state in terms that that would translate into a profit for Gala but he imagined that is what HL were asked to opine on and he assumed that “as media experts…they were being asked to advise on the likelihood of success of the films”.

He said he certainly looked at the film files in order to get a better understanding of the films which gave him comfort. He did not go through every single line of every single document, because he had a financial adviser that he expected to have already done that. When pressed he said that he “absolutely did study the detail” that he thought was appropriate and, if HL had given him a real technical document explaining how films work, etc, “I don’t think I would have understood it enough to opine. So I looked through what I understood, but there’s a limit to my understanding of the subject”. We note that Mr Lewis did not mention asking Ms Challons for confirmation that she had checked the position regarding the 30/70 split or for further details of how the waterfall operated.

He thought the documents came by courier on 25 November; he knew they came very promptly by courier. He agreed that realistically 2.5 days was not enough time to go through all the materials in detail if you are to read them properly. He was asked if he did not study the waterfall in detail because ultimately he was going to make a return out of tax relief so the precise mechanics of the waterfall did not matter. He said that was not his thinking at all. His thinking was purely that there was an awful lot of documentation. He trusted his financial adviser to give him the right guidance and was comfortable that the figures he had seen (in terms of the 30:70 split of gross receipts) were sufficient to make a return. We note that Mr Lewis did not have sufficient information to evaluate whether a 30/70 split of Gross Receipts at some point in the waterfall was in fact likely to result in him making a return.

It was the first time he was made aware of the specific films Gala would invest in. Looking at the nature of the proposal and the big Box Office names in those films, he thought that that there was a reasonable prospect that one of them would be a hit. However, other than taking a passing interest in the stars of the film, he was not terribly interested in what the films were about, as he understood that picking out a hit is inherently difficult.

He noted the conclusion. He understood that it is very difficult for anyone to be certain as to the likelihood of a film being a commercial success, but he expected that HL would have carried out a review of the relevant films, looked at what other films were coming out, and considered the stars and the directors to help them opine on this. He also knew that there is a certain amount of reputational risk at stake for HL if they got it wrong, so he considered their conclusion to be a third-party affirmation of the profitability of the slate. It just gave him a little bit more assurance that somebody with experience had actually looked at the movies in detail and it added further weight to his view at the time that investing in Gala might result in a profit.

He did not recall doing so but thought that he would have given the transaction documents at least a “once-over”.

He thought it was unlikely that he reviewed the film files in any detail because he is not an expert in films and would not be able to gauge whether a film would be a hit based on a review of a screenplay and they were not factored into his decision-making process.

He recalled skimming the legal opinions relating to Gala to gain some reassurance from the conclusions but he had already, in his mind, committed to the Gala opportunity. Overall, he thought they contained an interesting academic discussion, but he was more concerned about the arrangement in practical terms and he had already understood the commercial purpose behind it. He reviewed the opinions, because he wanted to ensure that what had been stated in the IM as regards tax mitigation was correct. However, as he did not have any experience of this area of tax law, he did not attempt to work through the tax considerations to consider whether or not he had the potential to make a loss relief claim. He entered Gala because he thought he was going to make some money. He was glad to see that there was some protection should things go wrong but could not quantify anything more than that because he did not have the experience or the qualifications to do so and, more importantly, that was not his intention when investing in Gala.

Based on all of the documents, he thought that there was a real commercial purpose behind the Gala arrangements given the change in the accounting treatment of P&A expenditure in the US. He understood that this would affect the film studio’s balance sheet quite significantly and saw a real commercial reason for the studio to get the P&A funded by someone else, but still take a percentage of the revenue, and having the ability then to call the option.

He thought that given that the rights to certain films were going to be purchased from a slate of several films (including films with big names with Box Office pull such as Jack Nicholson in Something’s Gotta Give), the risk was spread and there was an increased prospect that one or more of the films would be a Box Office hit, so that he would make a return on his investment.

A third-party expert, who he was familiar with, had appraised the films, with the conclusion being that there was a reasonable expectation of profit.

When taken to the letter, he agreed, in effect, that, from its terms, HL clearly did not know what films Gala would acquire rights in and so, contrary to what he said in his statement, he did not know from this what the transaction films were. He imagined that the different timings of films in production meant that it was not 100% possible to fix exactly which ones were on the ultimate slate at this stage. As he read it, HL were looking at a larger slate, which was likely to include a number of those which would get on to the final slate. He agreed that, hence, HL opined without knowing what films Gala would invest in. He said that, however, HL analysed all of the ones listed and, given he was told previously that the slate is typically 7, his understanding was that the transaction films were likely to be drawn from these names; otherwise, HL would not have been asked to do the analysis. Hence, his assumption was that the slate would contain a number of the films listed in the 2003 HL letter but not all of them. He agreed HL did not know exactly how the slate would end up.

It was put to him that it is difficult to see what sort of reputational risk would attach to HL given the limitations and disclaimers set out in their letter. He said that the disclaimers were absolutely standard practice and HL would not have been able to audit and independently verify the information that came from the studios. In his view, clearly if a significant number of these films appeared on Gala’s slate (and many of them did) and did not meet the expectations, then there would be reputational risk that HL had not done their job properly in analysing those particular ones, that they had not looked at the waterfall, and/or had not looked at who the key actors were or all of those things. He agreed that he was not involved in the production of the 2003 HL letter; he was reading what they said they had done. They analysed certain information regarding the slate of films which Gala proposed and so presumably were in discussion with Gala at the time because otherwise they would not have been able to start on any names.

He agreed that (a) he still did not know what films would be involved in Gala’s transaction on 25 November 2003; it was clearly something of a moving target. He said this was first time he had seen a complete list of names set out in that form and the fact they were sent to HL, for their opinion, suggested to him that they would be major components of the slate, and (b) no deal terms had been agreed even at this stage as far as he knew; his assumption was that Gala as an experienced promoter would enter into the transaction on sensible terms.

He had no recollection of reviewing the film files but thought he must have done. As a layman, he had no particular means of knowing whether something was going to be a success or not. Gala had a team of people who were experts in the field. That for him was better than him making any sort of amateur judgment on what films were going be successful; he had no experience or skill in that.

He was asked if he read the DA to see what was agreed as regards the profit share and it was put to him that he was indifferent to what had been agreed and so to whether Gala made any money. He said (a) he could not remember exactly what he did with those documents, (b) he relied on the promoters to choose the films and do the work required to establish that they were likely to be profitable, and (c) he had assumed it would be a 30:70 split because that was talked about previously. He did not think he checked that was the case but relied on Gala to do the necessary work.

When asked if he knew what was agreed in the end, he said “probably not, no” and he could not remember or he would have done at some point, but he now did not know. When pressed, he said that this would have been discussed in the Gala meeting, but he could not remember the specifics. He emphasised again that he placed reliance on the experts to negotiate appropriate terms and that, being an amateur, he would not have known what such terms were; he had no experience and had not been involved in this type of negotiation before and would not know what percentage is correct. It would depend on the type and size of film and such matters are beyond his scope of knowledge. That is what Gala were doing and why there were people in Los Angeles doing this as their day-to-day job. He absolutely expected that there would be the opportunity to make a profit from the films.

When asked if he asked anyone what had been agreed, he said that at the time he probably would have done so but does not recall now what that was and he believed he did at one of the Gala meetings, but he could not specify when that was and “I don’t know. Possibly I was told by Karina Challons, but again I can’t remember that.” Given his lack of recall on this point, we consider it reasonable to infer that Mr Mallett did not find out what had been agreed as regards the waterfall.

He confirmed that he did not ask for an updated opinion from HL that considered the films that Gala proposed to invest in.

The agreement was stated to be for a period of one year on the basis that, thereafter, it would automatically renew on a month-to-month basis. Invicta agreed to pay LBPC a fee equal to $150,000 payable in arrears in 12 equal monthly instalments of $12,500 on or before the last day of the month, commencing on 31 December 2003. Mr Ackerman described his fee as relatively low.

It was noted that Gala had engaged Invicta “to provide limited administrative oversight and quality monitoring services” and Invicta wanted to engage LBPC, on a non-exclusive basis, to undertake those services. The administrative services to be provided were to consist solely of the following:

“(a)

Collecting, filing, reviewing, analyzing and evaluating information relating to the marketing, sales promotion, advertising and distribution of the Films;

(b)

Monitoring SPR’s efforts towards the marketing, sales promotion, advertising and distribution of the Films;

(c)

Reviewing, evaluating and auditing SPR’s P&A expenditures with respect to the exploitation of the Films and the receipt of the underlying P&A services from the engaged P&A vendors;

(d)

Responding to inquiries from Invicta, Gala and/or SPR for information regarding SPR’s marketing, sales promotion, advertising and distribution of the Films and market research on film distribution, generally, including financial and statistical data on such activities;

(e)

Attending meetings with SPR and other related parties and furnishing written reports to Invicta and/or Gala with respect to such meetings; and

(f)

Furnishing regular, written reports to Invicta and/or Gala with respect to the foregoing services on a weekly basis (or at such other intervals as the parties mutually agree).”

Invicta and LBPC acknowledged and agreed that the services to be provided by LBPC were of an auxiliary nature and “in no event shall LBPC or any of its employees, officers or agent” (a) “interfere with, insinuate itself into, or otherwise be involved in, the negotiation, conclusion, enforcement of contracts with third parties by Invicta, SPR or Gala, with respect to the marketing, sales promotion, advertising or distribution of the Films, including, without limitation, the P&A expenditures with respect to the Films” and/or (b) “have any authority to solicit, negotiate or conclude any contracts or agreements which may bind Invicta, SPR or Gala in any manner whatsoever”.

The services were to be provided “diligently and to the best of such provider’s talents, skills and expertise,” and the relevant persons, including Mr Ackerman were “to devote, such time to the performance of the Administrative Services as may be necessary therefor. In particular, Justin Ackerman shall attend all meetings with SPR and other related parties.... and prepare or actively supervise and approve all written reports furnished by Administrator...”

LBPC agreed not to delegate the performance of any of the services to any individual or entity (other than its employees or officers) without the prior written consent of Invicta.

Subject to Invicta’s prior written approval as to the material terms of their engagement, LBPC was required to engage 2 independent contractors or employees to assist in providing the services to Invicta.

It was provided that no agency relationship was intended or created during the term of this agreement, LBPC was an independent contractor and that nothing in the agreement shall be “deemed or construed to create a partnership or joint venture...the relationship of principal and agent or otherwise create any fiduciary duty or any liability whatsoever of either party hereto....” and that neither LBPC nor any of its employees or officers, “shall make any representation that it is authorised to act as agent of Invicta, SPR or Gala, nor “have any right to incur any obligation or liability on behalf of Invicta, SPR or Gala or to bind any of them in any manner whatsoever.”

to assist with the initial discussions with the studios to convince them to commit to the proposal. Mr Ackerman attended numerous meetings with the studios and assisted with the presentations given to them;

to be involved in and assist with the selection process for the portfolio of films drawn from the slate (all films in the Sony slate for that year were available unless they fell outside the agreed criteria);

to receive, review and provide advice in relation to the proposed budgets, marketing plans and release schedules for the selected films;

to appraise the screenplay of the films and to advise on their prospects of being successful;

to locate office premises for LBPC to work out of for the purposes of carrying out its day-to-day activities on behalf of Gala;

to attend various meetings with the studio’s marketing team; to suggest changes to and agree revised marketing plans with Sony as set out in more detail below;

to attend conference calls with media buyers (the entities which handled media buying and held accounts with major print publications and television stations) and the studio to agree the media plans and relevant allocations;

to review the invoices received from the media buyers to ensure that expenditure had been incurred in accordance with the agreed marketing plans (whether varied or otherwise) and the daily payment schedules for P&A media buys;

to coordinate with Invicta, payment orders from the Gala distribution account; and

to act as liaison between Invicta and the studio on performance of pictures during the active distribution phase, and coordinate communication between Invicta and the studio.”

In consideration of £1.00 paid by Gala to SPE (a) SPE granted Gala the exclusive option during the period from 2 December 2003 to 27 January 2004 (the “Option Period”) to acquire from SPE or its applicable affiliate “Distribution Rights” in and to each of “the Pre-Release Pictures”, and (b) SPE agreed, during the Option Period, to negotiate with Gala as regards the licensing of such “Distribution Rights” on the terms of the agreement to “Post-Release Pictures” selected by Gala:

During the “Option Period” (a) Gala was required to review the content of each Plan “prepared by Gala or, at Gala’s request SPR” copies of which were attached to the agreement in respect of the first transaction films, (b) prepare or procure the preparation by SPR of a Plan in respect of “Secret Windows” and “Break Up Handbook” as soon as reasonably practicable after the date of the agreement, and (c) “commission an opinion from [HL] as to the commercial viability of each Picture”. Gala acknowledged and agreed that neither SPE nor any of its affiliates had any responsibility for the content of such opinion, and once the Plan in respect of a Picture had been reviewed by Gala and the opinion received by Gala, “Gala will decide whether to exercise its Option in respect of that Picture based on the contents of such [Plan] and opinion”.

If Gala notified SPE it wished to exercise the Option in respect of a “Pre-Release Picture”, under clause 5:

There was a similar process if Gala wished to obtain a licence of a “Post-Release Picture” but SPE had “sole discretion” whether to agree to such as licence.

Gala was permitted to exercise its Option to enter into a LA with respect to a “Picture” only if (a) it had available, at such time, sufficient funds (from the contributions and the SG loans) to pay the Initial Expenditure and the licence fee relating to it, (b) the contributions were equal to or greater than the Gala Expenses committed by Gala to that “Picture” and all other selected “Pictures” and the SG loan to Gala was equal to or greater than the licence fee relating to such “Picture” and all other selected “Pictures”, and (c) such Option was exercised no later than when 33% or more of the relevant “Distribution Expenses” had been incurred.

Gala agreed that (a) no less than 91.5% of contributions would be advanced to the expenditure account and applied towards payment of Gala Expenses for the selected “Pictures”, and (b) the Gala Expenses funded by the Initial Expenditure would be no less than, £82,350,000, and (c) an amount equal to 13.5% of the total contributions was to be used for the purpose of meeting the licence fees. This was subject to the proviso that if SPE had not, prior to 28 January 2004, included sufficient “Pictures” within the terms of the agreement to enable Gala to fully utilise the specified funds, Gala was obliged only (i) to advance such percentage of the contributions (not to exceed 91.5%) as equals the maximum amount of Gala Expenses which were capable of being funded with respect to the Pictures included within the terms of this agreement and/or (ii) to fund the maximum amount of Gala Expenses which were capable of being funded with respect to the Pictures included within the terms of the agreement, and (iii) to pay licence fees in an amount equal to 13.5% of “X”, where “X” equals the product of (A) Gala Expenses which are capable of being funded by Gala multiplied by (B) 1.0929.”

At the same time as executing a LA in respect of a selected “Picture”, Gala was required to enter into a debenture in favour of each of SPE and the applicable licensor in respect of the “Distribution Rights” in the form attached to the agreement.

SPE acknowledged that Gala would grant a charge and security interest to SG over certain of its assets including its interest in the selected “Pictures” and undertook that it would enter into a deed of priority and subordination with respect to the priority over the security interests to be granted by Gala and its members in the form attached.

Immediately upon acquisition by Gala of each “Picture” pursuant to an LA, Gala was to advance the Initial Expenditure in respect of that “Picture” to the expenditure account which was to be in the sole name of Gala.

Two representatives of Gala along with at least two representatives of SPR were to be signatories to the account. The signature of at least one each of Gala’s and SPR’s signatories were required to withdraw any monies including, but not limited to, “the Distributor Exploitation Expenditure” held in the account. No monies were to be deposited in the account other than “Distributor Exploitation Expenditure”.

Gala appointed SPR as its agent to withdraw monies from the account “solely to apply towards [Gala Expenses] to be incurred by Gala in connection with the relevant Picture and approved by [Gala] under the Marketing Plan or in accordance with clause 6.3 or 7” (see clause 6.2). In the definitions it was stated that the term “incurred” when used in the DA means:

“in connection with [Gala Expenses], that they shall be treated as incurred on the date that the goods or services being procured are supplied to [Gala] or SPR as agent for [Gala], which date shall be on or before 5 April 2004”. (Emphasis added.)

No money was to be withdrawn from the account unless an invoice had been addressed to Gala or to SPR as agent of Gala.

SPR agreed to apply sums from the account only on behalf of Gala in accordance with the Plan approved by Gala only on Gala Expenses.

Gala had a right of approval over all material aspects of the marketing of the “Pictures” throughout the specified territory during the “Term” including the level of total Gala Expenses “incurred”. However, this was subject to the proviso that once “the Distributor Exploitation Expenditure” had been “incurred” in full, then Gala’s rights of approval were to be exercised by Gala and SPR jointly and, in the event of any disagreement, SPR’s decision was to prevail. As it is stated in the definition of the term “incurred” in, effect, that the relevant goods and services to which the “Distributor Exploitation Expenditure” relates, would be supplied by 5 April 2004, it seems that the intention was that this proviso would apply from 6 April 2004 onwards. It was noted that Gala did not have a right of approval over those “Distribution Expenses” that do not constitute Gala Expenses.

Gala undertook and agreed that the Plan for each Picture “shall be approved by [Gala] prior to the execution of the [LA] in respect of that Picture” and SPR acknowledged that Gala “enters into the [LAs] and this Agreement on the basis that the [Plans] (which have been commissioned from SPR or its Affiliates at [Gala’s] request) are prepared in good faith by SPR or the applicable Affiliate.”

Representatives of each of Gala and SPR were to meet at SPR’s offices once a week during the term of the DA or, on a less frequent basis if either party was unable to attend any weekly meeting for any reason, to discuss changes (if any) which SPR wished to make to the Plans.

Clause 6: Under clause 6.3, if the Initial Expenditure for a “Picture” was not sufficient to pay for all of the Gala Expenses to be “incurred” in connection with that “Picture” and approved by Gala under clause 7, either (a) Gala “may” increase the “Distributor Exploitation Expenditure” in respect of that “Picture” and advance the same to the expenditure account “to meet the costs of the additional Gala Expenses to be incurred on its behalf in connection with that Picture” (clause 6.3.1), or (b) SPR “can” pay such additional cost from its own resources (clause 6.3.2). Under clause 6.4, if SPR wished to incur “Distribution Expenses” in respect of any “Picture” that do not constitute Gala Expenses, it could pay for them from its own resources.

Clause 7: If SPR wished materially to increase the Gala Expenses set out in the Plans (by a sum in excess 10% of the previously approved such expenses) or to decrease them (whether materially or otherwise):

As regards a decrease in Gala Expenses in respect of a “Picture”:

As regards a proposed material increase in Gala Expenses in respect of a “Picture”:

In consideration of the grant of “Distribution Rights” to SPR, “SPR shall pay to [Gala], in Sterling, in addition to the sums payable pursuant to clause 9 below, an Annual Royalty payable on each Payment Date during the Term save that no Annual Royalty shall be payable after 28 July 2011...”.

“Annual Royalty” is defined as an amount equal to annual interest computed at a specified rate, for the period ending on 28 January 2004 and thereafter the successive periods starting on 28 January in each year and ending 28 January in the next year or (if earlier) on the earlier of the last day of the Term or 28 July 2011 (“Payment Dates”). It was common ground that these sums were calculated to cover interest due on the SG loans and to produce a small profit over the term of the DA.

The sums payable pursuant to clause 9 are:

Notwithstanding any breach, default, event of force majeure or other event or occurrence of any nature, Gala shall not “terminate or rescind this Agreement or the license of Distribution Rights granted to SPR hereunder at any time-prior to the expiration of the Term”.

In the event of any breach by SPR of the DA, (a) Gala’s right were limited to a right to recover damages, if any, in an action at law, and (b) Gala waived “any right or remedy in equity, including, any right to terminate” the DA, or “to rescind SPR’s right, title and interest in and to the Pictures or any other right granted to SPR” under the DA or “to enjoin or restrain the distribution or exhibition of the Pictures or the use, publication or dissemination of any advertising in connection therewith”, and (c) without limiting the generality of (b), SPR’s rights with respect to the Pictures could not be terminated, cancelled, rescinded or otherwise affected by any failure of SPR to pay any amounts payable under the DA accruing or becoming payable by SPR to Gala and Gala’s sole remedy in any such event was limited as already set out.

(a) SPR could give Gala notice to terminate the DA if Gala was dissolved, liquidated or there was a similar event, and (b) (i) the DA would terminate in respect of a “Picture(s)” with immediate effect if the LA relating to the “Picture(s)” was terminated in certain circumstances, or (ii) in respect of all “Picture(s)”, immediately following the exercise by SPE of the Call Option on payment of the price for doing so. Subject to (2), following such termination SPR would have no further obligation to Gala under the DA in respect of the “Picture(s)” other than the obligations to repay any part of the Gala Expenses pursuant to clause 9.3 (see [258]).

On termination under these provisions or under clause 7.3, the “Distributor Exploitation Expenditure” relating to the relevant “Picture” which was yet to be “incurred”, in respect of a termination before 5 April 2004, at Gala’s option, or in respect of a termination thereafter, at the option of SPR, was either (a) to be applied in payment of Gala Expenses relating to another “Picture” or (b) to be treated as unspent “Distributor Exploitation Expenditure” in accordance with clause 9.3 (and the reference in clause 9.3 to 5 April 2004 was to be taken to be to such later date, if applicable, of any termination).

An amount calculated by (a) dividing the Underspend by the aggregate Distributor Exploitation Expenditure, and (b) multiplying the result by an amount equal to 13.5% of the aggregate of funds subscribed to Gala by all of its members, would be deducted from the Underspend and paid to Gala (subject to certain provisions which, in effect, allowed SPR to off-set any such sum against any licence fee which a licensor was obliged to return). In effect, therefore, SPR was obliged to repay to Gala a portion of the benefit it initially received as the licence fees.

The Underspend remaining, after deduction of any amount paid to Gala under (1), was to be advanced by Gala to SPR as a loan, which was repayable on the date upon which the Minimum Amount was due to be paid by SPR pursuant to clause 9.4 on the basis that payment of the Minimum Amount included amounts constituting the repayment of such loan in full on such date and that interest was to accrue on such amount.

The object was to enable Gala to acquire rights to any “Sequel” under the same terms commercially as applied under the Option.

It makes no sense for that ability simply to expire in February 2004; this was intended to deal with the situation going forward as the “Sequel” rights would not materialise until perhaps 3 to 5 years after that date. So counsel’s interpretation would render the option pointless. The period during which the option could be exercised was meant to extend to the time the rights to “Sequels” materialised.

He did not think that the Option Period was extended for any reason to do with this option. It was extended in relation to the transaction films and:

“not to sequel rights that had not even been given birth. It was not in the forefront of people’s minds to talk about sequel rights when they were still dealing with whether or not to exercise options over the pictures. That was the focus, not sequels.”

He seemed to agree that is how the licence fees were computed and that they exactly match Gala’s SG loan. He said that is logical because an investor does not borrow more or less than it needs and Gala knew exactly how much it needed to borrow for the films that it was looking to finance. He agreed that he always knew and intended that the aggregate licence fees would equal exactly Gala’s SG loan and said that most commercial deals are the subject of a formula:

“Once you agree what the parameters of a commercial transaction will be, you look to see and try to formulate an understanding of those figures within the context of that transaction. So you could say most things boil down to a formula. In this case what we had was a finite amount of money that we knew we could raise, and therefore it’s unsurprising that we would start off with, if you like, a pot of money and say: How can we make the best economic use of that money?”

He added that “the amount that we had was finite”, and it was necessary to allocate that to ensure that the full amount of cash available would always be enough to ensure that Gala could (a) acquire all of the selected films, and (b) have enough money to pay for the approved Gala Expenses.

He agreed that the amount of the licence fees is “fixed “but said that:

He agreed that he had not referred to this reduction in profits in his witness statement but said that it is in the 2002 financial statements of Sony group and:

“the figure is embedded in my mind. It shows 92.3% reduction in net profits for that year. It was a disastrous year for them. They were very, very keen to talk to us. Remarkably, it was in a year when their studio was experiencing better results than the rest of the divisions, but they were hungry for money, and that was the reason why they did this deal.”

He said that there was no “pass through” of the Rights and Gala was not just a funnel. He based this on his view of the legal and commercial position. He noted that the licences granted to Gala were for a longer 21-year period and asserted that Gala had a right to distribute through Sony as its agent, which was “buttressed by the fact that we actually spent money” from the expenditure account funded by Gala on Gala Expenses that were incurred both practically and legally by Gala. As he understood the arrangement both legally and commercially, Gala granted Sony “the sub distribution rights and were conducting distribution, which we were paying for directly, and at the time engaging SPR in respect of those activities as our agent”. As set out below, we do not accept that this is the effect of the arrangements.

He did not agree that the fact that Gala charged the Rights in favour of Sony reinforces the point put by counsel. He said essentially that this was a common arrangement and:

“When a producer is granted intellectual property rights by a third party, customarily there will always be a debenture to ensure that the rights are dealt with in the way that was commercially contemplated. There was nothing unusual about being granted rights and then by way of security...those rights being granted back [so that the] grantor can sleep at night knowing that the rights they granted are going to be dealt with in a proper fashion and that if the licensee, in this case Gala, behaved in a way that was contrary to what was contemplated, they had the right to enforce their security, which would be in addition to the rights that they would have had under the contract.”

In other words, Gala were granted rights which they then assigned by way of security to ensure that their obligations were complied with. It was never the case that Gala simply was used as a funnel. The debenture was there “to ensure that we did what we say we were going to”.

As regards the restriction in the DA and debentures on Gala’s ability to conduct business expect that provided for under the transaction documents:

He concluded that the debentures are what anybody that is used to this kind of transaction would say is bog standard: “We did nothing in terms of granting security that is uncommercial or non-standard or artificial for that matter.”

It was put to him that Sony was not going to let Gala, a special purpose vehicle, which was set up for the purposes of a tax avoidance scheme, anywhere near its rights to distribute films. He said:

He did not agree that Gala never owed a substantive obligation. His view was based on (a) his view of the legal effect of the transactions, in particular, that Gala had obligations under the LAs which it retained, and (b) the assertion that the real purpose of this activity was to enter into a DA with a studio where Gala participated in the distribution. He added that there are things that go on in addition to that, some of which relate to providing security to each party to ensure that “what we say will happen does happen”, but:

“there is not one single step in this series of transactions which is artificially introduced in order to simply give effect or, as you say, window dress the real purpose of this transaction. There is not one single artificial step that you would not see in a similar transaction of this nature.”

He was taken to a provision in the LAs that the “Distributor may procure that distributor’s sub licensee undertakes to perform....If and to the extent distributor procures such undertaking from distributor’s sub licensee, distributor shall have no further liability pursuant to this clause 7 to the licensor.” It was put to him that this is drafted on the basis that there was uncertainty about whether Gala would sub-licence the Rights to SPR but there was no uncertainty, as the DA was entered into at the same time as the LAs. He said that (a) that is the way lawyers draft things, he did not find this provision surprising, it was in numerous transactions that he had been involved with and of itself is not artificial, and (b) the term “may” was used rather than “shall” as, whilst it was contemplated that the sub distribution rights would go to SPR, there was always a possibility that it would go to somebody else in the group. He did not accept that when the documents were entered into there was no ambiguity because they are all set up as a package and were signed at the same time and were designed to give the impression of meaningful rights, obligations and activity.

When it was put to him that Sony retained the substantive rights and substantive obligations in relation to the films, he said he strongly disagreed:

“These are designed to do what they actually achieve, which is to grant rights to us. We don’t grant the same bundle of rights down. We retain important rights and the document achieves what was designed to achieve.”

Mr Yusef agreed that it was a condition of the DA that the Initial Plans were reviewed and approved. He said that was so that, at that time, the parties were “at one” in terms of substantially how the films were to be marketed and “in effect the agreement could not have been entered into unless that had happened”. He said that it is “not abnormal for parties to go through various steps in order to get to a point where they [are] both of the same mind,” and “we could not have approved that [Plan] unless various steps had taken place prior to that agreement being entered into.”

It was put to him that the sum effect of clause 7 of the DA is that any changes to the Plans, other than to the amount Gala was purportedly going to contribute to the marketing budget, were a matter for Sony. He said:

“No, because there were certain things that could have happened and in some instances did happen after the [DA] was entered into…we wanted to ensure that what Sony was spending either on its own behalf or on our behalf as its agent, or we were spending directly by way of invoicing to us, was in accordance with what we had agreed, and any deviation from that to the extent that it was material...would have been the subject of our approval with certain consequences arising from that. This was not a passive role that...Gala had both before and after the event.”

It was put to him that if Sony wished to increase the marketing spend on the films, it could do so by simply incurring that expenditure. He said that Sony could not just simply arbitrarily do that halfway through the distribution of a film without going through the approval process set out in the DA and could not just do whatever they liked:

“The commercial reality, which...is what governs how people behave in this contractual situation, is that it was not SPR’s preferred position to simply spend all the money however it liked in any single way. If it wanted to do that, it wouldn’t have involved us in the first place. Its desire for our money meant that they would have to get from us consent or... more like consensus. They obviously have to have a mechanism that ensures we do not destroy the distribution process mid-course. So what was agreed was if they came to us with a material change and we disapproved of it, we couldn’t use that as a mechanism to stop the production. So it was commercially realistic and plausible that they would then have the right to spend that money, but that was not what they were choosing to do. It would be commercially not sensible for them to say: “Let us enter into this complicated transaction and then just do what the hell we like”. That is not what happened and it was not the state of mind of the parties at the time.”

He agreed that if Sony wished to decrease the marketing spend on the film, it could do so “with different results” and, if Gala objected, Sony could simply terminate the agreement. He added that the likelihood of that scenario, “was commercially acceptable as a very low risk” as it is safe to assume that would be because it would be commercially unsound to spend the money originally envisaged if the film was not performing and “we probably would be as keen to decrease the budget as they would be in those circumstances. The likelihood that we would be in a conflict with Sony in those circumstances is extremely remote”.

It was put to him that Gala did not even have a meaningful right to be heard, because Sony could unilaterally cancel meetings (as they could be cancelled if a party could not attend). He said that to cancel meetings of substance without good cause would be an act of very bad faith and there was no “commercial logical reason why they would do that”. In fact, the experience throughout the whole period was that Sony were happy to meet Mr Ackerman and he met with them on a collegiate basis at least 3 or 4 times a week, sometimes more, and was a respected person within that process. He said he was aware there were times when meetings were rescheduled and, in his view, if a meeting was cancelled, there would be a good reason for it.

He added that the rights were meaningful and the approval of the Plans did happen. Even though the Plans had to be approved as a pre-condition to entering into the licence, “it is nevertheless the case that Gala had substantial rights to look at and approve the guts of the transaction, which is the [Plans]. Whether it happened before or afterwards was a matter of commercial convenience”. It would have been “cumbersome and would have delayed the marketing process if we had simply entered into” the licences “and then gone through the same approval process and work that we had done before the agreement. It was much more convenient to do the work before, approve the process and then enter into the agreement. The approval rights actually were exercised...And were substantial”.

He noted that Sony, “despite their size and strength were not in a position to just simply do what they want or push us around. There was a mechanism or mechanisms in place to ensure that other interests were protected”. He essentially made the same comments as he made under cross examination as regards Sony’s ability to decrease the spend.

As regards Sony’s ability to spend more on expenses for a film if Gala did not want to do so, he added that (a) it was right that Gala would have that right not to spend more, (b) Sony had 2 rights. They could spend the difference and recoup it or, “if the situation at that stage had become egregious and controversial, they would have the right to terminate”, and (c) commercially speaking, that right was judged at the time to be one Gala could agree to because:

“within the context of why the studio wanted to enter into this transaction, they wanted more and more of our money, not less and less. The likelihood that that situation would arise, in circumstances where we knew upfront how much the overall expenditure would be, and we had decided that we could cope with that, we didn’t think that that kind of situation would arise, given that Sony -- they are not really interested in spending more money than they need to maximise the performance of a film.”

He recalled, as there was a lot of discussion about it at the time, Sony wanted (a) to be a signatory to the account for the sole purpose of making sure that, once they had committed to their counterparties, such as McCann Erickson, based on the placement of Gala’s share of the distribution expenditure, Gala could not simply withdraw the money, and (b) to be sure that there was a provision in the document which gave them power to do so as an agent so that there would be some reason why their signatory was co-signing. They thought there would be an exposure to litigation in those circumstances. He added that there was no way in which Sony could simply just take money from the account as they pleased. Gala had the control, and whilst Sony had some degree of control, “to say we surrendered control is simply factually and legally not correct”.

It was put to him that he was speculating about Sony’s intentions and concerns. He said his comments are reflected in the actual arrangements. If Sony wanted to simply put monies into an account, they would have used their own account. They would not have gone through the process of agreeing for Gala to have an account. The money was not Sony’s but Gala’s and:

“we wanted to ensure that the money went in a specific way, which it did. There was no arbitrary way in which Sony could just take money willy nilly. Theirs was a defensive posture and not one of control. They wanted to make sure we didn’t do what they feared we would do, not the other way round. It wasn’t what actually happened”.

The money in the account was not Sony’s money as a matter of fact and law. Sony did not control and did not have a unilateral right to take that money and spend it any way it liked. It could only be spent, as the DA states, in the distribution of the transaction films, and the security agreements are perfectly standard and were entered into to protect SPR and ensure that SPR’s understanding of the deal actually is what happened in the sense that, as the secured party, like under a mortgage, it could exercise its rights if Gala was in default.

The plain meaning of the relevant provision in the LA is that Gala had to exercise its option to acquire rights in relation to any “Sequel” within the Option Period (of 2 December 2003 to 27 January 2004). We acknowledge that the documents are to be interpreted in accordance with business common sense and that, as Mr Yusef said, “Sequels” were not likely to be in contemplation until a later stage and an option which gave Gala rights only in such a limited window was not likely to be of much (if any) practical use to it. However, (a) the reference in the LAs to Gala’s right to acquire rights in “Sequels” on “the same terms” as set out in the Option is unequivocal and without limitation, and the Option Period is plainly a term of the Option, (b) as a matter of business common sense, (i) it seems unlikely that the intention would be for Gala’s right to subsist for an unlimited period with no end date, and (ii) given the overall effect and terms of the composite set of documents of which this document forms part, it is reasonable to suppose that the parties were willing to insert such a provision in the Option in the expectation that it was unlikely to have any practical utility. As set out below, a number of provisions were included in the documents which, on the face of it, give the impression that Gala had substantive rights/obligations as regards the distribution of the transaction films but which, on closer scrutiny, lack meaning and consequence.

In any event, Invicta/Gala can have had no realistic expectation that the LAs would remain in place for 21 years and/or that it would have any opportunity to acquire rights in “Sequels” given that, as we have concluded for the reasons set out in section 15, Invicta/Gala expected SPE to exercise the Call Option at the first opportunity and designed the arrangements so that it was inevitable that SPE would do so.

It was specifically stated in the DA that SPR assumed all of Gala’s executory obligations under the transaction documents in respect of the Rights and that, subject only to Gala’s approval rights in clause 7, SPR had the right to distribute and market the transaction films “in its sole and unlimited discretion”. For the reasons set out in [279] to [281] below, we do not accept that SPR was appointed, or acted, as Gala’s agent in the exercise of its rights under the DA.

Whilst the DA states that Gala was to have a right of approval “over all material aspects of the marketing of” the transaction films including the level of total Gala Expenses incurred but not of any other “Distribution Expenses”, this broad statement was, in effect, limited in that:

In effect, therefore, (a) Gala’s only substantive right or obligation to input into the distribution process was a right of approval of any material increase, or decrease, in approved Gala Expenses proposed by SPR, and (b) that right fell away as at 6 April 2004, by which time it was intended that the total approved Gala Expenses would have been “incurred”. With that context in mind, it is reasonable to interpret the requirement in the DA for representatives of Gala and SPR to meet once a week (unless either party was unavailable) to discuss changes SPR wished to make to the Plans, to contemplate meetings at which SPR would present any proposed material increase, or decrease, in approved Gala Expenses.

Under the DA, the consequences of Gala approving or objecting to any proposed material increase, or decrease, in approved Gala Expenses did not provide Gala with any meaningful way of controlling the level of those expenses or with any commercial advantage:

We do not accept Mr Vallat’s submission that it mattered in commercial terms whether Gala approved of a proposed material increase as, if Sony bore an increased cost itself because Gala did not approve it, Sony could then recover that cost only in a lower position in the waterfall, under the eighth provision. That is an inaccurate description of how the contractual provisions operate and, as set out in section 11, we cannot see what would fall in the eighth provision that would not be captured under the fifth provision. Mr Vallat also emphasised that there is more than one possible outcome where SPR proposed a decrease in Gala Expenses. That is of course correct but Gala’s rights in that respect ultimately only had the consequences already set out.

After he said “no”, he added that (a) Gala could check that what was spent from the expenditure account was in accordance with what had been agreed, and (b) that “any deviation from that to the extent that it was material...would have been the subject of our approval with certain consequences arising from that”.

He seemed to suggest that, in practice or, as he put it “commercial reality”, Sony would not necessarily choose to exercise its rights to incur additional Gala Expenses if Gala did not approve them under the process set out in the DA and that the level of expenses incurred was agreed by consensus due to Sony’s desire for Gala’s money. This was plainly not a comment on the legal effect of the provisions and, as noted, we do not accept that Sony’s participation was driven by anything other than its receipt of £15 million as licence fees. We have set out the evidence on how the approvals process operated in practice and our comments on that aspect of the arrangements in section 14.

He agreed with counsel’s description of how the provisions work as regards any proposed decrease in Gala Expenses and said the likelihood of that scenario, “was commercially acceptable as a very low risk”.

As the documents were drafted, any further sum which Gala put in the expenditure account to meet an increased Gala Expense would not be covered by the shortfall guarantee and related security arrangements. As explained in full in section 11, Gala would have to rely on recouping any such sum from Gross Receipts under the sixth provision in the waterfall. As noted, SPR was entitled under the fifth provision to recoup expenditure (including Gala Expenses) it incurred using resources other than those in the expenditure account in priority to Gala’s entitlement under the sixth provision.

Gala’s position under the waterfall would not otherwise be affected materially by whether any such increased Gala Expense was funded by additional monies Gala put in the expenditure account or by Sony from other resources: (a) the first to fourth provisions of the waterfall allocated Gross Receipts to SPR, (b) the fifth and sixth provisions operated as stated in (1), and (c) the level of Gross Receipts available for allocation between Gala and Sony under the remaining seventh to eleventh provisions of the waterfall would be the same, whether Sony or Gala was entitled to recoup any increased Gala Expense under the fifth or sixth provisions respectively. We note here also that how the total sum in the expenditure account was allocated between the transaction films could not affect Gala’s position under the waterfall (see our comments in section 13 at [373] to [380]).

Pursuant to the security arrangements, Gala assigned absolutely all of its rights under the LAs to SG and the relevant Sony entities. The security agreements in favour of SG secured Gala’s and the members’ obligations under the SG loans and the security agreements in favour of SPE, SPR, Columbia/Screen Gems secured Gala’s obligations under the Call Option, DA and LAs respectively. There was no point in time at which Gala held rights under the LAs (or the DA), which were free of the security agreements. As the UT held in the similar circumstances of Ingenious (see [156] of the UT’s decision and the Court of Appeal’s decision at [36] to [40]), the effect of the security arrangements was that, in principle, Gala had an equity of redemption, but this was a theoretical rather than a real right. An equity of redemption implies that the holder has a right to redeem the security and enjoy the rights which are secured. However, there was no way for Gala to redeem the security whilst keeping the Rights under the LAs.

Moreover, in the LAs and debenture granted to SG, Gala covenanted not to carry on any other business and so could not avail itself of any future opportunities, and Gala had no right to terminate or rescind the DA during its “Term” even if SPR was in breach of its obligations.

It is stated in the introduction to the DA that Gala had agreed both to sub-licence the Rights to SPR and to appoint SPR as Gala’s agent for the purpose of “incurring the Distributor Exploitation Expenditure upon the terms and conditions set out in the [DA]”.

However, there is no substantive provision in the DA under which Gala expressly appointed Sony to act as its agent in contracting with the third parties to whom approved Gala Expenses were or would be due:

As set out in [274], under the DA Gala sub-licensed the Rights to SPR, in effect, in their entirety, subject only to Gala’s limited rights of approval in clause 7. Accordingly, (a) SPR was free to take such action as it chose to market and distribute the transaction films, whether that involved putting together Plans, tracking the films, deciding on the best way to market the films, or engaging third parties to market and distribute the films and liaising with them, and (b) it was free to do so acting entirely on its own behalf in its own interests and for its own gain and had no duty to act in Gala’s interests.

This is reinforced by the fact that the DA makes clear that SPR had no responsibility or liability to Gala as regards the distribution of the transaction films. SPR could choose not to distribute them and owed no duty to Gala in respect of its decision-making process.

It is a characteristic of agency that the principal is in a position to control the agent, even if that control ultimately rests in the principal’s power to revoke the agency. Gala was not in a position to exercise any control over SPR. It could not terminate the authority for SPR to withdraw sums from the expenditure account to meet approved Gala Expenses, because the DA provides expressly that Gala was not entitled to terminate or rescind the DA under any circumstances.

We consider that, in the absence of any other evidence and in light of the points made above, the fact that the DA specified that funds were to be released from the expenditure account only on receipt of invoices addressed to Gala or SPR as Gala’s agent, does not of itself suffice to demonstrate that SPR was engaged to act as, or acted in its dealings with such parties as though it were, an agent for Gala only. Such limited evidence as there is indicates that Sony simply informed the third parties that invoices were to be addressed to Gala and otherwise its dealings with those third parties were unchanged by the arrangements with Gala (see [431] to [434], in particular, [433]). In light of that and given the contractual terms, we consider it reasonable to infer that SPR had the liability to pay such parties for the provision of their services and, in doing so, discharged its own liability, acting on its own behalf; that accords entirely with its sole and unlimited discretion to distribute the transaction films as it chose.

From Sony’s perspective:

From Gala’s perspective, for the duration of the DA, Gala did not have any meaningful rights or obligations to conduct or provide input into the distribution process, the exercise of which could affect, in any positive way, its economic and commercial position in relation to the transaction films:

We note also that, in our view, the limitations and restrictions on Gala’s activities in the relevant documents show that Mr Yusef’s claim that he had a long-term vision for Gala and ultimately wanted to float Gala on AIM (see section 1) is implausible.

Gala assumed an obligation under the DA to provide the Initial Expenditure of a total of £102 million into the expenditure account on the basis that it could be used only to meet approved Gala Expenses.

SPR assumed obligations under the DA, (a) to pay to Gala (i) the Minimum Amount, which was due at the end of the term or on an early termination, of an amount equal to the Initial Expenditure/total principal of the SG loans of £102 million, and (ii) the Minimum Royalty Payments, due annually during the term, of amounts sufficient to meet the interest due on the SG loans (and over the course of the term to produce a small profit), and (b) as was a requirement for Gala’s obligations under the DA to take effect, to procure the issue of the LC by Barclays.

SPE agreed under the Call Option that, if it exercised the option to acquire Gala’s “business” (as for the reasons set out in section 15, we consider it was inevitable that it would), it would pay a price of an amount at least equal to the principal of the SG loans/Initial Expenditure/Minimum Amount of £102 million.

Under the LC, which Barclays duly issued, Gala could demand from Barclays payment of sums equal to the Minimum Amount/option price and other Minimum Sums on the basis that payment of the relevant sum under the LC would satisfy SPR’s obligation to pay the corresponding Minimum Sums. In effect, therefore, Gala took a commercial credit risk on Barclays, rather than on SPR, as regards the receipt of these sums.

SPR assumed obligations under the security arrangements to Barclays, to reimburse Barclays for sums it paid under the LC and to place the Deposit of a sum equal to the Initial Expenditure/total principal of the SG loans of £102 million in an interest-bearing account held with Barclays. The funds in the account were subject to a charge in favour of Barclays and Barclays agreed to use the funds in the account to meet its obligations under the LC.

The effect of the SG loans and relevant security arrangements was that, in practice, the sums which Gala could demand under the LC, as funded by the Deposit, (a) were to be used, and could only be used, to meet interest on, and the principal of, the SG loans, and (b) were to be paid direct by Barclays to SG and applied by SG in settlement of sums due under the SG loans.

All of Gala’s 65 members took out the maximum borrowing from SG and the Minimum Sums were designed to match the interest and the capital due on the total SG loans. He said that the arrangements under the related LC amounted to “a fallback guarantee”; it was designed to pay up, if necessary, the difference between what Gala received under the normal income stream and the principal of the loans and the interest thereon.

Under the arrangements, the SG loans would be repaid in full, as regards both interest and capital, irrespective of how any film did commercially and even if Gala received no income from the films. He said that would normally be the case in any film transaction where there is distribution involved; it would be abnormal if the sub-distributor did not pay an advance, (a) on account of the distributor’s share of revenue and/or (b) as a minimum guarantee due irrespective of any payments under the waterfall. He emphasised that there was actually an activity of film distribution in relation to which SPR agreed to pay the Minimum Sums and to guarantee them under the LC; they were to be paid as consideration for SPR’s acquisition of distribution rights and were due irrespective of the performance of those rights. He said it is not abnormal but customary for a distributor to place obligations upon itself so that if the performance does not reach a particular level, the licence holder receives a minimum amount. It is “not an artificial arrangement that is put in place simply to put into effect a desired result” and reflects “what actually happens in the business…there may be some exceptional cases, but it is the normal course of business for a distributor or sub-distributor to pay an advance for a minimum guarantee”.

He did not initially agree that it was part of the proposition that the studio would fund the LC. He said: “We just wanted a letter of credit. How it was funded was not our concern”. He knew how it would be funded, but the placing of the cash deposit “was not necessary” in that, for example, Sony may have had relationships with other banks who would have issued such a letter without a cash deposit if they were happy with the credit of Sony. He found out that there was to be a cash deposit but “it did not need to happen that way”. All he needed was a LC “to back up the contractual obligation to provide minimum guarantees. How Sony funded that was initially not my business...”

Mr Yusef was taken to a chain of correspondence between Barclays, Sony and lawyers relating to the LC and deposit:

Mr Yusef said that this demonstrated his point that the deposit was not provided for at the outset as a done deal and that it was during the course of the discussions and the negotiations for the LC that this was confirmed. He added that “all we cared about was that there would be a letter of credit to back up the obligation. How Sony did that was their affair. I guessed, because it is not abnormal, that that is what would happen”. He “came to know that that is what would happen” and it was always intended that the transaction would have a LC and he understood the possibility that it could be collateralised by a deposit but it did not need to be. Sony could have supplied the LC without putting a deposit there if it had the credibility. He came to understand that that was not what was going to happen during the course of the discussions, and at a certain point it became clear and it was agreed that there would be one LC with a deposit. That was what was eventually agreed.

He was taken to a draft term sheet sent to a studio (Disney) which stated: “The distributor will be required to procure a standby letter of credit from a bank acceptable to Gala and its bankers to secure payment in the event that the distributor fails to pay...Distributor must fund this incident from its own resources.” He then seemed to accept that he knew Sony would have to fund the LC. He said that this reinforces that the LC had to be funded by Sony but that how it funded it was a matter for Sony. His further comments include that:

“So at that point it didn’t matter to me how the letter of credit was funded, as long as it was funded….Whether it was funded from its own resources or from using the money that it received from Gala, it did not matter at that point to me…I didn’t know at the point in question that the studio would use the money that it received as part of the transaction to fund this letter of credit, because it didn’t matter as long as it funded it…What we are talking about is how it funded it. I always accepted that the studio - in fact, we insisted that the studio funds it. It is a question of how it funds it...As long as they put up a deposit for the letter of credit, how they did it was not of concern to me.” (Emphasis added.)

The function of the money provided to Barclays was “to secure the obligations of Sony, and…that was necessary...because Sony in 2002 had posted a fall in…their net profit, of a staggering 92.3% from the previous year. So Barclays were never going to accept them just issuing the letter of credit...that money had to match our obligations to SG, a different entity....”.

The money that went from SG into the expenditure account “goes towards the distribution expenditure that’s actually incurred as a matter of fact by Gala. The money happens to be the same amount of money…”

That is not a proper description of what actually happened as it fails to address the purpose of the borrowing as far as the members were concerned. The monies were not borrowed, introduced into the partnership capital account and then given over to Sony. Actually, the monies, which were borrowed on a full recourse basis, were put into the expenditure account to defray the distribution costs that were incurred directly by Gala. There were a good room full of invoices in the name of Gala.

Gala suffered a detriment because it defrayed the expenditure to the extent that it agreed to do so in the DA. The purpose was emphatically not as counsel asserted; it was to incur an obligation to pay expenditure under the DA and to engage in a trade of distribution. The tax relief that was derived from that undertaking was designed to mitigate the potential for loss in the event that Gala did not make a profit from film distribution. It was downside protection.

Gala had agreed voluntarily to enter into a DA with SPR in order to engage in the trade of distribution and participate in the distribution of the transaction films and, in the course of that, it (not SPR) actually incurred expenditure. He agreed that, if the expenditure had not included the borrowed monies, the loss and the tax relief would only have been a fraction of that claimed. He emphasised again that the members’ SG loans were on a full recourse basis and was not risk free: So to include the full recourse loan element in the equation (as well as the cash contributions) was both commercially and, in every other respect, fair and proper. He added that the borrowing was not “primarily” to inflate the loss but was to do with the “entry level that was required in order to enter into the transaction in the first place” as:

“Sony’s main interest was to secure alternative funding for its P&A burden at a level and at a volume that would make an impact on its overall business…had we said that we were going to raise and participate at a level of, say, 20 million, they wouldn’t have entertained this transaction at all…they were disappointed with the fact that we only introduced 100 million…the primary purpose of the borrowing of each individual member was to put the partnership in a position where it could become…a player in the transaction. Had we not done that, we wouldn’t have done the transaction. The transaction wouldn’t have happened…the primary motive…was to raise enough money for the partnership to make an impact…”

It was put to him that the £15 million was the benefit Sony received in return for being involved in the scheme; it was the scheme fee. He said that “to all intents and purpose...it was the payment for the licences” and the principal studio benefit was that Gala paid for a percentage of the overall distribution expenditure on the transaction films. That was the primary reason why Sony entered into this transaction:

“$15 million in the scheme of things does not get the executives of Sony excited. What excited them was...the fact that somebody else was going to pay a portion of their distribution fees and, more importantly, the possibility that a larger sum would be paid in that way, thus relieving part of the burden that they had arising from the accounting problems that they were encountering at the time.”

It was put to him that it was a scheme fee, and the purpose of the scheme is the generation of the purported loss and the tax relief. He said that he disagreed very strongly for the reasons he had stated. When pressed, he said “no” and:

“The principal purpose of the borrowing was to put [Gala] in a position where it could engage in a meaningful way with the studio…the studio wasn’t interested in contracting with us unless we were able to provide a deal size that would make sense for them…the real benefit to the studios is that under this transaction as contemplated a significant amount of money was going to be put on the table to enable the studio to be relieved of a portion of its P&A commitment. That was the real purpose of this transaction and it was the driver, and the amount of money was significant. The level of input had to be significant and therefore the borrowing was to enable [Gala] to contribute a significant sum…a £15 million fee would not have got Sony or any other studio to the negotiating table, if that’s all that they were going to benefit from.”

When it was put to him that he was speculating about Sony’s intentions he said he was not speaking for Sony or any other studio but “for the state of mind that existed on our side and what we needed to do to get Sony to the table, not only in relation to my negotiations with SPE and SPR, but it was clear to me that from discussions with all of the studios that volume was king”. He said that expression had been put to him. It was clearly made known to me that this transaction would only happen if “we were able to introduce volume”.

Mr Yusef emphasised that there was no circular movement of funds: (a) in fact the funds contributed by the members went to the expenditure account which was used to defray an amount deployed to defray the Gala Expenses, and (b) the amount that went from Sony to Barclays is not the same money that was raised by Gala. It was Sony’s own money.

He also stressed that the SG loans were full recourse loans but however small the risk was perceived at the time it was not entirely risk free as events showed. In the banking crisis, Barclays was able to continue functioning without resorting to a bail-out from the government, but those events (in 2006 to 2008) showed that a guarantee from a bank was not necessarily as copper bottom as you would imagine. He thought that a number of the investors were aware of that and he remembered having discussions with several of them who said they understood the LC arrangement was not without risk. Not all of the 65 members were investment bankers. In fact, quite a small number of them were.

In overall economic and commercial terms, SPR gained nothing from this aspect of the arrangements except the ability to fund the Deposit without an actual cost to it:

Gala and the members had no material risk of suffering an actual economic loss of £102 million. In economic and commercial terms:

We note that the overall arrangements could have operated in precisely the same way if Gala had been funded only by cash contributions and a much lower amount of Initial Expenditure had been provided.

SPR would have agreed, under the DA, to procure the issue of the LC, knowing that Barclays required it to provide the Deposit in order for Barclays to proceed to do so, unless SPR was simultaneously to receive from Gala a sum equal to the Deposit. That is particularly so given that the only material benefit Sony received from the Gala arrangements was £15 million (see section 9), and

Gala would have agreed, under the DA, to provide the Initial Expenditure unless it considered that would ensure that the LC, as a critical or fundamental part of the structure, would be issued to it. Invicta/Gala can hardly have expected SPR to be willing to provide the Deposit, without it being put in funds to do so, given they were evidently aware that the only benefit Sony would obtain from participating in the arrangements was £15 million.

We do not accept that, as far as Mr Yusef/Invicta/Gala were concerned, the principal purpose in taking out or arranging for SG loans of a total of £102 million and providing the Initial Expenditure of £102 million was to put Gala in a position where it could engage in a meaningful way with Sony, as Sony wanted to secure a large volume of funding for its distribution expenses:

It makes sense that a sub-distributor would agree to pay a distributor/licensor a shortfall guarantee and to support that obligation with a letter of credit (a) in return for the grant of a right to distribute films, on the basis that that right is potentially of value to it, and/or (b) in return for the provision by the distributor/licensor of something else of value to it under the relevant transactions. However, that is not the situation here: (i) the arrangements operated essentially simply to pass the Rights, in all material respects, from one Sony entity to another, via Gala; following closing, SPR was in substantially the same position as regards its entitlement to distribute the transaction films as it is reasonable to suppose the original Sony owner of those rights would have been in but for these transactions, and (ii) overall, the only material benefit that Sony received from its involvement with Gala was £15 million paid as licence fees to the licensors, in reality, as a fee for Sony’s participation in the structure (see, in particular, section 9).

Realistically, the shortfall guarantee and related security arrangements cannot be viewed, as Mr Yusef, in effect, suggested, as an arrangement made to secure payments which Gala hoped to realise under the waterfall in operating a trade of film distribution on the basis that Gala had put £102 million at risk or forked that sum out under the DA for the purposes of that trade. As set out above, (a) the very effect of these arrangements was that Gala did not put any part of the sum of £102 million at risk in the operation of any activity related to the distribution process, whether by funding SPR’s distribution activities to the tune of that sum or otherwise, and (b) Gala had no realistic prospect of receiving a share of Gross Receipts under the waterfall in excess of its notional entitlement to receive a sum equal to the approved Gala Expenses (see section 11).

first, an amount equal to 35% of the Gross Receipts “to be retained by SPR as a distribution fee”,

second, “an amount equal to all Participations payable in respect of the Pictures”, broadly being sums payable to persons such as actors, and

third, an amount equal to 10% of “the Distributor Exploitation Expenditure” in respect of the Pictures “to be retained by SPR as a marketing overhead charge”,

The fourth provision stated that (a) Gala was to receive an amount equal to 60% of the total “Cost of Production” of the “Pictures” less the total licence fees in respect of the “Pictures” (subject to certain provisos), which Gala was to pay to the licensors on the basis that each licensor was to receive a pro rata portion of such Gross Receipts according to the amount owed to that licensor relative to the total amount owed to all licensors until the Cost of Production of the “Pictures” was paid in full, and (b) Gala irrevocably directed and authorised SPR to pay such amounts directly to the licensors.

Mr Yusef said that (a) the reference to Gala in this provision is a mistake – the provision should say the relevant sum would be received by SPR - and that this was picked up by everybody at the time, and (b) this provision was the subject of heavy negotiation and that is why he knew that the mistake was known to everyone. In our view, however, the reference to Gala is unlikely to be a mistake given that this provision corresponds to the provision in the LAs which required Gala to pay such a sum to the licensors. In any event, it is clear that the relevant sum was to be retained ultimately by Sony group members whether payment had to be routed through Gala or not.

“Distribution Expenses” paid for by SPR from its own resources referred to in (a) clause 6.3.2, which applies where the Initial Expenditure for a Picture was not sufficient to pay for all of the Gala Expenses to be incurred in connection with that Picture and approved by Gala under clause 7, or (b) clause 6.4, which applies to expenses which did not constitute Gala Expenses.

“Distribution Expenses paid for by SPR from its own resources referred to in clauses 7.4 and 7.6.2, disapproved or not paid (as appropriate) by Gala because there was insufficient Distributor Exploitation Expenditure in respect of that Picture to pay for the same” (emphasis added). We find the highlighted wording difficult to make sense of. We note that:

“Distribution Expenses” incurred by SPR in respect of a “Picture” prior to the date of the LA relating to that “Picture”.

Under the sixth provision, Gala was entitled to an amount equal to the “Distributor Exploitation Expenditure” in respect of the “Pictures” expended on approved Gala Expenses, to be applied by Gala in recoupment of such expenditure.

This was subject to a proviso that, at SPR’s sole option, the sterling equivalent of all Gross Receipts payable to Gala pursuant to the waterfall (defined as “the Distributor Share”), up to but not exceeding an aggregate amount equal to the total of all “Distributor Exploitation Expenditure” put in the expenditure account on 2 December 2003 and 28 January 2004, could either be (a) paid to Gala, or (b) retained by SPR until the date upon which SPR was due to pay the Minimum Amount (pursuant to clause 9.4 of the DA) when it would be paid to Gala on the basis that “payment of the Minimum Amount includes amounts constituting the payment of such amount in full on such date”. Interest was to accrue on any such retained Distributor Share at an agreed rate and was payable as part of (and was included within) the Annual Royalty.

Mr Yusef said that the distribution expenditure that Gala was due to receive at this particular level was, in fact, guaranteed by the Minimum Amount and the proviso is in effect saying “because we are guaranteeing that you will receive a Minimum Amount, we don’t need to pay you monies that fall due until such time as that money equals the money that we have on deposit” under the LC, which supported the Minimum Sums. In our view, it is unrealistic to suppose that, if SPR were to receive Gross Receipts sufficient to trigger Gala’s entitlement under this clause before the end of the term of the DA, SPR would pay the relevant sum to Gala immediately rather than exercising its right to retain it until such time as the Minimum Amount was due (so that it would then be regarded as included in that amount). There is simply no commercial reason for SPR to want to make an earlier payment. Therefore, as a matter of commercial reality, we view Gala’s entitlement under this provision as notional. In practice, the effect of the sixth provision and the proviso is that (a) Gala was to receive a sum equal to the Initial Expenditure as the Minimum Amount, and (b) its entitlement to Gross Receipts under the remainder of the waterfall was not to take effect until there were sufficient Gross Receipts for it to receive notionally an amount equal to the Initial Expenditure/Minimum Amount.

Until Gala had received an amount equal to 2% of the “Members Equity Contributions”, namely, the total cash contributions of £25,168,254, (a) Gala was entitled to an amount equal to 30% of the “Distributor Portion” and (b) SPR was entitled to an amount equal to 70% of the “Distributor Portion” and to the balance of the Gross Receipts in excess of the “Distributor Portion”.

The “Distributor Portion” was a sum to be computed each and every time it was payable under the waterfall, as a percentage of the Gross Receipts relating to the “Pictures” which, when the computation was to be made, remained to be applied under the waterfall (after the payment in full of all prior payments and claims under the waterfall):

“equal to the percentage of the total Distribution Expenses in respect of the Pictures incurred (through the date of such computation) by Gala out of the Distributor Exploitation Expenditure.”

Using Sony’s figures the “Distributor Exploitation Expenditure” is $179,852,622 and, expressed as a percentage of the total “Distribution Expenses” of $387,021,098, the “Distributor Portion”, is 46.5%. This provision, therefore, entitled Gala to 13.95% (30% of the “Distributor Portion” of 46.5%) of the remaining Gross Receipts (after application of all the prior provisions) until it received 2% of the cash contributions, namely, as calculated by HMRC, £503,365 or $875,156.

This provided that SPR was entitled to an amount equal to “the SPR Discretionary Exploitation Expenditure”. This was, in respect of a “Picture”, the costs of distribution:

“paid for by SPR from its own resources referred to in clauses 7.4 and 7.6.2 but excluding those Distribution Expenses disapproved or not paid (as appropriate) by [Gala] and incurred by SPR because there was insufficient Distributor Exploitation Expenditure in respect of the Picture to pay for the same”.

Given the highlighted wording, this provision is premised on the basis that SPR may pay for “Distribution Expenses” falling within clauses 7.4 and 7.6.2 which are not captured within the second limb of the fifth provision. However, in light of the points we have made above on the interpretation of the highlighted wording (which mirrors that in the fifth provision), we cannot see what could fall within these clauses which would not fall within the second limb of the fifth provision. Therefore, it seems that in reality it is highly unlikely that there would be any sums which fall within this provision – as they would already be covered by the second limb of the fifth provision.

Under the tenth provision, until Gala had received under the seventh, ninth and this provision an aggregate amount equal to 8% of the total cash contributions, (a) Gala was entitled to an amount equal to 10% of the “Distributor Portion” and (b) SPR was entitled to an amount equal to 90% of the “Distributor Portion” and the balance of the Gross Receipts in excess of the “Distributor Portion”.

This entitled Gala to 4.65% (10% of 46.5%) of the remaining Gross Receipts (after application of the above provisions) up to an additional 3% of members’ contributions (which HMRC calculated to be £755,048 or $1,312,734). In total under the seventh, ninth and tenth provisions, as calculated by HMRC, Gala was entitled to a total of £2,013,460.

Finally, under the eleventh, provision (a) Gala was entitled to an amount equal to 1% of the “Distributor Portion”, and (b) SPR was entitled to an amount equal to 99% of the “Distributor Portion” and the balance of the Gross Receipts in excess of the “Distributor Portion”.

At this stage, therefore, Gala was entitled to 0.465% of the Gross Receipts remaining after the 35% distribution fee and Sony was entitled to the balance (in addition, of course, to the distribution fee). As calculated by HMRC, for every $1 entering the waterfall: (a) Sony was entitled to 35 cents under the first provision (as the distribution fee of 35%), (b) Gala was entitled to 0.465% of the remaining 65 cents (approximately 0.3 of a cent in every $1) and Sony was entitled to the balance, and (c) overall, therefore, Gala was entitled to 0.3% of the $1 and Sony is entitled to 99.7% of the $1, a profit sharing ratio of 1:334.

Gross Receipts of $735,640,830 (of which $644,352,882 were actual receipts to 31 March 2006 and the balance were projected receipts over the next 10 years).

A 35% distribution fee of $255,236,126 to be recouped under the first provision of the waterfall.

A total of $671,067,397 to be recouped from the Gross Receipts under the second to sixth provisions of the waterfall comprising (i) $56,796,771, as regards Participations, (ii) $18,012,262, as regards SPR’s marketing overhead charge, (iii) $205,554,401, as regards 60% of the total Cost of Production, (iv) $210,851,340, as regards “SPR’s Shortfall Exploitation Expenditure”, and (v) $179,852,622 of approved Gala Expenses.

On the basis of the above figures, the Gross Receipts are insufficient to cover $190,662,693 of the total sums to be recouped under the second to sixth provisions.

$1,032,411,380 of Gross Receipts would be needed so that, after Sony takes its 35% distribution fee, the remaining 65% of Gross Receipts would be sufficient for the full sums specified in the second to sixth provisions to be recouped:

For Gala to receive its full entitlement under the seventh to tenth provisions, assuming in Gala’s favour that Sony incurred no “SPR Discretionary Expenditure”, a further $75 million of Gross Receipts would be required:

At the end of the stages set out at (1) and (2), (a) for the full sums to be paid under the first to sixth provisions, and (b) for Gala to receive its full entitlement under the seventh, ninth and tenth provisions of $3,500,624 or £2,013,460, there would have to be total Gross Receipts of $1.1 billion.

Example 1: On the assumption that the Call Option was exercised in 2006 on payment of a price equal to the Minimum Amount and disregarding any Minimum Sums paid before the exercise of the Call Option:

Example 2: On the same assumptions as in example 1 but in this case, taking account of the Minimum Sums received prior to the exercise of the Call Option, as reducing the sums Gala would otherwise need to receive in order to make a profit:

The “circular” arrangements relating to the repayment of the SG loans had nothing to do with Gala’s alleged trade. They were put in place to inflate Gala’s alleged expenditure and so to increase the amount of the loss and the resulting tax relief for members. This is similar to the situation in Icebreaker 1 LLP v HMRC [2011] STC 1078 (UT) (“Icebreaker”) and Acornwood LLP and ors v HMRC [2016] STC 2317 (UT) (“Acornwood”), where it was held, broadly, that sums which LLPs claimed to have incurred wholly and exclusively for the purposes of a film distribution trade but which were guaranteed to be returned to the LLPs were not, on a realistic analysis, part of such a trade at all. In Icebreaker, for example Vos J held, at [64], (a) not only that the relevant sum was not so incurred but that indeed it was “not made for the film distribution trade at all”, and (b) it was made so that the LLP could be assured that it and, therefore, its members, would recover the loans that its members borrowed from the bank, and which had been used precisely to finance previously that sum by way of investment into the LLP: “The sum…was expended and disbursed for the sole purpose of investment and security and not for Icebreaker’s film trade properly so regarded.” We have set out further details of this case in Part D.

Further or alternatively, viewing the facts realistically, on the type of analysis in Ramsay, the Minimum Sums were matched by an equal liability under the SG loans owed, in effect, by Gala; such sums are not intended to be taken into account in computing “profit” as an excess of income over costs. In substance, Gala assumed the responsibility for the members’ SG loans, in particular, given that they were to be repaid from the Minimum Sums (see the description of the loan terms in section 3 of Part A).

Once he had been taken through the provisions, it was put to Mr Yusef that (a) the eleventh provision is a truly remarkable end to a truly remarkable waterfall: The initial major sums all go to Sony, sums go to Gala under the sixth provision but subject to the proviso, the sums under the seventh, ninth and tenth provisions give Gala “pitiful entitlements” to revenues until it has recovered an amount equal to 8% of £25 million and, under the eleventh provision, Gala gets 1% and SPR 99%, and (b) assuming that of every dollar that comes through the waterfall there is 65 cents left at the eleventh stage, Gala would get 1% of “Distributor Portion” (1% of 45%,), namely, 0.46% of the 65 cents or 0.299 of a cent of a dollar and Sony would get 99.7 % and the profit sharing ratio is 1 to Gala and 334 to Sony. He agreed with these ratios without questioning these figures or any hesitation.

It was put to Mr Yusef that the waterfall gives a result far away from the 30/70 split he said he was seeking under the tough negotiations he referred to (which HMRC do not in any event accept took place) and it is an “absolute joke”. He said:

He was asked how much Gross Receipts would need to come through the waterfall in order for Gala to receive a single penny. He said that “we went through that exercise at the time, and I presume so did [HL]” and for “Gala to receive an amount in excess of the amount that it put in, the Gross Receipts of all of the 6 pictures would have to exceed I think roughly a billion. I don’t have the sum.” It was put to him that there is no evidence of an extensive exercise. He said that:

It was put to him that Sony referred to the approved Gala Expenses as “SPR Exploitation Expenditure”. Mr Yusef said that this document was prepared by Sony’s accounts team, who are not used to this kind of transaction, and on the face of it they made a mistake; legally and accounting-wise it was not Sony’s expenditure. He said that there was also a mistake in that the 60% recoupment of production cost should be less the initial licence fees as was raised with Sony at the time.

It was put to him that these figures show that, even if around three-quarters of a billion comes through the waterfall, there is still a yawning gap to be measured in hundreds of millions before Gala gets a penny. He said that, apart from various mistakes, the document shows that the actual performance of the transaction films was three-quarters of a billion. However, in 2003/04, “when we were assessing the viability of these films from the point of view of Gala receiving profits”, Invicta was looking at whether Gala would receive sums under the waterfall in excess of the distribution expenditure that Gala, not SPR, directly incurred, plus the cash contributions. The document shows that they achieved three-quarters of what they hoped to achieve and, “in this industry a margin of error in terms of actuals and estimates of 25% to 30% is well within the margin of error. This is a highly volatile business.” He thought that as an industry position it is not a joke and it is not unreasonable.

He emphasised that the fact that the transaction films “did not perform as we had hoped was a disappointment to us, as it was a disappointment to Sony, but if they had achieved in excess of their projections they would have not only “made money - not a lot, but we would have made money” but also:

“our downside….was protected, first of all, by the amount that we restricted Sony in terms of their production recoupment and, secondly, because we had the downside protection of the tax. The combination of these three elements made this a very good deal for the investors.”

He agreed that, on the basis of the Sony figures, in order for Gala to recoup £102 million of Initial Expenditure/principal of the SG loans around a further 300 million of Gross Receipts (in addition to the $735,000,000 shown in the document) would need to come through the waterfall.

It was put to him that for Gala to receive a sum equal to the cash contributions of around £25 million prior to the Call Option being exercised in 2006, $7 billion would need to come through the waterfall. He asked for this to be explained. Counsel said he had been through every millimetre of the waterfall, shown Mr Yusef the relevant percentages and, on the basis of the Sony figures, Mr Yusef had agreed that to get to the starting blocks a billion of Gross Receipts would need to come through the waterfall. Counsel added that around $13 billion of Gross Receipts would need to come through the waterfall on the assumption that the Call Option was not exercised in 2006. Mr Yusef said that he did not recognise that “in terms of the exercise that we did at the time”. When it was put to him that there is no evidence of that exercise other than one page in HL’s letters, he said the letters cannot be just dismissed:

“They are not a fly by night firm. They would have looked at that. They would have looked at the waterfall. They would have examined the films,…and they would have come to the conclusion that we can make a profit.”

It was put to him that many billions of Gross Receipts would be required for Gala to receive £25 million but that is totally fantastical and in practice not a penny came through. Mr Yusef said that:

“in practice not a penny came through, because the films didn’t perform as projected, but the reality is, had they [performed as] projected, we think that we would have made a profit. That’s what we believed at the time…because of the work that we did and the appraisal that we received. That’s what we believed. If you are saying to me, "What you believe wasn’t correct", that’s a different matter, but what I believed, what Mr Ackerman believed and what [HL] believed was that based on that waterfall we would make a profit.”

It was put to him that he did not believe or was disinterested in a profit on the basis of film income and/or there was no possible rational basis for any such belief, as billions and billions of Gross Receipts would have to come through the waterfall for a profit to be realised and that, whilst the aspiration was a 30% profit share for Gala, the parties signed up to a profit share of less than a third of 1 cent. He said that he disagreed very strongly.

It was put to him that (a) from the INDb website there were $741 million of box office receipts in respect of the transaction films, (b) a letter from Mr Bold at SFP dated 18 October 2005 states that all the films apart from Breakin’ All the Rules were successful box office releases earning between them over 700 million and a further 300 million from home entertainment, and (b) the films were successful and the actual receipts were exactly in line with Sony’s projections. He said that “in terms of what we needed the films did not perform” and Sony’s predictions “were not our predictions” and:

“our predictions were based on the information that we got from Sony, plus also the projections that were made by Mr Ackerman and myself and the total bundle of analysis that was undertaken by [HL]. So for the films to perform to three-quarters of what we anticipated and hoped is I think a good result, not a bad result, but it nevertheless was not what we were hoping for…It was not Sony’s expectation that these films would only gross 750 million…”

He later noted that the figure Mr Bold referred to constitutes Sony’s gross receipts and not the Box Office receipts; first, there is the aggregate ticket price from which theatre owners take their cut which could be as much as 50%, depending on the film, then the distributor receives its share from which it pays the participants (people like the actors and the director) which is usually calculated by reference to box office receipts. So he thought Mr Bold’s reference to “Box Office” receipts is wrong but he is right to say that the films were successful in terms of the performance.

He added that (a) Sony’s document is not a prediction of receipts as such but a statement of actual receipts of Sony, as at March 2006, plus a projection of receipts for the next 10 years, whereas (b) “at the time we believed that….the slate of pictures could generate in excess of $1 billion” and in 2004 when they made their projections, they were not projecting income of 730 to 750 million but “monies far in excess of that as being the projected possibilities for those 6 films” and “that is a totally different exercise” and it was disappointing because that did not happen in terms of the actual performance. When it was put to him he had not put this figure in his statement and he was asked what the figure was that he hoped for, he said “we believed...we needed to get to break-even was 1.1 billion” and, when pressed on what he thought the films would result in “a low of 1.2 and a high of 1.5 billion…for the first cycle”. When it was put to him that would have left Gala billions and billions of pounds short of a profit, he said he did not agree and “we didn’t understand that to be the case at the time”.

He agreed that in order for Invicta, SG and Sony to get their fees from the scheme and for the members to obtain tax relief not a single ticket to a single cinema needed to be sold. He said, however, that Sony’s remuneration was in respect of the grant of rights under the LAs and was “always tied to the grant of rights rather than to the exploitation of the rights” thereby granted. It is not a studio benefit in the normal sense of leasing.

It was put to him that a slate wide profit was not something that was focused on or aimed, his statements that he negotiated a deal with Sony which would put Gala high up the food chain and would allow Gala to make a good return if Gala chose a commercial hit is demonstrably incorrect and Gala’s position under the waterfall was so poor that, despite Box Office returns of three quarters of a billion, Gala did not get a penny. He said it was the focus and they “put a lot of effort, time and reliance on the analysis that was made at the time”; Gala expended money:

“as an expense in the hope that that money would come by way of the waterfall, the bums on seats, as it were….we did a lot of analysis. We relied on the [HL] analysis, which had this waterfall. [HL] knew the aggregate amount of expenditure roughly that was projected to be spent, and we relied on that. As it turned out, the performance was not as hoped for. That’s all I can say about that, but to suggest…we were not interested in the profit motive, I can’t agree with that…”

When pressed, he said that Gala got all or most of its distribution expenditure:

“through the waterfall there was a recoupment of distribution expenses, which was guaranteed by letter of credit. So we didn’t receive that money only because it was going to flow through a different way, but to say that we didn’t receive that money one way or the other is not correct.”

It was put to him that all parties would have been in exactly the same position as they were in had not a single ticket had been sold to a single transaction film. He asked if counsel was looking at the situation at the end of the 2003/04 year or forever as he could give a different answer depending on what counsel meant. He then said “I would have to say no but I could have said yes if you had asked me a different question” and he hoped to clarify that later.

There was no realistic possibility that, by the time of the first exercise date, or when the Call Option was actually exercised, Gala would receive under the waterfall a share of Gross Receipts sufficient for Gala and the members to recoup their outlay under the structure in excess of £102 million, which the structure was designed to ensure was returned to Gala (plus interest thereon) regardless of the level of Gross Receipts; namely, a sum equal to the cash contributions of £25 million. That is the case whether or not the Minimum Sums are taken into account in the computations as income receipts of Gala.

There was no realistic possibility that, over term of the DA and beyond, Gala would make a profit in respect of the transactions, if the Minimum Sums are left out of account as income receipts of Gala (as we consider they should be for the purposes of the “with a view to profit” test (see Part C)).

It is reasonable to suppose that Sony was in the best position to produce actual and estimated figures of the relevant receipts and expenses and that it took reasonable care in doing so given (a) its status as a major film studio, (b) that it produced and marketed and distributed the transaction films and had all the relevant financial information, and (c) that Sony plainly had an interest in working out as accurate a position as possible as, on any view, it had a great deal at stake financially in relation to the exploitation and success of the transaction films. Mr Yusef said that Sony and Gala both initially estimated greater Gross Receipts than those shown in Sony’s figures. However, as set out below, (i) there is no evidence of, or of any viable basis for, any such higher estimates, (ii) Sony’s figures correspond broadly to what was actually achieved and, (iii) in any event, assessing the position as set out in [330], Mr Yusef’s estimated higher Gross Receipts are still fall far short of what was required for Gala and/or the members to make a profit/return from Gala’s share of them.

We have concluded in section 15 that Invicta/Gala structured the arrangements so that it was inevitable that SPE would exercise the Call Option at an early stage (and that was how Invicta/Gala intended to ensure that the members would make a positive return from the transaction in the form of the tax benefit). As set out in section 4, our view is that a “business” such as Gala and a reasonable investor in it, who had a serious interest in whether and to what extent the “business”/the investor could make a profit/return from a purported trade of film distribution (a) would realise from the design of the arrangements, at least that it was likely (if not inevitable), that Sony would exercise the Call Option as soon as possible, and (b) therefore, would want to consider the likely level of Gross Receipts and Gala’s likely share of them as at the first exercise date (albeit that they may want further assessments by reference to later dates). See also our conclusions on the trade issue and the “with a view to profit” issue in Part C.

Total Gross Receipts of $1,032,411,380 would be required for the sums referred to in the second to sixth provision of the waterfall to be paid in full.

Total Gross Receipts of $1.1 billion would be required for Gala to receive its full entitlement to $3,500,624 or £2,013,460 under the seventh, ninth and tenth provisions of the waterfall.

Total Gross Receipts of $13.5 billion (if Minimum Sums paid prior to exercise of the Call Option are not taken into account as receipts of Gala) or $7.1 billion (if such Minimum Sums are taken into account as receipts of Gala) would be required for Gala to recoup its expenditure of around £15 million on the licence fees and of £8.8 million on Invicta’s fees.

These sums are far in excess of (a) the expected Gross Receipts which Sony’s calculations show of around $735,000,000, (b) the actual receipts of around $741,000,000 from box office receipts and around $300,000,000 from other exploitation, and (c) the Gross Receipts Mr Yusef said Invicta/Gala estimated would arise as set out below. In fact, Gala did not receive a penny under the waterfall, even though the transaction films were regarded as “successful” (as set out in Mr Bold’s letter) and the transaction films generated sums in line with Sony’s predictions.

At no time in his lengthy statement did Mr Yusef explain precisely what he/Invicta/Gala/HL considered or estimated, when the arrangements were put in place, as regards the likely level of Gross Receipts from the transaction films, what Gala may receive as its share under the waterfall or what level of Gross Receipts was required to enable Gala/the members to recoup their full outlay under the transactions, whether over the term of the transactions or by the time of the first exercise date. It was only at the hearing that (a) when questioned on the IM, he suggested that Gala expected to realise Gross Receipts in excess of those shown in scenario 3 (see section 4), (b) when questioned on the HL letters, he referred to HL coming up with a figure of just under $1 billion of Gross Receipts for Gala to receive sums in excess of the Initial Expenditure (see section 6), (b) when cross-examined in relation to the waterfall, he initially gave a figure of over $1 billion of Gross Receipts and said he did not have the sum but added later, as though he were certain of the position, that the figure “we believed...we needed to get to break-even was $1.1 billion” and, when pressed, the figure Invicta/Gala thought would be achieved was a low of $1.2 and a high of $1.5 billion of Gross Receipts for the first cycle on the basis, so he said, of a very extensive exercise carried out by Invicta with HL and Mr Ackerman. He asserted, therefore, that the transaction films did not perform as expected although he considered that what was achieved was still a good result in a volatile industry.

Nor did Mr Yusef mention in his witness statement (a) what the actual ratio for sharing “Gross Receipts” was under the terms of the waterfall, (b) why it was he apparently thought that a 30/70 ratio could be achieved or that this was “tempting” for Sony (see [92]) in light of the huge disparity compared with the actual ratio ultimately achieved, and/or (c) what difference confining SPR’s recoupment of “Production Costs” was likely to make to Gala’s overall position in the waterfall given the rest of its terms.

As set out below, Invicta/Gala did not make any realistic appraisal of Gala’s prospects of receiving Gross Receipts.

Mr Yusef’s evidence on the figures he gave regarding Gross Receipts is unreliable given (a) that he did not include these figures in his statement and did not explain that a 30/70 ratio for sharing Gross Receipts was not achieved, (b) the changes in his evidence on the likely level, and Gala’s estimated share, of Gross Receipts, (c) the lack of any mention of these figures in the documentary evidence, (d) as set out in sections 6 and 13, the lack of evidence that Invicta/Gala in fact carried out any exercise which enabled them to make a realistic assessment of what may come to Gala through the waterfall, whether through HL or otherwise, and (e) that he presented Mr Ackerman as having carried out or been involved in such an assessment when, in fact, as Mr Ackerman was very clear, he did not do so and Mr Yusef knew that was not Mr Ackerman’s role. On Mr Ackerman’s evidence, Mr Yusef deliberately kept Mr Ackerman’s role and that of HL separate and Mr Ackerman only attended one meeting with HL. We refer also to our comments on Mr Yusef’s credibility as a witness at [337].

In any event, as set out above, Mr Yusef’s own estimated figures of likely Gross Receipts of $1.1 to $1.5 billion do not provide a reasonable basis for the proposition that Gala and/or the members had a realistic prospect of making a profit/return through Gala’s receipt of a share of Gross Receipts.

As HMRC illustrated, in going through the terms of the waterfall and, as Mr Yusef accepted in cross-examination, the actual ratio for sharing “Gross Receipts” amounts to nothing like a 30/70 split (after various deductions). Mr Yusef maintained that the waterfall was a good deal for Gala on the basis that it was an achievement to obtain SPR’s agreement to limit its recoupment of “Production Costs” and to pay the Minimum Sums (as supported by the security arrangements) thereby providing the members with “downside protection”. Mr Vallat relied on these factors in support of his submission that the waterfall was commercial, and Gala/Invicta expected to make a profit under it. However, (a) in our view, any benefit for Gala from limiting SPR’s recoupment of “Production Costs” is so theoretical as to be illusory, given that, as the waterfall otherwise operates, for Gala/the members to make a profit/return from Gala’s share of Gross Receipts would require such vastly greater Gross Receipts to be generated than those actually realised or those which Mr Yusef states were estimated, and (b) as set out in section 10, the Minimum Sums and related security arrangements were plainly included in the structure as part of the arrangements for Gala to seek to generate an enhanced “self-funded” loss of the desired amount without Gala/the members having a material risk of a corresponding economic loss.

We consider that, when the transactions were completed, either (a) Mr Yusef was aware of the real scale of Gross Receipts that would need to come through the waterfall for Gala and/or the members to make a profit/return from such receipts (whether looking at the position if the Call Option was exercised at the first exercise date or the position if the arrangements stayed in place for a longer period), or (b) if he was not so aware, that lack of awareness can only be explained on the basis that he was indifferent to and disinterested in what would be needed.

As regards our conclusion in (1)(a), we note that (a) Mr Yusef plainly understood how the waterfall operated and what the ultimate ratio for sharing Gross Receipts was. As noted, he said he found the waterfall simple to understand, (b) he/Invicta designed and put the arrangements in place, (c) on his own evidence, he/Invicta/Gala received full relevant financial information from Sony, such as information on the level of Participations and overall distribution expenses, (d) for the reasons set out in section 15, it is implausible that Mr Yusef did not expect SPE to exercise the Call Option on the first exercise date, in particular, given that he designed the arrangements to have run their course by around the end of the 2003/04 tax year and he/Invicta operated Gala on that basis, and (e) in light of the points made in (a) and (b), it is also implausible that he did not understand that, on exercise of the Call Option on or around that date, Gross Receipts of $1.1 to $1.5 billion would leave Gala billions of pounds short of making a profit (and of the members making a return but for the effect of the tax relief).

As regards our conclusion in (1)(b) we note that (a) even if Mr Yusef did not focus on the precise figures, he was evidently aware that the terms of the waterfall fell far short of what he said he tried to achieve in terms of a 30/70 profit sharing ratio. In light of the points made in [335(3)] above, his asserted belief that the waterfall achieved a good result for Gala is implausible, (b) for the reasons already given, we do not accept that Mr Yusef/Invicta had negotiations with Sony on the terms of the waterfall as he set out, and (c) neither he nor anyone else involved in the Gala arrangements sought to make or obtain a meaningful appraisal of Gala’s prospects of receiving Gross Receipts under the waterfall whether by reference to the first exercise date or otherwise (see section 7, section 13 (at [385] to [397]) and our conclusions in Part C).

For all the reasons set out in section 15 (and see our conclusions in Part C), Mr Yusef’s lack of concern with the likely level of Gross Receipts and what share of those receipts Gala may receive under the waterfall and with obtaining a meaningful appraisal in that regard is explicable by the fact that he/Invicta/Gala intended and expected that the members would make a return from the tax relief claimed in respect of the loss alone, on the basis that they designed the arrangements so that it was inevitable that SPE would exercise the Call Option as soon as it could so that the members would obtain the tax benefit.

We have set out in section 13 why we do not accept that the work done by, and appraisals received from, Mr Ackerman and HL provide a basis for Mr Yusef’s/Invicta’s/Gala’s apparent belief that the films would make a profit for Gala.

We have set out in sections 2, 9, 10 and 15 why we do not accept Mr Yusef’s evidence that the vision was that this was just Gala’s first phase, Sony were not interested in a deal for an upfront licence fee of £15 million but in a long-term arrangement for the reasons he set out, and the primary motivation behind obtaining the SG loans was to raise enough money for Gala to make an impact and not to inflate the loss.

We have set out in section 4 why we do not accept that Gala has shown that, had the transactions been solely about achieving a tax advantage, this could have been achieved much more simply, without the effort that Gala went to.

It is apparent from the discussion above, why we do not accept Mr Yusef’s evidence that the actual Gross Receipts fell within the 25-30% margin of error in relation to a £1 billion estimate and was a good result for Gala albeit it was not what Gala had initially hoped for.

Mr Vallat noted that Gala negotiated that under the waterfall Sony would recoup some of its expenditure on distribution expenses only under the eighth provision. However, as explained above, we cannot see realistically what could fall within the eighth provision which would not be captured within the fifth provision.

Mr Vallat said that Gala aimed for a 30:70 profit share but this was only achieved in a limited fashion in the first iteration of the deal. It is plain that in fact there was no 30:70 split of Gross Receipts at any point in the waterfall in any fashion.

Mr Yusef agreed that the waterfall is cross-collateralised in the sense that if Gala was involved in 2 films and one was successful and the other unsuccessful, Gala’s share of any Gross Receipts would be reduced by virtue of the less successful film. He noted that it “works the other way too, of course”.

It was put to Mr Yusef that: If films, A, B and C, each cost 100 and generate 200, 10 and 10 of Gross Receipts respectively (a) if there is a separate waterfall for each film, A would receive 100 of Gross Receipts but B and C would receive nothing, and (b) if there is a single waterfall with cross-collateralisation, no money would come through the waterfall at all as there is aggregate expenditure of 300 and aggregate Gross Receipts of 120. He said that is not how it works, counsel had given “a very advantageous example” and it could also be the opposite and:

“The objective of cross-collateralisation is to use the profits of one to subsidize the losses of the other. But also, the objective is to maximise profits over a portfolio of films so that you’re not dependent on the performance of one to get results. This is a very speculative business. Even the most fancied of films can often, because they also tend to be very expensive...end up not making the kind of profits that one would expect…the whole concept of cross-collateralisation is the reason why studios are profitable. If they had to put all of their money on each occasion on the performance of each of the films that they make, their profitability would be less assured. So what we were trying to do was exactly that; it was spread our bets. That is a prudent thing to do. It is also...an industry accepted way of investing in film distribution. We didn’t invent this concept. It’s something that we simply followed.”

He added that counsel’s example is arithmetically correct but there would be other circumstances where that example would not work and:

“cross-collateralisation does not always have the result that you are claiming. It’s not a given fact that every single circumstance where you have a slate of films it is bound to work in the way you have suggested.”

It was put to him that you do not spread your bets by aggregating expenditure and performance but by having separate waterfalls and that would be the commercially sensible thing to do. He said that in his experience it would be “very, very rare....to have a slate of films where the investors would...uncross-collateralise” and it would not be sound. He had never come across it and most people in the film industry would say, from a finance point of view, that it makes more sense to aggregate or cross-collateralise not just expenses but also profit potential. In the end, over time, the experience in the industry has been that that is a sounder way to invest in a portfolio than in a single picture enterprise.

He did not agree “as strongly as it is possible for me to do so” that if there was a serious interest in making profit from film receipts, cross collateralisation would not have been a feature of the arrangements. He said that (a) it would not have been normal or wise, to enter into a single picture programme at any level, (b) the portfolio method of investment in film, which is a highly speculative business, is definitely the standard method of operation, and (c) anybody who sought to invest on a single picture programme would not be in a serious pursuit of profit, because it is not normal. This is not what happens in the industry. What Gala did was completely in conformity, in terms of a methodology of investment, with what anybody else would do in similar circumstances.

He agreed that he did not suggest a single picture programme but said that was for a good reason as he had already set out. He added that he would have had less trouble getting the deal across the table, from a studio point of view. They would have been happy with that “because over a period of time and over a slate, that would have been better for them. Worse for us; worse for Gala.”

It was put to him that (a) advising on film selection and reviewing the Initial Plans was not part of LBPC’s contractual obligations (and he had agreed the LBPC agreement accurately reflected his obligations) and (b) in any event, LBPC did not do this pursuant to the LBPC agreement as regards the first transaction films, given that it was executed only one day prior to the execution of the relevant LAs and the DA and that the DA specified that the Initial Plans had to be agreed before the LAs were granted. He seemed to agree that is correct but said that, during the period from the late summer 2003 until 1 December 2003, he did “review a substantial number of films...and made recommendations to Invicta as to which ones would be potentially good investments and which would not”, and he thought that there is ample documentation to that effect and “in entering into any investment agreement or trade with a studio it would be very unusual to not see...an initial marketing plan or distribution plan. Distribution is a core part of trading in media, and it is a dynamic side of media business. It changes in realtime with the marketplace”.

He added that he believed that the relevant provisions in the LBPC agreement “speak to my activities on films other than” the 3 first transaction films listed in that agreement and he read it as him providing services for the additional films as they were clearly part of the overall trading activity that was involved with the parties involved (Invicta, Gala and Sony). He agreed that the LBPC agreement runs from the day before the first transaction films were signed up.

The December letters were sent following his review of Sony’s Initial Plans which are the final pre-release plans to allocate distribution expenditure between locations and types of data intended to best capture the target audience for the film based on significant research by the studio and using data in respect of suitable comparators. Following that Initial Plan, “there will be a series of adjustments in real time to deal with market issues and looking at boosting spend in certain areas and diminishing it in others”. Such adjustments would differ greatly depending on the film and competition in the market. The Initial Plans that were developed were “nevertheless very sophisticated and well thought through so changes would typically be as a result of market factors”.

In his conclusions in the letters he was looking at the deployment of the media spend across various different categories and considering the chances of commercial success in light of this in the marketplace. Whilst this opinion is subjective it is “underpinned by a considerable amount of data and applying the wealth of my experience in the film industry”. He agreed at the hearing that he had not produced this data with his witness statement. Whilst the letters are in the same format, they are more of a formal record and were sent following a number of discussions with Mr Yusef and Mr Bamford regarding the content of the Initial Plans following his reviews and meetings with Sony. He also sent them key documents, such as the Initial Plans, so they would have had the opportunity to ask him questions on this prior to the letter.

He exhibited what he described as a “Greenlight Budget” for You Got Served which he said forms part of an example of Sony’s Initial Plans. This is essentially “the final go-ahead for the marketing spend for the film, setting out the amount of money that the studio feels is appropriate for marketing the movie to achieve the desired revenue results. These documents will generally provide broad details of the film.., the target release revenue and detail the estimated spend for P&A”. He would have reviewed equivalent documents and information for each of the films.

He noted that:

He said that (a) the letter of 5 December 2003 relating to Big Fish was “written following multiple meetings with the Sony marketing team” and during those meetings, which took place probably a month or even 2 months preceding this letter, “there were multiple variations to the marketing plan for this film” that he was consulted on by Sony, (b) he also had established by that point an independent relationship with McCann Erickson, who was the media buyer for Sony, and (c) the letter is written on the basis of having had a number of phone conversations with both Mr Yusef and Mr Bamford about those variations in different plans:

“The data and the granular activity of those marketing plans, it was my responsibility to identify and point that out to them, which I would have done in multiple calls with them and which I would also discuss with the Sony team.”

He added that he considered that it was a “unique” feature of the deal with Sony (as compared to trading with another studio) that:

“the head of distribution and the head of business affairs invited me to participate as a member of their distribution team and their meetings. I was free to comment and to advise and participate in discussions that were not made by one person. They were made by a team of people, of which I participated on, and which would involve, as I said before a dynamic market. As a film comes close to a theatrical release, many factors are involved in the media by the advertising plans, and they change sometimes week by week and day-to

-day during the initial release of the picture. All of that would have been covered in my work prior to issuing a letter like this.”

He agreed that the LA for “Big Fish” was entered into on 2 December before he sent his letter on 5 December 2003. It was put to him that as approval of the Initial Plan was a pre-condition of SPE entering into that agreement, necessarily that approval had already been given before he wrote this letter. He said that such a requirement is customary in entering into any engagement with a studio and one:

“would want to see what the very basic initial plan was, and... the marketplace is extremely dynamic and changes week to week and day by day, and it is those variations that determine the success or failure of a film as it is placed in the distribution network a studio has.”

When it was put to him that this letter is necessarily immaterial to Gala signing up to the agreement, he said that he provided it:

“on the basis of having done the work that I was asked to do with Sony and provide an opinion. We did so as soon as we could. As to the timing of Gala’s commitments or Invicta’s commitments with Gala here, I can’t comment on what the situation was here in the UK.”

He said that the December letter relating to 50 First Dates was again referencing the work he would have done in the preceding month or 2 with the Sony marketing team, and “this would be referring to a marketing plan that has now changed very significantly from the initial marketing plan, and this would be a letter on my behalf recommending to London that the changes I have monitored and participated in are worthwhile…” He said that he used the term “initial marketing plan” just then as “the very generalised first entry level concept Sony would have provided when he first looked at the screenplays and:

“We looked at the cast, the budget, the financial paradigm of each movie. The initial marketing plan that is referred to in this letter from me on December 14th would be referring to the plan that had been developed since that very first initiation by Sony....However, this initial marketing plan [referred to in the December letter] would be….a very considerable number of iterations from what we first looked at, and this word "initial" plan would refer to what happens next, as the movie now goes into a theatrical release activity...”

He added that Mr Yusef and Mr Bamford had been kept informed by him in several consecutive months prior to this letter being issued of his multiple meetings with the Sony marketing team and noted that:

“we would have had more than bi-weekly, probably 4 times a week, phone conversations as to what had been discussed in each of those meetings....I would usually have a meeting either around 10.00 in the morning at Sony or..; around 4.00 in the afternoon. Those meetings would be 2 to sometimes 4 times a week and I usually would call either Mr Bamford or Mr Yusef the following day to discuss with them what had been addressed at those meetings. Therefore, this letter, while it appears extremely brief, has background to it both in our files, in the business that we were conducting at the time.”

He did not agree that the letters relating to the first transaction films are of no practical import. He said that they “followed extensive work and extensive communication and extensive documentation to multiple different variants of the marketing plan with the Sony marketing team”. When pressed, he said:

“Again I find that statement difficult to accept. In terms of the dates, I see what you are alluding to, but in terms of the background of these letters, which needs to be taken into account, I beg to differ in that there was again extensive activity in connection with the marketing plans and with the studio prior to these letters being signed. So Mr Yusef and Mr Bamford would have been intimately aware of the same details in the various workups of the marketing plan by Sony from the period following our initial receipt of screenplays to the date of this letter. I am certain that all of that information and data was taken into consideration by people here in London when they entered into their agreements with parties here.”

When it was put to him that the letters in relation to the first transaction films were of no consequence and were “window dressing”, he said that he strongly disagreed and:

“These letters were provided as soon as was feasibly possible based, as I have said previously, on my work with the Distribution Department at Sony and the many iterations that were flowing from those meetings, all of which I shared on a bi-weekly, four times weekly basis with Mr Bamford and Mr Yusef. They are extensive, voluminous files documenting different changes in radio, media buying. There is a process in which I am involved, as I mentioned before, with McCann Erickson, to make sure that the accounting that Sony is using in terms of the cost of different media buying is being adhered to, and most people never get that level of access in a studio's distribution and financial systems.....They are of consequence, because they follow an extensive amount of work on my behalf with the studio and I am only issuing a letter at which point I feel that the studio has said “We now have the plan, the optimal plan and we are moving forward”. That’s not to be confused with a decision that has already been made to distribute the movie, but the refinements to create a profitable enterprise with each film in question has reached a point where they feel they are ready to exploit the property.”

It was put to him that this is simply an internal communication from May 2003 in which there is a statement that the media plan and basics for this release will be similar to that of Breakup Handbook. When asked where these items can be found, he said they would have been in the extensive filing in the offices in Los Angeles and that the iterations of the media plan leading up to when the film is released by the studio “are telephone book size documents of data and financial planning”. All of that was part of the filing system that was established in LBPC’s offices and he went as far as possible, with consultation from Sony, to duplicate their filing system so that when he was in conversations with their team, it was easy for him to refer to an iteration quickly. After he finished his contract with Invicta he “continued to store those files for Invicta for many years and it was in 2018 I believe that we shipped all of those files and all the data that was part of those files to London at the request of Mr Yusef”.

When it was put to him that the budget is not a Plan, he said that it is the “framework of the marketing plan” and that in referring to a “framework” he was looking at the comparative analysis referred to in the correspondence from Ms Cathy Schengen of 22 May 2003. She would have agreed with the head of marketing, Mr Smith, a “comparative analysis in marketing between these films, be that for genre, budget. It could be for a number of different reasons. They are making an allocation that again will then change as things go forward in realtime….”.

He added that the difficulty is “you are looking for a definitive document that is a single marketing plan” whereas his understanding of a Plan based on his involvement with the marketing department is that:

“that is a plan that is evolving over time, again because of the dynamic nature of the market, and I would say probably on this film alone there was probably several boxes of files based on McCann Erickson data expenditures, shifting decisions based on artwork, shifting decisions based on other factors in terms of messaging, be that in whatever media might have been the case. At the end of the day all of that material together would support this framework agreement, which is the departing point and driving forward in realtime. At the time at which I would have written my letter in December, I would have had access to a lot of the dynamic nature of that material.”

He was asked why he said on a number of occasions that he would have done something or something would have happened. He said he used the word “would” as meaning “I would have. In other words, meaning it did happen”.

In examination in chief he said he wanted to clarify that (a) there is a timing issue, but (b) Mr Ackerman had already provided an analysis of the relevant points before the documents were executed and after the execution of the documents, “we refreshed the analysis in order to bring the analysis up-to-date” and “make sure we were still happy with it”.

In cross-examination, he insisted that the approval of the Initial Plans would have been given by 2 December 2003 because Mr Ackerman “will have done the work before that date and would have advised us accordingly”. So whilst the “paperwork might not match we would not have entered into that document for that film unless the work that I know for a fact that he was doing had actually been done”. He said, speaking as the business mind of Gala it is “inconceivable” that:

“we would have received the letter on the 15th in relation to something that we say that we approved a week before, unless we actually had a basis on which to do that. We wouldn’t have just approved those documents without having had the benefit of Mr Ackerman’s advice prior to that date…, he did a lot of meaningful work. It wasn’t window-dressing, as you have suggested….I do think that the work that was done was certainly done before we entered into those agreements. The documents don’t reflect that, but I do not believe for a moment that we would have entered into the [DA] blind, without any reference to the marketing plans, because we spent so much time on them. The documents don’t reflect the work that was actually done in terms of the dates. I accept there’s a discrepancy of the dates but I don’t accept...that the work could not have been done prior to the 2^nd...”

In re-examination he said that these letters were, as far as he and Mr Ackerman were concerned “a recording or memorialisation of what we actually discussed or agreed prior to that time”. So to the extent that they post-dated 2 December they were “always a recording of what was actually agreed prior to closing. It is just inconceivable and not possible for us to simply on the day pitch up to the closing and…agree not just on a slate but all the other aspects that Mr Ackerman was involved with, without having had the prior discussions and agreement”. So in each case:

“we knew what Mr Ackerman’s recommendations would be, and the document is simply a recording of what was actually agreed prior to whatever date it may be. So the date itself is not the first date that we were made aware of his recommendation in relation to whichever part of the slate that the letter refers to.”

He said that “the commercial potential was tracking weaker than Sony I think had been hoping for” and he would have made that assessment in his research work in talking to parties not only at Sony but also outside and independent of Sony including agencies. He thought that it might have included Mr Depp’s own agent and their opinion about the film and how much support Mr Depp would give to the Plans for the film and he would have had the opinion of other professionals in the industry that he might have spoken to who knew and heard what the potential of the film was. So the phrase “weakening commercial potential of the film” incorporates “all of those different types of research into making an assessment like this…there are many reasons that a film’s commercial potential can change as it is being prepared for the marketplace..”

He added that in the letter he was trying to be effective in his communication to Mr Yusef and Mr Bamford, and he believed they both are well aware of what is involved in the phrase “commercial potential” or “weakening commercial potential”, and they certainly would have been aware of that based on the conversations he had with them.

He would have seen the waterfall by the time it was agreed, he participated in discussions as it was being negotiated, he was not party to all of the calls between London and Los Angeles on the finalisation of the waterfall but the DA would have been included in the documentation that was kept in the office, and he would have looked at it.

He was focused on the films and on trying to ensure that the relationship between Sony and Gala generated profit for both parties, and was tasked with advising Mr Yusef, acting on behalf of Gala, as to decisions on expenditure. He does not profess to know more about distribution specifics than a head of distribution like Mr Smith. However, he participated in meetings that he ran and was invited and authorised by Sony to make comments and contributions and changes in the various plans:

“So in any given film there would be put multiple plans. Some had significant variations, others less varied, but again a dynamic market based on pricing, based on the performance of other studio films at the time, all of which were being assessed from a financial point of view, as the point here was to make money. So the financial aspect of the film business is what ultimately really drives the business.”

He confirmed that he was not involved in financial modelling in London over what Gala would get through the waterfall based on certain premises. This evidence accords with his earlier evidence on the limits of his role compared with that of HL.

He initially said that any variation of an expenditure plan necessarily involves different monetary amounts, and in referring in the letter to monetary sums he was referring “to multiple plans that have been worked on with Sony, and where I become concerned that perhaps those plans are becoming more risky than originally hoped due to the troubled position of this particular film going into the market”.

He accepted that the premise of the letter is that but for his recommendation Gala would commit to a higher sum but added that the letter also reflects “a standard and frequent occurrence” in the film industry about which he was voicing concern in the letter that:

“often a studio if they have a film which is not a rip-roaring success out of the gate or that has tracking that is off the charts and they are...experts in that tracking, different distribution teams will make different types of educated decisions which are calculated risk. Those decisions may involve spending over and above their original marketing budget in order and with the belief of the executive or the team that by pushing more money into this film and creating more exposure, they will ride out and be able to lift the film. That is borne out again and again as a very standard occurrence in the motion picture industry. Sometimes it succeeds and other times it fails, and here in this letter I am recommending to Gala that whatever may go forward not to get drawn into that potential process, to try to cap its involvement.”

Much of the detail would have been discussed and agreed prior to the relevant date and “these numbers don’t just get created out of thin air and in isolation” but are the subject of several meetings and conference calls and dates have to be considered:

“within the context of that commercial reality. Numbers do not just get magicked up at the last minute...and very often the letters and the agreements are formalisations of what has been understood and agreed between the parties over a relatively long period of time.”

He agreed there is no document evidencing this but said the transaction documents could not have been executed unless the parties had a settled understanding of what their contents would be; the material terms were not agreed within a day or so of them being entered into. There was an ongoing, moving understanding of what the deal between the parties would be, but most importantly, Mr Ackerman as well as other members of the team would have known (a) the gross amount of expenditure contemplated in the Plans which he worked on with Invicta, which must have been approved and arrived at before the formal exchange of the DA because it is not a small incidental matter, and (b) the portion that Gala committed to in the formal agreements was a matter which was settled long before those agreements were entered into. So, in making recommendations in this letter, Mr Ackerman would have understood the amount of global and individual commitment.

He added that you cannot look at the date of the agreement in isolation; in order to “agree a fundamental point such as this it is necessarily the case that the parties would have reached that understanding prior to that date” given it was not just an incidental point. He said that it was the subject of several conference calls and personal meetings, some of which he attended and some of which Mr Ackerman attended where these material issues were discussed and the evidence for this lies in what actually happened:

“The way it works is that the decisions were made over several meetings and over several conference calls….some of which Mr Ackerman attended. Others it was meetings between me, Mr Bamford and…David Davis at [HL]… and all of those were memorialised not in a minute but in the agreement that was eventually signed.”

He said that the issues that came up for discussion at the time were (a) “whether or not additional expenditure should be incurred not just in relation to this film but any other films that may come within the slate” which would require additional funding in Gala, and (b) how much should be allocated to this film as opposed to other films. He added that they made the decision, “not to put all our eggs in one basket, as it were” so this issue of how much to spend on this film was a live issue.

Mr Ackerman said:

Mr Yusef said the point was that “the discussions were about whether or not we should be, as was indicated, finding a way to spend more”. He said that there was talk about raising more money and it was a question of whether Gala should increase the amount of expenditure that was being suggested at the time. His recollection is that Sony’s concern was to look at whether more should be spent, not less. Gala’s position was based on the advice of Mr Ackerman that the picture was unlikely to perform in the way that everybody had expected. So “it’s not a question of whether we should have spent 26.9 or not. It was a question of whether we should increase the amount of expenditure that was being suggested at the time”.

He said that he was aware that the slate was aggregated or cross-collateralised. That is a standard practice in slate financing with studios, and:

“the commercial performance of individual films would have an impact on the results of such cross collateralisation. If you invested in films that were all losers, you would do very badly. If you invested in films that were all winners, you would be better than making 6 Titanics. If you invested in a slate that was a mixed bag, as is generally the case with the motion picture industry, you would have some that performed well and that carried others that performed less well, and that would be determined in the cross-collateralisation, not to be confused with a waterfall structure, which is separate from cross-collateralisation, or an additional component of a commercial venture with a studio partner.”

He suggested that the notional allocation made a difference “in the end result” but did not give any clear or coherent explanation as to why that is the case. He commented that:

He said Gala spent more on the film than he recommended but the advice was followed in that “they did not commit to going out to raise more money and go deeper into supporting a film in partnership with Sony that I had said “don't go there””. He said he wrote the letter for the reasons set out in it and it was his remit and responsibility towards Gala and directly towards Invicta to provide commercial assessments on a picture-by-picture basis with a view to trying to maximise the investments that Gala was making in these pictures. He thought “we did a good job of that” and believed:

“Gala’s P&A business by nature is a commercial enterprise, it is last money in, first money out....So if you want to compare it to an investment in production where you would have a far longer tail and a far greater number of variables to assess on an ongoing basis, yes, you would have a greater share of profits because you are in a longer stream, but the actual cost of money would be far greater in the scheme of things. In the P&A business you have the advantage of seeing the product, seeing the scripts, knowing where the talent is in realtime in terms of reputation and star appeal, and you are able to participate in this case, which was exceptional at Sony, to a very significant degree in the marketing plans and the making of those marketing plans, and then in terms of the joint expenditure supporting those plans.”

When it was put to Mr Ackerman that the idea of Gala “going deeper” and raising more money is an invention, he said he thought initially Gala had hoped to raise £250 million but raised less. So his original support team proposal was probably made on the basis of £250 million expenditure but when it was clear that Gala would invest less and was being more cautious, “we downsized the team accordingly. That saved overheads and was what both Mr Yusef and Mr Bamford wanted”. He was aware through the trajectory of the process that Gala hoped to raise additional funds but did not know if that would have been done through Gala or another LLP. When he wrote this letter he did not know one way or the other whether Gala would or would not be raising further funds.

He did not agree that Gala’s rights under the waterfall worked on the basis that all of Gala’s so-called expenditure was aggregated: (a) In each case, there was an agreement on how much would be spent on (i) the licence for a film and (ii) the expenditure for that specific film, and (b) the gross receipts and the gross distribution expenses are cross-collateralised so that the expenses relating to one film which are not recouped from receipts for that film, could be relieved as expenses of gross receipts from the other films.

He disagreed with the proposition that the notional allocation of expenditure between films, as he described it, is an empty exercise. He did not accept that whether Gala allocated less expenditure to Secret Window and more to Breakin’ All the Rules” would not have made any difference at all to Gala as all of the expenditure allocated to all of the films was aggregated for the purposes of calculating Gala’s entitlement under the waterfall. He did not, however, give any reason for his view which makes any sense in the context of how the Gala arrangements operate. He said that:

He seemed to agree that if Gala reduced its contribution to distribution expenses, Sony would just pay the remainder and, under the waterfall, would recoup that from the Gross Receipts before Gala got anything. He said that is not something Gala would want to happen but agreed that this was not within his control. He added:

“but before that happens the important stage is that we would have the right to spend the money and if we had made an informed decision not to, then and only then would the right to spend the money fall on Sony…They even had the right, if I recall, of termination in such circumstances if the issue was substantial or material, but before that could happen we would have the right to spend the money as contemplated. It wasn’t in their gift in that sense.”

He added that Sony’s rights in this respect only arise in very specific circumstances and “was conditional on either Gala not agreeing to spend it or not in fact spending it”. He agreed that Mr Ackerman recommendation was that Gala should let Sony “carry the balance”.

It was put to him that Mr Ackerman’s advice did not ensure that Gala’s potential upside was maximised because of the way the waterfall works and his advice was a nonsense and Mr Yusef knew it was. He said that was not the case and:

“we had considered it very carefully at the time. We took his points very seriously. We discussed it at length both within Invicta and also with him, and he could have just as easily have asked us to spend more or recommend more. At the time I recall that Sony was toying with the idea of spending more, I think largely because of the artistic elements that were involved, but the feedback that we got quite clearly from Mr Ackerman was that this film was not going to perform, or was unlikely to perform, as was originally contemplated, and that’s what I took away from that encounter.”

Mr Yusef accepted that was how the Initial Expenditure was computed but said that it was important for Gala to ensure that there was enough money to service all of the transaction films. He said that there was a finite amount of expenditure available and that is where the formula comes from, but in terms of allocation:

“we needed to be sure that there would be enough money there at the end of the day that all 6 films could be serviced from the limited amount of money that we had…originally, we anticipated or hoped that we would be able to raise 250 million. As it turned out we had less. So at the time it was important to us that we made sure that we had money for all of the films, not just one. So that’s the reason behind the decision as to how much was incurred in relation to each of the films.”

He described that as the overriding consideration and stressed that (a) “it did matter how much we put into each picture, and it theoretically could have been possible that we decided to spend more money on this than the amount that was originally allocated or designated”, and (b) he spoke to Mr Ackerman at least twice a day, sometimes more, “about the very things we are now talking about and more…We discussed business in great detail and at length”.

Mr Ackerman said he was not involved in the structure of what was agreed between Gala’s partners and management. He was focused entirely on the commercial integrity or lack thereof of the films, and it was not his job to assess through a financial model operated in London by Mr Bamford as to the dynamic side of Gala’s investments. He was looking at the commercial performance, recommending which films he felt would have a stronger performance with a view to profit and where he saw changes and discrepancies, or in the case of Secret Window where he saw a weakness, and he was saying in the letter: “Try to limit your investment from going deeper if indeed Sony were to go deeper”.

As set out in section 11, the waterfall operates (a) by reference to the aggregate sums of (i) Gross Receipts realised from, and (ii) distribution expenditure and other costs incurred on, all of the transaction films, and (b) on the basis that Sony was entitled to a share of the total Gross Receipts equal to the total distribution expenses specified in the fifth provision in the waterfall, in priority to Gala’s entitlement to a share of the total Gross Receipts equal to the total approved Gala Expenses under the sixth provision in the waterfall. We note that there is a notional category of distribution expenses which Sony was entitled to recoup only lower down the waterfall (under the eighth provision) but, for the reasons already set out, we cannot see realistically what could fall in that category that would not already be captured under the fifth provision.

Under the terms of the DA, if SPR wished to incur Gala Expenses which Gala did not wish to provide funds for or, to incur other distribution expenses, it could simply do so (see section 9) and could recoup the cost under the fifth provision in the waterfall (see section 11). Gala had no contractual right to prevent SPR incurring such sums. Mr Ackerman did not suggest that he was seeking to prevent SPR itself from incurring further expenditure on Secret Window.

Therefore, if the total distribution expenditure on all of the transaction films was 140, of which Gala notionally contributed 60 (as monies in the expenditure account) and Sony contributed 80 (using resources other than those in the expenditure account), Sony would be entitled to recoup its 80 under the fifth provision in the waterfall, in priority to Gala’s ability to recoup 60 under the sixth provision in the waterfall. If Gala decided to limit its notional contribution to 40, then Sony could simply fund an additional 20 of expenditure so its contribution would be 100, and recoup all of that 100 under the fifth provision in the waterfall in priority to Gala recovering 40. Plainly, in that context, it cannot make any difference to Gala’s position under the waterfall whether it decided to allocate 10 of its total notional contribution of 60 to each of the 6 transaction films or 30 to one film and the remainder between the rest or in some other proportion.

Mr Yusef initially asserted that Mr Summers would have received the 2004 HL letter prior to him signing the acknowledgment. He noted that it could have been sent to him on 28 January 2004 by e-mail and it could have been sent to Mr Summers the next morning and then said: “That’s almost certainly what happened.” He recalls Mr Summers saying that he had a box of film files and that he had a lengthy discussion with his wife about them. When pressed, he suggested the letter of 28 January 2004 is not accurate but then said he could not comment on its accuracy but was going on the fact that the acknowledgment signed by Mr Summers presumes that he had the film files, as he knows to be the case because Mr Summers told Mr Yusef he had them.

It was put to him that it cannot be right that Mr Summers had the 2004 HL letter when he signed the acknowledgment because the 2004 HL letter is dated 30 January 2004:

It was put to him that the acknowledgement does not reflect reality. He initially said he could not comment. When pressed he said, in effect, that he could not say after 19 years exactly what the situation is but can only go on what the acknowledgement says and can only guess that Mr Summers would have received the final version of the 2004 HL letter - there were various versions of that around over quite a period of time and there was not that much variation between those and the final one.

It was put to him that in his witness statement he said that Gala did not receive the 2004 HL letter until 30 January 2004:

He agreed there is no evidence of a draft of the 2004 HL letter in the bundle. He said that (a) the evidence of a member receiving a draft/agreed version is provided by Mr Summers signing the acknowledgement. He is quite a senior guy who would not write something that he did not think to be true and he must work on that basis, and (b), when pressed, the evidence lies in the logic of the transaction. There is no way that, on 29 January 2004, HL would just decide that this is the approved version. They would have to get the version approved by Invicta, Sony and the board. That document would have existed in signature form long before the 30th. That has to be the case; it is just the way these things work. It is not possible they could just magic up that document in one day in a form that is approved by their board. When it was put to him he had not put any of this in his witness statement, he said it took months in 2018 to prepare the statement and there are many things that went on in that transaction that just do not come across but he could not possibly put in everything that happened 19 years later.

The minutes of the first meeting held on 2 February 2004 show 17 persons in attendance and those for the second meeting, at which the transactions were approved, show 9 persons as present (including Mr Bamford) and 11 persons in attendance. Mr Yusef said that both existing and prospective members would have had the film files by courier before the meeting.

As regards the timing of the meetings (at 12.00pm and 12.15pm) Mr Yusef said it was not uncommon that meetings do not happen precisely when they are scheduled to “just because of the physical business of getting through the business. It doesn’t always run to clockwork.”

It was put to Mr Yusef that only 11 members attended the second meeting. He noted that there are in attendance people who would have had powers of attorney as agents or advisers of those members who were not there such as Mr Pritchard. He listed 4 persons shown as present who were existing members. He said it is not true that the reason for the low attendance and why it does not matter that the majority of the members did not get the documents is because this is all about the generation of massive purported losses and there is no serious focus on slate profitability.

By this time HL would have known which of the films Invicta/Gala were targeting and it was left in a loose position because the situation was fast moving:

“We were looking at more than the 6 films that we acquired…the situation was fast moving, but…at the relevant time [HL], Justin Ackerman and we in turn by the time we received the film file,…everybody would have known which of the films we were going to include in the slate…this document was intended by all parties to be as fluid as possible, because the situation was changing daily. Release dates were changing daily. For example, I recall that one of the films, "Bad Boys 2", that fell out simply because….it fell foul of our definitions of which films we could include, because it had already been released and more than 30% of the expenditure had been incurred. So the situation was very, very fast-moving…but certainly in terms of the bundle of documents that [HL] would have needed from Sony, they had them, and altogether between Sony, ourselves and [HL] we were working to solidify which of the films that were actually going to be acquired so that they could make this opinion…we had actually included all of the films we ended up acquiring.”

When pressed, Mr Yusef added:

“everybody in the triangle knew which films we were targeting…I remember that I was on the calls pretty much on a nightly basis and the situation moved from one day to the next. That’s the way the movie business at this level functions, not for this deal but for all deals. The variables were many. It isn’t because they didn’t know. They had access to all of the information that Justin Ackerman would have had, that I would have had, either directly physically by fax or I would have made -- it would have been made known to me by Justin Ackerman over the phone…they knew 4 of the slate, because they would have known we had already signed them. The 2 others were still in a state of flux, but at the end of the day all of the films that we ended up with were in the frame for them to include in their assessment as to whether or not the slate would be profitable. They had the opportunity to look at the 6 films, 4 of which they knew for certain, 2 that were in the frame. The only reason why those 2 were still speculative is because there was the possibility that right up to the last minute that we could substitute one against the other. They would have known that.”

In the 2003 HL letter, HL referred to 9 films, only 3 of which were transaction films; Big Fish, a first transaction film, and Secret Window and Breakin’ All the Rules, the second transaction films, were not included.

In the 2004 HL letter, HL referred to 11 films in total including the transaction films and one film (Mona Lisa Smile) which was not included in the 2003 HL letter.

Our view is that Mr Yusef’s evidence that HL was aware of the specific films involved certainly at the time of the second transaction lacks credibility in light of the plain terms of the HL letters. Moreover, he and the other witnesses were at pains to stress that HL is a highly reputable firm. One would not expect such a firm to refer to 6 films in the 2003 HL letter and 5 films in the 2004 HL letter as films which “may be” included in the arrangements on which they were asked to opine, if they knew when they wrote the relevant letter that those films were not in fact to be included.

Given his references to the fast-moving situation and how everyone was working around the clock at this time, Mr Yusef could be taken to mean that HL formed an updated view which is not reflected in the HL letters. However, if that is what he meant, that also lacks credibility given that he did not mention that in his witness statement and no written updated opinion was provided to the members/prospective members.

HL were not giving a “dollars and cents” precise prediction of the likely Gross Receipts and profitability of each film but rather were just giving a bottom-line position as a general indication of how things stand, namely, that this deal gave a reasonable expectation of profit, and they do that in a perfectly explicable way. The fact that they do not include all their workings in the letter does not mean that the stated position is unreliable or inexplicable. The evidence was that the letters did not properly reflect the amount of work that HL would have done in order to reach their conclusion.

HMRC’s criticisms of the HL letters for not referring only to the specific transaction films does not recognise that Gala considered all the films on the slate and refers to those which may be included in those that Gala might acquire. It makes sense that the composition of the slate was less important given that HL was commenting on the deal and on the overall package rather than giving detailed comments on individual films. 

The fact that HL did not refer to Big Fish in the 2003 HL Letter was discussed at the meeting in November 2003 and the members decided to go ahead with that film.

Mr Yusef was clear that HL’s opinion on the profitability of the slate was critical to Gala. If HL was wrong, in a sense that does not matter; the important thing is that Gala had every reason to believe that it was possible to make a profit.

He signed the pack of documents relating to his admission to Gala on 15 January 2004 and they were received by Gala on 20 January 2004.

He thought that the 2004 HL letter must have been sent to him on or after 30 January 2004 and that he went through it at the time because he considered it to be important, given it was giving an appraisal of the likelihood of him making a return:

As regards the other documents:

He did not attend the meeting held on 2 February 2004, as he understood that it was only held formally to admit members and all the documentation had already been filled in to enable him to join.

As regards his on-going involvement:

He now very vaguely remembers the decision being made to extend the time limit for Sony to exercise the option. He would say most of it just passed by in a flood of noise and he frankly had many other much more urgent matters to deal with. This completely slipped his mind at the time, and for some time afterwards.

He confirmed that he would not have had the 2004 HL letter any earlier than 30 January 2004 and agreed he did not have it when he signed the admission form or the acknowledgment on 15 and 29 January 2004 respectively. His only recollection is that he received a large box and there were some film scripts in there.

It was put to him that realistically the HL letter cannot have given him any comfort, as he did not have it when he signed up unconditionally on 29 January 2004. He said it gave him some additional comfort as (a) it referred to actors he had heard of, and (b) he made his decision to invest in Gala “on the basis of the calibre of the people that were involved and what they were trying to do. This letter on very professional looking notepaper from a top investment bank/financial adviser “certainly is a very good sort of additional item to have” and it certainly made him feel more comfortable about what he was doing.

He was asked if he took the view that the HL letter was about whether he would make a return as opposed to whether Gala would make a profit. He replied that he did not think it was that sophisticated. It was “more an illustration that we were engaged in a business that was credible, had structure and there were real people involved” both in terms of HL, whom he had heard of at the time and some of the actors and actresses. He added that he used to live in Japan between 1997 and 2000 and Sony, at the time, was probably in the top 5 biggest Japanese companies on the stock market and “everything that I read in here as a generalist tells me credible, credible, credible”.

He agreed that the HL letter was a very high-level letter and said that it obviously was not referring to his own specific financial outcomes. He thought it is fair to say, as regards any investment in the film industry, an investor would invest in a film that stars well-known actors rather than people you had never heard of.

When it was put to him that the HL letter is not focused on the specifics of the transaction and the relevant films and does not assist with the prospects of the particular films in generating revenues or profits he said it does not address that directly but “just shows that a very well-respected investment bank thinks that what we are doing is sensible and that Sony Pictures is engaged actively with Gala in choosing a slate of movies. I don’t think it’s meant to be a financial projection, no.”

He was not sure when the other materials arrived. He said that he definitely read the basics of the transaction documents, although he would have only done what was required to confirm his participation. He thought to this date he had never read any film scripts. He confirmed what he said in his witness statement on this and commented that generally, at that point, he was dealing with a lot of paperwork every day and was in the habit of dealing with it quite quickly.

It was put to him that he did not review the documents because he did not need to worry about the splits of revenue or the prospects of revenue arising as he had the comfort in his mind that, come what may, the tax relief would produce a return for him. He said he thought that is a partial answer, but that is not all of it. He vaguely recalled there is an element in the IM outlining fees that go to certain groups that are part of the promotion of the investment. He said that those people were effectively paid to handle the transaction, produce the transaction documents, provide the legal opinions, choose the films and manage the structure. So the tax relief was part of it, but he thought the films would be fun, he had never done anything like this before, it seemed credible, other people had done it and other people were being paid to do the relevant work:

“It really felt like it had some structure and substance. Now did I take a lot of that on trust from a general awareness of what was happening? Yes. Did I spend 500 hours examining every transactional document and cashflow? I admit I did not, but I tend not to do that in any of the investments I do, and…In any investment I make, unless I am managing it myself,...I’m relying upon the people who are involved to do what they say they’re going to do and do the best they can for the investors. So, you know, at a certain point I can never know as much as other people about this, because it’s not my speciality. You have to bet that the people who are doing it know what they’re doing.”

When it was put to him out that there were 2 meetings on 2 February 2004, he said he stood by his comment in his statement; he was assuming that his admission to the partnership, with others, was a relative formality and he imagined that the partnership business would proceed accordingly. It was put to him that he did not attend because he wanted to sign up to the scheme, sit back and eventually the tax relief would roll in. He said he thought the process of Gala would continue, there were many members other than him, there are LLPs or situations he has been involved with that “would not jump through quite as much documentation as this…this is a decent amount of documentation to evidence the activity of an LLP in my eyes.” He added that, in reality, he was just one of many people so maybe there was a bit of laziness, but also his own personal presence or not was not going to be the ultimate decision on what Gala did or did not do on that day. He noted that at LLP meetings, quite often most people attend either virtually or by phone.

As set out above, we do not consider that, under the terms of the DA, Gala had any meaningful contractual right to participate in the distribution process.

Whilst both Mr Yusef and Mr Ackerman gave lengthy comments on their activities in their statements and at the hearing, much of this is vague and unparticularised with a lack of any specific examples of what input Mr Ackerman/LBPC and Invicta had in relation to the distribution of the transaction films or what meaningful consequence any involvement in discussions with Sony had for Sony or Gala.

Once LBPC reviewed and approved the Initial Plans in the December letters, LBPC (a) met Sony on at least a weekly basis for an initial discussion in relation to any variations to the original plans and to suggest changes to the Plans; (b) discussed media slots with McCann Erikson, Deluxe Laboratories and Manning Gottlieb OMD. These are advertising agencies based in the US, Canada and UK respectively that handled media buying on behalf of Sony and held accounts with major print publications and television stations; (c) reviewed the amended Plans, as revised following earlier discussions with Sony; (d) reported back to Invicta to either approve (for the most part) or reject (on occasion) the revised Plans; and (e) reviewed and approved the significant volume of invoices received by Gala to ensure that they were in accordance with the Plans and budgets.

Invicta continued performing tasks on behalf of Gala until the Call Option was exercised. For around 6 months after the transactions were completed, Mr Yusef was completely preoccupied with Gala and estimated that activities for Gala took up around 6 hours, or 80%, of his working day.

Mr Ackerman reported to Invicta on the Initial Plans and on the on-going review process as regards variations to the Initial Plans and regularly reported back to Mr Yusef.

Mr Yusef was in near-daily contact with Mr Ackerman in LA during that first 6 months or so after completion of the first transaction. Typically, on the day of a meeting that Mr Ackerman had with Sony to discuss variations to the Plans (or the day after), there would be a call around 3pm UK time (7am LA time) so that Mr Ackerman could explain what the meeting was about, and a call around 11pm or midnight (2pm or 3pm LA time) for him to report back on the conversations that took place at of the meetings.

Mr Ackerman would go through in some detail any changes that were proposed and why, his responses and suggestions to Sony relating to those changes and what changes had been discussed and agreed in principle. Whilst Mr Ackerman had Gala’s authority to propose changes which he considered would better market the films, he required final sign off by Mr Yusef on behalf of Gala before approving any changes with Sony.

Mr Ackerman was required to report back to Sony on his discussions with Mr Yusef at subsequent meetings. Assuming that the amended reports were in accordance with what had been discussed and verbally agreed, the process was that: (a) Mr Ackerman would write to Mr Yusef with a memo or report to confirm what the proposed changes were and provide his comments on them. Invariably (but not always), Mr Ackerman’s recommendation would be to approve the variations; (b) Mr Yusef then reviewed the proposed variations to ensure that he was ultimately satisfied with what was being proposed and, as Mr Ackerman and he had already reviewed and verbally agreed the changes, invariably he then confirmed to Mr Ackerman in writing that the proposed amendments to the marketing budgets were agreed; and (c) Mr Ackerman would write to Sony to confirm that the proposed changes to the marketing budgets were agreed by Gala, and Sony would then action the amendments to the Plans.

Mr Yusef exhibited what he put forward as 3 examples of this process. He said that he received over 60 reports or memos from Mr Ackerman in which, following a series of discussions with Sony, he recommended amendments to the Plans. He did not think that these were major amendments. Had that been the case, it would have been evidence of failings on Sony’s part in drawing up the Initial Plans (and, therefore, on Gala’s (and Invicta’s) part in agreeing to a deal with Sony). They were:

“after all, the most successful studio at this time. However, as is typical in the industry, the marketing plans did require discussion and tweaking as the public’s reactions to the films could be assessed, and Gala’s role (via Mr Ackerman) was to actively work with the studio to get to a position where both parties were in agreement with the proposed changes and spending commitments to maximise revenue and we were adding our experience to the process.”

Invicta would not always agree to unilateral changes proposed by Sony. The Secret Window letter is an example of Mr Ackerman being concerned that the Plans exceeded the film’s commercial potential: “I recall that we agreed with Mr Ackerman’s recommendation and did not agree for Gala to incur the additional expenditure. Whilst this is the only specific example that he could recall this is not unexpected because: (a) Sony are experts in the field (which is why we selected them) with access to a lot of real-time data and, therefore, “we would not expect to disagree with them often in relation to marketing changes (despite Mr Ackerman’s own expertise) and it was a collaborative effort to get things right”; and (b) secondly, although this is the only example in writing, Mr Ackerman would already have taken part in earlier meetings with Sony whereby:

“I expect that he would have discussed and likely pushed back on suggested amendments which would likely have resulted in changes by Sony that were agreeable to him.”

Once any amendments to the Plans had been approved by Gala and the service providers had incurred the expenditure in accordance with those Plans, Mr Ackerman received at the LA office the invoices relating to that expenditure. Thereafter, Mr Ackerman’s role was to review the invoices, carry out a reconciliation exercise to ensure that they had been incurred in accordance with the agreed expenditure and report back to Invicta with a request to pay. Mr Buckley and he then carried out a further reconciliation exercise before any money left the relevant bank account of Gala, to satisfy themselves that what was being spent was consistent with what had been agreed.

Sony was also a signatory to the expenditure account to provide Sony with the comfort that the money was in the account and was available before they committed to a significant outlay. Once all was approved, he would authorise Gala to make the payment.

A one-and-a-half-page memo dated 1 March 2004 from Mr Ackerman to Invicta (copied to Gala) in which he said that he had met with Sony that day, gave brief details of earnings, expected earnings and major spending on distribution expenses as regards the first transaction films and said there were no marketing changes to discuss.

(a) A letter dated 17 March 2004 from LBPC to Invicta in which Mr Ackerman said that on 15 March 2004 he sent Invicta a memo in which he made a number of recommendations in connection with SPE’s distribution of the first transaction films and asked for Invicta’s approval for confirmation to SPE, and (b) letter dated 18 March 2004 from Invicta to LBPC in which Invicta confirmed approval. The memo of 15 March 2004 referred to was not exhibited so we do not know what recommendations were made.

A letter of 19 March 2004 from LBPC to Mr Litt confirming on behalf of Gala that “we are in agreement with the recommendations made by SPE on 1 March 2004 in connection with the distribution expenses for the first transaction films”. Again, we do not know what the recommendations were.

(a) A fax dated 5 April 2004 from LPBC to Invicta in which Mr Ackerman said:

“Please note the attached spending option for Fifty First Dates for the week of March 8 2004. SPE held a savings of $661,000 prior to the weekend of 03/05/04. My analysis of these minor marketing adjustments show that these developments fall within the previously approved distribution and marketing campaign strategy for this film.

Invicta managed the process of receipt of the SG loans into the account of Gala in respect of each of the separate transactions and arranged for the licence fees to be paid by Gala.

Invicta personnel drew up the necessary accounts and financial statements. Mr Bold of SFP facilitated the accounting process and carried out an “audit” of the business activities of Gala and LBPC.

Invicta remained in contact with members for the duration of Gala. Some members were more actively involved than others. For example, some members simply wanted to know things were going well at every year-end. Others, such as Mr Cadogan and Mr Thacker, were deeply involved and we would often deal with queries they had. Mr Thacker, in particular, was very interested in the process and keen to learn, and would often be influential in terms of explaining and reporting back to the other members.

On behalf of Gala, Invicta also instructed MRI Moores Rowlands (which merged business with Mazars with effect from 16 April 2007) to audit the annual financial statements at the end of each financial year.

He said that Mr Ackerman was engaged by Invicta pursuant to the contract but that Invicta acted as an agent for Gala in doing so (as provided for under the MSA) and it was always understood by the parties that his services were rendered to Invicta, acting on behalf of Gala.

It was put to him that (a) the Secret Window letter does not illustrate that Gala rejected a revision to a previously agreed Plan and (b) there is no documentary evidence of any other such instance. He said that the Secret Window discussion was a rejection of a suggestion that a Plan be varied upwards. He reiterated that the Initial Plan had been agreed at that point because it was the subject of numerous discussions between Invicta and Sony. It was not just produced overnight. The marketing of a film occurs over a number of months and there would have been weeks of discussion prior to 2 December 2003 when the Plan was in formal agreed form. The contract simply memorialises what was actually being agreed by the parties. He said that he used the term “for example” in his witness statement as regards Secret Window as an illustration of the point he was making, namely, that the situation was capable of rejection. He did not mean that there are hundreds of other examples. He agreed that there was no other example in the evidence provided to the tribunal.

We note that it is plain that the Secret Window letter does not provide an illustration of Gala rejecting a proposed change to a previously agreed Plan (see section 13) and, as Mr Yusef agreed, there is no such other example.

It was put to him that he was speculating in his comment that Mr Ackerman was likely to have pushed back on amendments to the Plans suggested by Sony. He said (a) this comment reflects his understanding of what happened, as based on the daily conversations and the oral reporting that took place after the meetings, (b) much of what occurred in the meetings was based on a collegiate and joint affair, nobody had a “green light power”, it was a consensual situation, and “knowing the realtime reporting that I was given, it is more than a presumption or an assumption as to what happened”, (c) Mr Ackerman was very active, very well respected and was listened to and Mr Litt, who originally was resistant to Mr Ackerman being involved, remarked on a number of occasions that he “really knows his stuff” and that Mr Smith got on with him. He based his statement on what he understood from Mr Ackerman and Mr Litt. His response, therefore, lacked any specificity as to what actually occurred, he provided no specific example of any “push back” and overall it adds nothing to our understanding of whether and how (if at all) Mr Ackerman contributed to the “collegiate” and “consensual process”.

It was put to him that any discussions Invicta had with Mr Ackerman about Plans or amendments to Plans were without consequence, practical import or reality, and there is no evidence to the contrary. He said that he did not accept that for the reasons he had already given,

and that the back-up evidence is:

“the work that we did prior to the start of the theatrical release of these pictures, the analysis that was made in relation to which pictures out of the overall portfolio of Sony films should be selected to form the slate, the analysis that was undertaken on our behalf by Mr Ackerman, the appraisals that were undertaken on Gala’s behalf by [HL], the daily interactions that Mr Ackerman had not only with Sony, but also with the agents that were working to book the slots. There lies the evidence. The degree of work that Mr Ackerman, for example, undertook was not a cursory thing. It’s true to say that he was and is a very well-known person within film production as well as film distribution and the work is there to see. It is represented in the fact that there’s a huge amount of written material, particularly in the form of the purchase orders, the invoices, all of which were available on many, many occasions to HMRC, and that represents that body of documentation, which….is huge. It is not one or two boxes. Therein lies the evidence. Therein lies the result of all of the work that culminated in the expenditure being incurred and in the invoices being rendered in the name of Gala. That is a complete answer to your question.”

We comment elsewhere on the lack of any serious appraisal by Gala/Invicta of Gala’s prospects of making a profit from the transactions through the receipt of Gross Receipts and the limitations and/or inadequacies of Mr Ackerman’s letters and the HL letters (see sections 3, 6, 12 and 13). Otherwise, the work which Mr Yusef asserts is there to see amounts simply to the invoices which Mr Ackerman reviewed to check that sums leaving the expenditure account related to approved Gala Expenses.

It was put to him that, on a realistic analysis of the facts, Sony marketed and distributed its own films acting on its own behalf, not as agent for Gala, in the same way as it would have done had Gala not been involved. He said that is not true: Sony could only secure the amount of money that Gala put in and hoped to put in, if Gala was actively involved in that transaction:

“we demanded, and we got a meaningful engagement at the highest level with the studio, and it wasn’t so much what benefit that had to Sony. It was a condition precedent to the deal actually happening. Sony agreed it because they knew they didn’t have a choice.”

In our view, the terms of the deal with Sony speak for themselves; for all the reasons set out in section 9, Gala did not have meaningful contractual rights to participate in Sony’s marketing and distribution of the transaction films. Moreover, as set out in section 2 and 10, we do not accept that Sony entered into these transactions for the purposes of securing funding for its distribution expenses; in fact, it did not receive any such funding.

It was put to him that if Gala or Invicta had contributed anything consequential, substantive in relation to the distribution and marketing of Sony’s films, there would be something in writing emanating from Sony. He said: “That is not the way that the film industry at any level works, particularly when dealing with a fast-moving dynamic situation.” The fact that the discussions are not documented does not mean they did not take place. He emphasised that it is not possible for the work that was undertaken by Invicta to have occurred overnight. It was the result of many weeks, if not months, of meaningful discussion and agreement by consensus of which Mr Ackerman was part. It is very rare for there to be conflict, particularly where the parties chose each other. There’s no written evidence from Sony as to the extent of the work that they did to get themselves comfortable with Mr Ackerman’s involvement, but that does not suggest that it did not happen. It’s illogical that it would not happen. They were not used to people coming to them in this way. They were entitled to be a little bit apprehensive about it and the fact that they got themselves comfortable without any written minutes or whatever is not surprising, because that’s how it works.

We accept that, the fact that there is no written record or communication from Sony does not necessarily mean that there were no meaningful discussions with Sony. However, we find it surprising that a major commercial group such as Sony would not engage in any written or email correspondence with a counterparty at all, if it was relying on that counterparty to provide meaningful input into its distribution and marketing activities.

It was put to him that his comment that Mr Ackerman reached the same conclusion as HL did in their reports is not correct in light of Mr Ackerman’s evidence on his role. He said that it was true that Mr Ackerman was not involved in negotiations for the waterfall but he did believe that he had some knowledge of the profitability position, “but more importantly, he had his own access to the same data that HL would have received from the studio….he would have had access to the draft marketing plans in various iterations. He would have had access to the other documentation that he himself referred to. So he could make his own independent judgment independent of HL as to whether these were films that Gala should had been involved with”. He meant in his witness statement that Mr Ackerman had access to data that would have allowed him to reach certain conclusions in terms of which film should be selected from a profitability point of view. In terms of a detailed analysis of the profitability of the films as they relate to Gala, “we relied on [HL’s] analysis, which would have included an analysis in relation to the waterfall. He then agreed that was not what Mr Ackerman was doing.

Mr Yusef said that Mr Ackerman’s role in coordinating payments from bank accounts and facilitating payments of invoices is “a natural function” which arises from Gala’s activities: “They’re partly administrative…we needed to ensure…that the films that the partnership was licensed to exploit were the films that the expenditure that we were paying related to”. It was critical as studios have maybe 25 or 30 films a year that they are pushing through their pipeline and often expenses for one film end up quite by accident into another; “It is a huge part of the trade that we are involved with”.

He did not agree that all that happened was that the name on the invoice changed from Sony to Gala. He said there was a commitment made by Gala to spend a significant amount of money on films they actually owned for a specific purpose. The actual business of whether the invoice said “Gala” as opposed to “SPR” was not an administrative function but the personification of the correct allocation of expenditure. The administrative function “was to make sure that the expenditure that was referred to was correctly allocated to the party that actually incurred that expenditure. It’s very important.”

When asked to explain how the Initial Expenditure was allocated between the transaction films. He said that the amount of money available to Gala was finite and:

“our desire to ensure that we actually ended up being involved in all of the films...would have governed more than anything else how much was allocated to each of the films. We wanted to make sure that all of them were covered, because, contrary to what has been asserted, cross-collateralisation can work both ways. It can work against you and it can work for you. It is not just a one-way street.”

He added that obviously, the starting point was how much initially Sony proposed to allocate in the draft Plans because one of the attractions of being involved with Sony was that they have a very sophisticated distribution apparatus and enjoy great relationships with all of the parties that supply the relevant services. Mr Ackerman would have been given access to that and it would then be the basis for the discussion at the distribution meetings.

Those distribution meetings, which included at all material times Mr Ackerman, would have consisted not only of people directly involved in the marketing department, but also representatives of the studio across the board who had any interest in the outcome of the movie. It was a high-level meeting of decision makers:

“for us to have access to that meeting was unique. As far as even today, almost 20 years later, I don't think that there is anybody that has access to those kinds of meetings. During those meetings, no-one person, including Paul Smith, (the head of marketing and a very key and powerful figure in the studio) did not have what they call a green light capability. It was a consensus forum. Mr Ackerman was part of that consensus.”

Prior to entering into the DA, “there was significant resistance from the operatives within the distribution company to the idea of somebody else coming along and being involved in that process” given it had never been done before. The sort of information that Mr Ackerman and therefore Invicta had prior to the release of the picture, was “commercially hugely sensitive”. There was also resistance to Invicta wanting an appraiser to have access to the same information that Mr Ackerman had access to. But when Invicta suggested HL they agreed to give them prime access to that documentation because HL maybe the year before that, had done a huge transaction where they had access to the kind of information that we were now asking them to have in relation to this slate.

Then, through various meetings, following which the Plan was set, and then thereafter during the distribution process for each film, there would be meetings of 2, 3, sometimes daily meetings, and Mr Ackerman would be involved with those and would have had access to exactly the same information as anybody else in that room. His views were not just given lip service to:

“I do recall when I sat with Mr Smith and a couple of other of his colleagues, when Justin wasn’t there, and I did make some enquiries. It was quite clear from the way they were talking that they didn’t treat him as a nuisance. They didn’t treat him as anything other than a professional person who was, you know, making a contribution. So that was the process within the distribution...”

Again, the fact that Mr Ackerman was able to attend meetings at Sony, that those meetings were a consensus forum and the assertion that his views were not just listened to adds nothing material to our understanding of what, if anything, Mr Ackerman actually contributed to the distribution process.

So how much was allocated for distribution for each film was a process that started with Sony and was a function of ensuring that the finite aggregate amount was split so that “all of the movies that we had identified would be funded by us in the way that was contemplated”. He repeated his views on cross-collateralisation and said it is “definitely preferable, as a financing tool, to invest in a slate or portfolio of films which are cross-collateralised than it is to invest in a single picture by picture process. That is conventional wisdom in the movie business”.

The distribution report of 1 March is a breakdown. In effect, it is a note or a minute of a meeting, and it deals with each of the films in question, as a way to update Mr Bamford and Mr Yusef as to where things were going. The norm, however, would be that this kind of discussion would take place almost on a nightly basis, and more often than not, twice a day (as already set out).

He said he was not expecting Sony to exercise the option in 2 years’ time and that the reason for terminating Mr Ackerman’s role was that “we were very conscious of the financial position”. He noted that (a) at the beginning Mr Ackerman worked substantially without a formal agreement, on the understanding there would be such an agreement should the transaction happen - so he did a lot of work then, which is quite common in the industry because the outcome is always uncertain and people “don’t tend to engage in formal legal contracts until such time as things are certain”, and (b) “we contemplated that this would be the first of many” and by “whatever date that we contracted we were not certain what the situation would be going forward”, but, in any event, Mr Ackerman “continued to perform services for us for many months some time after the Sony contract was terminated” because:

“at the point at which the option was exercised we didn’t just shut up shop immediately…We continued with him and the lease for quite some time after that. I can’t recall the date, but I have in mind that at least for one more year the offices were going and that Mr Ackerman rendered services in much in the same way that he rendered them outside of the contract in the early part. So what he did substantially wasn’t tied to a contract either before or after the date of termination. He continued to do work for us, as I recall.”

It was put to him that Mr Ackerman’s contract was not renewed because he knew that Sony would be pulling the plug shortly, that was always the intention and that was why he approved a lease on US premises for 1 year rather than 2 – hence, the revised lease ended on 28 February 2006, which was the original first exercise date. He said again that the reason for terminating LBPC’s contract was financial:

“No. The issue right from the very beginning was to control costs as much as possible...when we first started to talk about budgets with Mr Ackerman, the original first pass of the budget was much greater than we wanted it to be, but what he was suggesting was not unreasonable. It was just that some of it was a duplication of what we in London were doing or could do. For example, a lot of the accountancy work could and was done in London.”

He added that it was perfectly normal to have a lease which was year on year. “We didn’t know that the option would be exercised. It was not in our control” and “the intention of me, Mr Ackerman and Mr Bamford at the time that the lease would be extended on a year-to-year basis….it wasn’t tied to the option because we were not in control of that option.”