Deficiencies and improvements of the scheme of secured loans against copyright – the case of cinematographic works

By Chen Rui, Graudate School of Chinese Academy of Social Science,[Copyright]

China’s film industry has made a speedy progress over the last ten years, repeatedly hitting new records in terms of both grossing and single box office returns, while the film overhead investment costs also rise. To cope with the growing costs of investment, the film industry has gradually expanded channels for investment and financing, and as a result, direct investment, bank loans, copyright presale, government funding and others have become very popular in China. Of these financing methods, direct investment has still been the most commonly used, and bank loans and other channels have begun to play some role. For example, the movie Assembly and The Flower of War received loans respectively from China Merchants Bank and China Minsheng Banking Corp., Ltd.


Other than the direct investment approach which has been most commonly adopted in the majority of China’s films, the list includes major methods being adopted in film investment and financing and their representative works.


It can be seen from the above list that the so-called financing methods cannot be deemed as loans secured against copyright in full sense. According to The Research Report on Chinese Film Industry (2012) , the Bank of Jiangsu, China Minsheng Banking Corp., Ltd., Huaxia Bank, China Merchants Bank and other banks require that there be a clear source for repayment before the granting of loans for movies, for which movie businesses choose to put down the gains of their previous movies or their other account receivables, seek other forms of pledges, or even demand that legal representatives of the producers personally guarantee the loan.


Copyright guarantee has not played its proper role it should have because of complicated factors such as the lack of authenticity or uniform standards in auditing copyrights against cinematographic works, as well as difficulties in liquidating copyright assets. It may not be overlooked, however, it may also attribute to the inherent deficiencies of copyright guarantee system.


I. Deficiencies in copyright pledge scheme

Under Article 75 of China’s Guaranty Law and Article 223 of China’s Law of Chattels, the transferable property rights for intellectual properties, such as the exclusive right of trademark registration, patent, and copyright, may be pledged. Therefore, it can be seen that the form of IP guarantee is by statutory mandate through pledge. In legal terms, pledges include pawns and hypothecates, which means the debtor or a third party delivers possession of movables or rights to the creditor for bailments as securities for the debt. If the debtor defaults, the creditor may legally sell the bailments to realize his dues, wherein the debtor or the third party being the pledger and the creditor the pledgee, and the bailed immovable or hypothecate as delivered being the pledge. Hence, a pledge is a security interest in property requiring delivery of possession of the pledged chattel, and delivery of possession is the key. The fundamental difference between pledge and mortgage is that mortgage requires no delivery of property to the possession of the mortgagee, whereas the pledge does.


There is little difficulty for the pledge scheme to work in terms of movables as it is easy to deliver possession thereof, even for negotiable instruments such as bills of exchange, cheques, promissory notes, bonds, certificates of deposit, warehouse receipts, bills of lading, or shares of funds, stocks, certificates of stocks or accounts receivable which are transferable according to law. However, when it comes to possession of the property right in trademark registrations, patents and copyrights, delivery may not be as simple as that.


It is said that possession is the physical control of the possessor over things, or the power to exercise actual control and dominancy of chattels. Under China’s Law of Chattels, possession is limited to property, including movables and immovables. Possession in general is prima face ownership, an observable fact, prima facie legality, and right to continue possession.


The intellectual properties have the attributes of non-competing and nonexclusive objects in the public domain, and the information contained in the objects of IP right is intangible and cannot be kept exclusively. The objects under IP can be possessed by multiple individuals at the same time. Therefore, it is impossible to scheme possession over an IP object by using the traditional possession concept. China’s Law of Chattels defines pledge of movables as the pledge over movables, and hypothecate over property right akin to movables. IP pledge falls within the scope of hypothecate. In order to overcome the aforementioned shortcoming of IP right object possession, the right possession system is established to include the possession of IP rights. Such possession with property rights as object is called quasi-possession or bailment. As long as the possessor has the appearance that another person has sufficient reason to believe that he has the right to possess and he has exercised such right, the law protects his possession. In terms of effect, all provisions concerning possession apply to quasi-possession except those incompatible provisions.


There is still a different situation in the event of application of quasi-possession provision. Right to trademark and right to patent shall be enjoyed only after registration and therefore no application of quasi-possession system is required because such rights shall be only determined by its registration certificate which had substituted the effect of prima facie validity resulting from quasi-possession, it is impossible to generate bona fide acquisition effect, and not to mention acquisitive prescription effect. As to copyright and other IP rights not derived from registration, ownership cannot be ascertained except through observable facts. The Copyright Law (Article 11(4)) provides, “unless otherwise proven, a citizen, legal entity or other organization that signs a work shall be the author of a work.” The signature has the same prima facie validity as possession, except to the extent that the signature is in relation to the work whilst possession, the chattel. In this sense, a signature is the quasipossession of copyright. However, there is a legal problem for copyright as a guarantee for pledge: how can a party deliver such quasi-possession? According to the above logic, such transfer requires the copyright owner changes the author name into the name of the guarantor at first and then restores the original name after due liquidation of debts. This way is expensive in huge cost and difficult to operate in practice and will mislead social evaluation and affect the value of commodity. Therefore, the transfer of quasi-possession cannot be used for copyright guarantee.


Furthermore, there are some deficiencies in the effective elements of copyright pledge. Article 79 of China’s Guarantee Law provides that “where the right to exclusive use of trademarks, the property rights among patent rights and copyrights transferable according to law are pledged, the pledger and the pledgee shall conclude a contract in writing and record the pledge contract with the administrative department in charge. The pledge contract shall become effective upon completion of recordation.” Article 227 (1) of China’s Law of Chattels requires that “when pledging against a trademark registration, patent or copyright, the parties concerned shall conclude a contract in writing, and the interest in the pledge is perfected at the time when the pledge is recorded with the relevant authority.” It can be seen from the above that the validity of IP right pledge rests with recordation.


The copyright is automatically protected, i.e. , from the date the work is fixed, not relying on registration. The registration would merely provide prima facie evidence copyright validity when copyright dispute arises. Nor is recordation required for copyright assignment, which takes effect upon signing of the assignment contract as such between the author and the assignee. Under the requirement, however, recordation is necessary for copyright pledge. According to the Article 5 of China’s Measures for Recording Copyright Pledge,” the establishment, change, transfer, or lapse of a pledge over a copyright shall take effect upon recordation in the Register of Copyright Pledge.” The requirement for copyright creation and transfer is different from that for the validation of copyright pledge. Some scholars have argued that the same elements should be required for them in order to protect transaction security and the bona fide third party. Such system cannot full play its role to some extent due to the cinematographic works deficiencies in transfer of quasi-possession and elements for validation.

Financing method
Sample Movie
Financing amount  (total investment )
Investor
Bank loans
Assembly
50 (80)
China Merchants Bank
The Flower of War
150 (600)
China Minsheng Banking Corp., Ltd.
Copyright pre-sale
Dance
40 (200)
Japan
Government funds
Aftershock
60 (120)
Government of Tangshan City
Film funds
Painted Skin (II)
20 (150)
National Film Capital
Indirect sponsorship
If You Are the One
25 (50)
China Merchants Bank, Sichuan Jiannanchun Group Co., Ltd. and Hainan Airlines
Advertising expenditure
Cell Phone
6 (15)
Motorola (4), China Mobile (0.8) and BMW (1.2)


II. The Plight of cinematographic works pledge

According to the current practice, the warranty terms for film financing contract generally require that, in addition to a guarantee by physical objects, the producer agree that the collateral should cover his rights to the movie and all of his rights under all contracts he concludes that are related to the movie (including but not limited to film footage and master copy before the publishing of the film), including the film not finished. The right pledge for cinematographic works can be understood from the perspective of quasi-possession and elements for validation.


In terms of copyright pledge for unfinished cinematographic works, completion of shooting footages, important as it is in the creation process, is by no means the completion of cinematographic work, pending large amount of post-shooting editing and post production work. In China, any cinematographic work is further required to submit for examination and approval and obtain a license for public screening before its release. Strictly speaking, the film can be called cinematographic work only when its post-production has been finished and submitted for examination and approval. However, the film financing contract or contract for film copyright pledge needs to be concluded and agreed on before the beginning of shooting the film, or before the finish of the film. Under such circumstances, the copyright has not yet come into being, the film has not been finished, no recordation can be completed, but the pledge contract has come into effect. Moreover, China’s current system leaves no room for authorship change in order to make the quasi-possession effective. More importantly, according to Article 80 of China’s Guarantee Law, a pledger may not continue to use the pledged property or profit therefrom except under consent from the pledgee. Obviously this is an impossible situation, for the producers need to recover their investments through publication and exhibition of films. Therefore, such restrictions have become a huge challenge for producers.


For those finished cinematographic works, there is little significance in introducing copyright pledge as guarantee for films shooting and distribution because more than one half or the overwhelming majority of the total investments in films has been acquired at that time. Furthermore, pledge registration requires the transfer of possession, that is to say, the right of pledge can only be created by quasi-possession transfer through the change of authorship. However, in addition to the foresaid reasons, such way is difficult to operate because it is too rigid for cinematographic works which has been governed by the doctrine of validation upon recordation.


It is difficult to integrate copyright pledge system of cinematographic works into practice because it is too rigid and inconvenient to apply for registration, which has been an important obstacle for copyright pledge to full play its role in film financing at present.


III. Possible recommendations

Film financing guarantee is a complex system. For the abovementioned difficulties faced by pledge of rights, some scholars have pointed out that there is no constructive notice for pledge of rights, such as copyright in the property. Where these rights are used for debt guarantees, the only way of providing public notice is through recordation. Therefore, where security right is set on these rights, their characteristics seem more akin to the right of pledgee without possession of the collateral. However, for the pure convenience of custom and legislation, security rights set on the rights to the movables has still been included in the range of “pledge of rights.” Some scholars even explicitly point out that national recordation scheme should not be applied to copyright and should be substituted by a quasi-possession scheme because it is not suitable for the authorship to be transferred to the guarantor. Therefore, copyright cannot be used as the collateral of mortgage instead of pledge. The author agrees in this regard and likes to put forward some suggestions. The first is to change pledge into mortgage. Under such circumstance, it is, on the one hand, unnecessary to transfer the possession of the pledged property in order to avoid the disturbance from authorship change and the pledger may, without approval from the pledgee, continue to enjoy his right to use and right to gains from the mortgaged property; on the other hand, the pledger may, taking full advantage of the value attribute of cinematographic works, has the right to create repetitive mortgage and remortgage on that film after mortgage, avoiding the shortcoming that there can not be no repetitive mortgage and re-mortgage in pledge relationship, in order to fully realize the financing function of cinematographic works. Secondly, the right of pledge shall be created after the change from the doctrine of validation upon recordation into the doctrine of recordation against a bona fide third party after the conclusion of pledge contract between the copyright owner and the creditor. Meanwhile, such pledge contract can still be used for pledge recordation which generates no creation effect in right of pledge and has the effect against a bona fide third party after recordal. This method csn be used to protect the interest of a bona fide third party resulting from the validation requirement of copyright guarantee in practice.

 

(Translated by Yuan Renhui)


 

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