The Hollywood Economist

Concessions Are for Girlie Men

Arnold Schwarzenegger’s absurdly advantageous contract for Terminator 3.

The nonstop anecdotes that stars give in celebrity interviews about the stunts they supposedly performed, their favorite hobbies, and how much they enjoyed working with other stars may serve to hype their latest project—a job they are contractually required to do—but they evade a central issue: The art of the deal has come to replace the art of movies. To understand how the new Hollywood really works, one need only read stars’ contracts. Consider, for example, Gov. Arnold Schwarzenegger’s agreement for Terminator 3: The Rise of the Machines. It’s a state-of-the-art exercise in deal-making.

The contract, which was brilliantly put together by the Hollywood superlawyer Jacob Bloom between June 2000 and December 2001—requiring no fewer than 21 drafts—runs 33 pages (including appendices). For starters, Schwarzenegger got a $29.25 million “pay or play” fee, meaning he would be paid whether or not the movie was made. (At the time, that figure was a record for guaranteed compensation.) The first $3 million would be delivered on signing and the balance during the course of principal photography. For every week the shooting ran over its 19-week schedule, Schwarzenegger would receive an additional $1.6 million in “overage.” Then there was the “perk package”—a lump sum of $1.5 million for private jets, a fully equipped gym trailer, three-bedroom deluxe suites on locations, round-the-clock limousines, and personal bodyguards.

The producers Mario Kassar and Andrew Vajna did not agree to pay Schwarzenegger this record sum because he possessed unique acting skills—after all, the part he was to play (along with a digital double and stuntmen) was that of a slow-speaking robot. They also did not pay Schwarzenegger on the basis of his box-office track record. Indeed, his previous two films—End of Days (1999) and The Sixth Day (2000)—had failed both at the world box office and at video rental stores. Nevertheless, in the 10 years that had elapsed since Terminator 2: Judgment Day, Schwarzenegger’s image had become so inexorably linked in video games and TV reruns to the deadly robot that he had become the crucial element of the deal.

Kassar and Vajna, backed by the German-owned movie financier Intermedia Films, had already bought the sequel rights to the Terminator franchise for $14.5 million from the bankrupt Carolco Pictures and the initial producer, Gale Anne Hurd, and had spent another $5.2 million developing a script. Finally, they had lined up more than $160 million in financing: Warner Bros. would pay $51.6 million for North American rights, the Tokyo distributor Toho-Towa would pay $20 million for Japanese rights, Sony Pictures Entertainment would pay $77.4 million for the rest of the world, and Intermedia would earn another $11 million by transferring the copyright to German tax shelters. But Warner Bros., Sony. and Toho-Towa had all made their deals conditional on Schwarzenegger signing on to play the robot. So: No Schwarzenegger, no money.

Kassar and Vajna had no real choice but to accept Schwarzenegger’s terms (and they themselves would earn $10 million if the deal went through). Schwarzenegger’s demands did not stop with the guarantee of $29.25 million. He also insisted on—and got—20 percent of the gross receipts made by the venture from every market in the world—including movie theaters, videos, DVDs, television licensing, in-flight entertainment, game licensing, and so forth—once the movie had reached its cash break-even point. Such “contingent compensation” is not unusual in movie contracts, but, in most cases, Hollywood accounting famously uses smoke and mirrors to make sure to define “break-even” in such a way that a movie never reaches it.

Take video and DVD sales, for example. Under the standard Hollywood contract, studios credit the film with a video “royalty” equal only to 20 percent of the sales. That means that if sales of a DVD total $20 million, only $4 million of that is counted toward reaching the break-even point. But Schwarzenegger’s contract, thanks to the ingenious lawyering of Jake Bloom, allowed for no such evasion. In the case of DVD and video royalties, the contract specifies: “For purposes of calculating Cash Break even only, Adjusted Gross Receipts shall include a 100% home video royalty (i.e. home video revenues less costs).” So unlike weaker players, Schwarzenegger could count all the money taken in from DVDs and video, $20 million, less their actual cost, toward reaching the threshold where he gets his cut. (Click here to see how his contract defines cash break-even.) Since these payments to Schwarzenegger pushed back the cash break-even point of other participants—and added to the costs of the movie—it effectively came at the expense of less powerful talent (like writers) in the contract game.

Schwarzenegger also could decide who worked with him. The contract “pre-approval” clause gave him choice of not only the director (Jonathan Mostow) and the principal cast, but also his hairdresser (Peter Toothbal), his makeup man (Jeff Dawn), his driver (Howard Valesco), his stand-in (Dieter Rauter), his stunt double (Billy Lucas), the unit publicist (Sheryl Merin), his personal physician (Dr. Graham Waring), and his cook (Steve Hunter).

Finally, Schwarzenegger had the contract structured to give him every possible tax advantage. All the money was to be paid not to Schwarzenegger but to Oak Productions Inc., a corporate front he controlled. Oak Productions, in return, “lends” Schwarzenegger’s services to the production. Since Schwarzenegger didn’t get any money personally from the movie itself, he had more flexibility managing his exposure to taxes. For example, Oak Productions entered into a complex tax-reimbursement scheme with the production to help avoid additional tax liabilities that might occur abroad. (Click here to read the tax rider.) In return, Schwarzenegger agreed to make himself available for 18 weeks of principal photography, one week (on a nonexclusive basis) for rehearsals—if any were required—and five days for reshooting. In addition, he had to make himself available for at least 10 days, seven of them abroad, for promotional activities in connection with the initial theatrical release of the movie. This media work included everything from television and radio appearances to appearances at premieres and Internet chat rooms.

The negotiation of this contract did not come cheaply—the legal and accounting budget for the movie was $2 million—and, by the time all of Schwarzenegger’s demands were met, the budget of the film had risen to $187.3 million, making it the most expensive independently produced movie in history. (Click here to see where that money went.)

Even though Terminator 3 eventually had a world box-office gross of $427 million (at least half of which is kept by movie theaters), it barely broke even, except for Arnold Schwarzenegger, who, of course, had created his own “cash break-even,” and, under any scenario, made a small fortune from his image. In the bygone days of the studio system, the studios had exclusive contracts with their stars that allowed them to reap the profits from the images their PR machines had created. In the new Hollywood, the stars themselves reap the profit their brand names bring to a film. So it is not surprising that even after Schwarzenegger became the governor of California in 2004, his holding company protected his image rights by suing a small toy maker selling a Schwarzenegger-like bobblehead doll on the grounds that “Schwarzenegger is an instantly recognizable global celebrity whose name and likeness are worth millions of dollars and are solely his property.”