Melrose 2 Fund Sues Paramount, Claims Studio Cheated It Out of Film Profits (Updated)

The investor group says it provided nearly $375 million for projects including the “Transformers” franchise, but has received none of the profits

The investor group Melrose 2 is suing Paramount Pictures, claiming it put up $375 million to finance the "Transformers" movies and other projects, but hasn't received any of the profits.

According to a lawsuit filed in Los Angeles County Superior Court Tuesday, Paramount "understated the revenues received in connection with the exploitation of the Melrose 2-funded films."

Melrose 2 is suing for breach of contract, fraud and unfair business practices.

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The fund helped pay for 29 films, including "Mission Impossible 3," "Charlotte's Web," "Dreamgirls," "Flags of Our Fathers," "Blades of Glory," "Jackass 2" and all three "Transformers" movies. In total, the films have grossed nearly $7 billion.

In a written statement, Melrose 2's lawyer, Mark Holscher, said, "Paramount has deliberately inflated losses and under-reported gross receipts."

Paramount, meanwhile, issued a statement saying that the studio "has complied with its obligations to Melrose 2 and has been forthcoming in the audit process. We are disappointed that these sophisticated investors would choose to file a lawsuit filled with hyperbole that ignores the true facts rather than seeing that process through to completion. The Melrose 2 investors have already received almost 90% of their investment back under the financing agreement, and a number of the films in which they participate (such as the successful Transformers 3) remain in the earliest stages of their earning potential."

Still, Paramount spokeswoman Virginia Lam wrote, "the differences between the parties’ positions are relatively modest in amount and we are confident they can be resolved in the ordinary course.” 

Melrose 2 is a follow-up to the 2004 Melrose Investors fund. That fund invested $225 million in 25 Paramount films. Merrill Lynch and the investment bank Dresdner Kleinwort arranged the Melrose deal. Dresdner Kleinwort led Melrose 2.

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The lawsuit says that in September 2006, Paramount and Melrose 2 made a deal for the new fund to pay up to 25 percent of production costs of as many as 30 movies.

"The funding provided by Melrose 2 has served defendants well financially," the lawsuit says. "To date, Paramount has taken in more than $600 million in distribution fees alone from the Melrose 2-funded films, in addition to the untold amounts in actual profits."

The claim adds, "Five years after the agreement was signed, Melrose 2 still has not seen a dollar of profit from its $375 million investment. … This lopsided distribution of earnings comes about as a direct result of defendants' practice of understating gross receipts, delaying payments to Melrose 2, overstating production and distribution costs and hindering Melrose 2's ability to exercise its audit rights."

As an example, the lawsuit says that Paramount claimed that "Flags of Our Fathers" cost nearly twice its budgeted amount, but refused to provide documentation to the investors.

"Similarly, in connection with a later audit, defendants failed to provide the domestic and foreign production cost records for 'Dreamgirls' and 'Norbit,'" the lawsuit says.

Additionally, the suit says, Paramount has "been cagey about other sources of revenue."

It says that "although there appears to be a fair amount of product placement in Melrose 2-funded films such as 'Transformers,' 'Heartbreak Kid,' 'Blades of Glory' and 'Shooter,'" Paramount refuses to provide any formal accounting of any such advertising deals.

As a consequence, the suit adds, the fund cannot determine "whether it was properly credited for cost reductions in connection with those deals."