As Pink Floyd warned in their heyday: “Money, it’s a crime – share it fairly, but don’t take a slice of my pie.” The lyric now seems strangely prescient of a later royalty dispute with the band’s record label.
In a recent decision, 1 the band won part of an under-accounting claim against EMI. The case has been more widely publicised for the band’s successful attempt to preserve the artistic integrity of their concept albums by preventing EMI from selling their album tracks individually online. But, like many music business cases, the financial dispute is a rare instance of a wider issue coming to court – often decided on its peculiar facts, but often as not touching on a pecuniary question that is central to music industry contracts. The wider issue at stake here is the division of digital royalties – small beer until recently, yet slowly but surely becoming the main revenue stream for recording artists.
Record labels have generally treated any form of digital exploitation as a notional record sale, allowing the label to operate the same elaborate royalty machinery that has been devised over decades for physical sales. Until now, the labels have largely succeeded in resisting challenges to this monolithic structure, but with the rapid rise of digital distribution, successful artists are increasingly likely to challenge this perceived wisdom.
“Grab that cash with both hands and make a stash”
The temptation has always been there for labels to interpret royalties clauses in their own favour. As it is said, possession is nine-tenths of the law, and royalty administrators are inevitably prone to applying their own logic to the accounting process and waiting for a challenge from the artist in the form of a royalty audit.
This royalty dispute, like many others, turned on an audit, which revealed (in the auditors’ view) an under-accounting of over £10 million. In the band’s application for summary judgment, the High Court made two declarations that had been sought by Pink Floyd’s service companies (Pink Floyd) against EMI Records Limited (EMI). The declarations were that, on a proper construction of the relevant agreements:
(a) EMI should have accounted to Pink Floyd on an “at source” basis for online distribution; and
(b) EMI could not “unbundle” Pink Floyd album tracks and sell them individually online.
The Chancellor of the High Court, Sir Andrew Morritt, later ordered EMI to pay Pink Floyd’s legal costs and also refused to give EMI leave to appeal.
The Chancery division bell
Pink Floyd and EMI entered into a number of agreements between 1967 and 1992 relating to the exploitation of Pink Floyd master recordings. On 17 June 1999, the parties entered into an agreement terminating all earlier agreements relating to five named albums (June 1999 Agreement) and a master licence agreement granting EMI a licence to exploit those five albums (MLA). The parties then entered into a series of agreements between 2000 and 2005 under which a further four albums were licensed to EMI on the terms of the MLA.
Following an audit of the royalty statements provided by EMI to Pink Floyd between 2002 and 2007, the audit report indicated 15 areas of under-accounting by EMI. A claim form was issued on 31 March 2009, and a number of issues stated in that claim form were subsequently settled between the parties. Pink Floyd applied for summary judgment on the remaining issues to be resolved, and sought the two declarations on the basis that:
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(a) |
EMI had accounted to Pink Floyd for digital sales at the set percentage rate 2 of EMI’s own receipts, rather than “at source” receipts (i.e. receipts by EMI’s affiliates, licensees and/or sub-licensees, without deducting any sums retained by those third-party distributors); and |
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(b) |
EMI had wrongfully exploited tracks from the relevant albums as single downloads, ringtones and streaming.
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Obscured by clouds – accounting “at source”
The first declaration sought by Pink Floyd was that, on true construction of the June 1999 Agreement and/or the MLA, internet music providers (e.g. iTunes) were "sub-licensees, affiliates or any third party obtaining rights in this respect directly or indirectly from [EMI]" (third-party licensees) within the meaning of the relevant clauses of the June 1999 Agreement and the MLA, with the effect that EMI should have accounted to Pink Floyd on the basis of income received at source by such providers.
Clause 9(d) of the June 1999 Agreement (which was almost identical to the corresponding clause 6.1(b)(i) of the MLA) provided that, for online sales distribution by EMI or its associates (whether directly or by licence):
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such sales would be treated as sales of “Records” for all purposes of the agreement, except that the royalty for such sales would be a defined percentage share of EMI's receipts; and |
| (b) |
EMI's receipts should be calculated "at the so-called source" so as to be based on the receipts of EMI's third-party licensees. |
EMI argued in its defence that the true construction of such wording should not be taken to mean that the royalty due to Pink Floyd should be calculated on the receipts of the end retailer (e.g. iTunes). EMI based this argument on the fact that, by 1999, major record companies had moved from calculating artist royalties on retail prices (which was common in the 1960s) and towards wholesale or dealer prices. EMI contended that it became standard practice to use the words “at source” (primarily used in relation to music publishing) in this latter context to counteract the activities of unscrupulous record companies accumulating receipts in subsidiary or associated companies to avoid accounting to the artist on those receipts. It was argued that a music industry lawyer practising in 1999 would have understood the words “at the so-called “source” to apply only to capture monies received at the exclusive-licensee level, but not to expand the pool to online retailers, and that therefore the reference to third-party licensees would have been understood to refer to those companies to whom the record company exclusively licenses its catalogue for distribution in a particular territory, but not third-party retailers: to bring into account the price at which a third-party online retailer sells to consumers would effectively be moving back to a retail-price royalty basis. EMI admitted that the limitations it sought to place on the wording could not be derived from the wording of the relevant clause itself, but rather through evidence of common practice at the time derived from its expert witness, and from the absence of any reference to the word “retailers” in the clause.
Granting the declaration to Pink Floyd, the Chancellor held that EMI had no real prospect of success in its defence of the claim. EMI could not sustain an argument that the reference to third-party licensees should exclude retail sales. It is possible that a sub-licensee of EMI could be both a wholesaler and a retailer, and as a matter of construction it would not be possible to include wholesale sales and exclude retail sales in such circumstances. While in 1999 online or digital exploitation of sound recordings did not exist, it was contemplated, and crucially was contemplated in the opening words of clause 9(d) of the June 1999 Agreement.
“Careful with that axe, Eugene” – unbundling
For Pink Floyd, the final cut of an album should be just that. They are one of the few bands that have made it as (more or less literally) an album artist. They had managed to insist on a restriction on selling individual tracks without the band’s permission – something that is almost unheard of in most record contracts: most download platforms (notably iTunes) focus on selling individual tracks.
The second declaration sought by Pink Floyd was that, on true construction of the MLA, clause 4.13 of the MLA applied to online distribution, so that EMI had no right (without Pink Floyd’s prior written consent, which could be withheld in Pink Floyd’s absolute discretion) to exploit the recordings on the relevant albums by online distribution (or by any other means) other than the original album configurations.
Clause 4.13 of the MLA contained an undertaking by EMI (a) not to couple records delivered under the MLA with other master recordings or to sell them in any form other than as the current albums and (b) to exploit the albums in exactly the same form as to track listing and timing as delivered under the MLA, together with a specific restriction on selling any of the recordings as singles (except with Pink Floyd’s prior written consent, which could be withheld in Pink Floyd’s absolute discretion).
EMI did not dispute that it had permitted the exploitation of individual recordings from the relevant albums by the sale of single-track downloads, the use of parts of single tracks as ringtones and the streaming of single tracks. EMI asserted, however, that the restriction imposed by clause 4.13 of the MLA applied “only to the sale of physical records and not to recordings distributed online”. It pointed to other clauses in the MLA that only applied to physical product. EMI also set out alternative defences of consent and estoppel, which would go to trial regardless of whether the second declaration was made.
Pink Floyd contended that the purpose of clause 4.13 was to preserve the artistic integrity of the albums, and that it would be nonsensical for the clause not to extend to digital as well as physical recordings. This argument was supported by the definition of “Single”, which included “all other equivalent means of exploitation”, and by the definition of “Record”, which included “formats to be devised”.
As there was (on a summary-judgment application) no suggestion of a factual matrix to consider, the issue was purely a question of construction of the clause in the context of the MLA as a whole. The Chancellor started from the proposition that the clause was intended to preserve the artistic integrity of the albums, and found that such purpose was as relevant to online distribution as to sale of physical product. On the basis that the definitions of “Album” and “Record” did not include any limitation to physical product only and the definition of “Single” clearly included digital product by referring to “all other equivalent means of exploitation”, the Chancellor found that EMI could not demonstrate a real prospect of success in resisting the grant of the second declaration.
“Money, it’s a hit”
The case turned on the wording of the relevant contracts, so it actually gives few clues as to how the courts might in future interpret disputed digital royalty provisions. The mere fact that the court found for the artist might prove more important in encouraging other artists to litigate – although the interests of commercial confidence may well drive parties to settle differences entirely behind closed doors.
Nonetheless, the case captures something of the zeitgeist, with the rapid growth of the digital market and corresponding decline of the physical market. Recent IFPI figures show that global trade revenue to record companies fell 7.2% to US$17bn in 2009, but that digital music sales grew by 9.2% to US$4.2bn in the same period. 3 Globally, digital sales in 2009 accounted for 25.3% of all trade revenues to record companies, and these statistics and year-on-year trends suggest that digital sales (and other types of online exploitation) will continue to increase and will relatively soon outstrip falling physical sales.
Disputes of this type are therefore likely to become more frequent, especially for older record contracts, which may not have contemplated digital distribution. It will certainly encourage established artists to reconsider the small print of their record contracts. And success can breed contempt: as Spike Milligan used to say, “Money can’t buy friends, but you can get a better class of enemy.”
In fact, the Pink Floyd case is not representative of the most commonly encountered issue in commercial practice, which is not just the nature of the royalty base, but the level of the royalty rate.
“If you ask for a rise, it’s no surprise that they’re giving none away”
Artists will increasingly wish to receive a higher share of digital revenue. Equally, record labels will aim to preserve their share of digital revenue as their margins become slimmer with dwindling physical sales: digital revenue streams have to date been considerably less lucrative than physical sales (partly as consumption patterns are reverting to purchases of individual tracks, rather than of whole albums).
In older contracts, it is frequently unclear whether digital revenue should be treated as regular record income or as pure licensing income. Labels will consider download and similar income as substitutional of traditional record sales, and so a form of primary exploitation which, in order to compensate the label for its overhead costs (including marketing expenditure), justifies a higher share of income arising than in the more passive forms of third-party licensing (for which labels have long accepted a more straightforwardly equitable 50:50 split between label and artist). This issue came to a head in a US case, which it is instructive to consider alongside the Pink Floyd case.
“I’m all right, Jack – keep your hands off my stack”
In the “Eminem” case (heard in California in early 2009), 4 the rapper Eminem’s production company, FBT Productions, LLC, and his service company, Em2M, LLC (Eminem) argued that Aftermath Records, and its ultimate distributor UMG Recordings, Inc. (UMG), should have accounted to them on a “masters licensed” basis (under which Eminem was entitled to 50% of Aftermath’s net receipts), as opposed to a “records sold” basis (under which Eminem’s royalty varied between 12% and 20% of records sold). The relevant agreements did not expressly state which royalty basis should apply to sales of permanent downloads and mastertones of Eminem master recordings.
Under Californian law, when the meaning of the words in a contract is in dispute, the court must provisionally consider all extrinsic evidence relevant to the interpretations advanced by the parties. As neither party submitted evidence of negotiations between them on the point at issue, the court examined the nature of the contract and the surrounding circumstances to interpret the contractual language. Eminem argued that the relationship between UMG and third-party permanent download and mastertone providers is one of a licence and accordingly the “masters licensed” royalty rate should apply. Furthermore, Eminem argued that the purpose of a “masters licensed” provision is “to provide for a higher royalty rate when the record company licenses the master recordings to third parties because in such situations the record company does not incur the expensive incremental cost associated with manufacturing, packaging and distributing the physical records associated with a release by a third party”. Aftermath disputed that the “master licensed” provision should apply to downloads, contending that provisions such as the “masters licensed” provision typically apply only to compilation records and incorporation into movies, TV shows and commercials.
Eminem failed in the initial application for summary judgment, as the court found that, based on the conflicting evidence presented to it, the correct royalty basis under the relevant agreements remained a triable issue of fact. Eminem was, in any event, unsuccessful at trial when heard before a jury in March 2009: the court confirmed that the “records sold” royalty should apply to digital sales. As with the Pink Floyd case, the Eminem case turned on construction of a particular contract.
Another brick in the wall
Newer contracts avoid this ambiguity by specifically stating both the royalty rate for digital distribution and the royalty base to which that rate is to be applied. That begs the question, however, of what the rate and the base should be.
Before the late 1990s, the advent of digital distribution was not contemplated by the major recording companies. Artists still being accounted to under the terms of those agreements may find that their royalties from digital income are subject to packaging deductions and other deductions commonly applied to physical product. This practice has been much derided among the artist community.
In current record contracts, all of the major record companies account to the artist for digital download sales at the headline rate that applies to physical product (or a similar rate). So-called “packaging deductions” have largely been dropped for digital sales, although “service charges” are sometimes applied instead. The traditional physical sales model can be a awkward fit with new media platforms, especially those involving subscription or ad-supported business models where there is no actual per-unit wholesale price. Some artists have managed to make inroads into net-receipts accounting for streaming, but at present this is a minor concession as the income is often paltry. Mid-price and budget-price deductions still often apply to digital distribution, although the rationale is not so clear where (in contrast to physical sales) the fixed per-unit costs are very low.
Uncomfortably numb
Many artists now object to being accounted to on this basis. Artists’ advisers have long tried (almost routinely without success) to characterise digital exploitation as pure licensing income, on the basis that the record company only has to suffer marginal costs (incurring negligible format-conversion costs and having no physical product to ship). The royalty rate for third-party licensing income has traditionally been 50% of the label’s net receipts – a good deal higher than applying the headline physical royalty rate (between, say, 18% and 22%) to an artificial digital dealer price. In the UK, the Featured Artists Coalition has urged that artists should receive “fair compensation” as part of the new delivery agreements between record labels and technology companies, and it is conceivable that the artist community may yet try to bring collective pressure to bear; certainly, individual artists with clout are likely to seek to increase their share of digital revenues. To date, however, record labels have only been amenable to adopting a net-receipts royalty base (and a royalty rate in the order of 50%) under a licence of a successful catalogue. Nonetheless, it seems likely that at least “top talent” will be able to attract more competitive digital rates as digital sales begin to predominate.
At the same time, labels are looking for more imaginative ways of participating in the digital value chain and will remain reluctant to share all of the revenue derived with artists (for instance, revenue derived from an equity investment in a digital distributor – although this has proved controversial where shares have been issued in part consideration for track licensing, artificially driving down the per-play revenue attributable on track-by-track basis). Many of the current standard royalty provisions still treat digital income as a side-show, without engaging in the level of detail that such clauses will ultimately deserve.
Whether from a label or artist perspective, therefore, it is hard to see that the current digital royalty model is sustainable in the longer term, although it may take a number of years before a new norm emerges.
For now, most new recording artists – if not many labels – are some way away from Pink Floyd’s aspiration of “new car, caviar, four-star daydream – think I’ll buy me a football team”.
Ed Baden-Powell and Jon Baker
Ed Baden-Powell is a partner at Michael Simkins LLP in London, specialising in media and entertainment law, with a particular focus on music, sport, live events and new media.
Jon Baker is an associate at Michael Simkins LLP, specialising in media and entertainment law, with a particular focus on clients in the music industry.
Abstract:
In an application for summary judgment against EMI, Pink Floyd were recently granted two declarations on the division of digital royalties and unbundling of album tracks. This article explores the issues arising from the decision, as well as a US case on digital royalties due to Eminem. It also examines current commercial practice and how that might change in the evolving digital marketplace.
1 Pink Floyd Music Limited and Pink Floyd (1987) Limited v. EMI Records Limited [2010] EWHC 533 (Ch), 11 March 2010.
2 For reasons of commercial confidence, specific royalty rates were redacted from the final judgment, and parts of the hearing were conducted in private.
3 IFPI Digital Music Report 2010.
4 FBT Productions, LLC and others v. Aftermath Records and others, 07-3314, US District Court, Central District of California (Los Angeles). This case was also an application for summary judgment.
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