September 10, 2010

9th Circuit Rules Digital Music Download Deals Are Master Licenses

Arnold & Porter Advisory

On September 3, 2010, the Ninth Circuit decided F.B.T. Productions, LLC v. Aftermath Records, Case No. 09-55817, in favor of Howard Rice client F.B.T. Productions (click here to read the decision). The case is among the first published appellate decisions addressing how traditional music recording agreements apply to new methods of music distribution, such as iTunes and mobile phone ringtones. The case has important implications for musicians and other creative artists operating under older contracts, as well as for distributors and licensors of content.

F.B.T., a Detroit-based music producer, discovered the rapper Eminem in 1995, and three years later brought him to the attention of Aftermath Records, a subsidiary of Universal Music Group. F.B.T. and Eminem entered into standard form recording agreements with Aftermath. These agreements provide for different royalties for "Records Sold" and "Masters Licensed." The royalty for "Masters Licensed" is substantially higher than that for "Records Sold"-50% of net receipts from master licensing versus 12-20% of the adjusted retail price of records sold.

Beginning in 2001, Universal entered into a series of agreements to provide its music to third parties for use in digital download services, such as Apple's iTunes service, as well as for use as mobile phone ringtones (sometimes called "mastertones"). Universal took the position that downloads should be compensated under the "records sold" provision instead of the "masters licensed" provision. F.B.T., however, contended that the transactions between Universal and the third party distributors involved the licensing of a master because digital copies of the sound recordings were transferred to the third parties for the purpose of making further copies for distribution. Notably, in licensing the copies in this fashion, Universal had none of the costs associated with traditional manufacturing and distribution of physical records.

In 2007, F.B.T. sued Universal under the recording agreements for the higher royalty. Before the trial court, both sides moved for summary judgment on their respective interpretations of the contract, but the court found the agreements ambiguous and allowed the case to proceed to trial. A jury found for Universal, and the judge thereafter awarded more than $2.4 million in attorneys' fees against F.B.T.

F.B.T. retained Howard Rice to handle the appeal. In its unanimous ruling, the Court of Appeals found that the contract was unambiguous and that summary judgment should have been entered in favor of F.B.T. The Court agreed with F.B.T.'s contention that the transaction between Universal and third party distributors such as Apple was a license, not a sale, and that accordingly the higher royalty rate should apply to all proceeds received by Universal for digital downloads and ringtones. The Court of Appeals rejected Universal's contention that industry custom created any ambiguity. Universal relied on expert testimony to the effect that the "masters licensed" clause had previously been applied only to compilation records and incorporation of music into movies, TV shows and commercials. But the Court noted that permanent digital downloads and mastertones did not come into existence until 2001 at the earliest; thus, "the fact that the Masters Licensed provision had never previously been applied to those forms of licensing is immaterial."

F.B.T. was represented on appeal by Jerome B. Falk, Jr., Daniel B. Asimow and Sara J. Eisenberg.

What Are the Implications of the Case?

The case has important implications for many constituencies in the music industry, and potentially for others who create, distribute or license creative works such as books, films, and artwork.

For Recording Artists. The agreements at issue in F.B.T. were based on standard form recording agreements used at the time. Many other pre-2000 agreements are similarly structured and may even use identical language. The Ninth Circuit decision will be, at a minimum, highly persuasive in the interpretation of these agreements. Any recording artist whose work is being distributed digitally (and, of course, the agents for such artists) should carefully review the agreements under which they provided their services and determine if the agreement has a royalty structure that provides a greater royalty for the licensing of master recordings. The potential magnitude of these claims is significant, and artists and agents should act promptly to protect their rights. The F.B.T. decision demonstrates that litigation may be necessary to vindicate these contractual rights.

For Record Labels. Clearly, the F.B.T. decision disrupts the traditional royalty and accounting practices of record labels and demonstrates that relying on widespread industry custom is not always an effective defense in individual contract disputes. The wording of each agreement is paramount. Accordingly, any record label or other party that pays or distributes royalties in the music industry should review any applicable agreements and consider whether the F.B.T. decision affects its obligations. At a minimum, record labels may need to account for any potential liabilities in their financial statements. Record labels also may wish to review their current form contracts to make sure they are clear on the royalty treatment for digital downloads and ringtones so that future disputes can be avoided.

For Others in the Entertainment and Media Industries. Now that digital distribution of books, films, photographs, or other creative works is widespread, it is possible that older agreements dealing with such works contain provisions similar to those that gave rise to the F.B.T. dispute. Authors, artists, publishers, studios, and others in the entertainment and media industries should review any relevant agreements to identify any potential royalty or accounting issues raised by the F.B.T. decision. It may be prudent to address such issues proactively before they erupt into disputes.

For more information about this case, please contact Daniel B. Asimow at 415.677.6355 or Thomas A. Magnani at 415.677.6464.


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