A Primer on Licensing Music For Digital Distribution

Digital distribution contracts are still in their infancy as music industry practices in this area continue to solidify. As digital channels of distribution continue to penetrate the music world, it is increasingly crucial that entertainment professionals understand the nuances of licensing content for use online. This article explores current practices in this area.

A digital download is functionally similar to the sale of a CD single. Therefore, the licensing of musical content for this purpose varies little from the traditional process for albums and songs. The user must obtain both a master-use license from the owner of the sound recording and a mechanical license typically from the publisher for use of the song.

Regarding permanent downloads, “there's been an understanding in the business that if a record company has an existing mechanical license [to record a particular song] that enables them to manufacture and distribute CDs and CD singles, then that mechanical license should cover downloads,” says Tuhin Roy, Managing Director of the Digital Rights Agency. However, Lauren Apolito, Vice President of Business Development at The Harry Fox Agency notes that in Rodgers and Hammerstein Organization v. UMG Recordings Inc., 60 U.S.P.Q.2D (BNA) 1354, the U.S. District Court for the Southern District of New York ruled that a mechanical license did not necessarily extend to all online uses. Although UMG Recordings Inc. had obtained compulsory mechanical licenses from the Harry Fox Agency for the public distribution of sound recordings, use of the recorded compositions by UMG subsidiary Farmclub.com on its Web site was not acceptable. Rather than distributing recordings “to the public for private use” as is permitted by Sec. 115 of the U.S. Copyright Act, the Web site allowed users to listen to recordings of their choice in a streaming audio format. The district court further ruled that the defendant was not permitted to store the sound recordings on its servers. Because Farmclub.com's “server copies [were] neither intended for distribution to the public nor part of a process for distributing digital copies of the existing phonorecords, Section 115 would not give the Defendants a right to a compulsory license for the server copies,” the court concluded.

When it comes to Web sites that stream digital audio, the licensing process can vary from the traditional set-up. If the streaming service meets the requirements of the Sound Recording Performance Complement (SRPC) ' an addition to U.S. Copyright law defining rules for the digital performance of sound recordings ' a compulsory license for webcasting will apply. To satisfy the requirements of the SRPC, a site must not play more than two cuts from the same album consecutively or three songs consecutively from the same artist. In addition, the Web site can play no more than three cuts from a CD or four cuts by the same artist in any 3 hour period.

There is some debate among major players in the digital distribution arena regarding the requirement of mechanical licenses versus public performance licenses for Internet streaming. The Harry Fox Agency insists that a mechanical license should be required of webcasters because of the ephemeral copy that serves as a source file on the licensee's server in order to stream the audio, whereas performance rights societies such as ASCAP claim that the streaming of sound recordings is a performance like radio or television. If the Harry Fox agency is correct, a mechanical license and a master-use license would be required for the streaming of digital audio. If the performance rights societies get their way, a performance license will also be required.

The current practice is for webcasters to obtain and pay for mechanical licenses for streaming audio and limited downloads in accordance with an agreement reached in 2001 between the Recording Industry Association of America (RIAA) on one side and the Harry Fox Agency/National Music Publishers' Association on the other.

Key Licensing Deal Points

When a service, such as iTunes, Musicmatch or Napster, desires to license catalog from a record company for digital downloads, the parties negotiate what is commonly referred to as an “output deal.” In doing so, in the fluid and fast-moving world of Internet technology it is crucial to define terms that may not be common. These terms include:

• Content file: The digital file containing a sound recording or multi-track album of a licensor's content, including artwork, parental notices, videos and the core track data;
• eMaster: The digital copy of the licensor's content, including security encoding and all pertinent material ready for sale on the licensee's Web site;
• Device: Any digital player device that can receive and playback music files from another device; and
• Artwork: Cleared album artwork associated with the content hereunder licensed.

Authorization

The licensor must grant the licensee authority to reproduce content for exploitation. This includes for the source file on the licensee's server from which all copies are made. Licensees must also obtain authorization to convert the content into new file versions as necessary for exploitation. The licensee also negotiates for authorization to use clips and display associated artwork for the purpose of promotion. Other rights may be granted at the discretion of the parties involved. But the licensee rarely has the right to alter any content in any fashion beyond re-formatting for the purposes of digital exploitation.

Obligations

With the continued influx of hackers, spammers and virtual bandits, security controls are necessary for any Web site. Digital distribution licensees must ensure licensors that data protection controls are in place to prevent unauthorized downloads and other illegal activities. From the licensor's perspective, the licensee should be required to pay the cost of any fulfillment activities associated with the agreement at hand. Keeping up with technology updates, order fulfillment, library upkeep and other site-related issues is simply the cost of doing business and should have nothing to do with the licensor and its sub-parties.

Sites licensing music for online distribution also must agree to remove particular content if there is a problem with the record company's rights (although, one of the record label's responsibilities is to ensure proper clearance of material). In addition, the licensee must account to the licensor about revenues on a regular basis, and pay the licensee the proper, agreed-upon amounts for transactions completed within a specified time frame.

The obligations the licensor should fulfill include obtaining clearances for sound recordings and related artwork, providing approved content in the appropriate format ' such as MP4 ' to the licensee in a timely manner, divvying up royalty payments to artists and other record royalty participants and distributing mechanical royalties to publishers and/or administrators.

Exclusivity

Digital distribution deals are typically non-exclusive. From the record label's side, this works well because its catalog can be available throughout the Internet and not only on one site. Some online services have tried to negotiate exclusive deals for certain catalogs, but this is not standard practice. In fact, according to entertainment attorney Peter Strand of the Chicago office of Holland & Knight, “[t]here are interesting market pressures that may not make that necessarily the best business decision. iTunes is the first in the marketplace and would want to be the only place for certain artists, but you also have an entire consumer base of which a large percentage is not using that service and most companies are forward thinking enough to realize you need to have multiple services out there so people will learn that the Internet is a source for music. The risk on that is [service providers] give up market share and people go elsewhere.”

Term and Scope

The term for digital licensing deals is usually from 1 year to 18 months, and includes rights to a label's cleared material at the time of the deal as well as material cleared throughout the term. Cleared material refers to content legally available for digital use according to contracts in place at the artist-publisher/label level. Certain high-profile artists will have the right to block digital distribution. This has been negotiated in the artist deal with the record label, and has little impact on Web service/label agreements other than the fact that some content from the label's catalog may not be available.

Termination

Either party should have the right to terminate the agreement in accordance with pre-set terms agreed upon at the outset of the deal. Common reasons cited for termination are bankruptcy and breach of contract. Some labels have negotiated termination clauses that allow a cessation of the agreement after a short period of time (eg, 3-6 months) if the exploitation of the material does not meet a pre-determined performance standard. Upon termination, there may be certain portions of the contract that remain in effect, depending on terms negotiated at the time of signing.

Sublicensing/Assignment of Rights

Most often, no rights are assigned by the licensor to the licensee other than the right to distribute the content online. The licensee is usually required to agree that no sublicensing to a third party will occur. However, middle-man services such as The Digital Rights Agency and Orchard act as licensing agents and obtain rights to sublicense their clients' content. This type of activity is commonly reserved for independent licensors and is uncommon in deals with major record labels and publishing houses.

International Issues

As noted above, record labels generally take responsibility for obtaining and maintaining the appropriate mechanical licenses. Artist deals with domestic labels are generally struck with international distribution in mind. With independent or international labels, obtaining mechanical rights can get more complicated. Entertainment attorney Chris Castle, of the Los Angeles office of Akin Gump Strauss Hauer & Feld, explains: “What's different outside the U.S. is that societies tend to represent a whole lot more of the catalog of that country than the Harry Fox Agency does [in America]. The Harry Fox Agency handles somewhere between 60% and 80% of the copyrights in this country. Off shore, including Canada, you have one, quasi-governmental agency that represents [the mechanical and performance rights of] 95% of the catalog in the country.”

In addition to minor changes in licensing practice, the major complication presented by the international nature of Internet technology is jurisdiction. When an American-owned service operates out of Mexico with servers in Holland and customers all over the globe, jurisdiction can get complicated. This can become an important negotiation point.

Accounting

The sale of an eMaster occurs when it's delivered successfully to an end user, and the licensee pays the licensor the wholesale price each time this occurs. A common wholesale price, paid by the licensee to the licensor, is 65 cents per download.

In the typical digital distribution contract, the licensee will provide a proceeds statement to the licensor once per month with an accompanying payment, and the licensor will make the appropriate payments to each member of the royalty pool.

Royalty Entitlements

There is some debate on artist earnings from downloads. Depending on the circumstances, the artist is either paid via the artist royalty percentage on the retail “sale” of a download, or 50% of the record company's net earnings for the license for the online use. Most record labels have decided to treat downloads in the same manner as traditional sales and pay the artist the negotiated royalty rate in the form of a percentage of the retail price.

On the publishing side, once the record label receives payment from the online service at the statutory mechanical rate (currently 8.5 cents per song for songs under 5 minutes), checks are written to the respective publishers and administrators for the song. In the U.S., labels typically pay the Harry Fox agency, which then deducts a fee and passes along the royalties according to the publishing agreements in place.

The Internet sound-recording royalty is commonly divided 50% to the copyright owner (which is usually the record label), 45% to the featured artist and then 2.5% each to AFM and AFTRA.

Streaming audio is not necessarily considered a “sale” in the traditional sense of the word. For this, licensors are generally paid performance royalties based on a percentage of the subscription price according to the shares of “air time” noted on the census reports of online streaming activity.

While it is a hot-button issue debated by the RIAA and Harry Fox Agency, the streaming mechanical royalty is, in fact, an “infinitesimal amount of money … at approximately one-third of a cent per stream,” notes Castle.

For ephemeral copies, there is generally a one-time payment to the composition copyright owner of approximately 10 cents. The breakdown of payment to artists, publishers and other parties from downloads and streaming audio is generally the same.

Reversion

In agreements between online music services and owners of desired content, there is often negotiation regarding the removal of material in the interest of artist relations. Even though digital rights are addressed in modern recording contracts, older deals may not account for this type of distribution. In the event that content is licensed to an online service against the wishes of an artist or in violation of a previous deal, there may be circumstances that would require reversion of the content from the licensee to the licensor. This should be addressed in negotiations between licensors and licensees.

Digital distribution contracts are still in their infancy as music industry practices in this area continue to solidify. As digital channels of distribution continue to penetrate the music world, it is increasingly crucial that entertainment professionals understand the nuances of licensing content for use online. This article explores current practices in this area.

A digital download is functionally similar to the sale of a CD single. Therefore, the licensing of musical content for this purpose varies little from the traditional process for albums and songs. The user must obtain both a master-use license from the owner of the sound recording and a mechanical license typically from the publisher for use of the song.

Regarding permanent downloads, “there's been an understanding in the business that if a record company has an existing mechanical license [to record a particular song] that enables them to manufacture and distribute CDs and CD singles, then that mechanical license should cover downloads,” says Tuhin Roy, Managing Director of the Digital Rights Agency. However, Lauren Apolito, Vice President of Business Development at The Harry Fox Agency notes that in Rodgers and Hammerstein Organization v. UMG Recordings Inc., 60 U.S.P.Q.2D (BNA) 1354, the U.S. District Court for the Southern District of New York ruled that a mechanical license did not necessarily extend to all online uses. Although UMG Recordings Inc. had obtained compulsory mechanical licenses from the Harry Fox Agency for the public distribution of sound recordings, use of the recorded compositions by UMG subsidiary Farmclub.com on its Web site was not acceptable. Rather than distributing recordings “to the public for private use” as is permitted by Sec. 115 of the U.S. Copyright Act, the Web site allowed users to listen to recordings of their choice in a streaming audio format. The district court further ruled that the defendant was not permitted to store the sound recordings on its servers. Because Farmclub.com's “server copies [were] neither intended for distribution to the public nor part of a process for distributing digital copies of the existing phonorecords, Section 115 would not give the Defendants a right to a compulsory license for the server copies,” the court concluded.

When it comes to Web sites that stream digital audio, the licensing process can vary from the traditional set-up. If the streaming service meets the requirements of the Sound Recording Performance Complement (SRPC) ' an addition to U.S. Copyright law defining rules for the digital performance of sound recordings ' a compulsory license for webcasting will apply. To satisfy the requirements of the SRPC, a site must not play more than two cuts from the same album consecutively or three songs consecutively from the same artist. In addition, the Web site can play no more than three cuts from a CD or four cuts by the same artist in any 3 hour period.

There is some debate among major players in the digital distribution arena regarding the requirement of mechanical licenses versus public performance licenses for Internet streaming. The Harry Fox Agency insists that a mechanical license should be required of webcasters because of the ephemeral copy that serves as a source file on the licensee's server in order to stream the audio, whereas performance rights societies such as ASCAP claim that the streaming of sound recordings is a performance like radio or television. If the Harry Fox agency is correct, a mechanical license and a master-use license would be required for the streaming of digital audio. If the performance rights societies get their way, a performance license will also be required.

The current practice is for webcasters to obtain and pay for mechanical licenses for streaming audio and limited downloads in accordance with an agreement reached in 2001 between the Recording Industry Association of America (RIAA) on one side and the Harry Fox Agency/National Music Publishers' Association on the other.

Key Licensing Deal Points

When a service, such as iTunes, Musicmatch or Napster, desires to license catalog from a record company for digital downloads, the parties negotiate what is commonly referred to as an “output deal.” In doing so, in the fluid and fast-moving world of Internet technology it is crucial to define terms that may not be common. These terms include:

• Content file: The digital file containing a sound recording or multi-track album of a licensor's content, including artwork, parental notices, videos and the core track data;
• eMaster: The digital copy of the licensor's content, including security encoding and all pertinent material ready for sale on the licensee's Web site;
• Device: Any digital player device that can receive and playback music files from another device; and
• Artwork: Cleared album artwork associated with the content hereunder licensed.

Authorization

The licensor must grant the licensee authority to reproduce content for exploitation. This includes for the source file on the licensee's server from which all copies are made. Licensees must also obtain authorization to convert the content into new file versions as necessary for exploitation. The licensee also negotiates for authorization to use clips and display associated artwork for the purpose of promotion. Other rights may be granted at the discretion of the parties involved. But the licensee rarely has the right to alter any content in any fashion beyond re-formatting for the purposes of digital exploitation.

Obligations

With the continued influx of hackers, spammers and virtual bandits, security controls are necessary for any Web site. Digital distribution licensees must ensure licensors that data protection controls are in place to prevent unauthorized downloads and other illegal activities. From the licensor's perspective, the licensee should be required to pay the cost of any fulfillment activities associated with the agreement at hand. Keeping up with technology updates, order fulfillment, library upkeep and other site-related issues is simply the cost of doing business and should have nothing to do with the licensor and its sub-parties.

Sites licensing music for online distribution also must agree to remove particular content if there is a problem with the record company's rights (although, one of the record label's responsibilities is to ensure proper clearance of material). In addition, the licensee must account to the licensor about revenues on a regular basis, and pay the licensee the proper, agreed-upon amounts for transactions completed within a specified time frame.

The obligations the licensor should fulfill include obtaining clearances for sound recordings and related artwork, providing approved content in the appropriate format ' such as MP4 ' to the licensee in a timely manner, divvying up royalty payments to artists and other record royalty participants and distributing mechanical royalties to publishers and/or administrators.

Exclusivity

Digital distribution deals are typically non-exclusive. From the record label's side, this works well because its catalog can be available throughout the Internet and not only on one site. Some online services have tried to negotiate exclusive deals for certain catalogs, but this is not standard practice. In fact, according to entertainment attorney Peter Strand of the Chicago office of Holland & Knight, “[t]here are interesting market pressures that may not make that necessarily the best business decision. iTunes is the first in the marketplace and would want to be the only place for certain artists, but you also have an entire consumer base of which a large percentage is not using that service and most companies are forward thinking enough to realize you need to have multiple services out there so people will learn that the Internet is a source for music. The risk on that is [service providers] give up market share and people go elsewhere.”

Term and Scope

The term for digital licensing deals is usually from 1 year to 18 months, and includes rights to a label's cleared material at the time of the deal as well as material cleared throughout the term. Cleared material refers to content legally available for digital use according to contracts in place at the artist-publisher/label level. Certain high-profile artists will have the right to block digital distribution. This has been negotiated in the artist deal with the record label, and has little impact on Web service/label agreements other than the fact that some content from the label's catalog may not be available.

Termination

Either party should have the right to terminate the agreement in accordance with pre-set terms agreed upon at the outset of the deal. Common reasons cited for termination are bankruptcy and breach of contract. Some labels have negotiated termination clauses that allow a cessation of the agreement after a short period of time (eg, 3-6 months) if the exploitation of the material does not meet a pre-determined performance standard. Upon termination, there may be certain portions of the contract that remain in effect, depending on terms negotiated at the time of signing.

Sublicensing/Assignment of Rights

Most often, no rights are assigned by the licensor to the licensee other than the right to distribute the content online. The licensee is usually required to agree that no sublicensing to a third party will occur. However, middle-man services such as The Digital Rights Agency and Orchard act as licensing agents and obtain rights to sublicense their clients' content. This type of activity is commonly reserved for independent licensors and is uncommon in deals with major record labels and publishing houses.

International Issues

As noted above, record labels generally take responsibility for obtaining and maintaining the appropriate mechanical licenses. Artist deals with domestic labels are generally struck with international distribution in mind. With independent or international labels, obtaining mechanical rights can get more complicated. Entertainment attorney Chris Castle, of the Los Angeles office of Akin Gump Strauss Hauer & Feld, explains: “What's different outside the U.S. is that societies tend to represent a whole lot more of the catalog of that country than the Harry Fox Agency does [in America]. The Harry Fox Agency handles somewhere between 60% and 80% of the copyrights in this country. Off shore, including Canada, you have one, quasi-governmental agency that represents [the mechanical and performance rights of] 95% of the catalog in the country.”

In addition to minor changes in licensing practice, the major complication presented by the international nature of Internet technology is jurisdiction. When an American-owned service operates out of Mexico with servers in Holland and customers all over the globe, jurisdiction can get complicated. This can become an important negotiation point.

Accounting

The sale of an eMaster occurs when it's delivered successfully to an end user, and the licensee pays the licensor the wholesale price each time this occurs. A common wholesale price, paid by the licensee to the licensor, is 65 cents per download.

In the typical digital distribution contract, the licensee will provide a proceeds statement to the licensor once per month with an accompanying payment, and the licensor will make the appropriate payments to each member of the royalty pool.

Royalty Entitlements

There is some debate on artist earnings from downloads. Depending on the circumstances, the artist is either paid via the artist royalty percentage on the retail “sale” of a download, or 50% of the record company's net earnings for the license for the online use. Most record labels have decided to treat downloads in the same manner as traditional sales and pay the artist the negotiated royalty rate in the form of a percentage of the retail price.

On the publishing side, once the record label receives payment from the online service at the statutory mechanical rate (currently 8.5 cents per song for songs under 5 minutes), checks are written to the respective publishers and administrators for the song. In the U.S., labels typically pay the Harry Fox agency, which then deducts a fee and passes along the royalties according to the publishing agreements in place.

The Internet sound-recording royalty is commonly divided 50% to the copyright owner (which is usually the record label), 45% to the featured artist and then 2.5% each to AFM and AFTRA.

Streaming audio is not necessarily considered a “sale” in the traditional sense of the word. For this, licensors are generally paid performance royalties based on a percentage of the subscription price according to the shares of “air time” noted on the census reports of online streaming activity.

While it is a hot-button issue debated by the RIAA and Harry Fox Agency, the streaming mechanical royalty is, in fact, an “infinitesimal amount of money … at approximately one-third of a cent per stream,” notes Castle.

For ephemeral copies, there is generally a one-time payment to the composition copyright owner of approximately 10 cents. The breakdown of payment to artists, publishers and other parties from downloads and streaming audio is generally the same.

Reversion

In agreements between online music services and owners of desired content, there is often negotiation regarding the removal of material in the interest of artist relations. Even though digital rights are addressed in modern recording contracts, older deals may not account for this type of distribution. In the event that content is licensed to an online service against the wishes of an artist or in violation of a previous deal, there may be circumstances that would require reversion of the content from the licensee to the licensor. This should be addressed in negotiations between licensors and licensees.