Artists Seek Greater Share From Label Of Revenues From Digital Downloads

Two highly successful rock groups from the 1970s and '80s recently commenced a lawsuit in the U.S. District Court for the Southern District of New York against their former record company, claiming a larger share of revenue derived from paid digital downloads of their recordings. Allman v. Sony BMG Music Entertainment Inc. (Sony), 06 CV 3252. The plaintiffs also seek to represent similarly situated recording artists through certification of the litigation as a class action. The plaintiffs are the Allman Brothers Band and Cheap Trick, whose formidable catalogues of recordings remain tremendously popular and continue to fatten the bottom lines of several record companies in addition to the defendant Sony. (Sony is the successor-in-interest to the contracts that the plaintiff artists signed many years ago. Sony thus owns the rights to exploit the master recordings delivered pursuant to those contracts and bears the obligation to account and pay royalties to the artists.)

Artists: Digital Copies Are Licenses, Not Sales

The essence of the plaintiffs' claim is that Sony is calculating the artists' shares of revenue from digital download sales through services such as iTunes, Pressplay, Napster, Music Net and others ('music download providers') in the same manner that the label calculates royalties for physical sales of CDs through traditional retail outlets. The plaintiffs allege that this constitutes a mischaracterization that results in drastically understated royalty accountings for those sales. They claim that these are not physical sales, but are instead sales of digital copies of recordings that have been licensed to music download providers by Sony. The music download providers distribute digital copies of the licensed recordings to their subscribers, either in the form of a downloaded copy that can then be reproduced on an iPod or MP3 player, or as a 'stream' that can be listened to on a computer connected to the provider through the Internet. There is no physical device, such as a CD, anywhere in this process, and the entire transaction (subscription, payment, download or stream) is handled electronically through an end-user's computer. Accordingly, the plaintiffs claim, the royalty rate payable for licensing income, which is much higher than for physical sales, should apply. (A similar claim, though not a class action, was filed in May 2005 in the U.S. District Court for the Central District of California against Warner Music Group over Tom Waits' recordings. Third Story Music Inc. v. Warner Music Group Corp., CV05-3942. The matter settled on confidential terms after some discovery and a mediation.)

The traditional way of calculating royalties for the sale of physical records under the contracts of these legacy artists ' and for the majority of today's recording artists ' involves the deduction of numerous charges from income derived from such sales, including for: packaging; broken records; theft (known as 'shrinkage'); copies of CDs given to record stores as incentive to stock a particular record, possibly by a different artist (known as 'free goods'); and costs related to the extra expense of developing and commercializing so-called 'new technologies.' Many record companies, including Sony, still claim that CDs fall within this latter category. Also deducted are a percentage of sales as 'reserves,' which anticipate the return of unsold CDs to the record company for which the retailer must be reimbursed. Some years later, those reserves are liquidated based on the number of physical records returned to the record company, if any.

Under the plaintiffs' contracts, and under the contracts of many, if not most recording artists who signed contracts beginning in the early 1960s through the early 2000s, the sale of recordings in the form of digital downloads wasn't contemplated. What was contemplated was that recordings could be 'leased' or licensed to third parties who would then distribute the recordings to consumers and others. A typical scenario was the issuance of a 'synchronization' license for use of a sound recording in a motion picture. Under the recording contract, the record company and artist would equally share the net revenue derived from the license, and none of the 'traditional' deductions described above would be applied.

What distinguishes the Allman plaintiffs' contracts from the contracts artists have signed more recently is that record companies now include language that specifically characterizes a digital download as the sale of a physical record, like a CD, and accordingly apply the foregoing deductions, or variations thereof, with impunity. Hence, the putative class of recording artists that the Allman plaintiffs seek to represent will be limited to legacy artists whose contracts include no such characterization (or, as some would say, 'fiction').

Calculating Downloads

To fully understand the extent of the plaintiffs' claim, one must consider the practical effect of the two different methods of calculating royalties on the amount of royalties payable. The examples below are drawn primarily from the Allman complaint. The members of the Allman Brothers Band and Cheap Trick maintain that Sony improperly uses the Example 1 calculation for sales through music download providers when they should be using the calculation in Example 2. These calculations, however, are typical of how royalties are accounted in many, if not most, legacy recording artists' agreements, be they with Sony, the three other major record companies ' Warner Music Group, EMI and Universal ' or a number of smaller independent labels.

[IMGCAP(1)]

[IMGCAP(2)]

The examples below assume the retail price of a downloaded recording is $0.99, of which $0.70 is remitted to the record company.

In the second example, the artists receive royalties that are fully seven times greater than in the first example. Moreover, had the first example factored in the deduction for reserves, which Sony generally applies to royalty accounts, the amount payable would have been zero. (In fact, it would have been less than zero in this example, meaning that the artist's account would be in an 'unrecouped' position ' at least until the reserves for those sales were liquidated some years later.)

According to Nielsen SoundScan, Cheap Trick and the Allman Brothers Band have collectively sold about 1 million downloads since 2002. Based on this alone, the foregoing calculation supports a claim for underpayment of approximately $270,000. While this amount is perhaps only marginally significant after netting out litigation costs, if multiplied by the potentially thousands of identical, or nearly identical, claims made by other legacy artists, even if the class isn't certified, the resulting economic fallout could itself be a lasting, if unintended legacy. One wonders, then, why the plaintiffs' claims weren't addressed long before it got to this point.

Potential Impact Looms

For the foreseeable future, record companies such as Sony will continue to derive most of their revenue from sales of CDs through brick and mortar retail stores; however, sales of recordings via music download providers have been increasing steadily. By some accounts, such sales now account for as much as 10% of all music sold. Considering the significant ongoing sales of legacy artists' recordings, if the class is certified in Allman and the plaintiffs' claims prevail, the impact on the record companies' bottom lines will be enormous ' and will only increase as time goes on.

Because the major record companies collectively have thousands of legacy artists whose recordings are currently being sold through music download providers, and because a significant number (some would say the vast majority) of those artists have contractual provisions that are similar, if not identical, to those described above, it is likely that more lawsuits of this nature will follow.

Two highly successful rock groups from the 1970s and '80s recently commenced a lawsuit in the U.S. District Court for the Southern District of New York against their former record company, claiming a larger share of revenue derived from paid digital downloads of their recordings. Allman v. Sony BMG Music Entertainment Inc. (Sony), 06 CV 3252. The plaintiffs also seek to represent similarly situated recording artists through certification of the litigation as a class action. The plaintiffs are the Allman Brothers Band and Cheap Trick, whose formidable catalogues of recordings remain tremendously popular and continue to fatten the bottom lines of several record companies in addition to the defendant Sony. (Sony is the successor-in-interest to the contracts that the plaintiff artists signed many years ago. Sony thus owns the rights to exploit the master recordings delivered pursuant to those contracts and bears the obligation to account and pay royalties to the artists.)

Artists: Digital Copies Are Licenses, Not Sales

The essence of the plaintiffs' claim is that Sony is calculating the artists' shares of revenue from digital download sales through services such as iTunes, Pressplay, Napster, Music Net and others ('music download providers') in the same manner that the label calculates royalties for physical sales of CDs through traditional retail outlets. The plaintiffs allege that this constitutes a mischaracterization that results in drastically understated royalty accountings for those sales. They claim that these are not physical sales, but are instead sales of digital copies of recordings that have been licensed to music download providers by Sony. The music download providers distribute digital copies of the licensed recordings to their subscribers, either in the form of a downloaded copy that can then be reproduced on an iPod or MP3 player, or as a 'stream' that can be listened to on a computer connected to the provider through the Internet. There is no physical device, such as a CD, anywhere in this process, and the entire transaction (subscription, payment, download or stream) is handled electronically through an end-user's computer. Accordingly, the plaintiffs claim, the royalty rate payable for licensing income, which is much higher than for physical sales, should apply. (A similar claim, though not a class action, was filed in May 2005 in the U.S. District Court for the Central District of California against Warner Music Group over Tom Waits' recordings. Third Story Music Inc. v. Warner Music Group Corp., CV05-3942. The matter settled on confidential terms after some discovery and a mediation.)

The traditional way of calculating royalties for the sale of physical records under the contracts of these legacy artists ' and for the majority of today's recording artists ' involves the deduction of numerous charges from income derived from such sales, including for: packaging; broken records; theft (known as 'shrinkage'); copies of CDs given to record stores as incentive to stock a particular record, possibly by a different artist (known as 'free goods'); and costs related to the extra expense of developing and commercializing so-called 'new technologies.' Many record companies, including Sony, still claim that CDs fall within this latter category. Also deducted are a percentage of sales as 'reserves,' which anticipate the return of unsold CDs to the record company for which the retailer must be reimbursed. Some years later, those reserves are liquidated based on the number of physical records returned to the record company, if any.

Under the plaintiffs' contracts, and under the contracts of many, if not most recording artists who signed contracts beginning in the early 1960s through the early 2000s, the sale of recordings in the form of digital downloads wasn't contemplated. What was contemplated was that recordings could be 'leased' or licensed to third parties who would then distribute the recordings to consumers and others. A typical scenario was the issuance of a 'synchronization' license for use of a sound recording in a motion picture. Under the recording contract, the record company and artist would equally share the net revenue derived from the license, and none of the 'traditional' deductions described above would be applied.

What distinguishes the Allman plaintiffs' contracts from the contracts artists have signed more recently is that record companies now include language that specifically characterizes a digital download as the sale of a physical record, like a CD, and accordingly apply the foregoing deductions, or variations thereof, with impunity. Hence, the putative class of recording artists that the Allman plaintiffs seek to represent will be limited to legacy artists whose contracts include no such characterization (or, as some would say, 'fiction').

Calculating Downloads

To fully understand the extent of the plaintiffs' claim, one must consider the practical effect of the two different methods of calculating royalties on the amount of royalties payable. The examples below are drawn primarily from the Allman complaint. The members of the Allman Brothers Band and Cheap Trick maintain that Sony improperly uses the Example 1 calculation for sales through music download providers when they should be using the calculation in Example 2. These calculations, however, are typical of how royalties are accounted in many, if not most, legacy recording artists' agreements, be they with Sony, the three other major record companies ' Warner Music Group, EMI and Universal ' or a number of smaller independent labels.

[IMGCAP(1)]

[IMGCAP(2)]

The examples below assume the retail price of a downloaded recording is $0.99, of which $0.70 is remitted to the record company.

In the second example, the artists receive royalties that are fully seven times greater than in the first example. Moreover, had the first example factored in the deduction for reserves, which Sony generally applies to royalty accounts, the amount payable would have been zero. (In fact, it would have been less than zero in this example, meaning that the artist's account would be in an 'unrecouped' position ' at least until the reserves for those sales were liquidated some years later.)

According to Nielsen SoundScan, Cheap Trick and the Allman Brothers Band have collectively sold about 1 million downloads since 2002. Based on this alone, the foregoing calculation supports a claim for underpayment of approximately $270,000. While this amount is perhaps only marginally significant after netting out litigation costs, if multiplied by the potentially thousands of identical, or nearly identical, claims made by other legacy artists, even if the class isn't certified, the resulting economic fallout could itself be a lasting, if unintended legacy. One wonders, then, why the plaintiffs' claims weren't addressed long before it got to this point.

Potential Impact Looms

For the foreseeable future, record companies such as Sony will continue to derive most of their revenue from sales of CDs through brick and mortar retail stores; however, sales of recordings via music download providers have been increasing steadily. By some accounts, such sales now account for as much as 10% of all music sold. Considering the significant ongoing sales of legacy artists' recordings, if the class is certified in Allman and the plaintiffs' claims prevail, the impact on the record companies' bottom lines will be enormous ' and will only increase as time goes on.

Because the major record companies collectively have thousands of legacy artists whose recordings are currently being sold through music download providers, and because a significant number (some would say the vast majority) of those artists have contractual provisions that are similar, if not identical, to those described above, it is likely that more lawsuits of this nature will follow.