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Clearing Music Recordings and Compositions for Use in
Digital Music Services

Entertainment Law & Finance, Part I, February 2002.
By Steve Gordon


This is the first of a two-part series.

A new licensing landscape has developed to accommodate the digital delivery of music. Some of these new licensing structures have been created by legislation, others by the copyright owners themselves, and some are still evolving. Parties interested in the digital distribution of music need to identify the rights required and the companies, organizations or agencies that are authorized to grant licenses for such rights and how much such licenses may cost.

It is much easier for a party that akeady controls sound recordings, as record companies do, to launch a digital music service. Labels generally own the masters, and except for restrictions in their agreements with the artists, they can pretty much use the sound recordings for any commercial use without having to pay monies upfront to clear the rights. Those brave souls who decide to go into the digital delivery of music business but do not own sound recording masters must negotiate individual licenses with the owners of the masters. There is no compulsory license or statutory rate.

The deals vary in accordance with the quantity and quality of the records being provided. For instance, payment of substantial advances and a high royalty can be expected to obtain the catalog of an important label. On the other hand, a garage band with one CD to its name may be happy to license the music for no charge just to get some exposure.

The music service will seek the broadest possible rights to enable it to deliver music in a variety of ways or to experiment with which manner of delivery catches on with those who use the services. However, the provider may wish to strictly limit the manner in which its records may be used. For instance, a label may not wish a digital service licensee to offer permanent downloads because that form of delivery may negatively affect traditional retail sales.

A typical deal for securing content for a web service from content providers for downloading or streaming will entail an advance against royalties of between 25 percent and 60 percent or more of income generated from the service.

Another important deal point will be deductions from the royalties. Services will try to deduct such costs as credit card processing fees, costs connected to content storage, bad debts, fees retained by or paid to dis-tribution agents or other service providers, and payments to performance rights organizations for the public performance of songs embodied in the records. The content provider will, of course, try to reduce these costs by, for instance, insisting that the costs be prorated in propor-tion to the amount of content subject to the license, compared with the total amount of content used in the service.

The content provider may also demand that downloads and streams be offered at certain minimum prices because the provider has an interest in preventing displacement of record sales at traditional outlets. The provider may also need a minimum amount to pay artists' royalties and make mechanical payments.

Services Operated By the Content Providers
The five major multinational record companies that control the distribution of huge catalogs of prerecorded music have recently launched their own digital music services. These services -- Musicnet (a joint venture between AOL Time Warner, BMG and EMI) and Pressplay (a joint venture between Universal and Sony Music) -- are subscription-based services offering streaming and limited downloads. Other labels have offered downloads and streaming of their music on their own sites for several years.

Even the labels, which generally own the recordings that they distribute, must carefully review their agree-ments with each of their artists to confirm whether the labels have the rights necessary to commercially exploit the recordings online.

Whether the label has the rights to digitally distribute its own masters is important not only for the labels, but also for any service wishing to license content from them. If the labels don't have digital distribution rights, then they don't have the right to allow third parties to exploit such rights.

Only recording agreements written during the last few years are likely to cover digital downloading or streaming over the Internet. But record companies have claimed that long-used recording contract language under which the label receives the right to "distribute and manufacture records in any field of use, by any method and by any means or format now or hereafter known" applies to today's digital distribution. Though recently negotiated agreements give labels the right to distribute recordings "electronically," each artist recording agreement should be examined for any changes or other restrictions that might affect a label's right to use or license recording masters for Internet uses. In addition, a third-party service interested in licensing recordings from a record company for use in its service should require that the label warrant and represent that such restrictions do not apply to the licensed tracks.

Clearing the Songs
A mechanical license is required to make a copy of a song embodied in a sound recording. The owners of the songs (i.e., the songwriters or their representatives, the music publishers) receive "mechanical" royalties for the duplication and sale of records containing their musical compositions. With respect to the digital downloading of sound recordings, a mechanical license is necessary because downloading results in a new copy of a record. However, a "compulsory" license applies to downloading. In other words, the owner of song (pro-vided that it has been previously recorded and released) cannot deny a license to reproduce the song. The licensee is simply required to pay the license fee (currently the greater of 8 cents, or 1.55 cents per minute of playing time or fraction thereof) required under the copyright law.

Sec. 115 of the Copyright Act provides that a prospective user of copyrighted music can obtain a statutory license to use the music--including by means of digital phonorecord deliveries (DPDs)--by serving a valid notice on the music copyright owner in accordance with the procedures specified in ~ 115 and in related regu-lations. Under ~ 115, the recipient of such a compulsory license must account for and pay royalties to the music owner on a monthly basis. However, the user can also obtain a license from the Harry Fox Agency, the licensing subsidiary of the National Music Publishers' Association (NMPA). The Fox Agency acts as licensing agent for more than 27,000 music publisher principals, who in turn represent the interests of more than 160,000 songwriters. Although the rate is the same whether the licensee obtains a license directly from the owner or from the Fox Agency, the license issued by the Fox Agency requires quarterly accounting instead of monthly accounting. And many music publishers depend on the Fox Agency to handle these licenses and encourage songwriters to use the agency.

Therefore, a digital music service providing downloads of prerecorded music can use the compulsory licensing provision of the copyright law to clear and pay for the underlying music embodied in the records that it is offering for download. Most songs can be obtained through the Harry Fox Agency, and the price for each copy sold will be 8 cents, or 1.55 per minute of playing time.

Rights to Stream Compositions
Interactive on-demand streaming is an extremely popular model for the delivery of digital music. It is the principal format--together with the added feature of limited downloads tied to subscriptions--that the major labels have chosen for their new digital services, MusicNet and Pressplay. The advantage to these companies of this form of digital delivery of music, as opposed to permanent downloads, is that streaming does not directly compete with traditional "brick and mortar" (i.e., record store) sales.

There was serious debate for some time as to whether mechanical licenses were even required for on-demand streaming because no permanent copies of songs result from streaming. The music publishing community vigorously pressed the view, however, that on-demand streaming may displace normal record sales, and that songwriters should receive a royalty from streaming to compensate for lost mechanical income.

At least one court has found that a mechanical license is indeed necessary to digitally stream music. Last year, the U.S. District Court for the Southern District of New York con-firmed in The Rodgers and Hammerstein Organization v. UMG Recordings Inc., 60 U.S. P.Q. 2d 1354 (2001), that a mechanical license is required to digitally stream music. The case involved an online music service introduced by Universal, known as Farmclub.com. Farmclub.com copied thousands of recordings of musical works onto computer servers to stream to subscribers, but chose not to seek specific permission to stream the songs from the owners of the copyrights in the songs. In response, The Rodgers & Hammerstein Organization and other publishers and songwriters ffied suit for infringement of their numerous copyrighted songs.

Universal argued that its existing mechanical licenses to manufacture and distribute records of the plaintiffs' musical compositions permitted it to make copies of those recordings on Farmclub.com's computer servers and to operate its on-demand streaming service. Based on the wording of mechanical licenses issued by the Harry Fox Agency, which' were limit-ed to CDs, tapes and LPs, however, the songwriters and music publishers argued that the licenses did not extend to the server copies made for Farmclub.com. The court agreed and entered summary judgment in favor of the songwriters and music publish-ers, rejecting Universal's arguments that its existing licenses permitted it to make server copies of the plaintiffs' musical works and operate its on-demand streaming music service.

Last September, Streamwaves, another on-demand streaming Internet music service, became the first such service to negotiate and sign a licensing agreement for on-demand streaming with songwriters and music publishers through the Harry Fox Agency. Streamwaves' service provides subscribers with the ability to stream music to their computers on a title-by-title basis by making requests from a list of available compositions. The company provides several genre-based music services from which consumers may choose.

The agreement with the Fox Agency was especially noteworthy because Streamwaves recognized its obligation as a streaming-on-demand service to acquire licensing rights to copy and retain each music work in its electronic database. The agreement provides that the Fox Agency will issue licenses, monitor compliance, and collect and distribute royalties. Under the deal, Streamwaves will pay a 10-cent fixation fee per each rendition of a licensed song included in the service's database. Streamwaves will also pay a royalty equal to the greater of 10 percent of its gross revenues, or $1 per subscriber per month (whether a paying subscriber or not) per each unique genre of service.

In October, the Recording Industry Association of America (RIAA) and the NMPA announced another major deal for the mechan-ical licensing of on-demand streaming. The RIAA represents all the major record labels in the United States, including the biggest distributors of recorded music: Sony, Universal, AOL Time Warner, EMI and BMG. Under the agreement, the RIAA and its member labels and licensees, including MusicNet (AOL Time Warner, BMG and EMI) and Pressplay (Sony and Universal), will have access to every musical work authorized to be licensed by the Fox Agency. Under the deal, Fox will issue licenses for both on-demand streaming and limited downloads (that is, downloads that can be played only for a limited period of time or a limited number of times). Royalties will be paid on a retroac-tive basis from the commencement of services. Pending the determina-tion of the applicable royalty, the RIAA will pay the Fox Agency an advance of $1 million. If the two sides do not settle on a rate during the next two years, the recording industry will pay monthly advances totaling $750,000 per year until a rate is set.

In November, the Harry Fox Agency and Listen.com announced that they had reached an agree-ment on the licensing of musical works for Rhapsody, Listen.com's digital music subscription service. This agreement is modeled on the terms of the agreement between the Fox Agency and the RIAA for licensing on-demand streaming and limited downloads offered by Internet music subscription services. Under the agreement, Listen.com will have access to every musical work authorized by participating publishers. The Fox Agency will issue to Listen.com licenses to reproduce and distribute musical works through its subscrip-tion service, which offers sub-scribers unlimited on-demand play-back of a wide variety of musical content. Listen.com has financial backing from all five major record labels.

Under the Fox Agency's deal with Listen.com, no royalty is in place, but by agreement of both parties, a royalty will be determined and/or confirmed by the U.S. Copyright Office. That royalty will be payable on a retroactive basis. But pending that determination, Listen.com will pay the Fox Agency an advance of up to $500,000. If a royalty is not established during the next two years, Listen.com will pay monthly advances of up to $31,250 until the royalty is decided.

Steve Gordon is an entertainment attorney and consultant based in New York. Telephone: (917) 912-3400; e-mail: steve@stevegordonlaw.com. He formerly served as director of business affairs for Sony Music Entertainment.