Update On Webcasting Royalty Rates
Part I of II

Entertainment Law & Finance, August 2004.
By Steve Gordon

In September 2002, the author published an article in Entertainment Law & Finance titled "Examining Arguments in Controversy Over Webcasting Royalty Rates." Since then, there have been major new developments. New rates have been set, although the controversy regarding prices to be paid by small webcasters is still being challenged. This article, with Part II appearing next month, provides background on the new rates, explains how they work and offers an overview of this new medium.

Webcasting generally refers to the non-interactive streaming of audio on the Internet. It is sometimes called "Internet Radio." The content can originate from live or pre-recorded talk, live musical performance or sporting events, CD's or other pre-recorded media.

There are basically two types of webcasts: Internet-only services and streaming of standard broadcast radio stations on the Web. Internet-only webcasting often features one or more different channels of highly-themed genres of programming. Higher bandwidth results in better sound quality of and allows for a greater number of simultaneous listeners. Bandwidth, which is the number of "bits" of information transmitted per second, is usually the single largest expense in a webcaster's budget. For webcasters who transmit music, music clearance costs are often the second greatest expense.

Because webcasters frequently deliver their music at no charge to listeners, webcasters often contract with advertisers to obtain revenue to help offset expenses and return a profit. Of course, non-commercial webcasters such as National Public Radio (NPR) rely on different forms of support - that is, listener donations and or corporate underwriting. XM and Sirius Satellite Radio, which each transmit dozens of different types of music and other forms of programming, rely on customer subscriptions, although XM does have limited advertising on some of its stations. These subscription-based services are perhaps the greatest success in the brief history of webcasting. Many experts agree that as the technology becomes more sophisticated and consumers upgrade their home entertainment systems, the potential for Internet radio and webcasting are unlimited, unless, as the webcasting community argues, unaffordable royalty rates stamp them out before they have a chance to succeed.

In 1998, Congress passed the Digital Millennium Copyright Act (DMCA) to provide that eligible services may secure a "statutory" license for the use of sound recordings instead of having to negotiate with individual artists and labels. This statutory license, incorporated into Sec. 114 of the U.S. Copyright Act, covers public performances by four classes of digital music services:

Any of the above categories can secure a license to play records in their webcasts so long as they follow certain guidelines. That is why statutory licenses are sometimes referred to as "compulsory" licenses. Record labels did succeed in having the DMCA set up fairly restrictive guidelines, however. First, transmissions eligible for the statutory license must be "non-interactive." That is, Internet services cannot let listeners select particular songs or create playlists. This carves out a huge portion of music on the Internet, including the peer-to-peer (P2P) model. When it comes to interactive models of distributing music, the record companies can deny permission for any reason and can charge whatever they want to those they choose to deal with. A number of additional requirements are set forth in the DMCA, including that a webcaster may not play in any 3-hour period: more than three songs from a particular album, including no more than two consecutively, or four songs by a particular artist or from a boxed set, including no more than three consecutively.

The DMCA provides that rates for the statutory licenses for webcasting and Internet radio must be the rates that most clearly represent the rates that would have been negotiated in the marketplace between a willing buyer and a willing seller. The DMCA additionally stipulates that if the webcasters and the copyright owners (usually record companies) cannot agree on royalty rates for licenses, the rates and some of the terms of the license were to be established by the Librarian of Congress, who would be required to convene a copyright arbitration royalty panel (CARP) composed of three independent arbitrators. In June 2002, the Librarian of Congress rejected some of the terms and rates recommended by the CARP, and issued its own regulations and rates.

Small Webcasters Settlement Act

Many webcasters were unhappy with librarian's rates and complained that they could not afford paying .07 cents per song per listener. In response, Congress passed the Small Webcasting Settlement Act of 2002 (SWSA). The SWSA did not set new rates but allowed small webcasters and copyright owners another opportunity to negotiate an agreement on royalty rates for the period beginning Oct. 28, 1998, through Dec. 31, 2004. The Act stipulated that the negotiated rates were to be based on a percentage of revenues or expenses, or a combination of both; were to include a minimum fee; and were to apply in lieu of rates set by the Librarian of Congress. The Act also designated SoundExchange as the organization responsible for entering into agreements and distributing statutory royalties to copyright owners and artists. In December 2002, the U.S. Copyright Office published the resulting agreement under the Act.

All "small commercial webcasters/broadcast simulcasters" must qualify as "eligible small webcasters" in order to qualify for the special discounted rates available to eligible services. An "eligible small webcaster" is a webcaster/simulcaster that: complies with all provisions of the statutory license; and does not exceed certain gross-revenue thresholds for the reporting period in which it claims eligibility. Specifically, gross revenues for the period between Nov. 1, 1998 and June 30, 2002, must not exceed $1 million; gross revenues for 2003 must not exceed $500,000; and gross revenues for 2004 must not exceed $1.25 million. In calculating gross revenues for 2003 and 2004, other revenues, including but not limited to revenue from affiliates and third-party participation revenues, must be included for purposes of determining eligibility.

The rates are as follows:

The royalty rates set forth above include royalties for ephemeral recordings (needed to facilitate the transmission of performances of sound recordings), which are deemed to comprise 9% of such royalty payments.

Minimum annual fees are:

Dozens of small webcasters have signed up for the rates, but among a certain group there is continuing unhappiness. The Webcaster Alliance, an association of approximately 400 small webcasters, filed a complaint in 2003 in the U.S. District Court for the Northern District of California alleging anticompetitive conduct against the Recording Industry Association of America (RIAA). The crux of the complaint is that the new rates eliminate the commercial viability of most small commercial webcasters by imposing unreasonably high minimum fees. In April 2004, the district court granted the RIAA's motion to dismiss. Webcaster Alliance Inc. v. Recording Industry Association of America Inc., C 03-3948 WHA. The plaintiffs are appealing the ruling.

Webcasters contrast the minimum fees charged by SoundExchange for recording masters to the rates charged by the U.S. performing rights societies (PROs) ASCAP, BMI and SESAC for the use of songs. Any webcaster that wishes to operate legally and use copyrighted music must secure licenses from all three performing rights organizations as they collectively control the performance rights in virtually all songs that have been commercially recorded.

The ASCAP minimum fee is $264. The ASCAP Web site license provides three different rate schedules. The licensee may choose any one of the three schedules. Each schedule is based on a percentage of revenues. The first is approximately 1.615% of a Web site's gross revenues or $264, which ever is greater. The second and third schedules are alternatives designed to give some flexibility depending on how much music is used on the site. For instance, under the second schedule the percentage is 2.42%, but the amount against which this percentage is multiplied is adjusted to reflect income derived directly from the use of music on the site.

BMI's Web site agreement is also based on a percentage of revenues and offers two choices at the licensee's option: 1.75% of gross revenues or 2.5% of revenues derived from music sections of the site. The minimum payment was $264 for 2002, $269 for 2003 (with an annual CPI adjustment for future years).

SESAC's license works somewhat differently by charging .00802 (less than 1%) multiplied by the average number of page requests or hits per month and multiplied by 1.3 for pages with advertising. The minimum license for any 6-month period is $81 or $162 per year.

The key fact for small webcasters is the minimum fee, as many will not secure enough income to pay beyond the minimum and on that basis SoundExchange's advance requires approximately twice as much money as ASCAP BMI and SESAC combined. The percentage of income that SoundExhange charges is also approximately double that charged by aggregate by the PROs.

Steve Gordon is an entertainment attorney and consultant based in New York City who specializes in music, television and digital media. He has written a book, entitled "The Future of the Music Business" (Backbeat Books 2005). In addition, the author's Internet radio program on these topics can be heard at MyRealBroadcast.com. Web site: www.stevegordonlaw.com. The author expresses his appreciation to Reuben Atlas, his intern, for assistance in preparing this article.