CMU Trends

Trends: Reviewing the sales v licence debate

By | Published on Friday 26 January 2018

It’s four years now since CMU Trends last looked in on the sales v licence debate. But a new lawsuit filed by Enrique Iglesias against Universal Music is set to pose the question anew, this time very much from a streaming perspective.

The sales v licence debate has been rumbling on since the rise of iTunes in the mid-2000s. It centres on the question of what royalties labels should be paying heritage artists on digital income when their record contracts pre-date the digital age and therefore make no specific reference to downloads or streams.

Understanding the dilemma requires some knowledge of record contracts. When an artist signs a classic record deal, the label controls any recordings made under that arrangement. Usually the record company becomes the owner of the copyright in those recordings and as such enjoys the controls that come with the copyright, so the exclusive right to copy, distribute, rent out, adapt, perform and communicate the music.

The label then exploits those controls for profit, by making copies of recordings and selling them to music fans, or by allowing third parties to copy, distribute, rent out, adapt, perform and/or communicate tracks in return for a licence fee. The label will then be contractually obliged to share any monies generated with the artist. But on what terms? How is that money shared?

With the exception of income generated by things like radio and the public performance of music – where the artist’s share is dictated by law under the Performer ER system – how the money is shared out between artist and label is set out in each individual record contract, and therefore varies from deal to deal.

Firstly, the label will usually be able to recoup some of the costs it incurred at the outset of the deal. Any cash advance paid to the artist will almost always be recoupable, but other costs covered by the record company may also need to be paid back out of future income. The label may also be able to apply certain discounts and deductions before calculating what the artist is due.

The key royalty terms in the contract will usually provide the artist with a percentage share of any income. However – and this is key to the sales v licence debate – what percentage is paid will often vary according to how revenue has been generated. So the share of the money received by the artist may differ on a CD sale versus a download sale versus a compilation placement versus a sync deal.

Every record deal is different, both in terms of the way money is shared out, and the way royalty rates are defined and described. Though a common distinction in old contracts was between ‘sales income’ and ‘licence income’.

Sales income would traditionally cover scenarios where the label directly pressed copies of a recording onto vinyl or CD, and then sold those recordings via a retailer. Licence income would cover scenarios where the label gave a third party permission to exploit the controls of its copyright. So for example, when a track is included on a compilation put out by another label, or a sync deal, where a movie producer, games publisher or ad agency gets permission to synchronise a track to video.

Generally, artists would receive a much bigger share of the money on licence income versus sales income. So, in a 1990s major label record contract in the UK, the royalty paid to the artist on sales income would likely be around 15%, whereas with licence income it would probably be closer to 50%.

This difference was in no small part down to the fact that the label had to do a lot more work to generate sales income: ie producing, manufacturing, distributing and marketing the physical releases. Therefore, the label argued, it should see a bigger share of the money when revenues were generated that way.

It’s also worth noting that up until the 2000s, the record industry was primarily in the sales business. The vast majority of income was made selling physical discs, and the vast majority of a label’s operations would be focused on that activity. Therefore record deals were being much more generous to artists on what were basically periphery revenue streams, while keeping the majority of core revenue streams.

When the download boom began in the mid-2000s and suddenly iTunes was a key revenue stream, labels had to decide how to share that income with artists whose old record deals made no specific mention of digital music.

Most labels decided to define downloads as a sale and therefore pay the artist on iTunes income the same royalty they were receiving on CD. The argument went that when MP3s (or – technically on iTunes – AAC files) are sold through a download store, that is simply the digital equivalent of selling a CD in a record shop, and therefore downloads should be treated as sales for royalty purposes.

However, many artists with pre-digital record contracts – or, more to the point, their lawyers and managers – hit out at this assumption. After all, they argued, the deals done between the record companies and Apple were licensing deals. iTunes had a licence from the labels allowing it to make available recordings to the public, and in turn to allow its customers to copy and communicate individual tracks by downloading them. The record companies were then paid a licence fee in return for all that permission giving.

So, for those artists with an old record contract that made the sales v licence distinction – or something like it – there was an argument that iTunes money should be treated as licence income and therefore the higher licence royalty should be paid. Which, remember, could mean the artist receiving 50% instead of 15%.

Over and above the legalities of what any one artist contract said, many of the managers and lawyers who made this argument had another agenda. They reckoned that with the shift to digital, the costs of getting new music to market were coming down, and therefore the risks the label was taking on new releases were now lower.

Therefore, it only seemed fair that artists should see a bigger share of any subsequent income. The sales v licence argument was one way that artists might secure this bigger share, by interpreting their record contracts in a way that already providing a higher royalty when no physical products were being created.

Needless to say, few labels agreed with the artists who reckoned that they should be getting a 50% licence royalty on downloads.

Some did concede that their costs and risks would be reduced once the shift to digital was complete, and therefore there might be a case for paying a higher royalty on download revenue to artists on old record contracts. Though, the labels would usually add, their costs and risks weren’t that much lower than in the physical era, and therefore a shift from 15% to 50% on downloads wasn’t feasible.

As for the contractual interpretation side of the sales v licence debate, some labels maintained that their licensing deals with Apple weren’t really licensing deals. Even though they were clearly licensing deals. Others argued that, had downloads existed when these old record contracts had been written, it seems certain the label would have grouped that revenue stream with CDs and not with compilations and sync deals.

Unsurprisingly, in the US this dispute went legal. Although not the first lawsuit, the highest profile to date was the legal action pursued by Eminem collaborators FBT Productions against Universal Music’s Interscope. FBT Productions had a stake in Eminem’s Interscope-released records and argued that the major should be paying it a licence royalty on download income rather than a sales royalty.

FBT Productions ultimately prevailed in that lawsuit, resulting in a flood of litigation from other heritage artists eager to use the Eminem case as a precedent that labels should be paying higher licence royalties on all download income.

Some of those cases became class actions, meaning that any act with a similar record contract to those artists launching the litigation could benefit from any successful ruling. For a while it looked like many heritage artists could see their download royalties increase. In many cases they did, but generally only by a few percent.

While it seems certain that bigger name heritage artists – on the back of the FBT Productions ruling – probably secured much better rates via confidential back room deals, when the class actions were settled in public download royalties only rose slightly. So that artists on a 15% CD royalty might see something like 18% on download income. It wasn’t quite the outcome many managers of heritage acts had hoped for.

Most of the lawsuits filed on the sales v licence issue focused on download income. But, by the time many of them were ultimately settled, the download business had already peaked, and the streaming market was about to boom.

Most labels likewise pay a sales royalty on streaming income – or, where a slightly higher download royalty has been agreed and/or applied, that will also likely be paid out on monies generated by Spotify et al.

However, many managers and lawyers argue that, even if there was a case for treating downloads as a digital version of a sale, once you shift into streaming there is an even stronger case for saying this is licensing income and therefore the higher licence royalty should be paid out. If anything streaming is closer to radio than selling CDs, and on radio artists usually see 50% of the money (albeit under the aforementioned Performer ER system).

One of the first cases to raise the sales v licence question specifically with streaming in mind was a dispute between 19 Recordings – which represents a number of former finalists from the ‘American Idol’ programme – and Sony Music – which was the original label partner of the talent show franchise.

19’s lawsuit against Sony had many elements to it, including a number of other gripes with the way the major paid and reported royalties to the former Idols. It also raised questions about whether Sony should share kickbacks it receives from streaming services over and above payments directly linked to specific streams, such as equity in the streaming start ups or advances that are never allocated to specific track usage.

It also discussed what royalty should be paid to the artist on streams, given the Idol’s record contracts didn’t specifically talk about streaming income. Just like the earlier lawsuits focused on download monies, 19 argued that Sony’s deals with the streaming platforms were clearly licensing arrangements, therefore streaming income was licensing income, and therefore the higher licence royalty should be paid.

For a time it looked like we’d get some judicial scrutiny on this point from this case. Sony mainly returned to the argument that its licensing deals with Spotify weren’t really licensing deals, but distribution deals, which meant it was selling rather than licensing music. A game of semantics therefore ensued as the case went through the motions. Then earlier this month it emerged an out of court settlement had been reached in 19 v Sony, which means no judicial opinion on sales v licence will come out of the dispute.

The settlement of the 19 v Sony case is why this week’s legal filing by Enrique Iglesias against his former record company, Universal Music, is so interesting. It is primarily focused on how streaming income should be shared under the terms of his 1999 and 2010 contracts with the major, neither of which specifically mention streams. (As an aside, that the 2010 agreement doesn’t explicitly cover streaming income seems like quite an oversight.)

Iglesias’s contracts provide different royalty rates for different uses of his recordings, with a lower ‘album royalty rate’ for sales, and a 50% rate for licensing scenarios. In his new lawsuit, filed in Miami, Iglesias’s specifically references a catch all ‘any other use’ clause which provides a 50% royalty. His lawyers argue that, because streams are not specifically mentioned elsewhere in either contract, this clause should apply to streaming income, and therefore a 50% royalty should be paid.

Interestingly, it seems that Iglesias was initially paid the higher rate on streams by Universal for some of his recordings. He has actually released records for a number of Universal subsidiaries. According to a footnote in the lawsuit, for a time Interscope – which initially released his English language albums – was paying the 50% rate on streams. However, in 2016 it switched to paying the lower album royalty rate on streaming income, without explanation. We assume the lower rate was paid by the other Universal labels he worked with on streaming income throughout.

So, will this be the case that provides some judicial opinion on the sales v licence question from a streaming perspective? Probably not. Enrique Iglesias is a big enough star that it seems likely Universal will agree to a generous confidential back door deal that will stop the matter being properly discussed in court. Even if it was, the major would almost certainly argue that this case hinges on peculiarities of Iglesias’s record contracts, and any ruling in his favour wouldn’t set a precedent.

Iglesias’s lawyer does not agree. As the lawsuit was filed, he told journalists: “Despite [his] record-breaking success, Universal has wrongly insisted that artists like Enrique be paid for streams in the same manner as they are paid for physical records despite the fact that none of the attendant costs – production, distribution, inventory, losses – actually exist in the digital world. This is not what Enrique’s contract, or the contracts of many other artists, call for”.

He went on: “Artists, producers and songwriters should benefit from the reduced costs of streaming, not have their musical works spin unwarranted profits. Universal has long ignored, and is now attempting to distort, the clear terms of its artist agreements so that it alone reaps the savings from digital streams. After lengthy efforts to have Universal honour its contractual obligations, Enrique’s team regrettably concluded that he had no choice but to file this lawsuit”.

The sales v licence dilemma is one part of the wider digital pie debate that CMU Trends has considered before. Which is to say, is the way streaming income is shared – on average – between record labels, artists, songwriters and music publishers fair?

In most – though not all – cases, the labels see the biggest cut. Therefore labels generally argue the current system is fair. Meanwhile artists, songwriters and music publishers argue the digital pie should be sliced differently.

Having streaming revenue treated as licence income across the board would immediately see a re-slicing of the pie to the advantage of heritage artists (some of whom, it should be noted, will be on a sales royalty even – and much – lower than 15%, depending on how old their record contracts are).

There are other ways artists could see their cut of streaming money go up. Applying the Performer ER system to streaming in some way would mean artists (including sessions musicians) would have a statutory right to streaming royalties, in addition to any contractual right. Meanwhile, some sort of arbitration system whereby old record contracts could be revisited and revised to suit the digital age would be another approach.

Both Performer ER on streams and arbitration on old deals have been considered in Europe as copyright law is reviewed there. Alhough when the new copyright directive goes through it is unlikely to include anything on the former, and it’s not clear how useful the proposed ‘contract adjustment mechanism’ will be in achieving the latter.

Therefore, so long as the Iglesias lawsuit is active, many managers and lawyers will be watching with interest this latest chapter in the sales v licence debate.