Digital Downloads as Licenses, not Sales: UMG Audit May Reveal $4m+ Owed to Eminem

February 29th, 2012

In my post February’s Finest Litigious Moments, I mentioned the recent lawsuits brought by Kenny Rogers and Sister Sledge against their respective labels, claiming unpaid royalties.  Their claims primarily hinge upon the argument that digital music downloads are “licenses” rather than “sales,” requiring a 50/50 split rather than 10/90, under their recording agreements.

The Eminem Lawsuit

Eminem and his first label F.B.T. Productions (referred to individually and collectively as “Eminem” in this article, to avoid party confusion) filed a similar lawsuit in 2010 against UMG owned Aftermath Records and other related defendants such as Interscope and UMG.  On appeal from a jury verdict in favor of the defendants, the 9th Circuit reversed the judgment and held that summary judgment should have been awarded to Eminem (read the full opinion here).

The 9th circuit agreed with plaintiffs that the “Masters Licensed provision [in Eminem's recording contract, as amended] unambiguously applies to permanent downloads and master tones.”  This meant that Eminem was owed 50% of net monies received in connection to the downloads, rather than the 12 – 20% his label had been previously paying.  An upcoming jury trial, scheduled for April 4, will determine exactly how much money is owed to Eminem as a result of the decision.

The Audit Report

THR recently published a leaked audit report prepared for the plaintiff by Gary Cohen. The report details monies owed to Eminem from July 2005 through December 2009.  The audit indicates that treating digital music sales as “licenses” instead of “sales” would result in over $3.8 million owed to Eminem.  This figure does not take into account monies owed from foreign licenses and only looks at the 3.5 year period.  The audit also reveals other accounting inconsistencies, including underpayment for vinyl sales and overstated tv advertising costs.

Aftermath is disputing the audit report, arguing that the calculations  wrongly include Eminem side projects and that money received in connection with foreign sales should be calculated differently.

The audit report highlights the millions of dollars that may be owed to artists if digital downloads are considered “licenses” rather than “sales” under their recording agreements.  Will other artists also be successful in their attempts to recover the higher royalty rate?

The Record Contract Language

The Eminem case looked to the recording agreement, its amendments, and parole evidence to determine the outcome.  The outcome of future cases will likely also be determined by  the individual contract language as well as statutory and case law regarding the definition of a “license” vs. a “sale.”

In Eminem’s 1998 recording agreement with Aftermath, the “Records Sold” provision provided the Eminem receives between 12% and 20% of the adjusted retail price of all “full price records sold in the United States . . . through normal retail channels.”  The agreement later provides that “[n]otwithstanding the foregoing,” Eminem is to receive 50% of Aftermath’s net receipts “[o]n masters licensed by us . . . to others for their manufacture and sale of records or for any other uses” (this is known as the “Masters Licensed” provision).  The agreement does not define the terms “licensed” or “normal retail channels.” The 1998 agreement was superseded by a 2003 agreement, which increased some royalty rates but contained that same wording of the Records Sold and Masters Licensed provisions as in the 1998 agreement.

The 9th circuit interpreted the language of the Masters Licensed provision as broad, but unambiguous:

The parties’ use of the word “notwithstanding” plainly indicates that even if a transaction arguably falls within the scope of the Records Sold provision, [Eminem] is to receive a 50% royalty if Aftermath licenses an Eminem master to a third party for “any” use.  A contractual term is not ambiguous just because it is broad. Here, the Masters Licensed provision explicitly applies to (1) masters (2) that are licensed to third parties for the manufacture of records “or for any other uses,” (3) “notwithstanding” the Record[s] Sold provision.

The court then looked to whether Aftermath actually licensed the Eminem masters to the third party digital music retailers. A license is a “permission to act.”  Aftermath entered into agreements that granted permission to iTunes and other parties to use its recordings to produce and sell downloads.  Accordingly, the court held that those agreements qualify as licenses. Further, under traditional copyright law principles, Aftermath didn’t sell the recordings to iTunes because it retained copyright ownership of the recordings and the download distributors never obtained title to the digital files.  Case law interpretations of the Copyright Act have held that where a copy of copyrighted work is transferred by the owner with limitations on how that copy may be used and the owner is periodically compensated for the transferee’s exploitation of the work, the transaction is a license.

In 2004, Eminem’s agreement was amended to provide that “Sales of Albums by way of permanent download shall be treated as [U.S. Normal Retail Channel] Net Sales for the purposes of escalations” (emphases added). Escalations are when royalty rates are increased upon reaching specific sales targets. The amendment further state that “[e]xcept as specifically modified herein, the Agreement shall be unaffected and remain in full force and effect.”

Aftermath argued that this amendment clarified the Records Sold provision as setting the royalty rate for permanent downloads.  The court disagreed:

Read in context, the plan language of the amendment provides that sales of permanent downloads by third parties count towards escalations on the royalty owed when Aftermath itself sells records through normal retail channels.  It does not state, and in no way implies, that the royalty rate for the sale of the permanent downloads by third parties is set by the Records Sold provision.

The court also rejected Aftermath’s argument that industry custom indicated that the Masters Licensed provision only should applies to compilation records and incorporation into movies, TV shows, and commercials.  The court reasoned that the Masters Licensed provisions had never been previously applied to digital downloads because that form of exploitation only started in 2001.  The contract was not meant to be confined to the state of music industry in 1998.

Based on this analysis, the court reversed the judgment in favor of Aftermath and remanded for further proceedings, the next step of which is the April 4 jury trial to determine damages.