This blog was written in conjunction with our other fabulous Summer Legal Intern, Mr. Mark Goracke.  It revisits a '10 case that may have lasting effects on royalty rates for past, current and future music contracts.

In 2010, the Supreme Court’s denial of certiorari for a recent 9th Circuit opinion involving rap superstar Eminem may have far reaching effects on the content industry and the digital market, and also provides a good reason for content creators and those who disseminate that content to take a second look at their contracts.  While this case was decided over a year ago, the possible long term affects have still not even come close to being realized, which is why we’re discussing it now.

First, the background info:

            The case is called F.B.T. Productions v. Aftermath Records. Marshall Mathers, whom you might know professionally as Eminem, signed with F.B.T. productions (Eminem’s own production company) in 1995, and F.B.T. signed an agreement transferring Eminem’s exclusive recording services from F.B.T to Aftermath/Interscope Records in 1998. If you know anything about Em’s persona, and his fame and success, you know this probably isn’t the end of the story.   SPOILER ALERT!  It’s not.

See, under this new Agreement, F.B.T. and Eminem were entitled to royalties on certain records and licenses.  However, Eminem’s recording contract with Aftermath made a distinction between “Records Sold” in the physical sense – CDs, vinyl albums, aka things you can actually hold in your hands – and Masters Licensed– think  of Eminem’s surprising licensure of “Lose Yourself” in the Chrysler ad that debuted during last year’s Superbowl.

The “Records Sold” provision, provided that F.B.T./Enimem would receive between 12%-20% of the retail price for “full price records sold in the United States . . . through normal retail channels.” However, there is a separate provision for “Masters Licensed,” which specifies that “notwithstanding the Records Sold provision,” F.B.T./Eminiem would receive 50% of the net profit for the license of masters to others for their manufacture and sale of records or for any use.

Any use?  In nerdy lawyer speak, that says to me that it’s uses outside of Eminem’s physical records sold through F.B.T.  That means not only uses outside of physical records, but physical records NOT put out of F.B.T.  See, master recordings need to be licensed from their owners for any use outside of a distribution by the owner; this includes compilations put together by other companies (i.e. the “Now That’s What I Call Music!” series).  So if F.B.T. didn’t distribute the physical record, there’s a license involved, which, to me, means it falls under this latter clause.  More on this later.

Let’s continue our story.  In 2002, Aftermath’s parent company, Universal Music Group, reached an agreement with Apple to allow Apple to sell permanent digital downloads of Universal’s artists, including Eminem. (That’s three different labels, for those keeping score at home. Wonder how much the overhead cost of dealing with all these different parties costs everyone involved…). Since 2003, Aftermath has also had contracts with major cellular phone network carriers to sell Aftermath’s artists’ songs as ring tones, including Em’s rhymes.

FINALLY (I hope you’re still with us – it gets good soon), in 2003/2004, Aftermath and F.B.T. reached a new agreement, which replaced the old one. The new contract kept “Records Sold” and “Masters Licensed” provisions the same, but added that sales of digital downloads would be treated as U.S. Normal Retail Channel Net Sales for the purposes of escalations (basically, as total album sales surpass certain targets, the royalty rate increases).  WHEW!

So, what is this legal jargon all about?

Well, it’s F.B.T v. Aftermath, so let’s focus in on the real meat: the disagreement between F.B.T. and Aftermath is all about the Benjamins. Aftermath had been paying F.B.T. the “Records Sold” royalty rate (12-20%) for the sales of Eminem’s songs and albums on iTunes. F.B.T. brought suit, claiming that the “Masters Licensed” provision, not the “Records Sold” provision, governed the sales on both iTunes and ringtones. Aftermath moved for summary judgment, arguing that the amended contract – specifically stating that digital downloads would be treated as “U.S. Normal Retail Channel Net Sales” - showed clear intention that the parties intended the “Records Sold” provision to apply to permanent downloads like those on iTunes and ringtones through cellular networks. Royalties work in fractions of pennies per download, so it’s sometimes easy to overlook the vast sum of money it generates for artists, but the difference in rate is huge, especially for a popular artist like Eminem.  We’re talking additional royalties between 30-38% for everyring tone and download Eminem has sold since 2002.

Let’s do some quick math to see how this might pan out.  Apple takes about 1/3 of every download (34 cents), leaving us with 66 cents.  For simplicity’s sake, let’s assume F.B.T. is taking gross and not net for their share (although that it WAY too simple for the music industry).  Under a 20% royalty, that’s 6.6 cents/download.  Under a 50% rate, that 33.3.  And once you multiple by millions of downloads??  We’re talking the difference between 6.6 million and 33.3 million!!  And that’s ONE song. 

The District Court in California determined the contract was ambiguous and the jury found for Aftermath – which seems to make sense; many probably think that buying an album on iTunes is similar to buying a record and not really a license. But is this really about consumer perception? The 9th Circuit didn’t think so. They reversed, finding the contract unambiguously required that Eminem be paid the royalty rate set out in the Masters Licensed provision for sales of digital downloads and ringtones because, ultimately, it was Universal that licensed the use of Em’s songs to Apple, and Aftermath that licensed the use of the songs for ring tones.  Remember, if it isn’t distributed straight through the owner, there’s a license!

The 9th Circuit found that the use of ONE WORD - “notwithstanding” – to make all the difference.  As I quoted above:

“notwithstanding the royalty rate for records sold,” F.B.T./Eminiem would receive 50% of the net profit for the license of masters to others for their manufacture and sale of records or for any other use.

To the 9th Circuit, they clause read that even if a transaction fell under the Records Sold provision, F.B.T. gets the 50% Masters Licensed royalty ifAftermath licenses an Eminem master to a third party for “any” use (outside of physical records). Furthermore, Aftermath granted iTunes and cell phone companies permission to use its sound recordings to produce and sell permanent downloads and ringtones. Thus, we have a license in both instances, so Em gets paid the licensing rate, not the records sold rate. Now the The Supreme Court’s denial of cert (meaning that declined to take up the case) pretty much wraps up the issue and that’s that.

What does this mean for performers and musicians?

Long story short, the contract wasn’t written very well and ended up costing Aftermath a whole boatload of money. Sooo….read your contracts carefully and walk through it with an attorney that can explain it in plain English.  If they can’t, request that they contact the other party and find out that heck they were thinking, so it gets sorted before the parties sign anything.  But besides all that, what does it mean for you? It depends who you are.

If you are a content creator that gets paid different royalty rates for physical/traditional vs. digital licenses (musicians, authors, etc.) - check your past payments and make sure you’re getting the correct royalty payments for digital licenses of your work. If you haven’t been, you need to contact the other party to the contract, because, according to Eminem, you might be entitled to some cash monies.  If you are a content provider, first and foremost, check the language of your agreement with your artists (which, hopefully, is substantially the same across the board).  If the language is anything similar to the kind of language that is discussed in the F.B.T case (I would highly recommend reading the opinion to get the 360, or to hire a lawyer for an opinion), you might want to start thinking about correcting that rate and strategizing what you’ll do if your artists come a knockin’. Not only does this case have potentially far-reaching effects on current/past contract, but also the future. Make sure your future contracts set out clear and reasonable and royalty rates for digital sales and licenses. As sales in digital mediums become more and more popular as methods of obtaining content, it’s crucial that you do not make the same mistake Aftermath did, or it could cost you millions.