In a case involving the recordings of rap artist Eminem, the Ninth Circuit Court of Appeals ruled that rights to use permanent downloads and mastertones constitute licenses and not sales of recorded music for purposes of determining the applicable royalty rate. F.B.T. Productions, LLC v. Aftermath Records, Nos. 09-55817, 09-56069, 2010 WL 3448098 (9th Cir. Sept. 3, 2010). The Ninth Circuit relied on both contract interpretation as well as case law applying the meaning of the term “license” under the Copyright Act. The explosion of digital recordings and e-books has raised new issues with respect to who may exploit digital rights and the royalty rates applicable to new media.

Most recording contracts provide that an artist is entitled to receive royalties from both sales and licenses of recorded music. The distinction is important because the market royalty rates for sales of CDs or other physical media ranged from 10-25% while the conventional rate for licenses was 50%. F.B.T. Productions, LLC (“F.B.T.”) signed Eminem in 1995 gaining exclusive rights. Beginning in 1998, F.B.T. signed agreements with Aftermath Records (“Aftermath”) pursuant to which Aftermath would pay F.B.T. for sales and licenses of recordings consistent with then prevailing royalty rates (the “Contracts”). Aftermath later contracted with Apple Computer, Inc. to sell Eminem’s recordings through the iTunes store as permanent downloads and with cellular phone networks to sell mastertones to be used as ringtones. In connection with an audit conducted by F.B.T. in 2006, it was determined that Aftermath had been applying the royalty rate for physical media sales rather than licenses to the permanent downloads and ringtones. F.B.T. chal¬lenged Aftermath’s accounting.

The district court denied F.B.T.’s motion for summary judgment finding the agreement ambiguous. A jury subsequently returned a verdict for Aftermath, and the district court awarded Aftermath $2.4 million in attorneys’ fees. The Ninth Circuit reversed and vacated the attorneys’ fee award.

The Ninth Circuit ruled that the district court erred in determining that the Contracts were ambiguous. Aftermath did not dispute that it transferred to third parties the right to use Eminem’s recordings to produce and sell permanent downloads and ringtones. Looking to the dictionary meaning of “license” and interpretations of the Copyright Act, the court determined that Aftermath’s contracts with third parties permitting their use of the recordings to produce and sell permanent downloads and ringtones constituted licenses. “It is easily gleaned from … federal copyright law that a license is an authorization by the copyright owner to enable another party to engage in behavior that would otherwise be the exclusive right of the copyright owner, but without transferring title in those rights.” Id. at *9.

Aftermath put forth various arguments in opposition. It contended that, at the time certain of the Contracts had come into existence, the license provision only applied to incorporation of the recordings into movies, TV shows, commercials and compilation records, and that permanent downloads and mastertones came into existence only later. The court rejected this argument because Aftermath was permitted to exploit the recordings in any new media developed after the Contracts were executed. The court also found that F.B.T.’s lack of objection until after the audit did not mean that F.B.T. agreed with Aftermath’s interpretation. Aftermath claims it will challenge the decision.

New media developments after a contract has been executed oftentimes lead to disputes. The agreements in issue here did not specifically address permanent downloads or ringtones but the agreement did permit Aftermath to exploit new media. Thus, the royalty rate for the new media needed to be determined by the existing terms of the agreement which provided different royalty rates for sales and licenses. Artists with older contracts may be able to make similar arguments and obtain better royalty rates for new media that can be characterized as licenses under their contracts. Most newer contracts entered after digital recordings became prevalent provide that royalty rates for permanent downloads should be treated as equivalent to sales of CDs and thus subject to the lower royalty rate. With respect to older contracts, music labels will likely try to obtain retroactive contract amendments or waiver of claims on back royalties. Going forward, music labels will also need to consider whether the contractual provisions differentiating between sales and licenses make sense in today’s digital world. The reduced production costs of digital recordings may suggest that copyright owners should get a higher royalty rate for digital media like permanent downloads than with CDs. In contracts that reserve exploitation of new media to the original author or in contracts that may be ambiguous with respect to compensation for new media, the music label will need to negotiate anew.

The issues raised by new media are not limited to the music industry: authors and publishers of e-books face similar issues and new economic models may be on the horizon. Certain commentators have estimated that over the next five years 50-60% of book sales will migrate to e-books. Publishers are claiming their existing contracts give them rights to exploit a work in any “book form”, including e-books, although this position has been challenged. “[T]he law of New York … has arguably adopted a restrictive view of the kinds of ‘new uses’ to which an exclusive license may apply when the contracting parties do not expressly provide coverage for future uses.” Random House, Inc. v. Rosetta Books LLC, 283 F.3d 490 (2d Cir. 2002)(affirming denial of preliminary injunction to prevent e-book publisher from distributing e-books for which Random House had rights to publish work in book form). Emerging e-book publishers are obtaining digital rights directly from authors of existing books. With respect to new works, some authors and their agents are separately negotiating e-book sales and royalties with e-book on-line retailers in an attempt to obtain higher royalties for e-books than for print books. While there may be benefits to publishers and authors to have a single publisher of print and digital rights, authors and their agents appear to be using their leverage in this new frontier to achieve higher e-book royalty rates.

Particularly given the explosion in demand for digital media, record labels and artists, as well as book publishers and authors, should carefully review their existing contracts to determine whether new media issues, including digital rights, are addressed appropriately or whether such contracts need to be renegotiated.