The Second Circuit recently examined the proper basis for the royalty rate for a public performance license in American Society of Composers, Authors and Publishers v. MobiTV, Inc., 681 F.3d 76, 80 (2d Cir. 2012)1. The case concerned the appropriate royalty fees MobiTV owed American Society of Composers, Authors and Publishers ("ASCAP") for a blanket "through-to-the-audience" ("TTTA") license to publicly perform music in ASCAP's collection. The issue centered on whether the proper revenue base for a royalty calculation was the retail revenue received from wireless carriers' customers or the upstream wholesale revenue wireless carriers paid to cable networks for the content. The Second Circuit held that upstream wholesale revenue was the appropriate revenue base, notwithstanding that retail revenue is typically an excellent indicator of fair market value of content.

The ASCAP Decision

ASCAP represents about half of the nation's composers and music publishers, who grant to ASCAP the non-exclusive right to license public performances of their music. With an estimated 8.5 million musical works in its collection, ASCAP has faced concerns that its size grants it monopoly power in the performance-rights market. As a result, ASCAP is subject to a judicially administered consent decree. This consent decree requires ASCAP to issue a TTTA license to any qualified operator. The TTTA license allows the licensee to pay a single fee in exchange for the right of the licensee, as well as any of its downstream partners, to perform any of the music in ASCAP's repertoire. Under the consent decree, ASCAP must quote a reasonable price for such a license and enter into negotiations with the applicant. If negotiations fail, either party may request that the Southern District of New York, acting as "the rate court," determine a reasonable rate.

Mobi acts as an intermediary between wireless carriers and content providers, aggregating content from various providers and supplying backend infrastructure for delivery of the content to wireless carriers' customers. Mobi applied to ASCAP for a TTTA license, but the parties could not agree on a price for a public performance license. After reaching an impasse, ASCAP sought a reasonable royalty rate in the rate court, and the rate court examined what revenue base was appropriate for measuring the value of the public performance right at issue.

Under the consent decree, the rate court must begin its analysis by assessing the fee quoted by ASCAP. ASCAP's proposed fee formula used as a starting point the revenues that wireless carriers received from their customers, which the rate court rejected. Having rejected ASCAP's proposal, the rate court set out to determine a reasonable fee, as required by the consent decree.

The rate court used the wholesale price for the musical content as the revenue base. According to the rate court, the concept of "derived demand," which describes the relationship between downstream retail purchases and upstream payments to rights holders, applied because the seller of highly popular content could demand higher wholesale rates, resulting in the capture of any retail value at the wholesale level.

The rate court further reasoned that the price of Mobi's content when it is first sold gives "direct and immediate feedback" to content providers as to the value of the content. On the other hand, using the total retail revenues received by wireless carriers from their customers, as ASCAP proposed, resulted in an "unrealistic"starting revenue base that also included large amounts of revenues unrelated to the value of Mobi's content, such as revenues from telephone service and internet access. The court explained that there was insufficient nexus between Mobi's content and the wireless carriers' revenue base: much of the retail revenues received from sales to customers of wireless carriers were unrelated to the value of Mobi's content since retail customers paid a flat fee for a package of programming, regardless of whether they actually used any of Mobi's content.

The rate court concluded that ASCAP's proposed reliance on wireless carriers' revenue base resulted in an inflated starting value, which ASCAP then attempted to contract through layers of complex calculations "laden with unsupported and faulty assumptions" in order to reach its fee proposal. The court decided that because ASCAP's model raised many questions regarding the "intellectual rigor, fairness, and the cost and burden associated" of its implementation, adoption of the model would impose enormous transaction costs that would be "out of line with commercial realities."

ASCAP appealed, arguing that the rate court erred in basing the royalty rate on wholesale revenues. According to ASCAP, the rate court also erred in failing to test the reasonableness of the resulting fee and in failing to include in its royalty rate determination the value of upstream content acquired by other content providers but streamed using Mobi's backend infrastructure.

The Second Circuit disagreed with ASCAP, upholding the rate court's determination that the appropriate revenue base was the upstream wholesale revenue. The Second Circuit concluded that ASCAP's reliance on an earlier Second Circuit decision, United States v. BMI (Application of Music Choice), 316 F.3d 189, 194 (2d Cir. 2003) ("Music Choice II") was misplaced. In Music Choice II, the Second Circuit held that the retail price paid by customers was an excellent indicator of the fair market value "absent some valid reason for using a different measure."

Noting that retail revenue does not always fairly measure the value of content, the Second Circuit concluded that there were valid reasons for using a different measure in this case. The court supported its conclusion that the retail price here exceeded the fair market value of Mobi's content by pointing to the testimony of Mobi's fee expert on why wholesale revenue was the better basis for a royalty rate in the current case, and the "methodological difficulty" in separating out the relative value of Mobi's content versus other programming in the bundle offered to downstream retail customers.

The court noted that teasing out the extent to which a bundle's component drove the retail price would be an extremely complex task and rejected ASCAP's argument that the value of the different bundle components could be determined from the amount of data used. It did, however, suggest that ASCAP might have had a stronger case had it developed a "rational formula" for valuing the bundle components.

Regarding ASCAP's other contentions, the Second Circuit held that there was no requirement for the rate court to explicitly test the size of the fee resulting from its formula. The Second Circuit also concluded that the rate court did not err in excluding the value of licenses to content streamed by upstream content providers because Mobi was not required to pay for a second license and was instead entitled to rely on the upstream provider's assurances that the appropriate licenses had been obtained. In such cases, the Second Circuit noted, ASCAP retained the power to bring an infringement action against Mobi or other parties to protect its rights.

Strategy and Conclusion

Courts carefully scrutinize the basis for determining the fair market value of content. Although retail revenue remains can be a good indicator of fair market value of content, courts may require use of a different revenue base that is a better indicator, especially where the content provider cannot show sufficient nexus between the retail revenue and the content at issue. Such evidence might be more persuasive in certain circumstances, for instance, where content is offered as part of a package that includes other products and services, or where higher retail prices result from the higher quality or accessibility resulting from a particular mode of delivery (for example, customers were willing to pay more for CDs than for vinyl records even where both contained the same music).

Administrative advantages of a proposed fee model are an important consideration. While not a determinative factor, the administrative advantages of using a proposed revenue base is an important consideration, especially where an alternative model raises questions regarding the complexity of the calculations and the intellectual rigor, fairness, and costs associated with adopting the model.