F.B.T. Productions, LLC, et ano. v. Aftermath Records, et al.; Case No. 09-55817 (9th Cir. 2010)

In the first appellate decision addressing royalties under a standard recording agreement, the Ninth Circuit Court of Appeals on 3 September 2010 reversed a decision of the United States District Court for the Central District of California that addressed the question of whether digital music distribution is more properly characterized as a sale or as a license. The underlying agreement in the case, for music performed by rap artist Eminem (furnished by F.B.T., his prior record company), did not explicitly mention or address the relevant type of digital distribution: sales of permanent digital files through services such as iTunes or as mastertones (ringtones). A 2004 amendment that had added “Sales of Albums by way of permanent download” did not specify how these sales would be paid.

The question impacted the amount in royalties that the record company (affiliated with Universal Music Group) would be required to pay. The language in the recording agreement provided that the record company would pay a royalty of 12-20% of net receipts for “full-price records sold in the United States” (the “Records Sold” provision). However, “[n]othwithstanding the foregoing,” the record company was required to pay 50% on “masters licensed by [the record company] ... to others for their manufacture and sale of records or for any other uses” (the “Masters Licensed” provision).

The district court had held that the language of the record contract was not clearly unambiguous as to whether sales of permanent digitally-downloaded songs would trigger the Records Sold or Masters Licensed provision of the agreement. Based on extrinsic evidence in particular, the court noted that the industry custom conflicted but favored neither side, and that Universal’s iTunes agreement with Apple showed indicia of a license rather than a transfer of ownership. On finding ambiguity, the judge sent the question to a jury, which determined that the “Records Sold” provision was applicable to digital sales, just as with traditional sales of CDs in brick-and-mortar stores.

The appellate court unanimously reversed, finding that the contracts were unambiguous in F.B.T.’s favor and, therefore, the question of contractual interpretation should never have been sent to the jury in the first place. Relying substantially on language in the Copyright Act (against the defendants’ objections), the three-member panel distinguished between a “sale” and a “license.” The panel found that because Universal’s agreements with distributors such as Apple iTunes and cell phone carriers did not transfer title of an individual copy of a work or all rights in a work, the agreements did not contemplate a “sale” but rather looked more like a license. The court noted that the conditions that Universal placed on third-party distributors further indicated a licensing relationship. While the defendants pointed to evidence that the Masters Licensed provision had historically been applied primarily in cases where the particular song was incorporated in another’s product – such as a compilation record or motion pictures, television shows and commercials – the court rejected this historical evidence in light of the fairly recent arrival of digital music distribution via permanent download. Consequently, the panel concluded that “notwithstanding the Records Sold provision, [the defendants] owed F.B.T. a 50% royalty under the Masters Licensed provision for licensing the Eminem masters to third parties for any use.”

After denial of a request for rehearing, the defendants on 8 December 2010 petitioned the U.S. Supreme Court to hear the case, engaging a former Solicitor General of the United States as lead counsel on the petition. The brief argues primarily that the appellate court’s decision was erroneous as a matter of procedure, but it preserves the argument that the appellate court essentially over-read the Masters Licensed provision and gave short shrift to the Records Sold provision. It will take several months to learn whether the high court will agree to hear the case.

Outside of the court system, the defendants have stated that the holding has a narrow impact, applying to one particular type of agreement. The plaintiffs, not surprisingly, have taken an opposite view, describing the decision as an “earthquake” for the music industry. Regardless of which party is ultimately correct, the broad terms of the appellate decision and limited discussion of the specific language of the agreement may embolden those who create copyrighted content – whether audio, visual or audiovisual – to look at their agreements with those who distribute that content digitally. And if the language of those agreements arguably contemplates a higher payment structure for digital distribution, potential claims for additional royalties against distributors could surge based merely on the type of contractual arrangement or the structure of distribution deals with public-facing vendors.