Why it matters: Within a few weeks of each other in May 2015, the Second Circuit and a Southern District of New York court handed down opinions setting drastically different license rates that Internet radio service Pandora must pay to stream the music of artists represented by performing rights organizations ASCAP and BMI, respectively. On May 6, 2015, the Second Circuit affirmed the lower court's March 2014 determination, after a lengthy bench trial, that Pandora pay ASCAP a license fee of 1.85% of revenues. On May 28, 2015, also after a lengthy bench trial, Southern District of New York Judge Louis L. Stanton ordered Pandora to pay BMI a license fee of 2.5% of revenues. The strikingly different rates set by the courts in these parallel rate cases are illustrative of the problem the music industry is grappling with as it tries to monetize new forms of distribution. As Judge Stanton said in his opinion, "[t]he fact (not usual when traditional business models are evolving and shifting) is that Pandora cannot be accurately characterized as in any specific category for which rates have been established."

Detailed discussion: What is the correct rate that "new media" Internet radio service Pandora Media, Inc. should pay to secure public performance licenses from the performing rights organizations American Society of Composers, Authors and Publishers (ASCAP) and Broadcast Music, Inc. (BMI) to stream their respective members' music? This was the subject of two recent parallel "rate case" decisions in May 2015. On May 6, 2015, in Pandora Media, Inc. v. American Society of Composers, Authors and Publishers, Universal Music Publishing, Inc., Sony/ATV Music Publishing LLC and EMI Music Publishing, the Second Circuit affirmed a Southern District of New York judge's March 2014 order that Pandora pay ASCAP a license fee of 1.85% of revenue for the period January 1, 2011to December 31, 2015. A few weeks later on May 28, 2015, after a lengthy bench trial in the case of Broadcast Music, Inc. v. Pandora Media, Inc., Southern District of New York Judge Louis L. Stanton ordered Pandora to pay BMI a license fee of 2.5% of revenues for the period January 1, 2013 to December 31, 2016, which, according to BMI's attorney, represented "a 43% increase over the flat license fee of 1.75% of revenues Pandora was previously paying to BMI." The disparate rates set by the two parallel rate cases are further indicative of the general confusion in both the music industry and the courts about the best way for the performing rights organizations to monetize new media distribution.

Both the Second Circuit in the Pandora-ASCAP case and Judge Stanton in the Pandora-BMI case began their opinions with a general discussion of the performing rights organizations and the judicially administered consent decrees to which they are parties arising from years-long antitrust litigation with the government. Both opinions also discuss, in varying degrees of detail (the Pandora-BMI opinion, at 60 pages, is exceedingly thorough), the rise of the online music industry and the advent of digital streaming service Pandora in 2005, as well as the realization around 2010 by some of the major music publishers represented by ASCAP and BMI that the "licensing framework" of the performing rights organizations was not keeping up with this new form of distribution. This realization and the negotiations that followed led to major music publishers EMI Music Publishing, Inc., Sony/ATV Music Publishing, LLC and Universal Music Publishing, Inc., over the period from 2011-2013, making piecemeal "partial withdrawals" of the digital streaming public performance license rights from ASCAP and BMI in order to license them directly to Internet services such as Pandora at rates that more accurately reflected the marketplace. In 2013, both the district court in the Pandora-ASCAP case and Judge Stanton in earlier proceedings in the Pandora-BMI case addressed the legality of this partial withdrawal of rights from the performing rights organizations. The district court in the Pandora-ASCAP case had granted Pandora's motion for summary judgment on the issue in 2013, and the Second Circuit affirmed, holding that the "plain language" of the ASCAP consent decree "unambiguously precludes ASCAP from accepting such partial withdrawals" and thus "[t]he partially withdrawn works at issue remain in the ASCAP repertory." In his opinion in the Pandora-BMI case, Judge Stanton stated that he had reached the same conclusion when the partial withdrawal issue came before him in 2013, going one step further to say that it was "all in or all out": "When music publisher copyright holders exercise their right to withdraw their digital rights and revoke BMI's authority to license those compositions to Pandora and other new media services, those compositions no longer qualify for inclusion in BMI's repertory and BMI can no longer license them to Pandora or any other applicant. Thus, the publisher loses the whole list of BMI licensees for that composition."

A review of the "partial withdrawals" history was deemed necessary because the resultant direct licenses (with higher license rates) between the music publishers and Pandora figured prominently in Judge Stanton's rate decision in the Pandora-BMI case in that they were proffered by the publishers as marketplace "benchmarks" for Judge Stanton to consider in setting the proper licensing rate between Pandora and BMI. By contrast, the lower court judge in the Pandora-ASCAP case had denied ASCAP's request for additional discovery with respect to Pandora's more recent licenses for potential use as "benchmarks," and the Second Circuit held that the judge did not abuse her discretion in doing so. In both of the rate cases, Pandora had argued that the direct licenses should be disqualified as benchmarks because Pandora "had no alternative" but to enter into them, and thus the higher license rates were agreed to "under duress." Judge Stanton noted that, while the district court judge in the Pandora-ASCAP case had found this argument to be persuasive, he did not.

Thus, Judge Stanton found that, in determining whether a rate of 2.5% of revenues was "reasonable," he had to take into account "benchmarks" consisting of the rates "set in (or adjusted from) contemporaneous similar transactions." To this end, he analyzed the benchmarks proffered by both sides for review. BMI proffered the (1) direct license agreements with major music publishers Sony, EMI and Universal that called for agreed license rates ranging from 2.25% to 5.85% of revenues (Judge Stanton found that the direct licenses with Sony and Universal for the 2014 calendar year were the "best benchmarks because they are the most recent indices of competitive market rates") and (2) license agreements with Pandora's competitors, entered into between 2010 and 2013, which ranged in license rates from 2.5% to 4.6% of revenues. For its part, Pandora primarily argued that the "best and most comparable" benchmark was its long-standing license agreement with BMI that called for a rate of 1.75% of revenues.

In addition to the benchmarks, Judge Stanton stated that "one must also be aware of conditions in the music industry at the time of the particular transactions." In reviewing these conditions, Judge Stanton found that "[t]here is an unambiguous body of evidence that the prevailing BMI and ASCAP rates were believed to be too low. The publishers made their unprecedented withdrawals from the [performing rights organizations] because of their convictions that what those [performing rights organizations] were obtaining was well below what could be obtained through free market negotiations." The judge further noted that "[o]nce the rate negotiations were freed from the overhanging control of the rate courts, the free-marked licenses reflect sharply increased rates."

Based on all of the foregoing, Judge Stanton found that "[t]he evidence presented at trial shows that BMI's proposed license fee of 2.5% of Pandora's gross revenue is reasonable, and indeed at the low end of the range of fees of recent licenses." How does that square with the 1.85% rate affirmed by the Second Circuit earlier that month in the Pandora-ASCAP case? For one thing, it does not appear that the lower court judge in the Pandora-ASCAP case considered any of the higher-rate direct licenses between Pandora and the music publishers as benchmarks in setting the rate at 1.85% (buying into Pandora's argument that the direct licenses were entered into under duress and should thus be disqualified). Moreover, the Second Circuit's standard of review of the district court judge's decision was limited to one of "reasonableness," and the Second Circuit concluded after a review of the record that "the district court did not commit clear error in its evaluation of the evidence or in its ultimate determination that a 1.85% rate was reasonable for the duration of the Pandora-ASCAP license. We likewise conclude that the district court's legal determinations underlying that ultimate conclusion—including its rejection of various alternative benchmarks proffered by ASCAP—were sound." Interestingly, on June 26, 2015, Pandora appealed the Pandora-BMI case to the Second Circuit, where, presumably, the same standard of "reasonableness" will be applied to Judge Stanton's decision. It will be interesting to see how, if at all, the Second Circuit reconciles the two rate cases.

After the BMI decision was announced, ASCAP's President and Chairman Paul Williams said that "[t]his decision is welcome news for music creators, but make no mistake, Pandora will stop at nothing in their ongoing effort to shortchange songwriters. ASCAP and the music community must continue to fight for the urgent reforms needed to enable all songwriters, composers and music publishers to obtain fair compensation for the use of our music." David Israelite, president of the National Music Publishers Association, commented that, while the 2.5% rate was "still a small fraction of what music creators deserve, this decision sends a clear message that Pandora cannot continue to get away with growing its business on the backs of struggling songwriters—who deserve to be paid fair market for their work."

Click here to read the 5/6/15 Second Circuit opinion in Pandora Media, Inc. v. American Society of Composers, Authors and Publishers, Universal Music Publishing, Inc., Sony/ATV Music Publishing LLC and EMI Music Publishing, Nos. 14-1158-cv (L), 14-1161-cv (Con), 14-1246-cv (Con).

Click here to read the 5/28/15 district court opinion in Broadcast Music, Inc. v. Pandora Media, Inc., No. 13-cv-4037 (LLS) (S.D.N.Y. 2015).