Digital music also opened up an entirely new distribution channel previously unconsidered by both musicians and labels, whereby listeners accessed music online through a “license” rather than through the “sale” of a physical commodity. The standard recording contract through the end of the 1990’s usually included two separate royalty provisions. The first described the royalty rates for “full price records sold in the United States”, normally between 12 and 20% depending on the past and future success of the artist. These were royalties from CD’s and other phonograms and made up the bulk of artist and label revenue. The second provision concerned royalties for the “licensing” of the Master copy to third parties for any use, and was usually split 50/50 between artist and label.

Licensing to third parties was historically an ancillary business to physical record production, benefiting both artists and labels as their songs were used in commercials, movies, TV shows and other outlets. The traditional business model relied on national physical distribution channels that included record and CD pressing plants, storage warehouses, cargo delivery vehicles and promotional expenses, justifying a lower royalty to the musician. Since licensing entailed a minimal sunk cost, there was little excuse for paying artists the lower royalty rate from CD sales. The licensee (a TV show) bears the costs of mixing, synching and promoting the show while the licensor merely provides a master copy and the necessary permission.

When music began shifting towards digital distribution, record labels had already structured most of their artist contracts to rely on revenues from physical sales. The labels were undercapitalized and unprepared for a shift in revenue sharing to the licensing royalty, but eventually realized that the future of music would rely almost exclusively on licensing master copies to digital distributors. In the early 2000’s the labels finally recognized that many of their artist contracts would require higher royalties for licensed copies and moved to carve out specific rates for digital downloads or licenses; however, older artists were still potentially able to take advantage of the previously unseen business model and the higher royalty split.

*FBT Productions LLC v. Aftermath Records*

In May 2007, the rapper Eminem’s original record label filed a breach of contract suit against Universal Music Group (UMG), who had acquired a direct contractual relationship with the artist through a novation contract in 2000. Through the novation, FBT, the original label, became a passive income recipient retaining the right to receive royalties from Eminem’s recordings. FBT claimed that UMG had accounted for downloads through iTunes and sales of “mastertones” to wireless carriers under the “records sold” provision of the contract instead of the “Masters Licensed” provision, resulting in a substantial underpayment of royalties. Aftermath argued that the Records Sold provision applied because permanent downloads and mastertones are records, and because iTunes and other digital music providers are normal retail channels in the United States.

In March 2009, a jury found FBT was not entitled to royalties under the Masters Licensed provision for permanent downloads and mastertones. FBT appealed, and in September 2010 the Ninth Circuit reversed, holding that the royalties due from downloads and mastertones fell, as a matter of law, under the Masters Licensed provision of the agreements and were "licenses" as a matter of law. See F.B.T. Prods., LLC v. Aftermath Records, 621 F.3d 958, 967 (9th Cir.2010). The Supreme Court recently denied cert.

THE 50/50 ROYALTY SPLIT WILL APPLY TO MANY ARTISTS IN THE LONG TAIL CREATING NEW REVENUES THROUGH DIGITAL DISTRIBUTION

According to the Motown Alumni Association, “The ‘Masters Licensed’ clause and the usage of standard terms parallel the terms in a great many recording agreements.” Up to the onset of the digital revolution, most artists and labels signed boilerplate recording contracts without contemplating the license/sale distinction and the demise of the physical record. While labels have for the most part amended the recording agreements with successful artists that continue to sell digital downloads or mastertones, the musicians in back catalogs are unlikely to have settled the “Masters Licensed” dispute as applied to digital distribution.

These artists make up the bulk of the “long tail”, the obscure and relatively unknown musicians from the past few decades that never gained the necessary traction to become superstar hits. If listeners move towards a universal access model and begin to explore new artists and sounds (including artists from past decades), the old recording contracts will begin producing revenue streams and the labels will have to decide how to account for their royalties. To be sure, the distinction only applies to certain contracts with specific wording, but the commonality of the terms across contracts suggests a substantial number of artists with a right to a 50/50 split from digital distribution.