THE BLACK BOX OR “SOMETHING IS ABYSS HERE”
The infamous Black Box phenomenon is discussed in several chapters of this book. In the context of audits, let me make a few observations. The mechanical and performing rights societies of each country around the world, which are usually combined into one society per country, quite regularly realize that they cannot attribute the earnings of a particular song to a particular owner or publisher. What are they to do with this money? Customarily, they drop it into an account for later distribution. There are several kinds of income that end up in the abyss of Black Box accounts: unallocated income, unclassified income, and unidentified income. While they sound alike, they are not, and only your auditor knows for sure which is which.
In addition to the three above-mentioned categories, Black Box income will include monies which were set aside by a foreign rights society for expenses but that were not needed because the organization did not spend its full budget. There is also income representing monies reimbursed by rights societies by way of specific rebates of society commissions: for example, the Restausschutung payments by GEMA (Gesellschaft für musikalische Aufführungs- und mechanische Vervielfältigungsrechte) in Germany and similar payments by SDRM (Société pour l’Administration du Droit de Reproduction Mécanique), the mechanical rights society in France and STEMRA (Stichting Stemra), the mechanical and performing rights society in the Netherlands.
Some of this income represents surplus proceeds or collections (such as the Verwertungsverfahren proceeds in Germany), including those received by way of newly introduced types of distribution or newly introduced types of income in which monies are not separately allocated and attributed to specific musical compositions.
The sums that find their way into the Black Boxes of various countries can be enormous. For example, it is estimated that the Italian Black Box absorbs more than 30% of the gross income collected by SIAE (Società Italiana degli Autori ed Editori). Indeed, entire catalogues whose income has never been allocated correctly have been “lost” into one Black Box or another. One would like to think that the inability to allocate income from musical compositions on such a scale is due to carelessness and lack of diligence. However, I would be remiss if I were not to mention that over the years, a lot of Black Box income has been found to have been accumulated because various parties, including the foreign publisher members themselves (some of which were merely subsidiaries of the original US publisher in which writers placed so much trust), intentionally misallocated funds or misregistered (for example, registered with misspelling of authors’ names or the wrong author or copublisher shares) songs.
You may wonder how in the world an auditor could get access to the information needed to verify the accuracy of royalty statements from countries in which the Black Box exists. The answer varies from country to country, but if a knowledgeable auditor can get into the books of the company that is the official member of the relevant performing rights or mechanical rights society, the information is all there.
TELEVISION CAMPAIGNS
As stated in chapter 9, record companies often reduce the artist’s royalty rate—by as much as 50%—during the period in which they mount a television campaign to promote a record. No record company executive dealing with an auditor will volunteer the basis for the reduced royalty arising out of such a provision. The entry on the royalty account will merely indicate the reduction, and there will be a notation that the reduction in the royalties was due to promotional expenditures. It may cite the contractual provision: for example, “Promotional expenditures pursuant to Paragraph 7.07(b).” While there is nothing the artist can do about this, it is important for the auditor to verify that the promotional expenses in question were not only incurred, but incurred in an amount justifying the royalty reduction. For example, was the expense in the nature of a one- or two-time television buy, or was it a real campaign as contemplated by the contract? Frequent consultation with the artist’s attorney is appropriate in such situations.
INTEREST CHARGES
It is not unusual that when one party is adjudged to owe another party money damages for breach of contract (which would include the submission of inaccurate accountings), the party claiming the deficiency will seek (and occasionally receive) interest on the monies due that were either not paid at all or not paid on time. Both the federal government and state governments charge interest when taxes due have been underreported (and will often pay interest or credits when money is due to the reporter). This would seem to be an equitable way to compensate the damaged party with the intended salutary effect of discouraging similar acts in the future.
Record and publishing companies offer no such compensation—even in egregious situations. Nevertheless, it is customary to at least make the interest calculation. If the deficiency is due to a misunderstanding, or to a disagreement, or to a different interpretation of a contract clause—that is, mistakes in interpretation that do not represent a pattern of deception—the record company or publishing company can claim “innocence,” which will usually frustrate a claim for interest. However, processing errors, a total lack of payments, or cataclysmic underreporting or underpayments—like tax evasion versus tax avoidance in the IRS’s world—will more likely give resonance to the claim that interest is due. Merely asserting a claim for interest may be enough to ratchet up an eventual settlement.
The methodology of settlement between artists and record companies, or publishing companies and writers, is so entrenched that interest is rarely paid; indeed, it is often not even sought in view of the remote chance of recovering it. More likely, the auditing party will receive an “interest factor” in the context of an overall settlement. It will not be designated as such, but as long as the auditing party is satisfied with the total settlement figure, why should it matter how one categorizes the elements that make it up?
STATUTES OF LIMITATIONS
Most states have statutes that limit the number of years during which a person can assert a contract claim arising from a perceived breach. These statutes customarily establish the limits at six or seven years. However, record companies and publishing companies traditionally seek to modify these statutorily granted protections by reducing to one, two, or sometimes three—the number of years during which a person can assert such a claim. Their justification is that it is too difficult and costly to maintain records back as far as six years. The fact that such records must be kept longer under the rules and regulations of the Internal Revenue Service is conveniently ignored.
The goal obviously is to chip away at artists’ and writers’ opportunities to review their careers—and the attendant income—after as short a time as the company can get away with has passed. Even with today’s intricate global banking network and vast communications facilities, it can take at least a year and often two or more years before income earned in various parts of the world is reported. To require that an audit be conducted within days or weeks following (or preceding!) the submission of accounting statements is to deny the artist or writer the fair opportunity underlying the logic of states’ more generous statutes of limitations.
There are a couple of things that a negotiator can do to ameliorate this problem before the contract is entered into. In particular, in dealing with a multinational company, audit rights should be expanded to extend to subsidiaries and affiliates. (I have had deals fall through when such requests were refused. There is enough paranoia among artists to not add to it by a company’s reasonable request to audit wholly-owned subsidiaries.) Similarly, one can seek a provision permitting, under certain circumstances, a year-to-year extension of the period during which the right to audit remains viable if the gross sales of product reach certain levels. For example, the time period during which the artist or writer (or producer) experiences a substantial financial success is not only the time that an audit may really matter; it is also the time period in which the record company might be most receptive to the argument that a fair evaluation of one�
�s career cannot be made with blinders on. That is, it is reasonable to stipulate that when large blocks of income are to be reported, transferred, and examined, the artificial statute of limitations sought to be established by the record company should be extended.
While long-term (more than three years) audit provisions are never specifically granted, it is not unusual for a royalty-paying entity—particularly a music publishing administrator like a Universal Music Publishing Company—to agree to audits to be performed during the term, or to one comprehensive audit covering the entire term to be performed within one year following the end of the term. For a five-year contract, this audit would occur in the sixth year after commencement of the term. Sometimes, audits are conducted and no formal audit report is submitted. There are two reasons for this: first, the auditors may not have found anything significant or may want to wait to see how the company deals with a future accounting period; second, the auditors may have found an error in the client’s favor and are reticent to bring this to the company’s attention. Hence, this audit is never completed.
Mechanical Licenses and Mechanical Variances
A mechanical license is a license granted by the owner of a copyrighted musical composition giving another entity the right—for a fee—to record, manufacture, and distribute copies of the composition. Legally, however, the mechanical “license” document frequently used by music publishers is not a license agreement at all, which would be subject to the usual statute of limitations period of six or seven years, but a “variance,” or modification, of a provision in the US Copyright Act. The statute of limitations for claiming copyright infringement is three years from the date of infringement. Failure to pay, or pay correctly, gives rise to a copyright infringement claim rather than a breach of contract claim. Chapter 15, this page, discusses mechanical variances in more detail, but let me point out three issues that are relevant to the statute of limitations on audits.
One California Federal Court has ruled that the copyright law’s three-year statute of limitations might only apply to the period during which claims are sought—so that an infringement that continues well beyond the end of the initial three-year period following publication (even twenty-five years later) can give rise to ongoing claims for profits derived from ongoing infringements during the most recent three years of the copyright term. If affirmed on appeal, this ruling will be a godsend to songwriters and publishers who have always thought that their right to sue for an ongoing infringement would have expired years earlier. The jury is still out, as they say, as to whether these late-date infringement claims would allow the plaintiff to claim some of the special remedies of the Copyright Act such as minimum statutory damages, injunctions, and other remedies, or whether they might be limited to claiming only the profits of the infringing party.
1. In a contract negotiation in which a writer or music publisher (which may be the artist’s own company) is trying to extend the right to audit a record company’s books until, say, one year following the expiration of the deal (as mentioned previously, for a five-year deal, this would extend to as long as six total years), is it possible to recapture infringement claims that would otherwise have expired?
2. Record companies traditionally try to encapsulate all rights to object to royalty accountings in a fixed and predictable schedule—usually of two years’ duration—and to pursue such objectives in the courts. Under US copyright law, can the record company, by contract, reduce the three-year copyright infringement provision to two years?
3. Recording agreements now customarily include a “license” to mechanically reproduce the musical compositions on the record rather than have to comply with a separate variance document.
CONDUCTING AUDITS IN FOREIGN COUNTRIES
Naturally, it can be very expensive to conduct an audit of a record company in the United States. Yet both the cost and the logistics of conducting audits in more than one foreign country on behalf of a small publishing company or owner to the rights of a record catalogue can be even more daunting. I have two practical suggestions in this regard:
1. Audit one country at a time and proceed to other countries only if claims are detected in the first country or countries. When auditors begin to see common errors, they can move on into other countries.
2. If possible, combine resources and audit foreign companies in tandem with others similarly situated. For example, the Association of Independent Music Publishers (AIMP), based in New York, comprises hundreds of small companies. Banded together, these companies can—and do—pursue audits of companies that are common to their colleagues’ subpublishing schemes.
While there are very experienced music business auditors available outside of the United States (particularly in the United Kingdom), if you want to have the privilege of personally knowing your representative or using one you have successfully worked with in the United States in the past, there is no reason you should not engage that person’s services for audits outside of the United States. In addition, many US accounting firms have offices or correspondent firms outside the United States (again, particularly in the United Kingdom). Even if you ask your US representative only to oversee or review a foreign audit, or act as a consultant, you may be better served than if you let a foreign auditor, no matter how qualified, conduct the audit alone. Your US representative will know you better, know your catalogue and history better, and have a continuity with you that one-time auditors will not, by definition, have. I should also note that it is no more costly to have a US auditor go to Milan (the center of the Italian music business) than for a United Kingdom–based auditor to go to Milan. Airfares (we’re not talking Jet Blue or Ryan Air for these guys) and lodging expenses are similar, and the only issue is whether professional fees are competitive, which in large part they seem to be.
A FEW PRACTICAL SUGGESTIONS
It is not necessary for “fear” and “audit” to be spoken in the same breath. And an audit need not be expensive. In fact, it need not be formal. Remember, an audit is merely a process by which accounting statements are verified.
Desk Audits
There is often sufficient information within the recipient’s control such that regular monitoring of the statements will serve essentially the same purpose as a formal audit. If a recipient, attorney, or accountant has kept track of the recipient’s writing and recording activities, a fairly satisfactory job can be done on a regular basis to determine the accuracy of statements and accountings.
Here the issue is how to verify whether song licensing and master licensing—usually done by separate parties—show up consistently in accounting statements by publishers and record companies respectively; allowing for some overlap in accounting-period data, they should match. Most artists can identify their discography and their music catalogue (and if they cannot, it is not such a bad idea to hire someone to organize and categorize this information so it can be used). In addition, most artists these days have the right to approve the licensing of their recordings in films, TV programs, and commercials, and on compilation or flashback-type records. Those artists who control their own publishing administration may also have the right to approve the licensing of their songs, so there is some awareness of these uses that can be documented and filed for future use in an audit. In cases in which the recording right is automatic by virtue of Section 115 of the Copyright Act (Scope of Exclusive Rights in Nondramatic Musical Works: Compulsory License for Making and Distributing Phonorecords), publishers are notified formally and in writing. All of this data is readily available, and the information can be checked against accounting statements easily, without the delay or expense occasioned by a formal audit.
On receiving an accounting statement, it is advantageous and judicious to review it immediately. In doing so, the recipient should determine the following:
• Has the statement been received in a timely fashion?
• Does the statement cover all applicable copyrights (or masters)?
• Are the split
s (for example, those between artist and producer, between artist and record company, and between the writers, cowriters, and publishers) correct?
• On the statements of the record company, do all the catalogue numbers match the actual releases?
• Do the reported releases match the master-use licenses entered into by the record company? For example, Rhino is charged with licensing, TV, films, and record compilations, master recordings owned and controlled by the Warner Music Group’s record companies. Customarily, permission to issue these licenses is sought from the artist or the artist’s representative, and these requests should be maintained in a separate file so that they can be compared with the actual accounting statements when they are issued, sometimes years later. A license for a Greatest Rock Songs of the ’80s compilation record in New Zealand or some other foreign territory will not generate a royalty on an accounting statement for as long as three years after the sales occur.
Technicalities Do Matter
Do any notices have to be sent to preserve rights? Most contracts require that specific objections be made within a brief time after receipt of statements or any right to raise objections during an audit will have been waived. Believe me, when it comes to these “details,” the record company most certainly knows its standard contract provisions relating to audits and follows them to the letter. For this is where the money is, and their bottom line, like the bottom line of any business, it is the bottom line.
What They'll Never Tell You About the Music Business Page 40