On-Line Music Distribution Contracts

When an artist makes recordings available over an online music distributor ("OMD") such as mp3.com, the artist enters into a contractual relationship with the company. This is true whether the artist realizes it or not and whether the artist understands the terms of the contract or not. The vast majority of OMDs do not actually require the artist to "sign" a contract. Instead, the artist agrees to be bound by a contract which the artist can view online. In order to make recordings available, the artist must agree to the contract's terms by clicking on an icon containing a statement such as "I agree." It is likely that many artists click on these icons without a second thought and without reading, let alone trying to understand, the contract's terms.

One major disadvantage of OMD contracts is that they tend to be non-negotiable. In other words, you either agree to them or you don't (in which case you can't make your music available). Unlike traditional record contracts between artists and record companies which are often heavily negotiated in order to improve the deal for the artist, OMD contracts are generally offered on a take it or leave it basis. This is not likely to change since OMDs are operating on a quantity over quality basis and it would not be worth their while to negotiate with the many artists who want to make their music available. However, even though you probably can't negotiate any of the terms, it is still important that you understand what they are so you know what you're getting into.

Before addressing specific issues related to OMD contracts, it might be useful to examine the relationship between an artist and an OMD. Many artists compare these relationships to traditional record deals. However, this is not an accurate comparison. Under a traditional record deal, a record company signs an artist to provide its recording services. In return, the record company pays all recording expenses, distributes the album and markets and promotes the album. The record company also pays the artist a royalty for each record sold which, for new artists, usually amounts to about $1.25 per CD (although some of the expenses incurred by the record company are recouped from the artist's royalty). OMDs do not really operate as record companies - they do not pay for the artist's recordings and they don't do anything to market and promote the artist's recordings other than providing a page on their web site for the artist. In a sense, they operate more like record distributors. However, comparing them to record distributors is also a bit inaccurate since most OMDs do not make much income from distributing records. Instead, OMDs such as mp3.com make the vast majority of their income from advertising. In this sense, they are more like radio stations than record companies or record distributors since, like radio stations, they use music as content (which they generally don't pay for) in order to sell advertising.

It is also very important for artists to have realistic expectations when entering into a relationship with an OMD. Quite frankly, artists should not expect to sell many records this way. To date, it does not appear that any artist has achieved substantial record sales through OMDs. For example, according to music news service Webnoize, the average artist on mp3.com sells about half a CD a month. Instead of expecting to get rich selling your music online, you should view OMDs primarily as a promotional tool which will hopefully get you some publicity, expand your fan base and provide a slight source of income.

The following is a summary of some of the common issues to be aware of when considering whether to distribute recordings through OMDs.

1. Grant of Rights:

Normally, the artist gives the OMD the right to offer downloads and to sell recordings (usually by mail order). One thing that artists should avoid is any transfer of ownership of their recordings (or any songs contained in the recordings). Instead, the artist should merely grant the OMD a license to use the recordings in specified ways. Since OMDs do not pay for the recordings or have anything to do with creating them, there is no legitimate justification for an OMD to receive ownership.

Another important consideration is whether the contract is exclusive or non-exclusive. An exclusive contract with one OMD would prevent the artist from making its recordings available over other OMDs and possibly through traditional distribution through retailers as well. Therefore, it is rarely advisable for an artist to sign exclusively to one OMD.

Ideally, an artist should limit the OMD's rights to transmission or distribution by means of current technology (digital downloading and physical distribution by mail order). Since technology changes rapidly, there may be new forms of distributing music in the future and artists are better off keeping any rights to future technology.

Some contracts also give the OMD the right to use the artist's recordings in compilations with other artist's recordings. Artists should have a right to approve the use of their recordings in such compilations since OMDs usually do not pay royalties on compilations and an artist may not want to be associated with other artists contained on a compilation.

2. Term:

The term of an OMD contract refers to the duration of the contract. Generally, it is in the artist's best interest to keep the term short (month to month if possible; one year maximum). A short term gives the artist the flexibility to end the relationship if it is not working out to the artist's liking.

It is also beneficial for the contract to contain provisions allowing the artist to terminate the contract before the term expires in certain circumstances. Some of these circumstances would include the OMD's bankruptcy and the failure to account or pay royalties to the artist.

3. Compensation:

Most OMDs pay the artist a percentage of the sales price of any CDs sold through the OMD, commonly 50%. Consequently, if an artist's CD sells for $10, the artist will receive $5. However, it is important to note that most contracts provide that the artist is responsible for any royalties payable to producers and publishers or songwriters out of the artist's share of income.

If an artist's album is self-produced and the artist writes all the songs recorded, this is not really an issue. However, if an outside producer is involved, the producer will normally be entitled to a royalty on each CD sold - commonly about 35 cents under most traditional deals although producers may want a higher royalty for online distributions since the artist receives a greater royalty. Additionally, if an artist records songs written or owned by someone else, the artist would be responsible for paying mechanical royalties of 7.55 cents per song.

It is also very important to understand that most OMDs do not pay any royalties on free downloads of the artist's recordings. The rationale for this is that downloads are promotional in nature. Of course another point of view is that the OMD is receiving free content, without which it could probably not sell advertising. The OMD is therefore making money from the "free" downloads and artists should in fairness receive some compensation. Some OMDs have recently started experimenting with schemes for allocating a small portion of their advertising revenues among artists whose recordings have been downloaded which is a step in the right direction towards compensating artists.

4. Accountings:

Most OMDs account for and pay artists royalties owed on sales of their recordings on a quarterly basis (4 times a year). Many contracts also provide that the distributor can hold royalties under a specified amount. This is not unreasonable as long as the amount is not too high (e.g., $25) since the OMD does not want to make royalty payments for negligible amounts.

An OMD contract should give the artist a right to object to royalty statements and to examine or audit the OMD's books and records concerning sales of the artist's recordings. The OMD will normally impose limitations on the time period for objections and audits. Time limits for objections are often one year from the date an accounting statement is sent to the artist.

A longer period (2-3 years) is preferable since, in some situations, an artist would not have reason to suspect underpayment until it has received several statements for different accounting periods. An artist-friendly provision that OMDs are unlikely to agree to would specify that the OMD pay a penalty for any substantiated underpayments. Imposing a limitation that requires the artist to hire a certified public accountant to conduct an audit of the OMD's records effectively makes the audit rights useless since the vast majority of artists would be unable to afford to do so.

5. OMD's Obligations:

Generally, there are very few obligations imposed on the OMD other than the obligation to provide the artist with a web page where people can listen to sample recordings for free and the obligation to mail a copy of the artist's CD to customers who request and pay for one.

Since the benefits of OMDs are mostly promotional in nature rather than financial, it would be advantageous if the OMD was obligated to share information about visitors that download the artist's recordings. This information could be used by the artist to expand its fan base through mailing lists, etc. However, most OMDs refuse to make this information available to artists. This seems hypocritical since the OMD obviously intends to use the information for its own benefit, but is unwilling to let artists do so as well. An artist might also want the OMD to be obligated to report sales figures to Soundscan (a company that tracks records sales). If you end up selling a substantial number of CDs, it is possible that you may be contacted by record labels since they tend to pay attention to Soundscan.

One thing to be very wary of is an OMD that requires the artist to pay for a web page. This is totally unjustified since the cost of providing the web page is usually the only investment the OMD makes on behalf of the artist and it is a very minor one.

6. Warranties & Indemnity:

OMD contracts contain a provision under which the artist makes certain warranties or promises. For example, the artist will warrant that it owns all of the material that is supplies to the OMD. This would include the recordings, the songs contained on the recordings and any artwork and other information. If an artist has recorded someone else's songs without a license to do so or if someone other than the artist prepared the album cover artwork and the artist had not acquired ownership of the artwork from that person, the artist would be breaching this warranty. An indemnity provision says that if the OMD is sued and found liable for anything related to any of the artist's warranties, the artist must reimburse the OMD for its losses.

For example, suppose an artist warranted that it owned all the songs contained on its recordings, but there was actually one song owned by someone else. If the actual owner of that song sued the OMD for copyright infringement and won an award of $50,000, the OMD would have the right to be reimbursed the $50,000 from the artist as well as the OMD's legal fees incurred in defending the lawsuit. This is certainly reasonable since it was the artist that lied about having the right to make the song available. However, it is important for artists to consider whether they do in fact have all the rights they are claiming to have. Another problem could arise if an artist lets an OMD use recordings paid for by someone other than the artist (such as a record company or production company) since the party who paid for them may very well be the copyright owner of those sound recordings. Similarly, recordings which contain unauthorized samples of other recordings would constitute a breach of the artist's warranty.

7. Assignment Rights:

Many contracts give the OMD the right to assign its rights under the contract to third parties. This is an important right from the OMD's perspective since there is a trend toward OMDs being bought out by larger companies. Unlimited assignment rights, however, do not benefit the artist and, if possible, the artist should have the right to terminate the contract if the OMD is bought out.

8. Jurisdiction & Venue:

Since contracts are governed by state law, they will normally provide that any disputes under the contract are governed by a specific state's laws.

For example, if an OMD is located in California, its contract will probably specify that any disputes will be decided according to California law and that any claims must be brought in the California courts. Obviously, if an artist lives in New York, this would be quite inconvenient. In reality, this provision will often make it practically impossible for many artists to pursue claims they may have due to the costs involved.

Some contracts may contain arbitration clauses. Arbitration is an alternative to going to court to resolve disputes. Instead, the parties agree to be bound by the decision of an arbitrator (a neutral third party).

Arbitration is often described as a cheaper and quicker way of resolving disputes, but this is not always true. In fact, arbitration can be much more expensive and time consuming than bringing a lawsuit in some circumstances.

It is also much easier to abuse the arbitration process since arbitrators have no ability to enforce their decisions. Consequently, you could win an arbitration award and still have to file a suit in court to have your arbitration award enforced.