IP Law Daily Decision setting compulsory license rates and terms for music streaming tossed
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Thursday, August 13, 2020

Decision setting compulsory license rates and terms for music streaming tossed

By Thomas Long, J.D.

Streaming music providers not given adequate notice that the Copyright Royalty Board would make drastic, significantly adverse changes to the mechanical license royalty scheme.

In an interim victory for providers of streaming music services, the U.S. Court of Appeals for the District of Columbia Circuit has held that the Copyright Royalty Board failed to give adequate notice or to sufficiently explain critical aspects of its decision-making in connection with setting the copyright royalty rates for the rights of interactive streaming services to reproduce and distribute musical works for the period of January 1, 2018 through December 31, 2022. In the court’s view, the Board’s unexpected overhaul of the mechanical license royalty scheme was "significantly adverse" to the service providers. The Board failed to provide adequate notice of the rate structure it adopted, failed to explain its rejection of a past settlement agreement as a benchmark for rates going forward, and did not identify the source of its asserted authority to substantively redefine a material term after publishing its Initial Determination. In the court’s view, streaming service providers were not given notice that the Board would change the rate structure in such a "drastic" way. Therefore, the court vacated and remanded the Board’s adopted rate structure and percentages for further proceedings (Johnson v. Copyright Royalty Board, August 10, 2020, Millett, P.).

Four music streaming services—Amazon Digital Services LLC, Google LLC, Pandora Media, LLC, and Spotify USA Inc. (collectively, "Streaming Services"); the National Music Publishers’ Association and the Nashville Song writers Association International (collectively, "Copyright Owners"); and George Johnson, a song writer proceeding pro se, challenged royalty rates and terms established by the Board for the period January 1, 2018 through December 31, 2022 (84 Fed. Reg. 1918, Feb. 5, 2019).

Compulsory license. Section 115 of the Copyright Act creates a compulsory license that allows any person who satisfies certain conditions, including the payment of a royalty, to reproduce and to distribute phonorecords of a copyrighted musical work. This is known as the "mechanical license." The Copyright Royalty Board has the authority to set the rates and terms for the mechanical license. Section 115’s compulsory license, however, does not include the right to publicly perform a musical work, and it does not create a compulsory license for the sound recordings themselves. Interactive streaming services seeking the right to make, distribute, or publicly perform a sound recording, and those seeking the right to publicly perform a musical work, must negotiate with and obtain permission from the appropriate rights holders.

Pursuant to a prior settlement agreement, calculation of the applicable royalty rates for 10 categories of streaming-related offerings involved the following process. First, for each category, the service providers calculated the greater of (1) the "revenue prong," a percentage of the service provider’s revenue associated with the particular offering, and (2) the "total content cost prong," a percentage of the royalties paid by the service provider to sound recording copyright holders. Second, the service provider subtracted from the greater of the revenue and total content cost prongs the royalties it had already paid for the right to publicly perform musical works through that offering. Third, the service provider next calculated the minimum mechanical license payment, also known as the "mechanical floor," for each category of offering. Finally, the service provider was required to pay a royalty that was the greater of the amount calculated in step two or the mechanical floor calculated in step three.

Royalty-setting proceeding. On January 5, 2016, the Board initiated proceedings to determine the appropriate mechanical license royalty rates and terms for this period. The parties reached a settlement of the mechanical license royalty rates and terms for physical phonorecords, permanent digital downloads, and ringtones ("the Subpart A settlement"). On March 28, 2017, the Board adopted this partial settlement, over the objections of only George Johnson. The parties were unable to agree on the mechanical license rates and terms for other interactive streaming offerings, including standalone portable and non-portable subscription services and bundled subscription services. As a result, the Board was tasked with adjudicating those rates and terms through adversarial proceedings.

Parties’ proposals. The four Streaming Services all broadly sought to maintain the preexisting rate structure, but proposed to either lower or eliminate the mechanical floor. The Copyright Owners proposed a unitary rate structure for all interactive streaming and limited downloads, under which streaming services would pay the greater of (1) a per-play fee or (2) a per-subscriber fee. They also argued that the Board should retain the mechanical floor but should modify the rate structure so that mechanical license royalties are no longer offset by the payment of performance royalties. Johnson proposed that interactive streaming services be required to include a "Buy Button" that allowed customers listening to a song to voluntarily purchase a song as a permanent paid digital download, with 80% to 84% of the proceeds divided evenly between the owners of the musical work and the owners of the sound recording.

Initial Determination. On January 27, 2018, the Board issued its Initial Determination, with one of the three judges on the panel dissenting. The Initial Determination retained the "All-In" feature that allows interactive streaming services to deduct performance royalties, and it retained the mechanical floor. According to the Board, the mechanical floor was retained because it appropriately balances the streaming service providers’ need for the predictability of an All-In rate with publishers’ and songwriters’ need for a failsafe to ensure that mechanical royalties will not vanish. The Board, however, abandoned its prior use of different formulas and percentages to calculate the total content cost prong for different categories of offerings, adopting instead a single, uncapped total content cost rate that applied to all categories of offerings. The court noted that this approach meant that, as sound recording royalties increase, the mechanical license royalties generally will also increase, even if the interactive streaming services’ revenue is low as a result of revenue deferral strategies (such as discounted student plans). The Board’s position was that sound recording copyright owners’ royalty rates would naturally decline in the course of their negotiations with interactive streaming services, based on the Board’s assumption that these copyright owners would want the existing interactive streaming services to survive.

Rate setting—Shapley Analyses. The Board next considered the specific rates to apply within that structure, relying primarily on what are known as "Shapley Analyses" provided by the parties’ experts. The Shapley methodology is a game theory model that seeks to assign to each market player the average marginal value that the player contributes to the market. It first determines the costs that each player should recover, then divides the "surplus" among the players in proportion to the value of their contributions to the worth of the hypothetical bargain that would be struck. Drawing from the parties’ competing Shapley Analyses, the Board decided to increase the mechanical license royalty rates paid by interactive streaming services. The Board did not adopt any one expert’s report, but drew from multiple studies to construct a range of reasonableness for the royalty rates. The Board ultimately settled on 26.2% as the total content cost rate and 15.1% as the revenue rate, with those rates to be phased in gradually over five years. The Board also found that the mechanical license royalty rates should be set at zero in certain circumstances where user streams of copyrighted works produced no revenue for the streaming services. The Board rejected the alternative proposals advanced by George Johnson.

Dissent. The dissenting judge objected to the Board’s adoption of a rate structure that "was only proposed after the hearing, when the record had already been closed." He also argued that that uncapping the total content cost prong could imperil the existence of the interactive streaming services because sound recording copyright owners "may decide to keep their rates high despite the increase in mechanical rates," or they may simply create their own "in-house" streaming services and refuse to contract with the existing interactive streaming services at all.

Final Determination. After the parties engaged in various attempts to persuade the Board to reconsider aspects of its Initial Determination, the Board issued its Final Determination on November 5, 2018, and published a redacted version on February 5, 2019 (84 Fed. Reg. 1918). Final Determination closely tracked the Initial Determination. It adopted the same rate structure and rate percentages set forth in the earlier rulemaking, retaining the mechanical floor and uncapping the total content cost prong for all categories of offerings. The Board stood by its decision to phase in over five years, for all categories, a 15.1% revenue rate and a 26.2% total content cost rate.

Arguments on appeal. On appeal, the Streaming Services, Copyright Owners, and George Johnson challenged numerous aspects of the Final Determination. The Streaming Services argued that the Board’s decision impermissibly applied retroactively. They also challenged the Board’s rate structure and the specific rates applicable under that structure. The Streaming Services and the Copyright Owners each objected to the Board’s definition of certain terms. George Johnson challenged the Board’s acceptance of the Subpart A settlement, as well as its adoption of the final rate structure.

Retroactivity. The court rejected the Streaming Services’ retroactivity argument, holding that there was nothing retroactive about the Board’s rate determination. Although the Board in its Final Determination made its new rates effective starting on January 1, 2018—and not the statutory "default date" of April 1, 2019, the first day of the second month that began after publication of the Final Determination in the Federal Register—that did not constitute a retroactive effective date because that date was the parties’ long-agreed-upon start date. The statute and regulations permitted the parties to agree on a start date that was different from the default date. "Given the Board’s prospective announcement of the effective rate period in 2016 and the parties’ continuous agreement over the ensuing years to those dates, what was done here is a far cry from retroactive rate setting," the court said.

Rate structure. The court held that the Streaming Services were correct in arguing that the Board failed to provide adequate notice of the drastically modified rate structure it ultimately adopted. The court also held that the Board did not provide a reasoned explanation for its refusal to the prior settlement as a benchmark when setting the total content cost and revenue rates. Therefore, the court vacated and remanded the Board’s adopted rate structure and percentages for further proceedings.

Although the Streaming Services knew at a high level that the Board would be deciding the royalty rates and terms to govern the mechanical license, they did not have fair notice that the Board would take the dramatic step of uncapping the total content cost prong for every category of service offering, let alone pair that with significant increases in the total content cost and revenue prongs. This deprived them of the ability to present evidence about that rate structure. The court noted that no party had proposed or "even hinted" at the structure ultimately adopted by the Board. "So the Streaming Services had no notice that they needed to defend against and create a record addressing such a significant, and significantly adverse, overhaul of the mechanical license royalty scheme," said the court. "If the Board wishes to pursue its novel rate structure, it will need to reopen the evidentiary record."

Percentages. The Streaming Services also objected to the particular percentages adopted by the Board to calculate the revenue and total content cost prongs. The court disagreed with the contention is that it was arbitrary and capricious for the Board to rely on information drawn from different expert analyses in calculating the mechanical royalty rates, opining that this was "squarely within the Board’s wheelhouse as an expert administrative agency."

The court agreed, however, that the Board’s rejection of the prior settlement as a benchmark was without adequate explanation, calling the Board’s treatment of the settlement "muddled." Concluding that it was impossible to the discern the basis on which the Board rejected the settlement’s rates as a benchmark in its analysis, that issue was remanded to the Board for a reasoned analysis.

Definitions. The Streaming Services and the Copyright Owners each disputed the definitions of various terms set by the Board. The Streaming Services objected to the Board’s reformulation of how "Service Revenue" for bundled offerings was to be calculated. The Copyright Owners objected to the Board’s method for counting the number of subscribers attributable to student and family subscription plans for interactive streaming services. The court agreed with the Streaming Services, stating that "the Board has completely failed to explain under what authority it was able to materially rework that definition so late in the game." The court, however, found no merit to the Copyright Owners’ challenge, holding that the Board’s finding about the willingness (and ability) of students and families to pay was supported by substantial evidence.

George Johnson’s objections. Although the court called Johnson’s arguments "thoughtfully presented, it rejected all of them. Alone among the parties, Johnson proposed an inflation-based approach to rate setting, which, said the court, might well have been a reasonable option, but that fact was not enough to prevail under the deferential Administrative Procedure Act standard of review. There were other reasonable approaches available, and it was within the Board’s discretion to choose a method other than that proposed by Johnson.

The court also disagreed with Johnson that the Board erred by allowing "limited downloads" without compensation to the copyright owners (that is, with a mechanical royalty of zero). The Board concluded that it was reasonable "to distinguish promotional or non-revenue producing offerings from" the general "revenue-producing offerings" provided by the streaming services. "Johnson fails to explain why the Board’s adoption of those limited and economically balanced exceptions to the generally governing mechanical rates was unreasonable under the circumstances," the court said.

The court also agreed with the Board that it lacked the authority to impose the "Buy Button" requirement suggested by Johnson, and declined to go along with Johnson’s require to mandate a complete redesign of the rate structure.

This case is No. 19-1028.

Attorneys: George Johnson, pro se. Andrew J. Pincus (Mayer Brown LLP) and Scott H. Angstreich (Kellogg Hansen Todd Figel & Frederick PLLC) for Amazon Digital Services LLC, Google LLC, Pandora Media, LLC, and Spotify USA Inc. Kannon K. Shanmugam (Paul, Weiss, Rifkind, Wharton & Garrison LLP) for National Music Publishers’ Association and Nashville Songwriters Association International. Jennifer L. Utrecht, U.S. Department of Justice, for Copyright Royalty Board and Librarian of Congress.

Companies: Amazon Digital Services LLC; Google LLC; Pandora Media, LLC; Spotify USA Inc.; National Music Publishers’ Association; Nashville Songwriters Association International

MainStory: TopStory Copyright TechnologyInternet GCNNews DistrictofColumbiaNews

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