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Licensing requirements and royalty rates for online uses of music are undergoing sweeping changes, spurring litigation, appeals and even legislation in Congress. As a result, Webcasters are scrambling to re-evaluate and redirect their business models, as they may soon be forced to pay for huge increases in royalties to recording artists. The controversy began in March, when the Copyright Royalty Board created a new royalty payment scheme under which Webcaster payments would be based on a “per performance” calculation rather than the “aggregate tuning hours” basis more commonly used in the past. The board also set royalty rates for the years 2006 through 2010 at significantly higher levels than in the past. Although this decision was met with fierce opposition from Webcasters, the board denied all requests for reconsideration and rehearing. Despite this ruling, the board did create an optional transition period during which Webcasters may make limited use of the aggregate tuning hours option and extended the date on which the new royalties become effective to July 15. In the weeks surrounding this deadline, both sides have taken an active role in renewed litigation in court, pending legislation before Congress and ongoing settlement negotiations. The payment due date has passed, however, and the outcome of this controversy is still uncertain. As way of background, the 1976 Copyright Act gave copyright owners the right to authorize the public performances of copyrighted works, otherwise known as the “performance right.” The licensing requirements for performances of recorded music are complicated because there are two separate sets of copyrights involved. The first is the “song,” which refers to the notes and lyrics of a piece of music. The second set of copyrights is in the “sound recording,” which is the particular recorded version of a song. How online music is licensed Licensing for online music use is particularly complicated. Normally, the performance right is granted to all categories of copyrighted works, except for sound recordings. The Digital Millennium Copyright Act, however, created a performance right for sound recordings that are publicly performed by means of a digital transmission. Digital transmissions that conform to certain statutory specifications qualify for a compulsory license, which allows Webcasters to use a sound recording without first seeking permission directly from its copyright owner. SoundExchange Inc., a nonprofit organization that is designated by the U.S. Copyright Office, administers these compulsory licenses, collects the royalties from the licenses and pays the royalties to the copyright owners and performers. The Copyright Royalty Board, which is composed of three permanent judges appointed by the librarian of Congress, sets the royalty rate for the compulsory licenses. Digital rates first set in 2002 The board fixes royalty rates for digital transmissions industrywide and adjusts them every five years. The royalty rates were first set in 2002 and modified by several agreements between the recording industry and various groups of Webcasters. The 2002 royalty scheme technically expired at the end of 2005, but Webcasters have paid royalties at those rates through 2006 and continued to pay under this arrangement until the effective date of the board’s new royalty system. Under the prior scheme, all commercial Webcasters that did not qualify as “small commercial Webcasters” could calculate royalties for compulsory licenses in one of two ways. A “per performance” option allowed Webcasters to pay per song, per listener at the rate of $0.000762 per performance. The difficulty of tracking listeners in this way, however, led the vast majority of Webcasters to use another method based on aggregate tuning hours (ATH), in which one listener who listens for one hour would constitute one ATH, two listeners who each listen for a half an hour would also be one ATH, and so on. The fee for each ATH was $0.0117. When the Webcaster royalty rates were first adopted, strong protests from small commercial entities led to the Small Webcasters Settlement Act of 2002. The act allowed entities with less than $1.2 million in revenue to pay the higher of 10% of their revenue on the first $250,000 of the Webcaster’s revenue and 12% thereafter, or 7% of the entity’s expenses. Other categories of Webcasters, such as noncommercial and nonmusic Webcasters, also paid different rates. Noncommercial Webcasters paid a minimum rate of $500 a year, which allowed them to stream 146,000 aggregate monthly tuning hours of music. If the Webcaster exceeded those amounts, that entity would pay royalties on the excess either on a per-performance basis at $0.0002176 per performance or on the basis of aggregate tuning hours at $0.00251 per ATH. Furthermore, nonmusic Webcasters, those that primarily broadcast news, talk and/or sports, paid a reduced rate of $0.000762 per ATH. The broadcaster could also choose to pay at the same rate per performance, excluding 4% of performances from their calculations. Rates under the new decision The Copyright Royalty Board’s March decision significantly changed the royalty rates and calculation methodology for the period 2006 to 2010. In contrast to the old system, all commercial Webcasters, including those previously categorized as small commercial Webcasters or nonmusic Webcasters, must now pay using the per-performance calculation at increased rates. The new rates for commercial Webcasters are $0.0008 per performance in 2006, which will apply retroactively, $0.0011 per performance this year, $0.0014 per performance in 2008, $0.0018 per performance in 2009 and $0.0019 performance in 2010. The decision also sets a minimum fee of $500 per “channel” per year. Webcasters, however, still need clarification as to whether each separate stream of online music constitutes a channel for calculation purposes. Noncommercial Webcasters are still treated as a separate category under the new scheme but the basis on which they pay royalties has changed. Webcasters in this category must pay a minimum annual fee of $500 per channel or station. With that payment, they may conduct digital audio transmissions of up to 159,140 ATH per month. If a Webcaster exceeds this limit, however, the entity must pay additional royalties for transmissions in excess of the cap at the same rate that is paid by commercial Webcasters. Despite the objections that ensued, the Copyright Royalty Board found in April that no new evidence or clear error warranted a reconsideration of its March decision. Nevertheless, the board did make multiple changes. First, the board allowed a transitional option for 2006 and 2007, during which Webcasters can continue to use aggregate tuning hours as a basis for calculating and paying royalties in order to ease the shift in methodology and facilitate timely payment. Despite this concession, the board expressly rejected the use of aggregate tuning hours as a permanent part of the royalty structure. The second significant change the board made was to set a July 15 deadline for the payment of retroactive royalties for 2006 and 2007. The board refused to stay implementation of the new rates and terms until all administrative appeals and judicial review were complete. The board’s April decision has not settled litigation over the new royalties scheme. Instead, several interested parties, including the National Association of Broadcasters, have filed appeals with the U.S. Circuit Court of Appeals for the District of Columbia. To postpone the July 15 payment deadline, the parties also filed a motion to stay and suspend the board’s decision until all appeals have been heard. On July 11, however, the court denied that motion. A possible legislative fix Opposition to the new royalties scheme has also come in the form of proposed legislation. The Internet Radio Equality Act, H.R. 2060 and S. 1353, would vitiate the board’s new royalties scheme. The proposed bill gives Webcasters the choice of paying royalties amounting to either $0.33 per hour of sound recordings transmitted to a single listener or 7.5% of the revenues it received during that year that are directly related to those broadcasts. The act would also abolish the $500 minimum fee for each channel of Webcasting. Supporters in Congress fear that the new royalty rates and reporting methods will stifle creative Webcasters and a thriving Internet business model, which, according to Nielson Media Research, allows more than 70 million Americans to access music over the Internet each month. The legislation’s passage is still uncertain. Settlement negotiations are Webcasters’ greatest hope for a solution to this issue. Although large Webcasters will be significantly affected by the board’s decision, small Webcasters will be most affected. Some estimate that royalties for small Webcasters could reach as high as 300% to 1,200% of their revenues, forcing most, if not all, of them out of business. As a result, small Webcasters have met the board’s decision with staunch opposition. In response, SoundExchange offered to reinstate the terms of the Small Webcasters Settlement Act, which expired in 2005, for the 2006 to 2010 period. A coalition of small Webcasters rejected the offer, calling it only a temporary solution that would limit the amount of revenue small Webcasters could earn at $1.2 million without being penalized for success. Instead, the coalition seeks major changes to the board’s proposed scheme and supports a system that mimics the rates proposed by the Internet Radio Equality Act. SoundExchange has also suggested a settlement to preserve the old rates for noncommercial Webcasters. This proposal would maintain the $500 annual minimum fee for 146,000 aggregate tuning hours and would cap the royalty rate for additional listeners at $0.0002176 per performance or $0.00251 per ATH. However, the offer includes a new requirement that noncommercial Webcasters provide records on their use of sound recordings on a monthly basis. SoundExchange discussed this offer with only a small segment of noncommercial Webcasters, and no final agreement was reached. Recent negotiations Congress has also made strong calls for compromise. At a closed-door congressional meeting on July 12, SoundExchange offered to cap the annual per-channel minimum fee at $50,000, if the broadcaster would report everything that is played and adopts technology that limits the ability of listeners to copy broadcasts, i.e., engage in “stream-ripping.” The Digital Media Association, a lobby group representing large Webcasters such as Yahoo! Inc., RealNetworks Inc. and America Online, accepted SoundExchange’s offer, promising to improve reporting and to “research, identify, review and evaluate” the prevalence of stream-ripping and potential technologies to limit it. SoundExchange, however, denied making the offer as the Digital Media Association understood it and accused the organization of mischaracterizing the negotiations. In response, the Digital Media Association has criticized SoundExchange for reneging on its offer and demanding technology mandates that are unreasonable. As discussions become more contentious, the possibility of a solution in the near future looks unlikely. The hope for settlement has not entirely disappeared, as National Public Radio, representing public radio stations, reached a temporary agreement with SoundExchange on July 13 to delay enforcement of the new fees and to continue good-faith negotiations until at least Oct. 15. With much yet to be determined, the future of royalties for music use on the Internet is in flux. In the meantime, Webcasters face an uncertain future. Small Webcasters may be pushed out of business if these new rates are enforced. Even large radio broadcasters that are simulcasting their programming on the Internet are rethinking the economic viability of doing so. The bottom line is that, unless the court alters the board’s decision, legislation is enacted or a settlement is reached, all Webcasters, excluding public radio stations for now, must pay royalties at the new rates and must plan to calculate royalties using the per-performance methodology after 2007. Cydney A. Tune is counsel to Pillsbury Winthrop Shaw Pittman, based in its San Francisco office. Mark Bekheit, a student at Harvard Law School, is a summer associate at the firm.

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