American Idol Lawsuit Against Sony Sheds Light On Some Controversial Accounting Practices At Major Labels

19 Entertainment, the record company founded by “American Idol” creator Simon Fuller, has sued Sony Music Entertainment for allegedly cheating artists such as Carrie Underwood and Kelly Clarkson out of monies due to them. The lawsuit sheds light on some controversial accounting practices at the major labels and explores the minefield that is the various incomes streams that now comprise the modern music business. Issues raised include how a major label accounts for revenue generated from platforms like Spotify and iTunes, how advertising expenditures are treated, and whether Sony is required to share proceeds from battles on the copyright litigation front.

Copyright Litigation: Sony says its contracts with 19 concerning certain American Idol alumni provides for 19 to share in excess recoveries only from legal proceedings that Sony institutes in the name of 19 or a particular artist. Sony argues that this provision does not apply to proceedings that are brought in Sony’s name, including those aimed at stopping the broad-based copyright infringement of Sony’s catalog such as the action brought against the file-sharing website Limewire which settled for $105 million. 19’s position is that the contract gives Sony the right to sue in the artists' names and compel cooperation from them which logically necessitates that artists be compensated from the proceeds of such copyright infringement lawsuits. 19 maintains that Sony has many ways to bring a  lawsuit and that the manner in which Sony starts a litigation is of no consequence to 19’s right to receive a portion of any money which is attributable to the infringement of a particular 19 artist’s record.

Streaming Platforms: 19 claims that Sony underpays artists by paying the lower of two royalty rates on streaming income. Specifically, Sony treats music exploited on services like Spotify as "sales" or "distributions" rather than "broadcasts" or "transmissions." The effect of doing this according to 19 is to account for such deliveries as no different than downloads purchased. Sony says artist royalties are contractually tied to the language used in the major label's licensing deals with third party services. If that was not so, Sony argues, there would be no purpose in setting up a contract with two different royalty rates as Sony simply would be obligated to pay the higher rate. Sony argues that the language would be meaningless if it never had the possibility of treating streaming income as distributions. In opposition, 19 alleges that Sony is acting in bad faith by mischaracterizing what is happening in streaming which “robs 19 of the fruits of the Recording Agreements by purposefully avoiding using the correct operative words when Sony knew a 'broadcast' or 'transmission' was precisely what was occurring."

Royalty Escalators: The lawsuit also addresses what happens when consumers go to iTunes and buy individual tracks off an album. Though many of the songs were not released as "singles" per se, Sony treats them as singles to allegedly avoid having them count towards album sales that would trigger royalty escalators for the recording artists. Again, Sony points to the "unambiguous language" of the agreements: "If the parties intended multiple separate sales of Records that are not Albums to count as an Album, they would have said so" states Sony.  Sony says the interpretation that multiple individual tracks sold should be grouped as partial album sales "leads to absurd results," calculating the economic consequences being at most just "two dollars and change" even if millions of records were sold. 19 argues that its audit calculated an underpayment of $960,000 thanks to this practice, and further states: "It's easy to see that the labels can come out 20 percent to 40 percent (or even more) ahead if they sell 11 to 13 tracks individually to the same or multiple buyers, rather than the entire album in a single transaction to a single buyer."

Simon Fuller’s company 19 is alternatively looking to bring a claim against Sony for breaching its duty of good faith and fair dealing by allowing iTunes and other download providers to permit the "disaggregation of the Album format," allowing individual tracks to be sold for the alleged benefit of Sony and to the detriment of 19 and its artists. But according to Sony, "19’s assertion that the Agreements did not contemplate the changes to the music industry caused by the rise of individual track downloads is refuted by the fact...that all of the Agreements were executed after individual track downloads became a fixture in the music industry."

This lawsuit is still in its early stages but, whatever the outcome, it is sure to have important ramifications for the music business.

WALLACE COLLINS is a New York lawyer specializing in entertainment and intellectual property law.  He was a recording artist for Epic Records before attending Fordham Law School. T: (212) 661-3656.  www.wallacecollins.com