February 22, 2012 10:03pm PT by Eriq Gardner
Leaked Audit in Eminem Royalty Suit Highlights Huge Stakes for Record Industry
Over the last few months, the music industry has been rocked by multiple lawsuits alleging that artists such as Kenny Rogers, Sister Sledge, Rob Zombie and others have been cheated out of substantial money from the improper calculation of revenues from digital music. The plaintiffs in these cases assert that the music giants have been wrongfully treating digital music purchases as "sales" rather than "licenses," and thus only sharing 10-20 percent of revenue instead of a near 50-50 split they believe is owed.
Let's assume the plaintiffs are right. What comes next? Do record labels have any way to limit the damage and what kind of money is at stake?
The answer is coming soon. In 2010, in a breakthrough case involving Eminem's producers, F.B.T. Productions, the 9th Circuit Court of Appeals largely blessed the "license" interpretation, remanding the case down to the district court level to figure out what was owed by Aftermath Records, a subsidiary of Universal Music Group.
At an upcoming jury trial, the two sides will fuss over exactly how much money is due to Eminem's production team. In advance, THR has obtained the audit report prepared by the plaintiff's accounting expert that F.B.T. hopes to showcase before a jury. The report, which is being vigorously disputed by the defendants, represents millions of dollars in claimed revenue from digital downloads. It also shows the other ways that record labels supposedly withhold too much income from artists, from overstating the costs of advertising on TV to not sharing the proceeds of litigation winnings.
The trial is scheduled for April 4.
In preparation, both sides investigated the spoils of Eminem's lucrative career. Many of these audit reports remain under seal. But we've gotten ahold of one audit report, prepared by plaintiff's auditing expert Gary Cohen, which covers the period between July 1, 2005 and December 31, 2009. It represents the years when iTunes first burgeoned as an income source for the record industry. Here's a look at what F.B.T. claims is owed by Aftermath for this time period:
As you can see above, the plaintiffs believe that the difference in treating digital music as a "sale" instead of a "license" during this time period is worth $3,810,256. This potentially understates the damages. That's because the figure only represents only one slice. Foreign licensing is listed in a separate column ($131,749) and has become controversial. More on that issue in a moment.
You'll also see above that the auditor turned up all sorts of underreported income apart from the digital music issue. It's claimed, for example, that Aftermath held back too much on vinyl sales of albums including "Slim Shady," "Marshall Mathers," "Eminem Show," "8 Mile Soundtrack," and "Curtain Call." The record label also allegedly made accounting errors on units sold at U.S. military bases; allegedly withheld proceeds from litigation wins against Kazaa, Napster, and YouTube; allegedly messed up royalty calculations on tracks said to contain third party contributor like Dido or sampled work from Aerosmith; allegedly deducted too much for Dr. Dre's production work and the cost of his chartered air travel; and allegedly overstated the cost of doing TV ad campaigns on the "Curtain Call" album.
That's just a start. You'll also see that Aftermath held onto more than $2 million to pay its own legal costs in this very dispute. Keep in mind that this audit report only includes the time period between 2005-2009. We also understand that audit reports have also been prepared for the periods of 2002-2005 and 2010-2011. Against the defendants' objections, F.B.T. also is getting a large share on Eminem's latest releases, Recovery and Relapse, even though in 2009, after the litigation was filed, Eminem and Aftermath signed a new recording contract that explicitly pegged new royalty rates on sales and licenses of his new work. (Eminem was given a raise in his percentage.)
So how is Aftermath responding?
As U.S. District Judge Philip Gutierrez noted in an October order responding to the parties' dueling summary judgment motions, "The 9th Circuit only determined that the Masters Licensed provision dictates the royalty rate for proceeds from permanent downloads and mastertones. Under the Masters Licensed provision, FBT and Eminem are generally due royalties of 50 percent. It remains to be determined what figure that 50 percent is applied to." (ital ours)
In other words, 50 percent merely set a threshold on the general issue of how to treat digital income; it didn't tie up all the loose ends on the calculation of damages.
Aftermath's big argument after the 9th Circuit remanded the case was an attempt to apply "new medium and container deductions." The plaintiffs argued in response that the costs of licensing digitally were negligible. The judge said that the language of the agreement governing these types of deductions was ambiguous, but pointed to evidence that the record labels understood that it could only be applied to stuff like audio-tapes and CDs. The record labels had never tried to apply it to digital downloads before, and the judge deemed their failure to so to be implicit consent they couldn't.
The record label experienced more success on the issue of whether Eminem's "side projects" should be included in the 50 percent royalty calculation rate. The judge ruled they shouldn't.
Slightly less clear was the judge's ruling on which of Aftermath's "net receipts" should be apportioned to F.B.T. Anything going into Aftermath's pocket from Eminem's primary projects obviously gets included, but what about receipts to UMG's other affiliates, especially those overseas that distribute Eminem albums. That issue is still being furiously debated.
Aftermath now wants the judge to reject Cohen's report. This past week, it gave the judge several reasons. Among those given is that he included in his calculations "side projects" such as the chart-topping song, "Lose Yourself," and the "8 Mile Soundtrack." Additionally, the record label says that when foreign income comes into Aftermath's sister companies, different calculations apply. Cohen couldn't simply calculate the whole sale price of albums sold overseas, argued Aftermath. The plaintiffs believe that it would essentially mean that UMG could avoid exposure by merely shifting where the receipts come in.
The record label is also taking issue with some of Carter's other conclusions, including deductions it believes are warranted, and the understatement of mechanical fees paid. In sum, Aftermath is challenging Cohen as unreliable.
To Cohen's credit, he testified during a deposition that he wasn't supplied with "appropriate information" concerning foreign royalties and believed that "substantial additional amounts would be due F.B.T." And in his audit report, he pressed Aftermath for more information on things like public performance and blanket licensing revenue as well as more documentation on Aftermath's share of litigation settlements with Napster, Kazaa, YouTube and others. This last bit probably won't be a primary issue at trial, but could be of interest to artists out there wondering if they'll ever see a cut from the RIAA's legal efforts.
The case primarily shows just how many millions of dollars are at stake, even just for one artist. Now that several class actions have been launched on behalf of other artists, there's likely hundreds of millions of dollars more that will be fussed over. But the ongoing controversy also demonstrates that record labels aren't going to just roll over. They still intend to put up a good fight. Starting at a California jury trial on April 4.