Facebook's Music Licenses: What's Not to Like?

11/18/2017 03:24 pm ET

Facebook pays no royalties for the music that gives significant value to the platform. That’s often a surprising proposition for artists and songwriters, much less the general public.

Yet it is true—hitmakers and new artists, pros and amateurs alike do not get a penny from Facebook and the company doesn’t even attempt to license their work. Why should a multibillion dollar multinational corporation that anchors a large piece of the Internet economy and whose founder is planning on running for President of the United States get to pay music makers in exposure bucks?

The answer is that Facebook, like YouTube and many other user-generated content platforms hide behind the legacy DMCA “safe harbor” and its nonnegotiable, unconscionable, adhesion contract that controls the use of its platform.

Let’s set aside for the moment whether Facebook can get away with this legally as a contract matter and whether it induces infringement, and even whether Facebook’s recently revealed business plan of exploiting addictive behavior should be taken into account.

For whatever reasons, rumor has it that Facebook is evidently coming to the table and is in at least semi-active negotiations with at least some labels and publishers.

One may well ask what took so long—but if it were not for Universal Music Group’s pursuit of Facebook’s infringements through DMCA notices, it’s likely that Facebook would be blithely rolling on its monopolist juggernaut.

On the other hand, this is actually a good time to be negotiating these deals give the Congressional scrutiny of Facebook’s involvement in the 2016 Presidential election campaigns. We have the benefit of public statements by Facebook representatives under oath regarding what they can do and what they so far refuse to do which may come in handy in licensing negotiations.

These negotiations with rights owners may result in what will seem like a very big pop of up-front cash—but is it? And whatever the number, how will that money be distributed to the artists and songwriters that make it happen?

The whisper number is a $500 million industry-wide payment for labels and publishers to settle the past and to license on a go-forward basis. “Industry-wide” may very well mean “world wide” as well, although that may come as a surprise to artists and songwriters who live outside the U.S. For our purposes, let’s assume that the $500 million applies to the U.S. only, but our friends outside the U.S. may well have a different point of view.

One good thing is that it is unlikely that Facebook will be giving out any shares of stock so we can avoid another Spotify royalty debacle.

While $500 million sounds like a lot, considering the behavior it is not much, particularly compared to Facebook’s monopoly profits. Facebook COO Sheryl Sandberg has already told us that $500 million is a “nonmaterial” payment for Facebook.

And as former Facebook president Sean Parker has told us, Facebook’s exploitation of the human craving for dopamine is a fantastic business model.

Can Facebook Be Licensed?

What should the Facebook deal look like? Industry-wide settlements are large transactions that contain logistical packages, each of which should be fully thought through and given effect if the overall deal is going to work. These include the excluded rights, creator and accounting packages. Let’s consider each of those.

Excluded Rights: It is well to remember that rights holders do not have the ability to settle claims for matters outside of the enumerated rights of a copyright owner or contract rights granted by the artist or songwriter (either directly or under license). Examples of excluded rights include rights of publicity or exploitations subject to a marketing restriction.

Facebook is notorious for selling keywords of artist names as part of its advertising business. It would be unusual for an artist and especially a songwriter to have given up those rights as part of a record deal. There are a number of legal theories that artists can use to block this profit-making activity by Facebook such as right of publicity or misappropriation. These theories may be based on federal or state law claims.

Hearings over the last few weeks before the U.S. Congress demonstrate that Facebook has recently undertaken to control the sale of these keywords (such as Facebook’s sale of anti-Semitic keywords). The process is the same, and any license negotiation should not only exclude any purported grant of rights to sell the artist’s name as keywords but should require an affirmative obligation by Facebook to stop doing so.

Artists and songwriters frequently negotiate marketing restrictions on the use of the creator’s work in advertising. Online platforms are rife with examples of advertising being sold against activities that would violate many of the typical marketing restrictions. UGC platforms can exercise greater control over what is permitted on the service. Like the right of publicity, any license should require an affirmative obligation to prevent the sale of types of advertising against the creator’s works.

Creator Fairness: Record companies and music publishers derive their rights to recordings and songs primarily by contract but also by the legitimacy of consent. When these rights owners license to Facebook, they may receive a payment on the basis of their respective catalogs. Those payments can be either a prepayment of royalties to be deducted (or “recouped”) from future earnings or a settlement for past unlicensed uses in lieu of litigation (and statutory damages). 

Payments to be deducted from future earnings (commonly called “advances”) are recouped from specific songs, at least in theory. Payments for the past cover specific uses, again, at least in theory—but in order to match the settlement payment to specific songs the uses must be identified and matched. This requires some kind of an accounting system for songs and recordings. Facebook has none.

This means that in order for any settlement or go-forward license to have legitimacy with creators subject to it, both settlement payments and advances to the artists and songwriters who granted rights to the labels and publishers by contract must be fairly attributed and paid to them. This is not new—the issue has been on the table for years with litigation settlements and what is called “breakage” or the unrecouped portion of advances that do not roll over at the end of a license term. (See WIN’s “Fair Digital Deals Declaration.”)

Accounting: The Web 2.0 advertising supported business model has given rise to a system of royalty payments that gets more absurd by the day: Revenue share payments. Online services would like creators to take a share of what the service makes as their compensation. Not only is the calculation of revenue shares extraordinarily burdensome, it is almost guaranteed to deliver an ever shrinking royalty payment at the end of the snake—not that different than a ponzi scheme.

This is one reason rights owners with leverage demand large advances that will never recoup—another way of increasing the effective royalty to the rights owner. The rights owner shares the per-play payment with the creators whose works are performed, but then keeps the breakage at the end of the term.

Sounds confusing? This requires quite a sophisticated accounting system to pull all this off. A sophisticated accounting system that drives up the transaction cost to both the service and the rights owner. In fact, it’s entirely possible that hidden streaming accounting costs are more than the royalty payment itself, with or without the breakage.

In Facebook’s case, there is no accounting system. They have to build one. And since no one has been tracking songs or recordings or their uses this should tell you a couple of things. First, no settlement will ever cover all the infringed songs. This is essentially the same problem that Napster had (and to a degree is the same problem that Spotify has at least for songs). The genie is out of the bottle.

Most importantly, it’s entirely likely that if the revenue share model is perpetuated with Facebook, no one will have any idea whether their Facebook royalty statement is correct, if you ever get one. This will be true of a settlement but especially of a go-forward license.

In turn, unreliability of statements means that rights owners who can afford it will have to send in their accountants to conduct a royalty compliance examination, sometimes called an “audit.” Remember—royalty audits have nothing to do with GAAP accounting and they don’t require a certified public accountant. They require someone who knows where to look because all that is happening on a royalty compliance examination is checking whether the royalty statement and payment is in compliance with the contract upon which it is based.

And yes, audits also increase the transaction costs. That would tell you that you want to make that examination as simple as possible—and any lawyer who negotiates a Facebook agreement for a rights owner should be joined at the hip with their accounting department and their auditor. And it would be a lot easier if the payments required were based on a fixed penny rate and not on some revenue share hocus-pocus.

The main reason for this, of course, is not just avoiding the complexity but also the fact that Facebook will refuse to allow anyone to see how they arrived at the revenue to be shared in the first place. So if you can’t ever know what the revenue is, then how can you ever know if you got your share? Hmmm, “partner”?

Breach Upon Signing

The more complicated the deal, the more likely it is that Facebook will be in breach the day after closing. Since no one other than Universal has done anything to stop Facebook’s infringing behavior until now (assuming the rumor is true), will anyone do anything about a breach?

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