The legal Achilles’ heel of the catalog buyout craze: Termination rights

With music catalog sales in the second half of 2020 from Bob Dylan, Stevie Nicks and Imagine Dragons surpassing the gross domestic product of the American Samoa, the finance world can no longer ignore the value of music IP. New business models manifesting as publicly traded music royalty funds (e.g. Hipgnosis) and private marketplaces for royalty investments (e.g. Royalty Exchange) are tearing down the historically walled gardens of music rights ownership, by packaging and trading these rights like common stocks or bonds.

But implementing these new models will likely not be as smooth-sailing as their accompanying media hype might suggest. As tech-centric companies and investors press forward to capitalize on these radical investment opportunities, many of them fail to acknowledge issues that have been present in the music industry for decades.

In particular, music termination rights and the volatility of copyright protections are inescapable forces that can suddenly deprive copyright holders of their rights, or slash the value of their investments. As two misunderstood aspects of the music ecosystem, I’d like to take a moment to describe their implications on this transformative investment environment.

Termination rights: A brief overview

Also known as reversion rights, termination rights give copyright creators the right to recapture ownership of their copyrights by terminating prior assignments, transfers or licenses of their copyrights. At large, they are designed to give artists “a second bite at the apple,” as Congress recognized the imbalance of bargaining power at play, the uncertainty of a musical copyright’s future value and the history of widespread artist abuse.

Under the US Copyright Act of 1976, for transfers performed after January 1, 1978, creators have a five-year window to issue a termination request, starting 35 years from the date of the creator’s original transfer. As a protective statutory provision, these rights cannot be contracted around — i.e. they will defeat any contractual language purporting to make a copyright assignment (by the original creator) in “perpetuity.” Moreover, if a creator decides to exercise his rights to recapture their copyrights, they do not owe any present owners or licensees any compensation.

Given the 35-year mandate, 2013 was the first year under US law that artists could begin submitting termination requests to labels and publishers for their copyright transfers. For example, in May 2015, Victor Willis, lead singer and songwriter of the Village People, successfully recaptured 50% copyright ownership in 33 songs, including mega-hit “Y.M.C.A.,” that he had originally transferred to the publishers Scorpio Music and Can’t Stop Productions. This was despite a four-year litigation process from said publishers, which was ultimately unsuccessful.

One important caveat to this artist-friendly provision is that the 1976 Act expressly denies termination rights to any copyrights made under a valid, written “works-made-for-hire” agreement. According to § 101 of the US Copyright Act, a “work made for hire” is “a work prepared by an employee within the scope of his or her employment.” Additionally, a copyrighted work created by a non-employee can be a work for hire if:

• The work is made pursuant to a written purchase agreement that specifies it as a work-made-for-hire relationship, and
• The work falls into one of the nine enumerated work-made-for-hire categories, such as motion pictures, instructional texts and compilations.

Unsurprisingly, labels and publishers have fought tooth and nail to prevent termination rights from invalidating the copyrights assigned to them by artists. Work-made-for-hire provisions were an industry standard for both recording and publishing contracts in the ’70s. Even since the first termination rights were exercised in 2013, labels and publishers have tried to rope in artist sound recording and composition copyrights as work-for-hires, with two major arguments:

• Their artists should be classified as employees, and
• The compositions and sound recordings are part of a work-for-hire compilation.

While most courts find that these arguments are unreliable — i.e. that label-artist relationships do not qualify as employer-employee, and that music copyrights do not meet the law’s definition of a “compilation” — a victory for the artist is never certain. It ultimately takes a pivotal copyright law amendment or court verdict to straighten things out.

Reviewing just a handful of landmark federal- and state-level copyright cases over the past 50 years, involving the likes of Katy Perry, George Harrison, Robin Thicke and Prince, one can see that copyright verdicts regularly broaden and retract the playing field of copyright ownership. Moreover, trying to track copyright amendments over time, including the most recent Music Modernization Act, demonstrates an ebb and flow of copyright protections that could make one seasick. In an economic sense, each new copyright verdict and law can make your rights more or less valuable, a fluctuation that new entrants into music finance and investment may not comprehend.

How termination rights can devalue a royalty investment

The digitization of royalty tracking, collection and distribution has turned sluggish mailbox money into (relatively) quicker inbox cash. Not only has this significantly cut the cost of music catalog management for traditional music-industry stakeholders, but they have also paved the way for publicly-traded funds and marketplaces to create new market opportunities for artists and investors.

A prominent pioneer in the modern world of music investment funds is industry veteran Merck Mercuriadis’ Hipgnosis Songs Fund. To date, Mercuriadis and his team have spent over $2 billion acquiring dozens of catalogs from legacy songwriters and producers across pop, rock, hip-hop and more; recent acquisition announcements from the past week alone include Lindsey Buckingham’s publishing catalog, Jimmy Iovine’s producer catalog and a 50% stake in Neil Young’s song catalog. Investors can now purchase shares in Hipgnosis on the London Stock Exchange (ticker SONG), effectively owning an indirect interest in these copyrights.

As for the royalty marketplace craze, accredited private investors can now buy fractional music rights, such as a portion of a given song’s or catalog’s future performance royalties, directly from the copyright holders themselves. Top players in this ecosystem include SongVest and Royalty Exchange, which enable artists to auction off their rights to investors either for a limited term or indefinitely. For example, the performance royalty income of Shakira’s hit song Ojos Así is currently being auctioned on Royalty Exchange’s secondary market.

While these business models are innovative in how they use technology to package copyrights and royalty interests like any other financial commodity, legal hazards still lurk beneath the surface.

Generally speaking, while investors normally tout music royalties as predictable and recession-proof (i.e. “uncorrelated”) assets, nothing will protect a given copyright investment from a contraction of legal rights. As demonstrated in the landmark music-copyright cases cited earlier in this piece — and even in seemingly unrelated cases on fair use, such as the ongoing Supreme Court battle between Google and Oracle — copyright lawsuits can come out of the woodwork, are notoriously unpredictable and can result in court orders requiring an investor give up some or all of her rights.

That’s a whole separate rabbit hole to dive into; for the sake of this discussion, let’s consider a hypothetical, realistic scenario involving a termination notice gutting the value of a royalty fund investment virtually overnight. Say a publisher sells its music rights that it obtained from a legacy artist’s catalog in the 1980s to a music fund, or lists the catalog on a royalty marketplace. An investor then purchases stock in the fund, or royalties directly in the marketplace, with the expectation that the copyrights are still valid.

However, as an artist that transferred their work to the publisher in the 1980s, they can soon, if not immediately, unilaterally terminate their transfer to the publisher to recapture their copyrights. Even if the investor just paid for the stock or purchased the rights, this termination of the original transfer leaves the investor high and dry. As the rights return back to the artist, the investor will have some, or all, of the value of his investment taken from him without recourse.

In a phone interview between Water & Music and Mercuriadis this past September, the music investment pioneer claimed that 60% to 70% of the music rights purchased by the Hipgnosis Music Fund are older than 10 years. While we won’t know for sure about this ratio until the company’s next annual report in a few months, we do know that the fund purchasemany of these rights from Kobalt and other music publishers. Recognizing that those publishers likely received said rights from the artists when the songs were written, chances are a number of termination right timebombs lie waiting for Hipgnosis.

How royalty funds, marketplaces and investment firms should prepare

It’s important to note that while relatively few artists have acted on their termination rights relative to how many are qualified to do so — for a variety of possible reasons, such as lack of legal funds or lack of awareness of the statutory right as a whole — this could quickly change as artists and their teams observe the skyrocketing value of deals being done in the marketplace right now.

So how should these new funds, marketplaces and other royalty-driven business models adapt?

One concrete solution is to create and attach clear music rights transfer logs to any catalog acquisition or investment deal. Music rights transfer logs could establish a lineage of when an original creator transferred her rights in her music’s copyright, as well as provide a date-stamped history of subsequent transfers. Such a measure is vital for the sustainability of music investments moving forward, because knowing when termination rights could engage would enable financiers to better price in this risk of a potential conclusion to their investment. Otherwise, music investments, particularly in the secondary markets where rights anonymously pass from one investor to the next, could evolve into an expensive game of termination rights whack-a-mole.

Another solution is to include more transparent, plain-English disclaimers and educational resources for investors, especially for those who are not already versed in intellectual property law and music jurisprudence. Music rights marketplaces and other intermediaries need to hold themselves accountable for notifying the general public of the implications of copyright amendments, influential lawsuits and other esoteric risks beyond a cursory explanation of basic copyright terminology — e.g. in the appropriate cases, including a disclaimer that the original artist could one day undermine an investment by exercising their termination rights. Such measures will allow market participants to make more informed investment decisions and better assess the risk involved.

We must embrace that innovation is the lifeblood of artistry, and that the suppression of music business innovation generally results in more problems than it prevents. However, the new generation of opportunities to monetize music catalogs is not a simple silver bullet for maximizing profits, and new music entrants must acknowledge and adapt to the legal complexities of the industry they are building on.