19 Recordings Ltd. v. Sony Music Entertainment

Citations: 97 F. Supp. 3d 433; 2015 U.S. Dist. LEXIS 32767; 2015 WL 1223696Docket: No. 14-cv-1056 (RA)

Court: District Court, S.D. New York; March 17, 2015; Federal District Court

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Plaintiff 19 Recordings Limited, a record company, has engaged in exclusive recording agreements with contestants from the television show American Idol since 2002. For winners and select finalists, 19 has licensing agreements with Defendant Sony Music Entertainment, granting Sony exclusive rights to exploit the artists' recordings. In this diversity action, 19 alleges state-law claims against Sony for breach of contract and breach of the implied duty of good faith and fair dealing, asserting that Sony failed to pay the royalties due under the licensing agreements. Sony has moved to dismiss the complaint under Fed. R. Civ. P. 12(b)(6), contending that the claims are barred by the explicit terms of the agreements.

The background highlights that 19 has signed contestants from American Idol over its twelve seasons, allowing for individual licensing agreements with Sony for the winners and certain finalists, including notable artists like Kelly Clarkson and Carrie Underwood. The Licensing Agreement grants Sony the exclusive right to manufacture and sell the artists' recordings globally, in exchange for a complex royalty payment structure to 19. 19 has conducted an audit of Sony's records, alleging that Sony has denied access to necessary documentation and has systematically miscalculated royalty payments, leading to significant underpayment.

Under the legal standard for a motion to dismiss, a claim must present a "short and plain statement" showing entitlement to relief and be "plausible on its face." For breach of contract claims under New York law, a complaint must demonstrate the existence of an agreement, the plaintiff’s performance, the defendant’s breach, and resulting damages. The interpretation of a contract is a legal matter, and if ambiguity exists, a claim cannot be dismissed for failure to state a claim. However, if the contract is unambiguous, courts must adhere to its written terms, allowing for dismissal under Rule 12(b)(6).

In New York, contracts inherently include a covenant of good faith and fair dealing, which mandates that neither party shall act in a manner that undermines the other party's right to benefit from the contract. This covenant focuses on preventing arbitrary or irrational actions by a party with discretion, ensuring adherence to obligations presumed to be intended by both parties. However, it does not create independent obligations beyond those outlined in the contract and cannot serve as a separate cause of action when based on the same facts as a breach of contract claim. 

In the current case, 19 alleges that Sony improperly calculated royalty payments under the Licensing Agreement, claiming breaches of various provisions. Sony counters that 19 seeks to alter the agreement to claim additional royalties unjustly. The existence of the Licensing Agreement and 19's performance under it are not disputed, meaning 19's claims hinge on whether a breach exists as defined by the contract's clear language. 

19's specific claim involves Sony's failure to aggregate sales of single track downloads into "track equivalent albums" for royalty calculations, as stipulated in paragraph 7.1 of the Licensing Agreement. Additionally, 19 contends that Sony breached the implied duty of good faith and fair dealing by allowing digital service providers to separate albums into individual song downloads, benefiting financially without sharing those gains with artists. Paragraph 7.1 outlines royalty rates for different record types and specifies conditions for royalty escalations based on sales exceeding one million records, emphasizing that only full-price sales through authorized outlets count towards these calculations.

The parties have differing interpretations of the Escalation Clause in their Licensing Agreement. 19 believes it mandates a one percent increase in royalty rates when a Recording Commitment Album achieves worldwide sales of 1,000,000 units, arguing that electronic sales of individual tracks should be considered equivalent to album sales (referred to as "track equivalent albums" or "TEAs"). In contrast, Sony maintains that the Licensing Agreement's language only counts traditional sales of full Recording Commitment Albums, whether physical or electronic, toward the million-sale threshold. 

The agreement defines an Album as containing 12 to 25 tracks and having at least 45 minutes of playtime, while a Record is any reproduction of audio material. A Recording Commitment Album is described as an Album that is part of 19's obligation to deliver one full Album to Sony each contract period. Sony asserts that selling individual tracks does not qualify as selling an Album or a Recording Commitment Album, a view supported by the agreement's language.

The Escalation Clause specifies that it applies on an "Album by Album basis" and differentiates between Albums and other types of records. The Court agrees with Sony that the phrase "Records Sold of [a] Recording Commitment Album" refers solely to the sales of those Albums, not individual tracks. The Court also clarifies that while "Electronic Sales" includes various records, the Escalation Clause is concerned only with sales of full Recording Commitment Albums. 

19's claim that Sony has historically paid higher album royalties on individual track downloads is deemed inadmissible parol evidence, as it can only be considered if the contract is ambiguous. Additionally, even if Sony's practice of paying higher royalties for track downloads could be justified due to changes in the music industry, it does not obligate Sony to aggregate these sales for triggering the Escalation Clause.

The Court concludes that the Escalation Clause's plain language does not support 19’s interpretation, leading to the granting of Sony's motion to dismiss this claim. Furthermore, Sony's motion is granted regarding 19's claim of breaching the implied duty of good faith and fair dealing. The Licensing Agreement does not restrict Sony’s ability to sell disaggregated tracks; instead, it provides Sony with an 'unlimited right' to manufacture records by any method, making it impermissible to impose limits that contradict this express provision.

Regarding 19's claim of underpaid streaming royalties, the Licensing Agreement's paragraph 7.16 differentiates between two types of third-party agreements: those that characterize exploitation as 'broadcast' or 'transmission' and those that do not or describe it as 'distribution' or 'sales.' 19 asserts that all third-party streaming services should be classified as 'transmissions' or 'broadcasts,' warranting the higher royalty rate. The Court disagrees, stating that royalty payments depend on the characterization by Sony’s agreements with third-party services, not on 19's interpretation. If these agreements do not solely classify the exploitation as broadcasts or transmissions, the lower rate applies, even if they include such terms alongside 'distribution' or 'sales.' 19's breach claim hinges on whether Sony's agreements with third-party streaming services indeed classify the exploitation as solely broadcasts or transmissions, which is essential for determining the appropriate royalty rate.

The issue presented relates to the characterization of exploitation in third-party agreements between 19 and Sony, focusing on whether such exploitation is defined as distribution or sales versus broadcasts or transmissions. 19 acknowledges that the redacted agreements characterize exploitation as distribution or sales but speculates on potential additional characterizations. If 19's claims contradict the plain meaning of paragraph 7.16, they will fail; if not, factual issues arise that require outside materials for resolution. The Court, accepting 19's allegations as true at this stage, denies Sony's motion to dismiss the breach of contract claim but requires 19 to clarify its position within two weeks regarding the implications of the Court's findings on paragraph 7.16.

Regarding the breach of the implied covenant of good faith and fair dealing, the Court also denies Sony's motion to dismiss this claim. 19 argues that Sony mischaracterized the nature of the exploitation in a way that diminishes its contractual benefits, asserting that the ephemeral nature of the exploitation by third-party streaming providers justifies its claims. This claim hinges on different facts than the breach of contract claim and suggests that Sony’s characterization may be arbitrary or in bad faith, which would not violate the contract's terms but would undermine the expectations of the parties. Therefore, 19's allegations are sufficient to proceed.

Additionally, 19 contends that Sony improperly reduced its royalty rate for television-advertised sales of Compilation Albums, arguing that paragraph 7.5.1, which allows deductions for advertising costs, does not pertain to Compilation Albums.

Deductions for 'Records Sold' are limited and do not exclude Compilation Albums, contrary to 19's argument. 19 defines a Record as a product distributed for sale, which includes any reproduction of Audio Material. Audio Material is defined as recordings of an artist's performance under specific licensing agreements. 19 contends that paragraph 7.5.1's limitation excludes Compilation Albums, which feature multiple artists. This argument is rejected because the Licensing Agreement explicitly defines Compilation Albums as part of the Audio Material and includes them as Records Sold when distributed. There is no contractual language limiting Records to those of a single artist, and paragraph 7.11 supports royalty payments for joint performances. Additionally, paragraph 7.4.2 lists Compilation Albums among the types of Records Sold, reinforcing their inclusion in the agreement. Consequently, 19 cannot claim royalties on Compilation Albums while simultaneously arguing against covering Sony's advertising costs for those same albums. Thus, 19's argument fails, and Sony's motion to dismiss this claim is granted.

In a separate claim, 19 alleges Sony under-reported receipts from DSP settlements, citing a violation of paragraph 20.1 of the Licensing Agreement. However, 19 misinterprets this paragraph, which outlines two methods for Sony to address unauthorized record manufacturing or sales. 19 must cooperate at Sony's expense or allow Sony to pursue legal action, with 19's consent required. Sony can deduct its costs from any recoveries, with half of any excess recovery credited to 19's royalty balance.

Paragraph 20.1 does not affect the rule in paragraph 7.17, which states that party 19 is not entitled to income received by Sony on a general or label basis. Party 19's claim that Sony's lawsuits against certain digital service providers (DSPs) led to payments attributable to Artists’ Masters fails to establish a breach of contract. 19 is entitled to excess recovery only if the lawsuits were brought in its name with its express consent; otherwise, Sony can pursue lawsuits and retain settlement amounts. Since 19 did not allege that Sony failed to report settlements from lawsuits brought in its name, the claim does not sufficiently allege a breach, leading to the dismissal of this claim.

Regarding 19's assertion that Sony improperly deducted foreign television and radio advertising expenses from its royalties, 19 argues that Sony misinterprets paragraph 7.5.2, which governs royalties based on advertising expenditures in specified countries. Subparagraphs (a) and (b) set expenditure thresholds for the U.S.; if Sony exceeds these, it can deduct 50% of its advertising costs from 19’s royalties, subject to a $600,000 cap requiring 19's consent for additional spending. Subparagraph (c) applies to foreign countries, allowing Sony to withhold royalty payments until it recoups 50% of its advertising costs, with defined minimum and maximum expenses requiring 19's consent for amounts exceeding these limits.

Sony contends that subparagraph (c) operates on a campaign-by-campaign basis, enabling multiple campaigns without prior approval as long as each is within the specified limits. 19 disagrees, arguing this interpretation could permit unlimited campaigns for an Album without consent. The Court agrees with Sony's interpretation that subparagraph (c) lacks explicit "Album-by-Album" language, but it finds that other language within the subparagraph may still impose limits on spending by Album.

The Court finds subparagraph (c) of the provision too ambiguous to determine its meaning without additional evidence or clarification. Sony claims that subparagraph (c) allows for the deduction of advertising expenditures on a per-campaign basis, similar to the clearer language seen in paragraph 7.5.1. However, the Court notes significant differences in language and structure between the two provisions, particularly regarding the phrase "retained by Company on the Album the subject of the TV/radio advertising campaign," which lacks clarity. As a result, the Court denies Sony’s motion to dismiss based on this ambiguity.

Additionally, 19 accuses Sony of breaching the implied duty of good faith and fair dealing by underreporting record club income. 19 alleges that Sony permits record clubs to use its Masters below fair market value while receiving trademark payments to compensate for this underpayment, thereby classifying only part of the total income as reportable for royalty purposes. The Court denies Sony’s motion to dismiss this claim, finding that 19's partial audit provides sufficient grounds to infer wrongdoing at this stage of the proceedings. The allegations are considered distinct from 19's breach of contract claim, and even if Sony adheres to the Licensing Agreement with record clubs, it does not negate the possibility of bad faith actions in its agreement structuring.

Moreover, Sony's motion seeks partial dismissal of 19's Amended Complaint but does not contest several allegations, including improper royalty deductions, incorrect payments on Compilation Albums, failure to account for foreign sales, and various other claims related to royalty mismanagement and accounting practices.

Sony must notify the Court within two weeks whether it plans to file a responsive pleading regarding remaining claims. If it does not respond, it must explain why this should not be viewed as an admission of the alleged facts under Fed. R. Civ. P. 8(b)(6). Sony initially sought to dismiss claims for royalties related to Carrie Underwood and Kellie Pickler from 2006, citing contractual contestability provisions, but later indicated it would not pursue these claims, leading to the denial of this part of the motion as moot. The Court partially granted and partially denied Sony's motion to dismiss. A status conference is scheduled for May 1, 2015, with a requirement for the parties to jointly submit a revised case management plan and update on discovery status by April 24, 2015. Additionally, within two weeks of the opinion, the party must provide a letter regarding claims of underpaid streaming royalties, while Sony must clarify its intentions regarding claims it did not seek to dismiss. The Court accepted all allegations from the opposing party as true for the motion's purposes and determined that differences in the Licensing Agreements were irrelevant to the motion's resolution. The Court will apply New York law, as specified in the Licensing Agreement, to determine the substantive contract law applicable to the case. Furthermore, the Court agreed with Sony that certain contract provisions do not apply to permanent digital downloads, as they specifically address other forms of exploitation by streaming services.