United States of America, Music Choice, Applicant-Appellee v. Broadcast Music, Inc.
Docket: 01-6183
Court: Court of Appeals for the Second Circuit; January 13, 2003; Federal Appellate Court
Under the BMI Consent Decree, the United States District Court for the Southern District of New York served as a rate-setting authority to determine fair royalty payments from Music Choice to Broadcast Music, Inc. (BMI) for the distribution of BMI music. The court rejected BMI's proposed blanket license fee of 3.75% of Music Choice's gross revenues, which was in line with a deal made by Music Choice's competitor, DMX. Instead, the court set the rate at 1.75% of Music Choice's wholesale revenues, citing that the retail prices did not reflect the fair market value of the music due to additional costs not covered by the authors. The court concluded that the fair market value was better represented by wholesale prices, particularly as the distribution methods for cable, satellite, and internet were deemed analogous. BMI, a not-for-profit organization representing music copyright owners, operates under a court-approved consent decree due to anti-competitive concerns, allowing for rate determinations when agreements cannot be reached. Music Choice, a partnership that includes major corporations, provides a range of commercial-free music channels via cable, satellite, and the internet.
Music Choice transmits its channels to cable and satellite operators via its own satellite, which are then broadcast to the public. It offers approximately 40 channels on its website for Internet users. As of March 2001, Music Choice had around 6 million cable and wireless customers, 15 million satellite customers, and 1,500 Internet subscribers. Initially, Music Choice's channels were available only through cable providers as a premium service, costing customers about $10 per month, with Music Choice receiving a portion of that revenue. However, by 1993, the company recognized that this model was unprofitable. It shifted to offering its channels as part of basic packages through DirectTV and cable companies, eliminating the need for a separate tuner technology. Consequently, most customers now accessed the service as part of bundled programming rather than through a separate fee.
In 1989, Music Choice negotiated a blanket license with BMI, allowing for the distribution of copyrighted materials to cable and satellite companies and enabling those companies to further distribute the music to the public. This 'through-to-the-viewer' license was established to avoid the complications of a split license, which would require separate licensing for different transmission stages. The initial three-year agreement required Music Choice to pay a royalty of 2% of revenues for the first two years and 2.1% in the third year, calculated from both Music Choice’s sales and the operators' retail sales of the music. The structure of the royalties reflected BMI's insistence on recognizing the dual nature of the performances involved. The contract included a 'most favored nation' clause, ensuring that if BMI granted more favorable terms to another company, Music Choice would receive the same improved terms.
The licensing agreement between BMI and Music Choice initially operated effectively, but difficulties arose in attributing cable company revenues to Music Choice programming. Music Choice's music was bundled with a flat fee covering various programming types, complicating revenue identification. Meanwhile, BMI negotiated a deal with DMX, a competitor, transitioning to a royalty fee based on a percentage of DMX's wholesale revenues, which was set at 3.75% from October 1994 to September 1996, and increased to 4% until September 1999. This change aimed to maintain royalty levels, assuming cable operators charged retail customers double what they paid providers.
There is a dispute regarding whether the BMI-DMX agreement serves as a proper benchmark for Music Choice’s rates, with claims that specific circumstances may have skewed the negotiation. The original BMI-DMX agreement in 1991 mirrored the BMI-Music Choice agreement, with both utilizing a two-tier fee structure. A dispute arose over whether DMX should include the cost of tuners sold to retailers in its revenue calculations, resulting in a significant financial obligation to BMI. DMX's financial struggles led to a settlement with BMI for $222,625, maintaining similar rates by applying a doubled rate to wholesale revenues.
From October 1994 to January 1997, Music Choice extended an interim license agreement with BMI monthly, based on DMX’s terms. On January 31, 1997, Music Choice sought a blanket license from BMI for a ten-year period, but the parties could not reach an agreement.
BMI sought a determination of a reasonable license fee from the district court under the BMI consent decree. On November 15, 1999, the court established an interim fee of 3.0% of Music Choice's gross revenues from cable and satellite services and 1.75% for internet services, noting that final rates could differ significantly. A six-day trial in May 2001 followed, where BMI advocated for a 3.75% rate based on the DMX agreement, while Music Choice argued for a lower rate. In its July 20, 2001 ruling, the court noted that the DMX agreement was influenced by unique circumstances, particularly DMX's urgent cash flow needs, and thus deemed it unsuitable as a benchmark.
The court rejected the proposed 3.75% rate, elaborating that the DMX contract's rate was an attempt to reflect a combination of wholesale and retail revenues that did not accurately represent the fair market value of the music. It reasoned that retail prices included costs unrelated to the music itself, such as transmission services, and concluded that the true value of the music was reflected in wholesale sales to cable and satellite operators. Consequently, the court disallowed the retail revenue component of the DMX fee, ultimately setting Music Choice's fee at 1.75% of its wholesale revenues. The court's methodology mirrored its previous decisions under the ASCAP consent decree, affirming that BMI bore the burden of proving the reasonableness of its requested fee, and should the proof fail, the court would establish a reasonable fee based on available evidence.
In determining reasonable fees, the court assesses fair market value, defined as the price agreed upon by a willing buyer and seller in an arm's length transaction. This assessment often employs a benchmark approach, referencing agreements made between similarly situated parties, as suggested by the BMI consent decree's directive against disparate treatment of such licensees. The notion of fair market value is considered factual but hypothetical, and the district court's decisions are not entirely subject to the "clearly erroneous" standard due to potential reliance on impermissible factors or misapplication of legal standards.
The district court concluded that the appropriate royalty rate is derived from a percentage of the fair market value of music, but it erred by dismissing retail prices as indicators of fair market value, favoring wholesale prices instead. This led to a BMI rate significantly lower than previous agreements. The critique asserts that retail prices should be a primary measure of fair market value, as they reflect what consumers are willing to pay for the music itself, independent of retail operational costs. The argument emphasizes that expenses incurred by retailers to deliver music do not detract from the retail price's validity as a fair market value indicator, as customers primarily seek the music, not the associated costs of its distribution. Thus, retail revenues effectively measure the value of the music, despite the retailer's need to cover additional expenses.
Customers expressed a desire to purchase music recordings for $12, indicating that the retail price multiplied by sales volume reflects the fair market value of the music, despite some revenue being allocated to cover unrelated expenses. The method of music transmission—whether by cable, satellite, or physical media—does not alter this valuation principle. The district court mistakenly conflated the authorship of the music with the overall costs required to deliver it to consumers, suggesting that retail prices inherently exceed fair market value due to those additional expenses. The court's conclusion that wholesale prices represent fair market value was unsupported and flawed, as both retail and wholesale prices account for various operational costs unrelated to the music itself. Consequently, the district court's reasoning that retail revenues exceed fair market value due to such costs was equally applicable to wholesale revenues. The conclusion that retail revenues are an inadequate measure of fair market value is based on erroneous assumptions. The judgment is vacated and remanded for further consideration, with no specific rate determined at this stage.
In the case of National Cable Television Association v. Broadcast Music, Inc., the court found BMI's practice of issuing split licenses inconsistent with the BMI Consent Decree. The court acknowledged the complexities in determining the portion of fees attributed to music within bundled audio and visual programming but clarified that this was not the reason for rejecting retail revenue as an indicator of fair market value. It noted that if retail purchasers were willing to pay more due to benefits from a specific delivery method, it could suggest a higher retail price than the music's fair market value; however, this rationale was not applied by the district court.
The example of two competing retailers illustrated that differences in wholesale prices do not reflect the fair market value of identical goods; rather, they stem from operational differences. The court indicated that estimating fair market value by starting with wholesale revenue and making adjustments could be appropriate, especially given the challenges in pinpointing retail revenues from bundled packages.
The district court's decision to set BMI's royalty rate at 1.75% of Music Choice's wholesale revenues was questioned, particularly since BMI had also agreed to charge 1.75% of Music Choice's retail revenues from Internet distribution. This comparison was deemed flawed as it overlooked the difference between retail and wholesale sales. The court cautioned against using Internet rates as a benchmark for cable and satellite rates due to the vastly different customer bases.
Judge Katzmann concurred, agreeing that the district court erred in dismissing cable and satellite operators' revenue contributions. He suggested that the determination of 'fair market value' should remain open for reconsideration by the district court, taking all relevant information into account.
