Negotiating a Wireless License: Taming a New Frontier

Joshua Kaufman © 2005

Pick up a newspaper, magazine or trade journal and in all likelihood you will find an article on wireless licensing.  It seems that each week a new category of product or service is trying to port itself over to wireless.  Cell phones are changing and allowing for an ever expanding set of possible uses.  The most recent generation of phones equipped with broadband, hard drives & GPS are ushering in a new era in communications.  To call the new generation of devices simply phones is inaccurate and greatly understates what they really are.  These communication devices are opening up vast new arenas for licensing.  Are wireless deals any different?

Wireless licensing is different than regular licensing, but then on again it is the same as regular licensing, and yet at times it is the same and then it is different.  In reality when dealing with wireless licenses one finds that the deals and the agreements are in fact similar to traditional licensing but as with any specific area of licensing there are unique characteristics and different deal points. One key point to remember is that this is a new industry and the structure of the deals are still in flux, hard and fast guidelines are do not exist, parameters exist but nothing is fixed in stone. I would speculate since mobile technology is constantly changing the deals will always be evolving and we will never see  the generally rigid or permanent set of deal points like those which have evolved in general licensing.

One of the earliest and most popular types of wireless licensing has come in the form of music licensing for ring tones (what you hear when your phone rings), ring backs (what your caller hears if you do not answer) and true tones (when the original song is used). Compare how much more complicated rights clearance is in this forum then in traditional licensing.  Any time music is licensed a very complex set of rights clearance issues arise since there are a bundle of different and distinct rights attached to each song and  various people or entities own these overlapping rights.  For example, the person who you must first deal with is the individual(s) who owns the copyrights in the underlying song itself.  Music and lyrics may be owned by the same person or two or more people separately (one owns the lyrics and another owns the music) or it could be jointly owned (where the writer and lyricist own the whole song together).  When there is any use of the song they are entitled to compensation.  That can entail when a song is a recorded on an album, when it is played on the radio, television, used in a jingle, as a soundtrack, if somebody covers the song on a subsequent CD or any wireless use.  In each of those instances the songwriter(s) receives a payment but the payment is made to different entities rarely directly to the songwriter.  It is important to note that none of those payments go to the band that initially performed the song or perhaps even made it into a hit, but rather just to the writer(s).  The writer(s) almost always has an agent who in the music field is known as a “publisher.”  Therefore, when obtaining rights from a songwriter or arranging payment one usually deals with their publisher.  The publisher and the artist in a traditional deal split the royalties fifty-fifty.  (However, a successful artist might make negotiate a better percentage). 

OK, that takes care of basic rights, but that is only the beginning. Under copyright law when a song is “publicly performed” a license is required. .  How does this apply to wireless well, the question arises whether the playing of a part of a song as a ring tone or ring back is a “public performance” subjecting the person offering the ring tone to the obligation of paying a public performance royalty.  Songwriters, their publishers and the companies which they have delegated to monitor public performances and to collect fees for them (they are known as Performing Rights Societies such as ASCAP, BMI & SESAC) all have taken the position that such uses are public performances and demand payment. Therefore a public performance license must be acquired.

Next, copyright law provides for a separate licenses (“Mechanical License”) when somebody is going to cover a song on their own CD and sets a statutory royalty rates. When a song is downloaded as a ring tone or ring back is that considered a reproduction that would require the payment of a “Mechanical Licenses” it appears so. Therefore mechanicals need to be paid. They are generally paid to an organization called, the “Harry Fox Agency.”

Complicated enough?  It does not end there.  If the actual sound recording is played as the ring tone or ring back rather than a new version created especially for the phone then the record company must be compensated as well and a separate royalty negotiated with them.  You may be surprised to find out that if you license a 30 second segment of a song it will cost then if you license the whole song.  Illogical? Well not really just confusing.  In a standard record deal licensing a segment is considered a “license” and the record company has to pay the recording artist 50% of the royalty but a allowing the use of a whole song is considered the “sale” of a single the royalty paid the recording artist is only is about 12%. 

Finally, recording performers and record company receive money when there is a non-interactive digital performance such as internet radio or XM Satellite radio.  So there might a future situation (i.e. streaming music directly onto a cell phone) where a digital performance payment to the performers come into play as well.

Once you have worked your way through figuring out which rights you need, who you have to pay, which rates are controlled by the statute, which royalties are separately negotiated then you have to figure if  you can afford to pay these sums and still make a profit.  If an average ring tone which sells for $2.50 the pie is sliced as follows:  Owner of Master Recording [Record Label]: 40% ($1.00); Owner of Copyright in Composition [Publisher]: 10% ($0.25); Mobile Carrier: 25% (0.63); Application Service Provider: 15% ($0.37); Cost of Network Delivery: 0-5% ($0.06); Ringtone Aggregator: 0-5%) $0.13); Performance Rights Societies [ASCAP, BMI, SESAC]: 2-3% ($0.05); Branding and Promotion: 0-5% ($0.13).  (These figures and the accompanying graph were prepared by Steve Masur, Esq. of Masur  & Associates, LLC, a New York firm which extensively deals in ring tone licensing).

When it comes to the licensing of visual images (e.g. wallpaper and animations) the market is also new and the deals non-standard but generally not as complicated as music. To show the range in this area in the last year  I have negotiated deals where the royalties paid to visual artists or their publisher or agents (depending on who has the rights) range from a low of 5% and as high as 50%. Compare these deals to the traditional art licensing agreement in which most products are licensed in the 5%-8% range with paper goods and prints in the 8%-15% range.  As time goes on this industry will probably settle into regular norms but not necessary the same as the deals of the past since there are generally be lower cost of productions, i.e. no tangible products or prints to manufacture. These costs represent a large part of the licensee’s expenditures which in turn allow them to receive the lion’s share of the proceeds. Without hard production costs for actual products a 93%-7% licensee-licensor split might be hard to justify. I would anticipate a higher artist royalty to evolve in this area then in traditional art licensing (We have already seen this trend in some music deals where the record companies are not deducting the traditional “packaging fee” of 25% from the artists share of wireless proceeds).

When it comes to providing news services (from wire services, etc.) to the wireless platform this industry is also one which is just beginning to establish norms.  However, this industry segment is further along in standardizing its wireless deals as they seem to be evolving into a pattern similar to their web site arrangements which have been around  for  a number of years. Generally, I have been seeing royalty rates paid to the new services providers range anywhere from 15%-50% of receipts.

The related topics, when dealing with royalties, are advances and guarantees.  However, the size of those, as in all parts of licensing, depends on the potential of the revenue stream as viewed by the parties.  The higher the revenue potential that is anticipated by the parties the higher the advance and/or guarantee.  Therefore, in the wireless licensing deals which I have encountered the advances and guarantees span a very wide the spectrum, the same as they do in traditional licensing, from a few hundred dollars to hundreds of thousands of dollars. The only difference being, due to the youth of the industry, that they but are being based on a lot more guess work then extensive track records and research.

One of the trickier aspects in determining royalties, after one has figured out the basic percentages, is to ascertain how they are going to be calculated and allocated.  Problems arise when royalties are based on bundled products and ad revenues.  It is easy when products are sold separately products such as a ring tone or perhaps wallpaper. You have a stand alone product and price and you just “do the math.”  But what of products whose pricing is are bundled with other products. For example, a user subscribes to a news product in which they get current events, sports and entertainment news all for one fixed price, but there are separate providers for the current events, sports and entertainment components.  If you are the provider of the news or the sports or the entertainment segments how are you sure the various allocations of revenue accurately reflect the value of your contribution?  How are they tracked?  How is the pro-ration being made? How are ad revenues being divided (a particular tricky issue when not all the providers get a piece of ad revenues)? What if ads are added to the platform after the agreement has been signed which was based only on a subscription based fee splitting model? How do you account for promotions, free minutes, barter between the aggregator and deck provider? How is all this going to shown (if at all) on your royalty statement?   Since it is a new industry and the business models that the aggregators and carriers are using are evolving there are no pat answers.   All these questions make the audit clause provided for in any decently drafted  license agreement all the more important.

If you are licensor you want to have an audit clause with teeth that provides you with a meaningful audit.  The “boiler plate” simple one paragraph clauses giving a general and vague audit right simply does not cut it in this murky arena. From a licensor’s prospective you need access to meaningful documents not just licensee produced summaries. An audit right without appropriate documentation (some of it provided ahead of time) can be a paper tiger and can be rendered meaningless. Appropriate facilities need to be set up for your auditor to work in, copying facilities need to be available and particularly important is that knowledgeable personnel who can answer the auditor’s inevitable questions are available to assist the auditor.

What might have made sense when a deal was initially struck, as a result of the rapidly changing business model in wireless now become problematic but there is still time left on the contract, what to do? One technique which one finds used by cautious people in any embryonic industry is the “Most Favored Nation” (MFN) clause.  When the first internet deals came out, when the first software deals were struck we made our best guesses as to royalty rates and other aspects of the license agreements, but each party knew that the playing the field was constantly shifting. If a party had the clout it would demand a “Most Favored Nation”.  Specifically, they would agree to a certain royalty rate, advance or guarantee however, if the licensee subsequently (or it could be the inverse if the licensor) offered a better deal on a comparable license to a different party then this license was adjusted to match the other more favorable license. Using “Most Favored Nation” clauses provide participants with a degree of security that entering into an agreement in a new area that they will not look back upon it later and feel that they underpaid or overpaid.  It also allows entities a little more flexibility in compromising since they know that if they guessed wrong it will not haunt them for years but will be adjusted in the near future. 

Similarly, one tends to find shorter terms and narrower territories and rights being granted in wireless licenses today than you would find in more traditional licenses.  The reason harkens back to the youth of the industry and is in agreements for same reasons that people seek “Most Favored Nation” clauses. Since the industry is evolving one does not want to get themselves tied up for too long a period with what could be an unduly lean or overly broad contract (depending on what side of the license you are representing).

In a wireless licenses, as in traditional licenses, one needs to have a very concise description of the goods and services, term, territory, expansions, options, renewals, choice of law, forum clauses, force majeure, warrantees, limitations of liability, termination clauses, breach clauses, cure clauses, all of which are standard in traditional license agreements.  In wireless agreements, due to their unique nature, there are variations on the standard clauses which should be included.

The wireless mobile industry is evolving and changing at an incredibly rapid pace with new alliances, new products, and new technologies appear literally every week.  All of which are based on licensing agreements which also must changed on a regular and rapid basis to keep pace and to reflect the evolving realities of the market place.

Joshua Kaufman is a partner in Venable LLP and is head of their, Copyright and Licensing Group. He is one of the nation’s foremost copyright, licensing and art lawyers. He regularly publishes articles and speaks on related topics. He is an adjunct professor of law at American University law school. His practice is both transactional and litigation. He recently spoke out the LINK conference and authored chapters in the new, Licensing for Dummies and contributed to Licensing Royalty Rates 2005 Edition. He can be reached at 202.344.8538 or [email protected]

Copyright © 2005 MasurLaw