Compromise Bill Strengthens Audit Rights

SB 1034, effective Jan. 1, 2005 as Civil Code sections 2500 and 2501, affords recording artists some additional muscle to audit record companies, but there are many significant differences between the

Michael R. Morris is president of the California Copyright Conference and managing partner of Los Angeles law firm Valensi, Rose, Magaram, Morris & Murphy.

This summer, California enacted a new law, SB 1034, establishing a statutory set of basic recording-contract audit standards (ELW, 8/17).

SB 1034, effective Jan. 1, 2005 as Civil Code sections 2500 and 2501, affords recording artists some additional muscle to audit record companies, but there are many significant differences between the bill introduced by Sen. Kevin Murray, D-Los Angeles, in 2003 and the final law.

Advocates for recording artists can criticize the new law as a watered-down version of a bill originally containing tough sanctions against record companies that fail to properly account. However, SB 1034 does bolster the ability of artists to verify their earnings.

During the last two years, Murray held hearings on recording industry accounting practices in his capacity as chair of the Senate Select Committee on the Entertainment Industry. He concluded that record contracts usually contained one-sided auditing clauses, that auditing was prohibitively expensive for most artists and that there was, at the very least, "purposeful neglect on the part of record company accounting departments," resulting in many artists being "routinely underpaid royalties they are rightfully due."

Not surprisingly, all five major record companies vigorously contested Murray's conclusions, and the new law compromises much of the original bill. Yet, SB 1034 is a significant step in leveling the audit playing field between artists and record companies. Here's why:

1. SB 1034 Supersedes Contractual Restrictions: Notwithstanding any contractual restrictions to the contrary, SB 1034 affects all recording agreements subject to California law. Further, SB 1034 defines "royalty recipients" in a way that should include and benefit record producers.

2. Royalty Recipients Get an Annual Right to Audit: SB 1034 entitles recording artists to annually audit record companies. The artist must request an audit within three years after the end of a royalty earnings period, and a particular statement can only be audited once.

Since recording contracts usually include an annual right to audit, codifying this right is hardly groundbreaking. But most recording contracts limit the audit right to two years (or less) from the date a royalty statement is rendered, and SB 1034's three-year audit period is more artist-friendly.

However, SB 1034's audit window isn't suspended by a record company's failure to render a royalty statement. And recording agreements usually include an artist-unfriendly clause deeming a statement rendered and received within 90 days following the close of an earnings period-even if the statement wasn't sent-unless the artist notifies the label of its failure to account.

SB 1034 doesn't address a label's failure to timely account, and its clock starts running regardless of whether a royalty statement was ever sent. Accordingly, artists and their representatives should continue calendaring statement dates and promptly notify labels of tardiness.

3. The Right to Choose an Auditor Is Significantly Strengthened: SB 1034 lets an artist engage a qualified royalty auditor, regardless of whether that particular auditor is auditing the same record label for other artists. Most recording agreements prohibit this.

Given the finite number of experienced royalty auditors, this provision is an important pro-artist development.

Equally artist-friendly is SB 1034's provision allowing artists to hire auditors for a "contingency fee." Since many artists are otherwise unable to afford an audit at hourly rates, they should welcome this development.


Let's look at what was deleted from Murray's original bill:

1. SB 1034 originally penalized a record company that failed to pay more than 10% due in royalties by making the label pay audit costs, including auditor and legal fees, and interest on unpaid royalties.

The label would also have faced a stiff penalty equaling three times the amount of royalties exceeding a 10% underpayment. Moreover, if a label failed to pay more than 20% due in royalties, the artist could rescind the record contract.

2. SB 1034 originally entitled auditors to get a label's actual manufacturing and related records. Why is this important? Because an auditor's job would be streamlined by knowing how much product was made, what sales were unaccounted for, what the label characterized as nonroyalty units (i.e., "freebies") and the label's physical and perpetual inventory.

Also failing to make the final version of SB 1034 were provisions letting multiple artists on a label have one auditor concurrently audit for all of them and a section compelling mandatory arbitration of unresolved audit disputes (in lieu of usually more expensive and prolonged court litigation), with attorneys' fees being awarded if the arbitrator determined royalties were owed.

3. SB 1034 originally incorporated a novel-and extreme-section making a label's contractual duty to pay royalties also a "fiduciary duty."

This would have created a "moral right" in favor of the artist (in addition to a contractual right) to receive timely and accurate royalty statements. Further, it would have obligated record companies to act in the best interest of artists (analogous to the fiduciary duty owed by an agent or lawyer to a client).


In his summary of the hearings, Murray commented that the five major label conglomerates' denial of any wrongdoing when confronted with auditors' accusations that all royalty statements underreported royalties due artists reminded him of tobacco executives swearing before Congress that they did not believe tobacco was harmful to people's health.

This may be an extreme analogy. But if systemic underreporting of royalties has not exactly been declared carcinogenic, the endemic nature of the problem and the perceived lopsidedness of the relative bargaining positions of labels and artists were sufficient for California to pass a law incorporating material auditing rights into recording agreements of all labels doing business in the state.

The more sweeping-and severe-provisions for royalty underreporting failed to make the final law. However, SB 1034's passage, in conjunction with the heightened visibility of record industry accounting and contractual practices resulting from Murray's hearings (and other state actions, like the recent settlement between major labels and New York State Attorney General Eliot Spitzer due to the labels' failure to pay nearly $50 million in purportedly "unclaimed royalties") should bode well for artists seeking a fairer royalty shake.


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