Gavel, 2014.
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In their opening arguments in the BMI/Pandora rate court trial that began today in New York, the performance rights organization began by stating it is seeking a rate of 2.5% of total revenue, which Pandora countered by asking for 1.75% of revenue, the same rate it has paid for years.

The two organizations are getting set to square off on the life of the deal -- whether it will be for 4 years, as BMI wants or 5 years, as Pandora is asking for -- and what size deduction there will be to cover the cost of generating advertising. Judge Louis Stanton is presiding over the trial, which is being held in Federal Court in New York's Southern District.

The burden of proof is on BMI to justify the rate it is seeking. BMI's lawyer Scott Edelman of Milbank, Tweed, Hadly and McCloy said that if BMI's rate ask is reasonable, it should be adopted by the court. He cited the ASCAP rate court ruling of 2008, which determined that Yahoo's Launchcast service should pay 2.5% of revenue as a performance royalty to the performing rights organization. But later, Pandora's lawyer Kenneth Steinthal of King & Spalding pointed out the case was appealed and the rate was never affirmed, but rather remanded back to the District Court.


Edelman pointed out that Pandora has been paying BMI a rate of 1.75% of revenue in an experimental license since 2005, when it was known as Savage Beast. "Nobody could have predicted what a force Pandora would become," Edelman said. "At that time, digital music was only available on a desktop computer." Since then, of course, digital music has become available everywhere, from phones to cars, refrigerators and hot tubs. Meanwhile, Pandora's revenue grew from $19.3 million in 2009 to $637.9 million in 2013.

Back when Pandora's total revenue was $19.3 million, BMI made the decision to roll over the Pandora licensing contract at the 1.75% rate -- executives didn't think the board of directors would engage in costly rate court litigation for a service that only paid $343,000 in royalties that year. The 1.75% rate was in effect through the end of the license on Dec. 31, 2012.

Edelman expected that Pandora would make much of the lower 1.7% rate that BMI ageeed to with the Radio Music Licensing Committee in a license that also included digital simulcasts and iHeart's custom radio service. But again, BMI didn't want to hold up a deal worth hundreds of millions of dollars to fight over the "two one-hundreths of one percent of revenue" that iHeart radio's custom service would contribute, Edelman explained.

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In further justifying its 2.5% of revenue proposal, Edelman cited a series of direct deals with Pandora. For 2012, both Sony/ATV Music Publishing and EMI Music Publishing cut separate deals with Pandora that would pay them a pro-rated share of 2.25% revenue, implying that U.S. music publishers would collectively receive 5% of revenue. For 2013, Universal Music Publishing Group cut a deal that amounted to 3.38% of, implying an industry-wide rate of 7.5% of Pandora's revenue for publishing.

Edelman said that Sony/ATV, EMI and UMPG cut a deal for even higher rates for 2014, but those rates couldn't be disclosed. Nevertheless, he said those five deals represent the best benchmarks for rates set in a competitive market, and support the 2.5% of revenue rate that BMI is seeking.

Steinthal countered that the 1.75% rate that Pandora's been paying has been extremely rewarding to BMI, as the custom radio service's royalty payments to BMI grew steadily, from $240,000 in 2007 to $16.1 million in 2014. Meanwhile, as Pandora's overall royalty payments have grown, the scope of the BMI blanket license has shrunk, he argued. Now, with Pandora having to cut direct deals for Sony, EMI and UMPG, which comprise nearly 50% market share, along with many top songwriters which moved to Global Music Rights as of Jan. 1, BMI has been left with a "diminished offering," Steinthal said.

He also argued that the Sony and UMPG rates cut for 2014 are not competitive. The showdown over whether to pay whatever rates Sony/ATV, EMI Music Publishing UMPG and BMG Chrysalis (the three-publishers that were ruled out of BMI by Judge Stanton come Jan. 1) were demanding, Steinthal argued, was like being in the midst of a game of chicken. Except for one thing: those publishers managed to avoid withdrawing from BMI because they found a way to temporarily suspend their membership agreements and, after cutting deals with Pandora, rejoined BMI.

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Since they could all return to BMI retroactively, they had a security blanket, Steinthal argued. What good is a rate determined by a game of chicken when only one side -- Pandora -- is facing financial ruin, but the other side has no risk, he asked.

To put more salt in Pandora's wound, during the rate-direct deals showdown, those publishers gave stand-still agreements to all the other digital service and never did any other deals with any other service while they were temporarily out of the PRO. Consequently, Steinthal argues that the rates set in those deals with Pandora are the function of artificial circumstances.

BMI's lawyer Edelman anticipated Steinthal's argument, pointing out that Pandora chose to pull down BMG songs, rather than cut a deal with them, proving it could have done the same with the other publishers. The real reason Pandora did the deals with Sony/ATV/EMI and UMPG, he argued, was because they wanted to have their songs available for their listeners.

The trial continues today (Feb. 11) and is expected to last for three weeks.