NEW YORK–Most royalty auditors come into the artist/manager/attorney loop well after a recording or publishing contract is negotiated and signed.
Although the main function of an auditor is to determine whether royalties are being paid in accordance with an agreement, there are certain areas where a knowledgeable auditor can assist an artist’s other professionals during contractual negotiations by identifying potential areas of abuse or where future “contractual interpretation” differences may arise during audits.
One of the prevalent differences in “contractual interpretation” during audits is the party with whom an artist contracts. Although artists generally sign with a label, such as Interscope Records or Capitol Records, the deals are always worldwide, with the label’s affiliates handling all non-USNRC (U.S. normal retail channel) sales, such as foreign sales, foreign record club sales, compilations and special market sales.
A QUESTION OF ROYALTY
The issue of who is defined as “company” in the agreement is not a problem for normal retail channel sales, where royalties are paid on a percentage of the wholesale or retail price. However, when royalties are paid on a percentage of “company’s” net receipts, it can be a problem.
A record label’s affiliates generally retain from 15%-33% of receipts from non-NRC sales and remit the balance to the U.S. label. Artists then generally receive 50% of the label’s net receipts, which have been reduced by the “fees” of its affiliates.
When artists are paid royalties on a percentage of net receipts, it is calculated on what the U.S. label has received. Income retained by foreign and special market affiliates within the same corporation is not included in “company’s” net receipts.
This problem can be circumvented by bringing the publishing concept of “at source” into recording contracts. It’s puzzling that most publishing contracts calculate royalties “at source,” but record contracts rarely do. The first place where an affiliated company receives income is where an artist’s percentage of net receipts should be calculated.
DEFINING ‘NET SALES’
Another area where problems arise is when “net sales” are defined as less than 100% of actual sales less returns. I have seen numerous instances where “net sales” were defined as 85% of sales less returns, and record club or foreign royalties were calculated on 90% of “net sales.” In such instances, an artist will receive royalties on 76.5% of net sales (i.e. 90% of 85%), when the intention was for the artist to receive 90% on 100% of net sales.
Although “net sales” should not be defined as less than 100% of sales less returns, some record company royalty systems are geared towards “net sales” being defined as 85% of sales less returns (where standard free goods are factored into the net sales percentage).
In these cases, you need to ensure that the contractual definition of “net sales” does not unintentionally reduce the royalty basis for non-NRC sales, as detailed above unless there is explicit language in the agreement. Even then, it is generally not paid without having to first conduct an audit.
It’s a simple calculation to allocate unidentified income to specific artists, as long as the appropriate information is made available.
Without an explicit right to this type of income in the contract, information required for the calculation will be denied during an audit, and any claims of this type will be strongly disputed.