Thursday, May 22, 2014

Three Overlooked Points to Consider When Negotiating an Audit Clause

 
Here are three often overlooked points to consider when negotiating an audit clause:
 
1) What records will be subject to audit?
Most audit clauses allow a party's "books and records" to be audited. Typical variations include clauses that:
  • Clarify certain records that should be included in the scope of an audit (e.g., manufacturing records)
  • Limit the records subject to audit (e.g., "only records that specifically report sales of XXX")  
One way to improve this provision for clients with an audit right is to require that the books and records be made available in unredacted and electronic format.
 
Often more important than the type of books and records that would be subject to audit is the matter of whose books and records can be audited. For example, if you are a licensor, you may wish to include in your audit the books and records of your licensee's wholly owned subsidiaries or foreign affiliates (or your licensee's manufacturer). As another example, if your client may be audited by an ex-spouse, you may wish to expressly limit the audit rights to the personal books and records of your client, and not extend the audit right to any business or partnership in which your client may have an interest.
 
The entities that are subject to audit can make an enormous impact on the audit procedures and results.
 
2) Who must pay for an audit?
When representing royalty recipients, I suggest including a clause that requires the licensee, business partner or ex-spouse to pay for an audit that discloses an underpayment. This is standard in many industries, but less common in the entertainment industry. However, it is the most common "penalty" for underreporting that I see in contracts.
 
Note that most such clauses that I see are insufficient to cover the true cost of conducting and resolving an audit, which usually includes both accounting and attorney fees. If you are representing a party who may be liable for such audit fees, adding a cap of $10,000 is a good strategy, since a thorough audit will likely cost more than $10K and the cost of an audit may dissuade your payee from conducting an audit.
 
In any event, when I represent clients with a provision that requires the other party to pay for an audit, I advise them that they should not assume the other party will pay for the audit. This is because the audit costs are often waived in the audit settlement process.
 
3) Who may conduct an audit?
Many audit clauses require an independent CPA (and at times allow for an attorney) to conduct an audit, but if you have a client who wishes to conduct an audit of a licensee, business partner or ex-spouse, he or she will be best served by hiring an experienced auditor who may or may not be a CPA or an attorney – and who will focus on finding underpayments to his or her client, not overpayments (so strike “independent” as well as “CPA” if possible).
 
Also, some audit clauses require than the auditor not be engaged on a contingency basis or not be currently auditing the party that is subject to audit. Although most reputable auditors work on an hourly, not contingency basis, I were a royalty recipient, I would not want any restrictions on who I could hire and on what basis, especially given the very limited number of professionals who provide high quality royalty audits.
 
Bonus: Never overlook the objection clause
Although an audit clause is key, the objection provisions are often more important than the audit provision itself because it typically governs the time period subject to audit. However, the objection clause is a topic for a different post.
 
For a personalized consultation on accounting, audit and objection provisions, as well as contractual definitions, you are welcome to email me at cboschan@greenhassonjanks.com.

Sunday, March 30, 2014

Q&A With
Copyright Grant Termination Expert
Lisa A. Alter, Esq.


Lisa A. Alter, Esq.

Many music clients require sophisticated copyright grant termination strategies.  A most distinguished expert on this complex topic is New York attorney Lisa A. Alter. In the full length interview below, Ms. Alter graciously shares her intricate knowledge.

For more information about termination of grants of copyright or other copyright related matters, please visit www.alterandkendrick.com or contact Lisa Alter at lisa.alter@alterandkendrick.com or (212) 707-8377.


Cedar Boschan: What is a copyright grant?

Lisa Alter: A copyright grant is a conveyance of any or all rights in an original work of authorship (such as books, compositions, motion pictures and sound recordings) that arise under copyright.  Those rights may include the right to reproduce the work in copies or phonorecords and to distribute those copies, the right to create derivative works based on the original work and the right to publicly perform and/or display the work.

Boschan: Many entertainers earn a living from copyright grants to publishers, film studios and record companies.  Why would one want to terminate a copyright grant?

Alter: Termination rights can be very valuable. Typically, the author (or heirs) may be receiving only a fraction of the income derived from the exploitation of the copyrights under the grant.  Moreover, the author (or heirs) may have limited or no control or approval over how the copyrights are exploited.  Once rights have been terminated and recaptured in the U.S., the author or his/her heirs may self-administer the works, enter into an administration deal on terms more favorable than the original grant, renegotiate terms with the original grantee (perhaps for the world), or sell all or a portion of the copyrights to either the original grantee or a third party.  

Boschan: Under which conditions can one recapture a copyright after granting it to another party?

Alter: Some contracts provide for automatic termination of the grant after a term of years. For example, with respect to works that were copyrighted prior to January 1, 1978 the term of copyright protection is divided into an initial 28 year term and a 67 year extended renewal term. Unless the initial grant of copyright in these works expressly included a conveyance of “renewals and extensions” of copyright, the grant automatically terminates upon the expiration of the initial 28 year term. Other contracts may allow the grantor to terminate the grant in the event that certain conditions are or are not met.  With respect to “life of copyright” grants, the grantor may be able to exercise a statutory right of termination.  For pre-1978 grants made by the author or his/her statutory heirs, statutory termination may be effected during the five year period commencing 56 years after the date the work was first published or registered for copyright.  For post-1977 grants made by the author, the statutory termination may be effected during the five year period commencing 35 years after the date of the grant (or, where the grant includes the right of publication, the five year period commencing on the earlier of 35 years after publication under the grant or 40 years after the date of the grant).  In order to effect statutory termination for either pre-1978 or post-1977 copyrights, the statutory notice requirements must be fulfilled.

Boschan: Who may terminate a copyright grant?

Alter: The author, or if the author is deceased, the author’s statutory heirs may terminate a grant of copyright.  Statutory heirs include the author’s surviving spouse and children (and in the case of a deceased child, the children of such deceased child).  If the author leaves no surviving spouse, child or grandchild, the author’s executor, administrator, personal representative or trustee may terminate a grant in the author’s place.

Boschan: Works for hire cannot be recaptured.  How can one tell if one’s copyright is a work for hire?

Alter: Just because a contract says that a copyright is being created as a work made for hire does not mean that it is, in fact, a work made for hire.  The rules are different depending on whether the work was created before January 1, 1978 or on or after that date.  For pre-1978 works, the courts will typically apply an “instance and expense” test in determining if a copyrighted work is work made for hire, which examines whether the work in question was created at the instance and expense of the employer. From 1978 on, a work will be deemed to be a work made for hire if either (a) the work was created by an employee during the course of his/her employment (as determined by general agency standards), OR (b) the work was expressly commissioned as a work made for hire for inclusion in one of nine  enumerated categories (the categories include audio-visual works but, notably, do not including sound recordings).

Boschan: What steps do you take to terminate a copyright grant?

Alter: The first step is to evaluate all relevant information about the grant, the subject copyright(s), the author(s) and the parties to the grant.  Next, one determines the time frame for serving notice and, at the proper time, prepares the notice taking care that it complies in form and content with the criteria set forth in the Copyright Act and attendant regulations.  Then, one serves the notice on the original grantee and/or the grantee’s successor(s) in interest and records the notice in the Copyright Office.  It bears noting that the mechanism for proper service of notice of termination is complicated by design.  Since the effect of improper service may be forfeiture of one’s termination right, it is worth getting professional guidance in the process.  Recipients of notices of termination should also scrutinize the notice to ascertain whether the notice conforms to statutory requirements.

Boschan: After a copyright grant is terminated, what, if any, rights does the original assignee retain?

Alter: After a grant of copyright is terminated, the original assignee will retain the rights to derivative works created during the term of the grant.  For example, a music publisher who loses rights in a composition will retain the right to exploit sound recordings embodying the composition that were created prior to termination and will continue to collect mechanical license fees from the sale of those sound recordings. However, the publisher cannot release that sound recording in a different format or authorize new recordings of the composition after the effective date of termination.

Boschan: Does this apply in the USA only, or throughout the world?

Alter: Statutory termination is limited to the United States.  If a grant was a worldwide grant (whether made in the U.S. or abroad) the grant will terminate in the U.S. but continue outside the U.S.

Boschan: Do you help clients recapture foreign copyrights?

Alter: We frequently are asked to assist clients in asserting rights in the so-called “British Reversionary Territories” or “BRTs”.  There is a limited reversionary right that may be available in one or more of the countries that were part of the United Kingdom in 1911.  Depending on the date of the relevant grant made by an author, rights may automatically revert to the author’s heirs 25 years after the death of the author.  Keep in mind that for most of the BRTs the date of the grant is critical.  For example, in England the reversionary right only applies to grants made by an author on or before June 1, 1957.

Boschan: Are some copyrights easier to recapture than others?

The copyright termination provisions apply to all grants of rights under copyright.  There is no category of copyright that is “easier” to terminate.  Rather, the ease of termination will depend on the complexity of the relevant factors in the specific circumstances surrounding the copyrights and grants.

Boschan: What happens when there is a mistake on the termination notice?

Alter: Some mistakes may be deemed “harmless error” and will not invalidate the termination notice.  Other mistakes – including misidentifying the applicable termination provision, serving notice on the wrong party or failing to record a notice in the Copyright Office prior to the effective date of termination – may render the notice ineffective.  If a notice is ineffective and the time frame for serving notice closes before a new notice is served, then the author (or heirs) may lose the right to terminate the grant.

Boschan: Is terminating a copyright grant expensive?

Alter: The basic costs of serving a notice of termination by certified mail (not necessary, but recommended because it affords proof of service) and recording the notice in the Copyright Office are fairly minimal.  The related legal costs involved in reviewing a matter to determine the applicability of the statutory termination provisions, preparing the notice(s) of termination and implementing termination will vary, depending on the complexity of the situation.  Clearly, the more copyrights and/or contracts involved, the more complicated the process may be, which could impact the cost.  

Boschan: What happens after you notify a company of your client’s intention to terminate a copyright grant?

Alter: That depends.  Sometimes, the company will contact us right away to discuss reacquiring the terminated rights.  The original grantee (or its successor) has an exclusive negotiation period between the time that notice of termination is served and the effective date of termination (at least two years) during which it is the only party allowed to enter into a further grant of copyright with respect to the terminated rights.  In other circumstances, the company may remain silent in which case we may reach out to the company to discuss a new grant (if our client is interested in continuing its relationship with the company).  Otherwise, we wait until the rights actually revert on the effective date of termination, reclaim the works and help the client decide how the recaptured rights will be administered in the future.

Boschan: Do most people who are eligible to reclaim copyrights do so?

Alter: An increasing number of authors are exercising their termination rights.  Those who do not may simply be unaware of the opportunity.  An exception may be in a situation in which an author is deceased, leaving children and a spouse who is not the parent of those children.  In this case, a majority of the heirs may not be willing to act together to effect termination.  Since it is necessary for the spouse and at least one child to sign a termination notice, the opportunity to terminate may be lost. 

Boschan: Can you recover a partial interest in a copyright – for example, on behalf of one of two co-authors of a work?

Alter: Each author of a joint work may terminate a grant and recapture rights with respect to his/her share of the work.  There are frequently situations in which one author terminates a grant and recaptures his/her rights, while the rights of his/her co-author remain with the original grantee. The only caveat is that with respect to grants made by the author on or after January 1, 1978 where two or more authors were signatory to the same grant, a majority of those authors must sign off on the notice of termination.

Boschan: What about on behalf of only some of an author’s heirs?

Alter: Where an author is deceased, a majority of the author’s statutory heirs must execute the notice of termination.  For example, if an author dies leaving a widow (who by law has a 50% interest in the author’s termination rights) and two children (who share the remaining 50% interest), the widow plus at least one of the children must be party to the termination notice.  Once termination is effected, the rights will revert to all of the author’s statutory heirs in their pro-rata share (even those heirs who did not sign off on the notice of termination).

Boschan: How does the possibility of reversion impact the value of a copyright?

Alter:   Termination rights can be very valuable for authors or heirs.  However, the possibility of termination or reversion will undoubtedly have a negative impact on the value of a copyright for a grantee seeking to sell its assets.  For example, if a music publisher has a large catalog of compositions that includes songs which may, in the future, be subject to termination, a potential purchaser of the catalog may want to discount the value of the catalog to compensate for the potential loss of U.S. rights. Alternatively, a portion of the purchase price may be held back until the period for serving notice of termination closes without notice being served.

Boschan: How do you collaborate with accountants on copyright termination matters?

Alter: We collaborate with accountants on a variety of termination matters including analyzing potential termination issues affecting financial due diligence in connection with the sale or purchase of copyright catalogs, assessing the potential impact of copyright termination with respect to the appraisal of musical catalogs for estate, divorce, or other valuation purposes, and evaluating the potential risks or opportunities presented by the termination provisions for copyright owners or authors in conjunction with the accountants that represent them.

Boschan: Why do so few attorneys understand the intricacies of copyright grant terminations? 

Alter: The termination process is highly technical and involves a very particular knowledge base that many attorneys do not need to draw upon in their typical transaction or litigation practices.  Because of the potential complexities of termination – and the inherent dangers of lost opportunity if a termination notice is improperly served – termination matters are often referred to attorneys whose practice focuses in that area.

Boschan: What are the current “hot topics” in the world of copyright grant termination?

Alter: Perhaps the “hottest” topic involves the right to terminate grants of rights in sound recordings.  While in some instances record labels have taken the position that sound recordings are works made for hire and thus not subject to termination, this is certainly not uniformly the case.  A growing number of performing artists and producers are, in fact, serving notice of termination on record labels and either recapturing the rights to their sound recordings or renegotiating their agreements with the labels.

Another “hot topic” concerns so-called “gap issue” grants. That is, contracts that provided for the author to deliver works created over a term of years. Where that term begins prior to 1978 but continues thereafter, works created and delivered post-January 1, 1978 may fall into a “gap” in the termination provisions. The better approach is to treat these works as having been granted by the author when the work was created on or after January 1, 1978 despite the fact that the contract was signed before 1978.

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Lisa A. Alter is a partner in the firm of Alter & Kendrick, LLP in New York City. Her practice is focused primarily in the area of copyright law, with a particular emphasis on domestic and international music copyright issues. She advises composers, authors, musical estates, and music publishers on a wide variety of transactional and licensing matters, conducts in-depth copyright due diligence in connection with the acquisition, sale and/or administration of copyright catalogues, and consults on issues involving termination of grants, recapture of copyrights, and foreign reversionary rights. Her clients include songwriters, composers and performing artists, prominent musical estates, and music publishing companies.  Ms. Alter has testified as an expert witness in matters involving music publishing interests and copyright termination rights.  Ms. Alter is a graduate of Wesleyan University and New York University School of Law and she is the author of “Protecting Your Musical Copyrights” which has recently been released in its third edition.