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Why the valuation of intangible assets matters: the unstoppable rise of intangibles’ reporting in the 21st century’s corporate environmentCrefovi : 15/04/2020 8:00 am : Articles, Banking & finance, Capital markets, Consumer goods & retail, Copyright litigation, Emerging companies, Entertainment & media, Fashion law, Hospitality, Information technology - hardware, software & services, Insolvency & workouts, Intellectual property & IP litigation, Internet & digital media, Law of luxury goods, Life sciences, Litigation & dispute resolution, Mergers & acquisitions, Music law, News, Private equity & private equity finance, Technology transactions, Trademark litigation
It is high time France and the UK up their game in terms of accounting for, reporting and leveraging the intangible assets owned by their national businesses and companies, while Asia and the US currently lead the race, here. European lenders need to do their bit, too, to empower creative and innovative SMEs, and provide them with adequate financing to sustain their growth and ambitions, by way of intangible assets backed-lending.
Back in May 2004, I published an in-depth study on the financing of luxury brands, and how the business model developed by large luxury conglomerates was coming out on top. 16 years down the line, I can testify that everything I said in that 2004 study was in the money: the LVMH, Kering, Richemont and L’Oreal of this word dominate the luxury and fashion sectors today, with their multibrands’ business model which allows them to both make vast economies of scale and diversify their economic as well as financial risks.
However, in the midst of the COVID 19 pandemic which constrains us all to work from home through virtual tools such as videoconferencing, emails, chats and sms, I came to realise that I omitted a very important topic from that 2004 study, which is however acutely relevant in the context of developing, and growing, creative businesses in the 21st century. It is that intangible assets are becoming the most important and valuable assets of creative companies (including, of course, luxury and fashion houses).
Indeed, traditionally, tangible and fixed assets, such as land, plants, stock, inventory and receivables were used to assess the intrinsic value of a company, and, in particular, were used as security in loan transactions. Today, most successful businesses out there, in particular in the technology sector (Airbnb, Uber, Facebook) but not only, derive the largest portion of their worth from their intangible assets, such as intellectual property rights (trademarks, patents, designs, copyright), brands, knowhow, reputation, customer loyalty, a trained workforce, contracts, licensing rights, franchises.
Our economy has changed in fundamental ways, as business is now mainly “knowledge based”, rather than industrial, and “intangibles” are the new drivers of economic activity, the Financial Reporting Council (“FRC“) set out in its paper “Business reporting of intangibles: realistic proposals”, back in February 2019.
However, while such intangibles are becoming the driving force of our businesses and economies worldwide, they are consistently ignored by chartered accountants, bankers and financiers alike. As a result, most companies – in particular, Small and Medium Enterprises (“SMEs“)- cannot secure any financing with money men because their intangibles are still deemed to … well, in a nutshell … lack physical substance! This limits the scope of growth of many creative businesses; to their detriment of course, but also to the detriment of the UK and French economies in which SMEs account for an astounding 99% of private sector business, 59% of private sector employment and 48% of private sector turnover.
How could this oversight happen and materialise, in the last 20 years? Where did it all go wrong? Why do we need to very swiftly address this lack of visionary thinking, in terms of pragmatically adapting double-entry book keeping and accounting rules to the realities of companies operating in the 21st century?
How could such adjustments in, and updates to, our old ways of thinking about the worth of our businesses, be best implemented, in order to balance the need for realistic valuations of companies operating in the “knowledge economy” and the concern expressed by some stakeholders that intangible assets might peter out at the first reputation blow dealt to any business?
1. What is the valuation and reporting of intangible assets?
1.1. Recognition and measurement of intangible assets within accounting and reporting
In the European Union (“EU“), there are two levels of accounting regulation:
- the international level, which corresponds to the International Accounting Standards (“IAS“), and International Financial Reporting Standards (“IFRS“) issued by the International Accounting Standards Board (“IASB“), which apply compulsorily to the consolidated financial statements of listed companies and voluntarily to other accounts and entities according to the choices of each country legislator, and
- a national level, where the local regulations are driven by the EU accounting directives, which have been issued from 1978 onwards, and which apply to the remaining accounts and companies in each EU member-state.
The first international standard on recognition and measurement of intangible assets was International Accounting Standard 38 (“IAS 38“), which was first issued in 1998. Even though it has been amended several times since, there has not been any significant change in its conservative approach to recognition and measurement of intangible assets.
An asset is a resource that is controlled by a company as a result of past events (for example a purchase or self-creation) and from which future economic benefits (such as inflows of cash or other assets) are expected to flow to this company. An intangible asset is defined by IAS 38 as an identifiable non-monetary asset without physical substance.
There is a specific reference to intellectual property rights (“IPRs“), in the definition of “intangible assets” set out in paragraph 9 of IAS 38, as follows: “entities frequently expend resources, or incur liabilities, on the acquisition, development, maintenance or enhancement of intangible resources such as scientific or technical knowledge, design and implementation of new processes or systems, licenses, intellectual property, market knowledge and trademarks (including brand names and publishing titles). Common examples of items encompassed by these broad headings are computer software, patents, copyrights, motion picture films, customer lists, mortgage servicing rights, fishing licences, import quotas, franchises, customer or supplier relationships, customer loyalty, market share and marketing rights“.
However, it is later clarified in IAS 38, that in order to recognise an intangible asset on the face of balance sheet, it must be identifiable and controlled, as well as generate future economic benefits flowing to the company that owns it.
The recognition criterion of “identifiability” is described in paragraph 12 of IAS 38 as follows.
“An asset is identifiable if it either:
a. is separable, i.e. capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether the entity intends to do so; or
b. arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations“.
“Control” is an essential feature in accounting and is described in paragraph 13 of IAS 38.
“An entity controls an asset if the entity has the power to obtain the future economic benefits flowing from the underlying resource and to restrict the access of others to those benefits. The capacity of an entity to control the future economic benefits from an intangible asset would normally stem from legal rights that are enforceable in a court of law. In the absence of legal rights, it is more difficult to demonstrate control. However, legal enforceability of a right is not a necessary condition for control because an entity may be able to control the future economic benefits in some other way“.
In order to have an intangible asset recognised as an asset on company balance sheet, such intangible has to satisfy also some specific accounting recognition criteria, which are set out in paragraph 21 of IAS 38.
“An intangible asset shall be recognised if, and only if:
a. it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and
b. the cost of the asset can be measured reliably“.
The recognition criteria illustrated above are deemed to be always satisfied when an intangible asset is acquired by a company from an external party at a price. Therefore, there are no particular problems to record an acquired intangible asset on the balance sheet of the acquiring company, at the consideration paid (i.e. historical cost).
1.2. Goodwill v. other intangible assets
Here, before we develop any further, we must draw a distinction between goodwill and other intangible assets, for clarification purposes.
Goodwill is an intangible asset that is associated with the purchase of one company by another. Specifically, goodwill is the portion of the purchase price that is higher than the sum of the net fair value of all of the assets purchased in the acquisition and the liabilities assumed in the process (= purchase price of the acquired company – (net fair market value of identifiable assets – net fair value of identifiable liabilities)).
The value of a company’s brand name, solid customer base, good customer relations, good employee relations, as well as proprietary technology, represent some examples of goodwill, in this context.
The value of goodwill arises in an acquisition, i.e. when an acquirer purchases a target company. Goodwill is then recorded as an intangible asset on the acquiring company’s balance sheet under the long-term assets’ account.
Under Generally Accepted Accounting Principles (“GAAP“) and IFRS, these companies which acquired targets in the past and therefore recorded those targets’ goodwill on their balance sheet, are then required to evaluate the value of goodwill on their financial statements at least once a year, and record any impairments.
Impairment of an asset occurs when its market value drops below historical cost, due to adverse events such as declining cash flows, a reputation backlash, increased competitive environment, etc. Companies assess whether an impairment is needed by performing an impairment test on the intangible asset. If the company’s acquired net assets fall below the book value, or if the company overstated the amount of goodwill, then it must impair or do a write-down on the value of the asset on the balance sheet, after it has assessed that the goodwill is impaired. The impairment expense is calculated as the difference between the current market value and the purchase price of the intangible asset. The impairment results in a decrease in the goodwill account on the balance sheet.
This expense is also recognised as a loss on the income statement, which directly reduces net income for the year. In turn, earnings per share (EPS) and the company’s stock price are also negatively affected.
The Financial Accounting Standards Board (“FASB“), which sets standards for GAAP rules, and the IASB, which sets standards for IFRS rules, are considering a change to how goodwill impairment is calculated. Because of the subjectivity of goodwill impairment, and the cost of testing impairment, FASB and IASB are considering reverting to an older method called “goodwill amortisation” in which the value of goodwill is slowly reduced annually over a number of years.
As set out above, goodwill is not the same as other intangible assets because it is a premium paid over fair value during a transaction, and cannot be bought or sold independently. Meanwhile, other intangible assets can be bought and sold independently.
Also, goodwill has an indefinite life, while other intangibles have a definite useful life (i.e. an accounting estimate of the number of years an asset is likely to remain in service for the purpose of cost-effective revenue generation).
1.3. Amortisation, impairment and subsequent measure of intangible assets other than goodwill
That distinction between goodwill and other intangible assets being clearly drawn, let’s get back to the issues revolving around recording intangible assets (other than goodwill) on the balance sheet of a company.
As set out above, if some intangible assets are acquired as a consequence of a business purchase or combination, the acquiring company recognises all these intangible assets, provided that they meet the definition of an intangible asset. This results in the recognition of intangibles – including brand names, IPRs, customer relationships – that would not have been recognised by the acquired company that developed them in the first place. Indeed, paragraph 34 of IAS 38 provides that “in accordance with this Standard and IFRS 3 (as revised in 2008), an acquirer recognises at the acquisition date, separately from goodwill, an intangible asset of the acquiree, irrespective of whether the asset had been recognised by the acquiree before the business combination. This means that the acquirer recognises as an asset separately from goodwill an in-process research and development project of the acquiree, if the project meets the definition of an intangible asset. An acquiree’s in-process research and development project meets the definition of an intangible asset when it:
a. meets the definition of an asset, and
b. is identifiable, i.e. separable or arises from contractual or other legal rights.“
Therefore, in a business acquisition or combination, the intangible assets that are “identifiable” (either separable or arising from legal rights) can be recognised and capitalised in the balance sheet of the acquiring company.
After initial recognition, the accounting value in the balance sheet of intangible assets with definite useful lives (e.g. IPRs, licenses) has to be amortised over the intangible asset’s expected useful life, and is subject to impairment tests when needed. As explained above, intangible assets with indefinite useful lives (such as goodwill or brands) will not be amortised, but only subject at least annually to an impairment test to verify whether the impairment indicators (“triggers”) are met.
Alternatively, after initial recognition (at cost or at fair value in the case of business acquisitions or mergers), intangible assets with definite useful lives may be revalued at fair value less amortisation, provided there is an active market for the asset to be referred to, as can be inferred from paragraph 75 of IAS 38:
“After initial recognition, an intangible asset shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated amortisation and any subsequent accumulated impairment losses. For the purpose of revaluations under this Standard, fair value shall be measured by reference to an active market. Revaluations shall be made with such regularity that at the end of the reporting period the carrying amount of the asset does not differ materially from its fair value.”
However, this standard indicates that the revaluation model can only be used in rare situations, where there is an active market for these intangible assets.
1.4. The elephant in the room: a lack of recognition and measurement of internally generated intangible assets
All the above about the treatment of intangible assets other than goodwill cannot be said for internally generated intangible assets. Indeed, IAS 38 sets out important differences in the treatment of those internally generated intangibles, which is currently – and rightfully – the subject of much debate among regulators and other stakeholders.
Internally generated intangible assets are prevented from being recognised, from an accounting standpoint, as they are being developed (while a business would normally account for internally generated tangible assets). Therefore, a significant proportion of internally generated intangible assets is not recognised in the balance sheet of a company. As a consequence, stakeholders such as investors, regulators, shareholders, financiers, are not receiving some very relevant information about this enterprise, and its accurate worth.
Why such a standoffish attitude towards internally generated intangible assets? In practice, when the expenditure to develop intangible asset is incurred, it is often very unclear whether that expenditure is going to generate future economic benefits. It is this uncertainty that prevents many intangible assets from being recognised as they are being developed. This perceived lack of reliability of the linkage between expenditures and future benefits pushes towards the treatment of such expenditures as “period cost”. It is not until much later, when the uncertainty is resolved (e.g. granting of a patent), that an intangible asset may be capable of recognition. As current accounting requirements primarily focus on transactions, an event such as the resolution of uncertainty surrounding an internally developed IPR is generally not captured in company financial statements.
Let’s take the example of research and development costs (“R&D“), which is one process of internally creating certain types of intangible assets, to illustrate the accounting treatment of intangible assets created in this way.
Among accounting standard setters, such as IASB with its IAS 38, the most frequent practice is to require the immediate expensing of all R&D. However, France, Italy and Australia are examples of countries where national accounting rule makers allow the capitalisation of R&D, subject to conditions being satisfied.
Therefore, in some circumstances, internally generated intangible assets can be recognised when the relevant set of recognition criteria is met, in particular the existence of a clear linkage of the expenditure to future benefits accruing to the company. This is called condition-based capitalisation. In these cases, the cost that a company has incurred in that financial year, can be capitalised as an asset; the previous costs having already been expensed in earlier income statements. For example, when a patent is finally granted by the relevant intellectual property office, only the expenses incurred during that financial year can be capitalised and disclosed on the face of balance sheet among intangible fixed assets.
To conclude, under the current IFRS and GAAP regimes, internally generated intangible assets, such as IPRs, can only be recognised on balance sheet in very rare instances.
2.Why value and report intangible assets?
As developed in depth by the European Commission (“EC“) in its 2013 final report from the expert group on intellectual property valuation, the UK intellectual property office (“UKIPO“) in its 2013 “Banking on IP?” report and the FRC in its 2019 discussion paper “Business reporting of intangibles: realistic proposals”, the time for radical change to the accounting of intangible assets has come upon us.
2.1. Improving the accurateness and reliability of financial communication
Existing accounting standards should be advanced, updated and modernised to take greater account of intangible assets and consequently improve the relevance, objectivity and reliability of financial statements.
Not only that, but informing stakeholders (i.e. management, employees, shareholders, regulators, financiers, investors) appropriately and reliably is paramount today, in a corporate world where companies are expected to accurately, regularly and expertly manage and broadcast their financial communication to medias and regulators.
As highlighted by Janice Denoncourt in her blog post “intellectual property, finance and corporate governance“, no stakeholder wants an iteration of the Theranos’ fiasco, during which inventor and managing director Elizabeth Holmes was indicted for fraud in excess of USD700 million, by the United States Securities and Exchange Commission (“SEC“), for having repeatedly, yet inaccurately, said that Theranos’ patented blood testing technology was both revolutionary and at the last stages of its development. Elizabeth Holmes made those assertions on the basis of the more than 270 patents that her and her team filed with the United States patent and trademark office (“USPTO“), while making some material omissions and misleading disclosures to the SEC, via Theranos’ financial statements, on the lame justification that “Theranos needed to protect its intellectual property” (sic).
Indeed, the stakes of financial communication are so high, in particular for the branding and reputation of any “knowledge economy” company, that, back in 2002, LVMH did not hesitate to sue Morgan Stanley, the investment bank advising its nemesis, Kering (at the time, named “PPR“), in order to obtain Euros100 million of damages resulting from Morgan Stanley’s alleged breach of conflicts of interests between its investment banking arm (which advised PPR’s top-selling brand, Gucci) and Morgan Stanley’s financial research division. According to LVMH, Clare Kent, Morgan Stanley’s luxury sector-focused analyst, systematically drafted and then published negative and biased research against LVMH share and financial results, in order to favor Gucci, the top-selling brand of the PPR luxury conglomerate and Morgan Stanley’s top client. While this lawsuit – the first of its kind in relation to alleged biased conduct in a bank’s financial analysis – looked far-fetched when it was lodged in 2002, LVMH actually won, both in first instance and on appeal.
Having more streamlined and accurate accounting, reporting and valuation of intangible assets – which are, today, the main and most valuable assets of any 21st century corporation – is therefore paramount for efficient and reliable financial communication.
2.2. Improving and diversifying access to finance
Not only that, but recognising the worth and inherent value of intangible assets, on balance sheet, would greatly improve the chances of any company – in particular, SMEs – to successfully apply for financing.
Debt finance is notoriously famous for shying away from using intangible assets as main collateral against lending because it is too risky.
For example, taking appropriate security controls over a company’s registered IPRs in a lending scenario would involve taking a fixed charge, and recording it properly on the Companies Registry at Companies House (in the UK) and on the appropriate IPRs’ registers. However, this hardly ever happens. Typically, at best, lenders are reliant on a floating charge over IPRs, which will crystallise in case of an event of default being triggered – by which time, important IPRs may have disappeared into thin air, or been disposed of; hence limiting the lender’s recovery prospects.
Alternatively, it is now possible for a lender to take an assignment of an IPR by way of security (generally with a licence back to the assignor to permit his or her continued use of the IPR) by an assignment in writing signed by the assignor (1). However, this is rarely done in practice. The reason is to avoid “maintenance”, i.e. to prevent the multiplicity of actions. Indeed, because intangibles are incapable of being possessed, and rights over them are therefore ultimately enforced by action, it has been considered that the ability to assign such rights would increase the number of actions (2).
Whilst there are improvements needed to the practicalities and easiness of registering a security interest over intangible assets, the basic step that is missing is a clear inventory of IPRs and other intangible assets, on balance sheet and/or on yearly financial statements, without which lenders can never be certain that these assets are in fact to hand.
Cases of intangible asset- backed lending (“IABL“) have occurred, whereby a bank provided a loan to a pension fund against tangible assets, and the pension fund then provided a sale and leaseback arrangement against intangible assets. Therefore, IABL from pension funds (on a sale and leaseback arrangement), rather than banks, provides a route for SMEs to obtain loans.
There have also been instances where specialist lenders have entered into sale and licence-back agreements, or sale and leaseback agreements, secured against intangible assets, including trademarks and software copyright.
Some other types of funders than lenders, however, are already making the “intangible assets” link, such as equity investors (business angels, venture capital companies and private equity funds). They know that IPRs and other intangibles represent part of the “skin in the game” for SME owners and managers, who have often expended significant time and money in their creation, development and protection. Therefore, when equity investors assess the quality and attractiveness of investment opportunities, they invariably include consideration of the underlying intangible assets, and IPRs in particular. They want to understand the extent to which intangible assets owned by one of the companies they are potentially interested investing in, represent a barrier to entry, create freedom to operate and meet a real market need.
Accordingly, many private equity funds, in particular, have delved into investing in luxury companies, attracted by their high gross margins and net profit rates, as I explained in my 2013 article “Financing luxury companies: the quest of the Holy Grail (not!)“. Today, some of the most active venture capital firms investing in the European creative industries are Accel, Advent Venture Partners, Index Ventures, Experienced Capital, to name a few.
2.3. Adopting a systematic, consistent and streamlined approach to the valuation of intangible assets, which levels the playing field
If intangible assets are to be recognised in financial statements, in order to adopt a systematic and streamlined approach to their valuation, then fair value is the most obvious alternative to cost, as explained in paragraph 1.3. above.
How could we use fair value more widely, in order to capitalise intangible assets in financial statements?
IFRS 13 “Fair Value Measurements” identifies three widely-used valuation techniques: the market approach, the cost approach and the income approach.
The market approach “uses prices and other relevant information generated by market transactions involving identical or comparable” assets. However, this approach is difficult in practice, since when transactions in intangibles occur, the prices are rarely made public. Publicly traded data usually represents a market capitalisation of the enterprise, not singular intangible assets. Market data from market participants is often used in income based models such as determining reasonable royalty rates and discount rates. Direct market evidence is usually available in the valuation of internet domain names, carbon emission rights and national licences (for radio stations, for example). Other relevant market data include sale/licence transactional data, price multiples and royalty rates.
The cost approach “reflects the amount that would be required currently to replace the service capacity of an asset“. Deriving fair value under this approach therefore requires estimating the costs of developing an equivalent intangible asset. In practice, it is often difficult to estimate in advance the costs of developing an intangible. In most cases, replacement cost new is the most direct and meaningful cost based means of estimating the value of an intangible asset. Once replacement cost new is estimated, various forms of obsolescence must be considered, such as functional, technological and economic. Cost based models are best used for valuing an assembled workforce, engineering drawings or designs and internally developed software where no direct cash flow is generated.
The income approach essentially converts future cash flows (or income and expenses) to a single, discounted present value, usually as a result of increased turnover of cost savings. Income based models are best used when the intangible asset is income producing or when it allows an asset to generate cash flow. The calculation may be similar to that of value in use. However, to arrive at fair value, the future income must be estimated from the perspective of market participants rather than that of the entity. Therefore, applying the income approach requires an insight into how market participants would assess the benefits (cash flows) that will be obtained uniquely from an intangible asset (where such cash flows are different from the cash flows related to the whole company). Income based methods are usually employed to value customer related intangibles, trade names, patents, technology, copyrights, and covenants not to compete.
An example of IPRs’ valuation by way of fair value, using the cost and income approaches in particular, is given in the excellent presentation by Austin Jacobs, made during ialci’s latest law of luxury goods and fashion seminar on intellectual property rights in the fashion and luxury sectors.
In order to make these three above-mentioned valuation techniques more effective, with regards to intangible assets, and because many intangibles will not be recognised in financial statements as they fail to meet the definition of an asset or the recognition criteria, a reconsideration to the “Conceptual Framework to Financial Reporting” needs being implemented by the IASB.
These amendments to the Conceptual Framework would permit more intangibles to be recognised within financial statements, in a systematic, consistent, uniform and streamlined manner, therefore levelling the playing field among companies from the knowledge economy.
Let’s not forget that one of the reasons WeWork cofounder, Adam Neumann, was violently criticised, during WeWork’s failed IPO attempt, and then finally ousted, in 2019, was the fact that he was paid nearly USD6 million for granting the right to use his registered word trademark “We”, to his own company WeWork. In its IPO filing prospectus, which provided the first in-depth look at WeWork’s financial results, WeWork characterised the nearly USD6 million payment as “fair market value”. Many analysts, among which Scott Galloway, begged to differ, outraged by the lack of rigour and realism in the valuation of the WeWork brand, and the clearly opportunistic attitude adopted by Adam Neumann to get even richer, faster.
2.4. Creating a liquid, established and free secondary market of intangible assets
IAS 38 currently permits intangible assets to be recognised at fair value, as discussed above in paragraphs 1.3. and 2.3., measured by reference to an active market.
While acknowledging that such markets may exist for assets such as “freely transferable taxi licences, fishing licences or production quotas“, IAS 38 states that “it is uncommon for an active market to exist for an intangible asset“. It is even set out, in paragraph 78 of IAS 38 that “an active market cannot exist for brands, newspaper mastheads, music and film publishing rights, patents or trademarks, because each such asset is unique“.
Markets for resale of intangible assets and IPRs do exist, but are presently less formalised and offer less certainty on realisable values. There is no firmly established secondary transaction market for intangible assets (even though some assets are being sold out of insolvency) where value can be realised. In addition, in the case of forced liquidation, intangible assets’ value can be eroded, as highlighted in paragraph 2.2. above.
Therefore, markets for intangible assets are currently imperfect, in particular because there is an absence of mature marketplaces in which intangible assets may be sold in the event of default, insolvency or liquidation. There is not yet the same tradition of disposal, or the same volume of transaction data, as that which has historically existed with tangible fixed assets.
Be that as it may, the rise of liquid secondary markets of intangible assets is unstoppable. In the last 15 years, the USA have been at the forefront of IPRs auctions, mainly with patent auctions managed by specialist auctioneers such as ICAP Ocean Tomo and Racebrook. For example, in 2006, ICAP Ocean Tomo sold 78 patent lots at auction for USD8.5 million, while 6,000 patents were sold at auction by Canadian company Nortel Networks for USD4.5 billion in 2011.
However, auctions are not limited to patents, as demonstrated by the New York auction, successfully organised by ICAP Ocean Tomo in 2006, on lots composed of patents, trademarks, copyrights, musical rights and domain names, where the sellers were IBM, Motorola, Siemens AG, Kimberly Clark, etc. In 2010, Racebrook auctioned 150 American famous brands from the retail and consumer goods’ sectors.
In Europe, in 2012, Vogica successfully sold its trademarks and domain names at auction to competitor Parisot Group, upon its liquidation.
In addition, global licensing activity leaves not doubt that intangible assets, in particular IPRs, are, in fact, very valuable, highly tradable and a very portable asset class.
It is high time to remove all market’s imperfections, make trading more transparent and offer options to the demand side, to get properly tested.
3. Next steps to improve the valuation and reporting of intangible assets
3.1. Adjust IAS 38 and the Conceptual Framework to Financial Reporting to the realities of intangible assets’ reporting
Mainstream lenders, as well as other stakeholders, need cost-effective, standardised approaches in order to capture and process information on intangibles and IPRs (which is not currently being presented by SMEs).
This can be achieved by reforming IAS 38 and the “Conceptual Framework to Financial Reporting”, at the earliest convenience, in order to make most intangible assets capitalised on financial statements at realistic and consistent valuations.
In particular, the reintroduction of amortisation of goodwill may be a pragmatic way to reduce the impact of different accounting treatment for acquired and internally generated intangibles.
In addition, narrative reporting (i.e. reports with titles such as “Management Commentary” or “Strategic Report”, which generally form part of the annual report, and other financial communication documents such as “Preliminary Earnings Announcements” that a company provides primarily for the information of investors) must set out detailed information on unrecognised intangibles, as well as amplify what is reported within the financial statements.
3.2. Use standardised and consistent metrics within financial statements and other financial communication documents
The usefulness and credibility of narrative information would be greatly enhanced by the inclusion of metrics (i.e. numerical measures that are relevant to an assessment of the company’s intangibles) standardised by industry. The following are examples of objective and verifiable metrics that may be disclosed through narrative reporting:
- a company that identifies customer loyalty as critical to the success of its business model might disclose measures of customer satisfaction, such as the percentage of customers that make repeat purchases;
- if the ability to innovate is a key competitive advantage, the proportion of sales from new products may be a relevant metric;
- where the skill of employees is a key driver of value, employee turnover may be disclosed, together with information about their training.
3.3. Make companies’ boards accountable for intangibles’ reporting
Within a company, at least one appropriately qualified person should be appointed and publicly reported as having oversight and responsibility for intangibles’ auditing, valuation, due diligence and reporting (for example a director, specialist advisory board or an external professional adviser).
This would enhance the importance of corporate governance and board oversight, in addition to reporting, with respect to intangible assets.
In particular, some impairment tests could be introduced, to ensure that businesses are well informed and motivated to adopt appropriate intangibles’ management practices, which should be overseen by the above-mentioned appointed board member.
3.4. Create a body that trains about, and regulates, the field of intangible assets’ valuation and reporting
The creation of a professional organisation for the intangible assets’ valuation profession would increase transparency of intangibles’ valuations and trust towards valuation professionals (i.e. lawyers, IP attorneys, accountants, economists, etc).
This valuation professional organisation would set some key objectives that will protect the public interest in all matters that pertain to the profession, establish professional standards (especially standards of professional conduct) and represent professional valuers.
This organisation would, in addition, offer training and education on intangibles’ valuations. Therefore, the creation of informative material and the development of intangible assets’ training programmes would be a priority, and would guarantee the high quality valuation of IPRs and other intangibles as a way of boosting confidence for the field.
Company board members who are going to be appointed as having accountability and responsibility for intangibles’ valuation within the business, as mentioned above in paragraph 3.3., could greatly benefit from regular training sessions offered by this future valuation professional organisation, in particular for continuing professional development purposes.
3.5. Create a powerful register of expert intangible assets’ valuers
In order to build trust, the creation of a register of expert intangibles’ valuers, whose ability must first be certified by passing relevant knowledge tests, is key.
Inclusion on this list would involve having to pass certain aptitudes tests and, to remain on it, valuers would have to maintain a standard of quality in the valuations carried out, whereby the body that manages this registry would be authorised to expel members whose reports are not up to standard. This is essential in order to maintain confidence in the quality and skill of the valuers included on the register.
The entity that manages this body of valuers would have the power to review the valuations conducted by the valuers certified by this institution as a “second instance”. The body would need to have the power to re-examine the assessments made by these valuers (inspection programme), and even eliminate them if it is considered that the assessment is overtly incorrect (fair disciplinary mechanism).
3.6. Establish an intangible assets’ marketplace and data-source
The development most likely to transform IPRs and intangibles as an asset class is the emergence of more transparent and accessible marketplaces where they can be traded.
In particular, as IPRs and intangible assets become clearly identified and are more freely licensed, bought and sold (together with or separate to the business), the systems available to register and track financial interests will need to be improved. This will require the co-operation of official registries and the establishment of administrative protocols.
Indeed, the credibility of intangibles’ valuations would be greatly enhanced by improving valuation information, especially by collecting information and data on actual and real intangibles’ transactions in a suitable form, so that it can be used, for example, to support IPRs asset-based lending decisions. If this information is made available, lenders and expert valuers will be able to base their estimates on more widely accepted and verified assumptions, and consequently, their valuation results – and valuation reports – would gain greater acceptance and reliability from the market at large.
The wide accessibility of complete, quality information which is based on real negotiations and transactions, via this open data-source, would help to boost confidence in the validity and accuracy of valuations, which will have a very positive effect on transactions involving IPRs and other intangibles.
3.7. Introduce a risk sharing loan guarantee scheme for banks to facilitate intangibles’ secured lending
A dedicated loan guarantee scheme needs being introduced, to facilitate intangible assets’ secured lending to innovative and creative SMEs.
Asia is currently setting the pace in intangibles-backed lending. In 2014, the intellectual property office of Singapore (“IPOS“) launched a USD100 million “IP financing scheme” designed to support local SMEs to use their granted IPRs as collateral for bank loans. A panel of IPOS-appointed valuers assess the applicant’s IPR portfolio using standard guidelines to provide lenders with a basis on which to determine the amount of funds to be advanced. The development of a national valuation model is a noteworthy aspect of the scheme and could lead to an accepted valuation methodology in the future.
The Chinese intellectual property office (“CIPO“) has developed some patent-backed debt finance initiatives. Only 6 years after the “IP pledge financing” programme was launched by CIPO in 2008, CIPO reported that Chinese companies had secured over GBP6 billion in IPRs-backed loans since the programme launched. The Chinese government having way more direct control and input into commercial bank lending policy and capital adequacy requirements, it can vigorously and potently implement its strategic goal of increasing IPRs-backed lending.
It is high time Europe follows suit, at least by putting in place some loan guarantees that would increase lender’s confidence in making investments by sharing the risks related to the investment. A guarantor assumes a debt obligation if the borrower defaults. Most loan guarantee schemes are established to correct perceived market failures by which small borrowers, regardless of creditworthiness, lack access to the credit resources available to large borrowers. Loan guarantee schemes level the playing field.
The proposed risk sharing loan guarantee scheme set up by the European Commission or by a national government fund (in particular in the UK, who is brexiting) would be specifically targeted at commercial banks in order to stimulated intangibles-secured lending to innovative SMEs. The guarantor would fully guarantee the intangibles-secured loan and share the risk of lending to SMEs (which have suitable IPRs and intangibles) with the commercial bank.
The professional valuer serves an important purpose, in this future loan guarantee scheme, since he or she will fill the knowledge gap relating to the IPRs and intangibles, as well as their value, in the bank’s loan procedure. If required, the expert intangibles’ valuer provides intangibles’ valuation expertise and technology transfer to the bank, until such bank has built the relevant capacity to perform intangible assets’ valuations. Such valuations would be performed, either by valuers and/or banks, according to agreed, consistent, homogenised and accepted methods/standards and a standardised intangible asset’s valuation methodology.
To conclude, in this era of ultra-competitiveness and hyper-globalisation, France and the UK, and Europe in general, must immediately jump on the saddle of progress, by reforming outdated and obsolete accounting and reporting standards, as well as by implementing all the above-mentioned new measures and strategies, to realistically and consistently value, report and leverage intangible assets in the 21st century economy.
Founding and managing partner of Crefovi
(1) “Lingard’s bank security documents”, Timothy N. Parsons, 4th edition, LexisNexis, page 450 and seq.
(2) “Taking security – law and practice”, Richard Calnan, Jordans, page 74 and seq.
On 30 March 2019, the UK will crash out of the EU without a withdrawal deal in place, and without a request for an extension of the 2 years’ notification period of its decision to withdraw. No second referendum will be organised by the current UK government. Therefore, what’s in the cards, for the creative industries, in order to do fruitful business with, and from, the UK in the near future?
My previous article on the road less travelled & Brexit legal implications, published just after the Brexit vote, on Saturday 25 June 2016, delivered the main message that it was worth monitoring the negotiation process that would ensue the notification made by the United Kingdom (UK) to the European Union (EU) of its intention to withdraw from the EU within 2 years.
We have therefore been monitoring those negotiations for you, in the last couple of years, and came to the following predictions, which will empower your creative business to brace itself for, and make the most of the imminent changes triggered by, the crashing of the UK out of the EU, on 30 March 2019.
1. End of freedom of movement of UK and EU citizens coming in and out of the UK
On 30 March 2019, UK citizens will lose their EU citizenship, i.e. the citizenship, subsidiary to UK citizenship, that provide rights such as the right to vote in European elections, the right to free movement, settlement and employment across the EU, and the right to consular protection by other EU states’ embassies when a person’s country of citizenship does not maintain an embassy or consulate in the country in which they require protection.
Since no withdrawal agreement will be signed by 29 March 2019, between the EU and the UK, UK nationals living in one of the 27 EU member-states will be on their own, as no reciprocal arrangements will have been put in place, in particular in relation to reciprocal healthcare and social security coordination, work permits, right to stand and vote in local elections.
UK nationals living in one of the states which are members of the European Free Trade Association (EFTA), i.e. Iceland, Liechtenstein, Norway and Switzerland, will also have no safety net, as the UK will also crash out of the EU bilateral agreements with EFTA members, such as the EEA Agreement which ties Iceland, Liechtenstein, Norway and the EU together, on 29 March 2019. Meanwhile, “the UK is seeking citizens’ rights agreement with the EFTA states to protect the rights of citizens“, as set out on the policy paper published by the UK Department for exiting the EU.
It therefore makes sense for UK nationals living in a EU member-state, or in one of the EFTA states, to reach out to the equivalent of the UK Home Office in such country, and inquire how they can secure either a visa or national citizenship in this country. Since negotiating some new bilateral agreements with EU member-states and EFTA states will take years, for the UK to finalise such negotiations, UK nationals cannot rely on these protracted talks to get any leverage and obtain permanent right to remain in a EU member-state or an EFTA state.
For example, France is ready to pass a decree after 30 March 2019, to organise the requirement to present a visa to enter French territory, and to obtain a residency permit (“carte de séjour”) to justify staying here, for UK citizens already living, or planning to live for more than three months, in France. Therefore, soon after 30 March 2019, British nationals and their families who do not have residency permits may have an “irregular status” in France.
While applying for a “carte de séjour” is free in France, and applying for French citizenship triggers only a 55 euros stamp duty to pay, EU nationals living in the UK, or planning to live in the UK, won’t be so lucky.
Indeed, it will set EU nationals back GBP1,330 per person, from 6 April 2018, to obtain UK citizenship, including the citizenship ceremony fee. However, there may be no fee to enrol into the EU Settlement Scheme, which will open fully by 30 March 2019, in particular if a EU citizen already has a valid “UK permanent residence document or indefinite leave to remain in or enter the UK”. The deadline for applying in the EU Settlement Scheme will be 31 December 2020, when the UK leaves the EU without a withdrawal deal on 30 March 2019.
Business owners and creative companies working in and from the UK will be impacted too, if they have some employees and staff. It will be their responsibility to ensure and be able to prove that their staff who are EU citizens, have all obtained a settled status: in a display of largesse, the UK government has therefore published an employer toolkit, to “support EU citizens and their families to apply to the EU Settlement Scheme“.
For short term stays of less than three months per entry, the UK government currently promises that “arrangements for tourists and business visitors will not look any different“. “EU citizens coming for short visits will be able to enter the UK as they can now, and stay for up to three months from each entry“.
To conclude, leaving the EU without a withdrawal agreement is going to create a lot of red tape, and be a massive time and energy hassle for EU citizens living in the UK, their UK employers who need to ensure that their staff are all enrolled into the EU Settlement Scheme, and for UK citizens living in one of the remaining 27 EU member-states. There will be no certainty of obtaining settled status from the UK Home Office, until EU citizens have actually obtained it further to enrolling into the EU Settlement Scheme. This is going to be a very anxiety-inducing process for EU citizens living in the UK, and for their UK employers who rely on these members of their staff to get the job done.
Contingency plans should therefore be put in place by UK employers who have EU citizens on their payroll, in particular by setting up offices and subsidiaries in one of the remaining 27 EU member-states, so that EU citizens whose settled status was refused by the UK Home Office may keep on working for their UK employers by relocating to this EU member-state where they will have freedom of movement thanks to their EU citizenships. Besides the Home Office and immigration lawyers’ fees, UK employers need to take into account the legal, accounting, IT and real estate costs of setting up additional offices and subsidiaries in a EU member-state, after 30 March 2019.
2. Removal of free movement of goods, services and capital
The EU internal market, or single market, is a single market that seeks to guarantee the free movement of goods, capital, services and people – the “four freedoms” – between the EU 28 member-states.
After 30 March 2019, the single market will no longer count the UK, as it will cease to be a EU member-state.
While it was an option for the internal market to remain in place, between the UK and the EU, as such market has been extended to EFTA states Iceland, Liechtenstein and Norway through the agreement on the European Economic Area (EEA), and to EFTA state Switzerland through bilateral treaties, this alternative was not pursued by the UK government. Indeed, the EEA Agreement and EU-Swiss bilateral agreements are both viewed by most as very asymmetric (Norway, Iceland and Liechtenstein are essentially obliged to accept the internal single market rules without having much if any say in what they are, while Switzerland does not have full or automatic access but still has free movement of workers). The UK, as well as EFTA members who were less than keen to have the UK join their EFTA club, ruled out such option, not seeing the point of still contributing to the EU budget while not having a seat at the table to take any decisions in relation to how the single market is governed and managed.
2.1. Removal of free movement of goods and new custom duties and tariffs
As far as the removal of the free movement of goods is concerned, it will be a – hopefully temporary – hassle, since the UK does not have any bilateral customs and trade agreements in place with the EU (because no withdrawal agreement will be entered into between the EU and the UK by 30 March 2019) and with non-EU countries (because the 53 trade agreements with non-EU countries were secured by the EU directly, on behalf of its then 28 member-states, including with Canada, Singapore, South Korea).
On 30 March 2019, the UK will regain its right to conclude binding trade agreements with non-EU countries, and with the EU of course.
While the UK government laboriously launches itself into the negotiation of at least 54 trade agreements, including with the EU, customs duties will be reinstated between the UK and all other European countries, including the UK. This is going to lead to a very disadvantageous situation for UK businesses, as the cost of trading goods and products with foreign countries will substantially increase, both for imports and exports.
Creative companies headquartered in the UK, which export and import goods and products, such as fashion, design and tech companies, are going to be especially at risk, here, with the cost of imported raw material increasing, and the rise or appearance of custom duties on exports of their products to the EU and non-EU countries. Fashion and luxury businesses, in particular, are at risk, since they export more than seventy percent of their production overseas.
Since the UK has most of its trade (57% of exports and 66% of imports in 2016) done with countries bound by EU trade agreements, both UK companies and UK consumers must brace themselves for a shock, when they will start trading after 30 March 2019. The cost of life is going to become more expensive in the UK (since most products and goods are imported, in particular from EU member-states), and operating costs are also going to increase for UK businesses.
While some Brexiters claim that the UK will be fine, by reverting to trading with the “rest of the world” under the rules of the World Trade Organisation (WTO), it is important to note that right now, only 24 countries are trading with the UK on WTO rules (like any one of the 28 member-states of the EU because no EU trade deal was concluded with these non-EU countries). After 30 March 2019, the UK will trade with the rest of the world under WTO rules, as long as the other state is also a member of the WTO (for example, Algeria, Serbia and North Korea are not WTO members). Moreover, some tariffs will apply to all UK exports, under those WTO rules.
It definitely does not look like a panacea to trade under WTO rules, so the UK government and its Bank of England will weaken the pound sterling as much as possible, to set off the financial burden represented by these custom duties and taxes.
Creative companies headquartered in the UK, which export goods and products, such as fashion and design companies, should now relocate their manufacturing operations to the EU or low wages and low tax territories, such as South East Asia, as soon as possible, to avoid the new customs duties and taxation of goods and products which will inevitably arise, after 30 March 2019.
While a cynical example, since James Dyson was a fervent Brexiter who called on the UK government to walk away from the EU without a withdrawal deal, UK creative businesses manufacturing goods and products must emulate vacuum cleaner and hair dryer technology company Dyson, that will be moving its headquarters from Wiltshire to Singapore this year.
Moreover, the UK will face non-tariff barriers, in the same way that China and the US trade with the EU. Non-tariff barriers are any measure, other than a customs tariff, that acts as a barrier to international trade, such as regulations, rules of origin or quotas. In particular, regulatory divergence from the EU will make it harder to trade goods, introducing non-tariff barriers: when the UK will leave the EU customs union, on 30 March 2019, any goods crossing the border will have to meet rules of origin requirements, to prove that they did indeed come from the UK – introducing paperwork and non-tariff barriers.
2.2. Removal of free movement of services and VAT changes
On 30 March 2019, UK services – accounting for eighty percent of the UK economy – will lose their preferential access to the EU single market, which will constitute another non-tariff barrier.
The free movement of services and of establishment allows self-employed persons to move between member-states in order to provide services on a temporary or permanent basis. While services account for between sixty and seventy percent of GDP, on average, in all 28 EU member-states, most legislation in this area is not as developed as in other areas.
There are no customs duties and taxation on services, therefore UK creative industries which mainly provide services (such as the tech and internet sector, marketing, PR and communication services, etc) are less at risk of being detrimentally impacted by the exit of the UK from the EU without a withdrawal agreement.
However, since the UK will become a non-EU country from 30 March 2019 onwards, EU businesses and UK business alike will no longer be able to apply the EU rules relating to VAT, and in particular to intra-community VAT, when they trade with UK and EU businesses respectively. This therefore means that, from 30 March 2019 onwards, a EU business will no longer charge VAT to a UK company, but will keep on charging VAT to its UK client who is a natural person. Also, a UK business will no longer charge VAT to a EU company, but will keep on charging VAT to its EU client who is a natural person.
Positive changes on VAT are also in the works, because the UK will no longer have to comply with EU VAT law (on rates of VAT, scope of exemptions, zero-rating, etc.): the UK will have more flexibility in those areas.
However, there will no doubt be disputes between taxpayers and HMRC over the VAT treatment of transactions that predate 30 March 2019, where EU law may still be in point. Because the jurisdiction of the Court of Justice of the European Union (CJEU) will cease completely in relation to UK matters on 30 March 2019, any such questions of EU law will be dealt with entirely by the UK courts. Indeed, UK courts have stopped referring new cases to the CJEU in any event, since last year.
2.3. Removal of free movement of capital and loss of passporting rights for the UK financial services industry
Since the UK will leave the EU without a withdrawal agreement, free movement of capital, which is intended to permit movement of investments such as property purchases and buying of shares between EU member-states, will cease to apply between the EU and the UK on 30 March 2019.
Capital within the EU may be transferred in any amount from one country to another (except that Greece currently has capital controls restricting outflows) and all intra-EU transfers in euro are considered as domestic payments and bear the corresponding domestic transfer costs. This EU central payments infrastructure is based around TARGET2 and the Single Euro Payments Area (SEPA). This includes all member-states of the EU, even those outside the eurozone, provided the transactions are carried out in euros. Credit/debit card charging and ATM withdrawals within the Eurozone are also charged as domestic.
Since the UK has always kept the pound sterling during its 43 years’ stint in the EU, absolutely refusing to ditch it for the euro, transfer costs on capital movements – from euros to pound sterling and vice versa – have always been fairly high in the UK anyway.
However, as the UK will crash out of the EU without a deal on 30 March 2019, such transfer costs, as well as new controls on capital movements, will be put in place and impact creative businesses and professionals when they want to transfer money from the UK to EU member-states and vice-versa. While the UK government is looking to align payments legislation to maximise the likelihood of remaining a member of SEPA as a third country, the fact that it has decided not to sign the withdrawal agreement with the EU will not help such alignment process.
The cost of card payments between the UK and EU will increase, and these cross-border payments will no longer be covered by the surcharging ban (which prevents businesses from being able to charge consumers for using a specific payment method).
It is therefore advisable for UK creative companies to open business bank accounts, in euros, either in EU countries which are strategic to them, or online through financial services providers such as Transferwise’s borderless account. UK businesses and professionals will hence avoid being narrowly limited to their UK pound sterling denominated bank accounts and being tributary to the whims of politicians and bureaucrats attempting to negotiate new trade agreements on freedom of capital movements between the UK and the EU, and other non-EU countries.
Also, forging ties with banking, insurance and other financial services providers in one of the remaining 27 member-states of the EU may be really useful to UK creative industries, after 30 March 2019, because the UK will no longer be able to carry out any banking, insurance and other financial services activities through the EU passporting process. Indeed, financial services is a highly regulated sector, and the EU internal market for financial services is highly integrated, underpinned by common rules and standards, and extensive supervisory cooperation between regulatory authorities at an EU and member-state level. Firms, financial market infrastructures, and funds authorised in any EU member-state can carry out many activities in any other EU member-state, through a process known as “passporting”, as a direct result of their EU authorisation. This means that if these entities are authorised in one member-state, they can provide services to customers in all other EU member-states, without requiring authorisation or supervision from the local regulator.
The European Union (Withdrawal) Act 2018 will transfer EU law, including that relating to financial services, into UK statutes on 30 March 2019. It will also give the UK government powers to amend UK law, to ensure that there is a fully functioning financial services regulatory framework on 30 March 2019.
However, on 30 March 2019, UK financial services firms’ position in relation to the EU will be determined by any applicable EU rules that apply to non-EU countries at that time. Therefore, UK financial services firms and funds will lose their passporting rights into the EU: this means that their UK customers will no longer be able to use the EU services of UK firms that used to passport into the EU, but also that their EU customers will no longer be able to use the UK services of such UK firms.
For example, the UK is a major centre for investment banking in Europe, with UK investment banks providing investment services and funding through capital markets to business clients across the EU. On 30 March 2019, EU clients may no longer be able to use the services of UK-based investment banks, and UK-based investment banks may be unable to service existing cross-border contracts.
3. Legal implications of Brexit in the UK
On 30 March 2019, the European Union (Withdrawal) Act 2018 (the “Act“) will take effect, repeal the European Communities Act 1972 (the “ECA“) and retain in effect almost all UK laws which have been derived from the EU membership of the UK since 1 January 1973. The Act will therefore continue enforce all EU-derived domestic legislation, which is principally delegated legislation passed under the ECA to implement directives, and convert all direct EU legislation, i.e. EU regulations and decisions, into UK domestic law.
Consequently, the content of EU law as it stands on 30 March 2019 is going to be a critical piece of legal history for the purpose of UK law for decades to come.
Some of the legal practices which are going to be strongly impacted by the UK crashing out of the EU are intellectual property law, dispute resolution, financial services law, franchising, employment law, product compliance and liability, as well as tax.
In particular, there is no clarity from the UK government, at this stage, on how EU trademarks, registered with the European Union Intellectual Property Office (EUIPO) are going to apply in the UK, if at all, after 30 March 2019. The same goes for Registered Community Designs (RCD), which are also issued by the EUIPO.
At least, some clarity exists in relation to European patents: the UK exit from the EU should not affect the current European patent system, which is governed by the (non-EU) European Patent Convention. Therefore, UK businesses will be able to apply to the European Patent Office (EPO) for patent protection which will include the UK. Existing European patents covering the UK will also be unaffected. European patent attorneys based in the UK will continue to be able to represent applicants before the EPO.
Similarly, and since the UK is a member of a number of international treaties and agreements protecting copyright, the majority of UK copyright works (such as music, films, books and photographs) are protected around the world. This will continue to be the case, following the UK exit from the EU. However, certain cross-border copyright mechanisms, especially those relating to collecting societies and rights management societies, and those relating to the EU digital single market, are going to cease applying in the UK.
Enforcement of IP rights, as well as commercial and civil rights, is also going to be uncertain for some time: the UK will cease to be part of the EU Observatory, and of bodies such as Europol and the EU customs’ databases to register intellectual property rights against counterfeiting, on 30 March 2019.
The EU regulation n. 1215/2012 of 12 December 2012, on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters, will cease to apply in the UK once it is no longer an EU member-state. Therefore, after 30 March 2019, no enforcement system will be in place, to enforce an English judgment in a EU member-state, and vice-versa. Creative businesses will have to rely on domestic recognition regimes in the UK and each EU member-state, if in existence. This will likely introduce additional procedural steps before a foreign judgment is recognised, which will make enforcement more time-consuming and expensive.
To conclude, the UK government seems comfortable with the fact that mayhem is going to happen, from 30 March 2019 onwards, in the UK, in a very large number of industrial sectors, legal practices, and cross-border administrative systems such as immigration and customs, for the mere reason than no agreed and negotiated planning was put in place, on a wide scale, by the UK and the EU upon exit of the UK from the EU. This approach makes no economic, social and financial sense but this is besides the point. Right now, what creative businesses and professionals need to focus on is to prepare contingency plans, as explained above, and to keep on monitoring new harmonisation processes that will undoubtedly be put in place, in a few years, by the UK and its trading partners outside and inside the EU, once they manage to find common ground and enter into bilateral agreements organising this new business era for the UK.
What are business owners obligations, in terms of registering beneficial ownership of their companies? How do these obligations differ, in France and the United Kingdom, even though such obligations stem from the same European legislation, i.e. the European Directive 2015/849 dated 20 May 2015 on money laundering?
1. What is this all about?
On 20 May 2015, the Directive (EU) 2015/849 of the European Parliament and of the Council on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, amending Regulation (EU) No 648/2012 of the European Parliament and of the Council, and repealing Directive 2005/60/EC of the European Parliament and of the Council, was published (the “Directive“).
As set out in the recitals of the Directive, and in order to better fight against money laundering, terrorism financing and organised crime, “there is a need to identify any natural person who exercises ownership or control over a legal entity (…). Identification and verification of beneficial owners should, where relevant, extend to legal entities that own other legal entities, and obliged entities should look for the natural person(s) who ultimately exercises control through ownership or through other means of the legal entity that is the customer“.
In addition, “the need for accurate and up-to-date information on the beneficial owner is a key factor in tracing criminals who might otherwise hide their identity behind the corporate structure“.
Chapter III (Beneficial ownership information) of the Directive relates to such topic.
In particular, article 30 of the Directive provides that “member states shall ensure that the information (on beneficial ownership) is held in a central register in each member state, for example a commercial register, companies register or a public register (…). Member states shall ensure that the information on the beneficial ownership is adequate, accurate and current” and accessible “to competent authorities, without any restriction; (…) and to any person or organisation that can demonstrate a legitimate interest“.
These persons or organisations shall access at least the name, the month and year of birth, the nationality and the country of residence of the beneficial owner as well as the nature and extent of the beneficial interest held.
2. Registration of beneficial ownership in French companies
With typical Gallic nonchalance, and while the deadline to transpose the Directive in each member-state was 26 June 2017, France transposed the Directive almost one year later, through its Ordinance n. 2016-1635 of 1 December 2016 reinforcing the French mechanism against money laundering and the financing of terrorism and of the Decree n. 2017-1094 of 12 June 2017 relating to the registry of effective beneficiaries as defined in article L. 561-2-2 of the French monetary and financial code (the “Ordinance” and the “Decree” respectively), with a compliance deadline of 1 April 2018.
The Ordinance and Decree, which have now been incorporated in the French monetary and financial code, compel all companies operating in France to register their beneficial owners with the Registry of Commerce and Companies of the competent Commercial court (the “Registry“).
2.1. Beneficial ownership and filing with the Registry
The notion of beneficial ownership is not defined in the Decree, although is it defined in the Directive as including each natural person who either ultimately owns, directly or indirectly, more than 25% of the share capital or voting rights of the company, or exercises, by any other means, a supervisory power on the managing, administrative or executive bodies of the company or on the shareholders general assembly.
The information that must be filed is essentially identical to that required by financial institutions and other entities such as law firms, in order for them to carry out their mandatory Know-Your-Client (KYC) procedures.
2.2. The initial filings
The declaration of beneficial ownership must be filed at the Registry when a company is first registered with the Registry or, at the latest, within 15 days as of the date of issuance of the receipt of registration (article R. 561-55 of the French monetary and financial code) i.e. when it is created or opens a branch in France.
2.3. Corrective filings
For companies already registered, the deadline for the declaration is 1 April 2018. If subsequent updates are required, new filing must be made within 30 days as of the fact or the act giving rise to a required update (article R. 561-55 of the French monetary and financial code).
2.4. On the beneficial owner
The declaration must set out the owner’s name and particulars, as well as the means of control exercised by the beneficial owner and the date on which s/he became a beneficial owner (article R. 561-56, 2. of the French monetary and financial code).
2.5. Persons having access to the register of beneficial owners
Access to the register of beneficial owners is limited to magistrates of the civil courts and the Ministry of Justice; investigators working for the Autorité des Marchés Financiers (French financial markets regulator); agents of the Direction Générale des Finances Publiques (Directorate-General for Public Finances); qualifying credit institutions, insurance and mutual insurance companies and investment services providers; and any person authorised by a court decision to this effect.
2.6. Penalties for non-compliance
The new provisions of the French monetary and financial code provide remedial penalties with the possibility for any person having a legitimate interest to bring an action in order to force the defaulting company to fulfil its obligation to declare its beneficial owners (article R. 561-48 of the French monetary and financial code).
Punitive provisions have also been introduced: failure to declare the beneficial owners to the Registry or filing a declaration involving incomplete or inaccurate information is punishable by 6 months of imprisonment and a fine of Euros 7,500 (article 561-49 of the French monetary and financial code).
3. Registration of beneficial ownership in British companies
Well within the deadline to transpose the Directive in each member-state of 26 June 2017, the United Kingdom transposed the Directive on time, through its new paragraph 24(3) of Schedule 1A of the Companies Act 2006, as amended by Schedule 3 to the Small Business, Enterprise and Employment Act 2015 (the “Companies Act” and “Enterprise Act” respectively), with a compliance deadline of 30 June 2016.
The Companies Act and Enterprise Act, compel all companies operating in the United Kingdom to keep a register of Persons with Significant Control (“PSC register“) and to file this PSC information via their confirmation statements, upon the due filing date of their respective confirmation statements with Companies House, i.e. the British equivalent to the French Registry of Commerce and Companies of the competent Commercial court (“Companies House“).
3.1. Beneficial ownership and filing with Companies House
The notion of beneficial ownership, or significant influence or control, as set out in the Companies Act, is defined in the Companies Act as including each natural person who either ultimately owns, directly or indirectly, more than 25% of the share capital or voting rights of the company, or exercises, by any other means, a supervisory power on the managing, administrative or executive bodies of the company or on the shareholders general assembly.
UK companies, Societates Europae (SEs), Limited liability partnerships (LLPs) and eligible Scottish partnerships (ESPs), will be required to identify and record the people with significant control.
3.2. The initial filings
The PSC information must be filed with the central public register at Companies House when a company is first registered with Companies House, i.e. when it is created or opens a branch in the UK.
In addition, new companies, SEs, LLPs need to draft and keep a PSC register in relation to them, in addition to existing registers such as the register of directors and the register of members (shareholders).
3.3. Corrective filings
For companies already registered, on 6 April 2016, the Companies Act required all companies to keep a PSC register and, from 30 June 2016, companies started to file this PSC information via their confirmation statements.
As each company has a different filing date, based on the anniversary of their respective incorporation, it took up to 12 months (i.e. 30 June 2017) to develop a full picture of all UK companies’ PSCs.
3.4. On the beneficial owner
Before a PSC can be entered on the PSC register, you must confirm all the details with them.
The details you require are:
- date of birth;
- country, state or part of the UK where the PSC usually lives;
- service address;
- usual residential address (this must not be disclosed when making your register available for inspection of providing copies of the PSC register);
- the date s/he became a PSC in relation to the company (for existing companies, the 6 April 2016 was used);
- which conditions for being a PSC are met;
- this must include the level of shares and/or voting rights, within the following categories:
- over 25% up to (and including) 50%;
- more than 50% and less than 75%;
- 75% or more;
- the company is only required to identify whether a PSC meets the condition relating to the control and significant influence, if they do not exercise control through the shareholding and voting rights conditions;
- this must include the level of shares and/or voting rights, within the following categories:
- whether an application has been made for the individual’s information to be protected from public disclosure.
3.5. Persons having access to the register of beneficial owners
A company’s PSC register should contain the information listed in paragraph 3.4 above, for each PSC of the company. However, that may not always be possible. Where, for some reason, the PSC information cannot be provided, other statements will need to be made instead, explaining why the PSC information is not available. The PSC register can never be blank and such information must be provided to Companies House.
Unlike in France PSC information is freely available, for each company, on Companies House’s website.
As the PSC register is one of the company’s statutory registers, each UK company must keep it at its registered office (or alternative inspection location). Anyone with a proper purpose may have access to the PSC register without charge or have a copy of it for which companies may charge GBP12.
If compared with the French situation, it is therefore much easier to obtain the PSC register for a UK company, than for a French company.
3.6. Penalties for non-compliance
Company officers who fail to take all reasonable steps to disclose their PSCs are liable to be fined or imprisoned (by way of a prison sentence of up to two years) or both. If an investigated person fails to respond to the company’s request for information, the company is allowed to “freeze” the relevant shares by stopping proposed transfers and dividends in relation to those shares.
Annabelle Gauberti is the founding partner of Crefovi, our London and Paris law firm specialised in advising the creative industries in general, in particular on their corporate and business law requirements. She is a solicitor of England & Wales, as well as an “avocat” with the Paris bar.
Annabelle is also the president of the International association of lawyers for the creative industries (ialci).
Where does Netflix stand, in terms of expanding its business model, content and distribution channels, worldwide? Where is it heading towards, in the current content distribution ecosystem?
1. Netflix’s state of play in 2018
On 15 May 2015, during the “In conversation with Ted Sarandos” event at the Cannes Film Festival, I asked Netflix’s chief content officer why not acquiring some major film studios in order to have more power and clout, while negotiating the shortening, or even removal, of the “first theatrical window” to release audiovisual content into the public domain worldwide. Surely, through vertical integration, Netflix would be able to successfully convince countries’ governments and theatre owners, around the world, that adopting its day-and-date release strategy is a win-win solution for all?
Ted Sarandos was visibly annoyed by my question at the time, dismissed it entirely by saying something to the effect that buying independent or major studios would not work because Netflix would not get access to their back catalogue anyway, which was where the real cash was. I was baffled by the narrow-minded approach adopted by Sarandos in his reply to my points, but thought he may have snapped that back at me because I was putting him on the spot in front of an audience of more than 300 people, at the most prestigious film festival on earth!
Three years down the line, and my envisioned best strategy for Netflix to beef up its worldwide presence, not only online, but also in the brick and mortar space, is becoming a reality. I was dead on the money: Netflix reported yesterday that they are in advanced talks to acquire Luc Besson’s EuropaCorp studios.
This is the only way forward, for Netflix, as it has almost reached saturation as far as the distribution of its content on its website and online applications are concerned, worldwide. Indeed, Netflix members with a streaming-only plan can watch TV shows and movies instantly in over 190 countries (Netflix is only not yet available in China, nor is it available in Crimea, North Korea, or Syria due to US government restrictions on American companies there). Moreover, in key markets such as the US, Mexico, Brazil and Argentina, Netflix had a penetration rate as high as 72% in the second quarter of 2017.
While more and more consumers subscribe to Netflix streaming plans around the world, with a total number of 117.58 million streaming subscribers worldwide in the fourth quarter of 2017, the average length of subscription to Netflix is 43 months per US broadband households. Therefore, Netflix benefits from a loyal and dutifully paying customer base, which is growing at a 18% rate year-on-year. Fixed as well as operating costs, and overheads, are relatively low for Netflix, since it only counts approximately 5,400 employees (by comparison, Microsoft has 124,000 while Apple has 123,000) and since it does not need any plush real estate or other types of tangible assets as part of its successful business strategy. Meanwhile, Netflix’s revenues in 2017 were USD11.69 bn – increasing more than tenfold between 2005 and 2016 – and Netflix’s net income in 2017 was at a comfortable and cushy USD559 million.
Basically, Netflix is swimming in cash, having now successfully implemented its scaling-up strategy in the online space, worldwide. All this disposable income needs being reinvested back into the business, co-founders Reed Hastings and Marc Randolph not being the types of guys slaving for Netflix’s shareholders by splurging into annual dividends’ distributions. In fact, Netflix never paid dividends to its shareholders in the past 10 years!
2. First step of Netflix vertical integration strategy: leap into content creation and production
In the last 5 years, 1997 founded Netflix, which started out as a postal DVD rental company, successfully implemented the first steps to its vertical integration strategy, no matter what Sarandos has to say on the subject.
The real decision-maker, here, is co-founder, chairman and CEO Reed Hastings, who has fully grasped that Netflix must own every product or service of its supply chain, to make real money. In this context, vertical integration entails owning distribution as well as content. Hence, the leap into content creation and production for Netflix, as licensing existing content was merely enough to beef up its budding catalogue and render it attractive to a wider and ever more culturally-diversified customer base growing exponentially around the world.
Making beaucoup bucks comes from owning 100% of the content, without any licensing royalties to pay back to rightowners. Such fully-owned content can even be licensed back, opening up new revenue streams such as content licensing or even a branded channel with traditional distributors, for Netflix. Films can be easily snatched up at film markets in Sundance, Berlin, Cannes and the American Film Market in Santa-Monica all year round, and Netflix’s deep pockets let it pick the very best of the crop on offer from sales agents and distributors avid to ingratiate themselves with streaming video on-demand services (“SVoD services“). Film and show projects and productions are also brokered directly between the talent and Netflix, the most notable examples of that being Netflix’s production and commission of House of Cards, Orange is the new Black, The Crown, Making a Murderer, and Stranger Things. In 2018, Netflix Originals’ busy-bee content pipeline is made up of 80 films that the company has either acquired or commissioned, which sounds positively outlandish compared to the 12 films released by Disney, and 20 released by Warner Bros, in 2018.
Owning the content also solves the headache posed by the theatrical distribution model which, according to Ted Sarandos, “is pretty antiquated for the on-demand audiences we are looking to serve”. Netflix, he said, is not looking to kill windowing but rather to “restore choice and options” for viewers by moving to day-and-date releases. Indeed, Netflix has brokered many recent theatrical deals – it plans to release the sequel to Ang Lee’s Crouching Tiger, Hidden Dragon day-and-date online and in Inmax theatres. This (overdue) move into day-and-date release positively enrages theatre owners and exhibitors, especially further to the snafu triggered by Netflix managing to get two of its original films, Okja and The Meyerowitz Stories, chosen to compete in the official selection of the 2017 Cannes film festival.
3. Next step of Netflix vertical integration strategy: film studios’ acquisitions
Netflix’s vertical integration and expansion strategy does not stop here, though, because it still has so much disposable income to invest and, hey, why not acquiring more content, stakeholders, market share and clout in the films’ and shows’ sectors, if you can, right? SVoD services like Netflix have declared an open war on the fragmented audiovisual content industry which has prospered for decades, grazing on horizontally segmented industry models. Netflix is at the forefront of structuring end-to-end vertical SVoD services, going direct to consumers and ruthlessly bypassing theatres, broadcasters, networks, cable operators and even television manufacturers. This digital revolution transforms television and filmed entertainment, especially traditional broadcast TV, and is fostered by the big and fast-growing inroads of internet and over-the-top (“OTT“) video platforms such as Netflix, Amazon and Google’s YouTube.
Shaken at its core, a wave of consolidation is subsequently coming to the entertainment content delivery industry, with Netflix ready to snatch up any shaky yet prestigious film studio that comes along, such as Luc Besson’s EuropaCorp studio. Not only does the studio Besson co-founded in 1999 has a rich and high quality original content library and back catalogue (comprising Lucy, Taken, Le Grand Bleu, Valerian and the City of a Thousand Planets, among others), but striking an exclusive direction and production deal with seminal and highly creative Besson would reinforce the prestige of Netflix, while making the platform even more appealing to European, and Asian audiences, in particular.
I predict that, should the right opportunity comes along, Netflix will repeat this vertical expansion masterstroke and acquire more major and/or independent studios.
It is true that vertical expansion has boundaries, in particular due to the anti-competitive risks that it entails, and that the issue of vertical integration in the entertainment business has been the main focus of policy makers since the 1920s. For example, in the United States v Paramount Pictures Inc. case, the US Supreme court ordered on 3 May 1948 that the five vertically integrated major studios, MGM, Warner Bros, 20th Century Fox, Paramount Pictures and RKO, which not only produced and distributed films but also operated their own movie theatres, sell all their theatre chains. However, today, many media conglomerates already own television broadcasters (either over-the-air or on cable), the production companies that produce content for their networks, and also own the services that distribute their content to viewers (such as television and internet service providers). Bell Canada, Comcast, Sky plc and Roger Communications are vertically integrated in such a manner – operating media subsidiaries and providing “triple play” services on television, internet and phone services in some markets. Additionally, Bell and Rogers own wireless providers, Bell Mobility and Rogers Wireless, while Comcast is partnered with Verizon Wireless. Similarly, Sony has media holdings through its Sony Pictures division, including film and television content, as well as television channels, but is also a manufacturer of consumer electronics that can be used to consume content from itself and others, including televisions, phones and PlayStation video game consoles.
In this context, it is quite difficult imagining Netflix slapped with any anti-competition lawsuits or investigations, because it goes on a buying spree of film studios, even one of the “Big Six” majors.
4. Masterstroke of Netflix vertical integration plan: broadcasting networks and theatre chains
The next stage of the vertical integration and expansion strategy of Netflix, in addition to buying, producing and commissioning its own content, and in addition to acquiring film studios, is to delve into distributing its own content in the “real” world (i.e. offline sphere), either on other media distribution channels such as a broadcasting network, or in movie theatres.
I predict that, in 10 years, if TV is still a medium used by consumers, Netflix will have its own TV channels and broadcasting networks. In the future, if people still attend movie theatres from time to time, to watch special effects films there in particular, Netflix will also invest in buying back fledging exhibitors’ chains, causing direct competition to China’s Dalian Wanda-owned cinema group which is currently on a buying spree of theatre chains across Europe and the US.
This “online to offline strategy” is currently being implemented with brio by originally pure player Amazon, which is currently buying brick and mortar retail spaces all other the world, in order to continue its competitive assaults on traditional grocery stores and malls, increase its market share and get closer to its clients’ base worldwide. Amazon is at a way more mature growth point than Netflix, of course, but provides excellent footprint of the future roadmap that Netflix is undoubtedly going to implement.
5. No space for Apple in Netflix vertical integration strategy
Some commentators in the entertainment and finance industries pretend that Apple will buy Netflix but this is an oversight.
Firstly, Netflix has zilch incentive to accept an acquisition offer, even from a tech behemoth like Apple, because it is in such a strong strategical and financing position, and will be in that sweet spot for many more years to come in spite of its lesser-known SVoD competitors, such as Amazon Prime, Hulu and Vudu, tagging along.
Secondly, and thanks to such solid said vertical integration strategy and financials, Netflix’s valuation is simply too high, now. It is trading at all-time highs, with a USD94bn market cap.
Thirdly, co-founder Reed Hastings, who still very much keeps a tight rein on Netflix as its chairman and CEO and enjoys the ride, is unlikely to sell his business at a meagre premium of 6% or so (USD100bn).
Finally, Apple’s specialty and strength lie in its hardware and products, not so much in its software and services (apart, perhaps, from Apple’s video editing software, Final Cut Pro): the integration of Netflix into Apple will reinforce the latter’s positioning as a serious software and online applications’ provider, but will do absolutely nothing for the former’s vertical integration strategy, which now charges ahead towards film studios’ acquisitions, broadcasting networks’ acquisitions and theatre chains’ acquisitions.
Annabelle Gauberti is the founding partner of Crefovi, our London and Paris law firm specialised in advising the creative industries. She is a solicitor of England & Wales, as well as an “avocat” with the Paris bar.
Annabelle is also the president of the International association of lawyers for the creative industries (ialci).
The GDPR is upon us: what is it? How is it going to impact you and your business? What do you need to do in order to become GDPR compliant?
There is not a moment to waste, as the stakes are very high, and since becoming GDPR compliant will definitely bring competitive advantages to your business.
On 27 April 2016, after more than 4 years of discussion and negotiation, the European parliament and council adopted the General Data Protection Regulation (“GDPR”).
Why the GDPR?
The GDPR repeals Directive 95/46/EC on the protection of individuals with regards to the processing of personal data and on the free movement of such data (the “Directive”).
The Directive, which entered into force more than 20 years’ ago, was no longer fit for purpose, as the amount of digital information businesses create, capture and store has vastly increased.
Data, the bigger the better, is here to stay. Today’s data more and more greases our digital world. Control of data is ultimately about power and data ownership does seriously impact competition on any given market. By collecting more data, a firm has more scope to improve its products, which attracts more users, generating even more data, and so on. Data assets are, today, at least as important as other intangible assets such as trademarks, copyright, patents and designs, to companies. The stakes are way higher, today, as far as data ownership, control and processing are concerned, and GDPR addresses that data flow in the 21st century, as we all engage with technology, more and more.
Moreover, many legal cases, brought up in various member-states of the European Union (“EU”), pinpointed the severe weaknesses and gaps in providing satisfactory, strong and homogeneous protection of personal data, relating to EU citizens, and controlled by companies and businesses operating in the EU. For example, the Costeja v Google judgment, from the Court of Justice of the European Union (“CJEU”), commonly referred to as the “right to the forgotten” ruling, was handed down on 26 November 2014. This ground-breaking judgment recognised that search engine operators, such as Google, process personal data and qualify as data controllers within the meaning of Article 2 of the Directive. As such, the CJEU ruling recognised that a data subject may “request (from a search engine) that the information (relating to him/her personally) no longer be made available to the general public on account of its inclusion in (…) a list of results”. Through this decision, the CJEU forced search engines such as Google to remove, when requested, URL links that are “inadequate, irrelevant or no longer relevant, or excessive in relation to the purposes for which they were processed and in the light of the time that has elapsed”. It was a huge step forward for personal data protection in the EU.
In addition, data breaches at, and cyber-attacks of, thousands of international businesses (Sony Pictures, Yahoo, Linkedin, Equifax, etc.) as well as EU national companies (Talktalk, etc.) make the news, consistently and on a very regular basis, dramatically affecting the financial and moral well being of millions of consumers whose personal data was hacked because of these data breaches. These attacks and breaches raise very serious concerns as to whether businesses managing personal data of EU consumers are actually “up to scratch”, in terms of proactively fighting against cyber-crime and protecting personal data.
Finally, the GDPR, which will be immediately enforceable in the 28 member-states of the EU without any transposition from 25 May 2018, unlike the Directive which had to be transposed in each EU member-state by way of national rules, standardises all national laws applicable in these member-states and therefore provides more uniformity across them. The GDPR levels the playing field.
When will the GDPR enter into force?
The GDPR, adopted in April 2016, enters into force on 25 May 2018, ideally giving a 2-year preparation period to businesses and public bodies to adapt to the changes.
While many EU business owners take the view that the changes brought by the GDPR onto their businesses, will be of little or no importance or just as important as other compliance issues, there is not a minute to spare to prepare for compliance with the new set of complex and lengthy rules set out in the GDPR.
What is at stake? Which organisations are impacted by the GDPR?
A lot is at stake. All businesses, organisations or entities which operate in the EU or which are headquartered outside of the EU but collect, hold or process personal data of EU citizens must be GDPR compliant by 25 May 2018. Potentially, the GDPR may apply to every website and application on a global basis.
As most if not all multinationals have customers, employees and/or business partners in the EU, they must become GDPR compliant. Even start-ups and SMEs must be GDPR compliant, if their business model infer that they will collect, hold or process personal data of EU citizens (i.e. customers, prospects, employees, contractors, suppliers, etc).
The stakes are very high for most businesses and, for many companies, it is becoming a board-level conversation and issue.
To ensure compliance with the new legal framework for data protection, and the implementation of the new provisions, the GDPR introduced an enforcement regime of very heavy financial sanctions to be imposed on businesses that do not comply with it. If an organisation does not process EU individuals’ data in the correct way, it can be fined, up to 4% of its annual worldwide turnover, or Euros 20million – whichever is greater.
These future fines are way larger than the GBP500,000 capped penalty the UK Data Protection Authority (“DPA”), the Information Commissioner Office (“ICO”), or the maximum 300,000 euros capped penalty that the French DPA, the “Commission Nationale Informatique et Libertés” (“CNIL”), can currently inflict on businesses.
What are the GDPR provisions about?
The GDPR provides 99 articles setting out the rights of individuals and obligations placed on organisations within the scope of the GDPR.
Compared to the Directive, here are the new key concepts brought by the GDPR.
4.1. Privacy by design
The principle of privacy by design means that businesses must take a proactive and preventive approach in relation to the protection of privacy and personal data. For example, a business that limits the quantity of data collected, or anonymises such data, does comply with the “privacy by design” principle.
This obligation of “privacy by design” implies that businesses must integrate – by all appropriate technical means – the security of personal data at the inception of their applications or business procedures.
Accountability means that the data controller, as well as the data processor, must take appropriate legal, organisational and technical measures allowing them to comply with the GDPR. Moreover, data controllers and data processors must be able to demonstrate the execution of such measures, in all transparency and at any given point in time, both to their respective DPAs and to the natural persons whose data has been treated by them.
These measures must be proportionate to the risk, i.e. the prejudice that would be caused to EU citizens, in case of inappropriate use of their data.
In order to know whether a business is compliant, it is therefore necessary to execute an audit of the data processes made by such company. We, at Crefovi, often execute some audits certified by the CNIL or the ICO.
4.3. Privacy impact Assessment
The business in charge of treating and processing personal data, as well as its subcontractors, must execute an analysis, a Privacy Impact Assessment (“PIA”) relating to the protection of personal data.
Businesses must do a PIA, a privacy risk assessment, on their data assets, in order to track and map risks inherent to each data process and treatment put in place, according to their plausibility and seriousness. Next to those risks, the PIA sets out the list of organisational, IT, physical and legal measures implemented to address and minimise these risks. The PIA aims at checking the adequacy of such measures and, if these measures fail that test, at determining proportionate measures to address those uncovered risks and to ensure the business becomes GDPR compliant.
Crefovi supports companies in performing PIAs and in checking the efficiency of the security and protection measures, thanks to the execution of intrusion tests.
4.4. Data Protection Officer
The GDPR requires that a Data Protection Officer (“DPO”) be appointed, in order to ensure the compliance of treatment of personal data by public administrations and businesses which data treatments present a strong risk of breach of privacy. The DPO is the spokesperson of the organisation in relation to personal data: he or she is the “go to” point of contact, for the DPA, in relation to data processing compliance, but also for individuals whose data has been collected, so that they can exercise their rights.
In addition to holding the prerogatives of the “correspondant informatique et liberté” (“CIL”) in France, or chief privacy officer in the UK, the DPO must inform his/her interlocutors of any data breaches which may arise in the organisation, and analyse their impact.
Profiling is an automated processing of personal data allowing the construction of complex information about a particular person, such as her preferences, productivity at work or her whereabouts.
This type of data processing can generate automated decision-making, which may trigger legal consequences, without any human intervention. In this way, profiling constitutes a risk to civil liberties. This is why those businesses doing profiling must limit its risks and guarantee the rights of individuals subjected to such profiling, in particular by allowing them to request human intervention and/or contest the automated decision.
4.6. Right to be forgotten
As explained above, the right to be forgotten allows an individual to avoid that information about his/her past interferes with his/her actual life. In the digital world, that right encompasses the right to erasure as well as the right to dereferencing. On the one hand, the person can have potentially harmful content erased from a digital network, and, on the other hand, the person can dissociate a keyword (such as her first name and family name) from certain web pages on a search engine.
4.7. Other individuals’ rights
The GDPR supplements the right to be forgotten by firmly putting EU citizens back in control of their personal data, substantially reinforcing the consent obligation to data processing, as well as citizens’ rights (right to access data, right to rectify data, right to limit data processing, right to data portability and right to oppose data processing), and information obligations by businesses about citizens’ rights.
Is there a silver lining to the GDPR?
5.1. An opportunity to manage those precious data assets
Compliance with GDPR should be viewed by businesses as an opportunity, as much as an obligation: with data being ever more important in an organisation today, this is a great opportunity to take stock of what data your company has, and how you can get most advantage of it.
The key tenet of GDPR is that it will give you the ability to find data in your organisation that is highly sensitive and high value, and ensure that it is protected adequately from risks and data breaches.
5.2. Lower formalities and one-stop DPA
Moreover, the GDPR withdraws the obligation of prior declaration to one’s DPA, before any data processing, and replaces these formalities with mandatory creation and management of a data processing register.
In addition, the GDPR sets up a one-stop DPA: in case of absence of a specific national legislation, a DPA located in the EU member-state in which the organisation has its main or unique establishment will be in charge of controlling compliance with the GDPR.
Businesses will determine their respective DPA with respect to the place of establishment of their management functions as far as supervision of data processing is concerned, which will allow to identify the main establishment, including when a sole company manages the operations of a whole group.
This unique one-stop DPA will allow companies to substantially save time and money by simplifying their processes.
5.3. Unified regulation, easier data transfers
In order to favour the European data market and the digital economy, and therefore create a favourable economic environment, the GDPR reinforces the protection of personal data and civil liberties.
This unified regulation will allow businesses to substantially reduce the costs of processing data currently incurred in the 28 EU member-states: organisations will no longer have to comply with multiple national regulations for the collection, harvesting, transfer and storing of data that they use.
Moreover, since data will comply with legislations applicable in all EU countries, it will become possible to exchange it and it will have the same value in different countries, while currently data has different prices depending on the legislation it complies with, as well as different costs for the companies that collect it.
5.4. A geographical scope extended by fair competition
The scope of the GDPR extends to companies which are headquartered outside the EU, but intend to market goods and services in the EU market, as long as they put in place processes and treatments of personal data relating to EU citizens. Following these residents on internet, in order to create some profiles, is also covered by the GDPR scope.
Therefore, European companies, subjected to strict, and potentially expensive, rules, will not be penalised by international competition on the EU single market. In addition, they may buy from non-EU companies some data which is compliant with GDPR provisions, therefore making the data market wider.
5.5. Opening digital services to competition
The right to portability of data will allow EU citizens subjected to data treatment and processing to gather this data in an exploitable format or to transfer such data to another data controller if this is technically possible.
This way, the client will be able to change digital services provider (email, pictures, etc.) without having to manually retrieve all the data, during a fastidious and time-consuming process. By lifting such technical barriers, the GDPR makes the market more fluid, and offers to users enhanced digital mobility. Digital services providers will therefore evolve in a more competitive market, inciting them in providing better priced and higher quality services, as their clients will no longer be hostages to their initial provider.
5.6. Labels and certifications
The European committee on data protection, as well as EU institutions, will propose some certifications and labels in order to certify compliance with the GDPR of data processes performed by businesses.
Cashable recognition and true asset for the brand image of a company, labels and certifications will also become a strong commercial tool in order to gain prospects’ trusts and to win their loyalty.
What are the actionable steps to take, right now, to become GDPR compliant?
There is not a moment to lose to implement the following steps, below:
- Decide on the ownership of implementing the GDPR provisions in your organisation; assign ownership to the best suited department or team (Legal? Compliance? Technology?);
- Liaise with your one-stop DPA, as several of them have prepared useful explanatory information or guidance to comply with GDPR, such as the ICO in the UK, the CNIL in France and the Data Protection Commissioner in Ireland (the latter being the DPA of many a digital giant, such as Google, Facebook and Twitter);
- Draft a map of the data processes in your organisation, and identify the gaps in GDPR compliance in relation to these various processes – we, at Crefovi, have drafted some detailed documents on how to make this mapping of data processes and treatments and to support you on identifying the gaps in GDPR compliance;
- Value the various data processes and treatments and assess which ones are high risk and make a list of your high-risk data assets;
- Execute a PIA on those high-risk data assets (such as Human resources’ data, customers’ data) – Crefovi supports companies in performing PIAs and in checking the efficiency of the security and protection measures, thanks to the execution of intrusion tests;
- Implement legal, technical, organisational and physical measures to lower risks on those data assets and become GDPR compliant;
- Ensure that your contractors and sub-contractors have put compliant security measures in place, by sending them a list of points to check;
- Do privacy awareness training for your employees as they must understand that personal data is anything that can be linked directly to an individual and that there will be some consequences if they break the GDPR provisions and steal personal data;
- Develop a Bring Your Own Device policy (“BYOD”) and enforce it within your organisation and among your employees, since you are accountable for all data user information stored in the cloud and accessible from both corporate devices (tablets, smartphones, laptops) and personal devices. Also, when employees leave or are terminated, make sure that you have included BYOD in your off-boarding process, so that leaving staff lose access to company confidential data immediately on their devices;
- Check and/or redraft the information notices or confidentiality policies in order that they set out the new information required by the GDPR;
- Put in place automated mechanisms in order to obtain explicit consent from EU citizens, especially if your business deals with behavioural data collection, behavioural advertising or any other form of profiling;
- Put in place a solid management plan in case personal data breaches happen, which will allow you to comply with the mandatory requirement to notify your DPA within 72 hours – our in-depth experience of alert, risk management, analytical and notification plans, in France and the United Kingdom, put us, at Crefovi, in a great position to support our clients to prepare for the demanding requirements set out in the GDPR.
 “The world’s most valuable resource is no longer oil, but data”, The economist, 6 May 2017.
 “Preparing for the general data protection regulation: a roadmap to the key changes introduced by the new European data protection regime”, Alexandra Varla, 2017.
Annabelle Gauberti is the founding partner of Crefovi, our London and Paris law firm specialised in advising the creative industries in general, in particular on their personal data and cybersecurity requirements. She is a solicitor of England & Wales, as well as an “avocat” with the Paris bar.
Annabelle is also the president of the International association of lawyers for the creative industries (ialci).
Why authors, songwriters, composers, music publishers, movie producers, scriptwriters as well as digital service providers have everything to win in finding a consensus on copyright in the digital era.
Back in July 2015, I wrote a detailed article on neighbouring rights in the digital era and how the music industry may cash in on this exponentially expanding source of income.
Two years down the line, and further to attending the 2017 Cannes Film Festival and Midem, I am convinced that the dominance of digital distribution channels, and streaming in particular, is accelerating in the creative industries.
Focus 2017, the report on world film market trends published by the Marché du Film at the 2017 Cannes Film Festival, notes that, while films available on transactional Video On Demand (TVOD, such as iTunes) and subscription VOD (SVOD, such as Netflix or Amazon Prime) are on the rise, there are still barriers to release on VOD in Europe. The main obstacle being the perception that the level of revenues from VOD exploitation is still low, with 80% of revenues generated by 20% of films as well as high marketing costs. Another hurdle to full scale development of VOD services is the legal protectionism that some countries, such as France with its “cultural exception”, put in place to limit the disruptions that any blatant financial and commercial success of digital service providers would trigger, towards local theatres, national exhibitors, locally-made film productions and the local public.
Be that as it may, such obstacles will not pass the test of time and will be swept away by the sheer force of consumers’ demands and expectations, driven by a more tailored, user-friendly and personalised approach to consuming audio or video content, at any point in time, in any geographical location and on any device.
Already, the music sector, which has always been the creative industry the most quickly affected and disrupted by the digital revolution, is much more attuned to the potentialities of streaming and adapting its own business model in order to monetise such digital revolution for the benefit of all stakeholders involved. For example, the largest digital music service provider, Spotify, confirmed that it had over 140 million active users worldwide, in June 2017, up from the 100 million figure that was declared a year ago.
At Midem 2017, much talk was made about transparency, fair remuneration, the value gap, to sensibilise Midem attendees and the music business in general, to the needs of including copyright owners in this digital success story. Indeed, how can such supply chain of great audio content work, if copyright owners (i.e. publishers, songwriters, composers) feel disenfranchised and left out of the commercial and financial boon represented by streaming? They will just refuse to keep their songs on digital services providers’ platforms, such as Spotify, Apple Music and Deezer, if they do not get well compensated for such use, potentially crippling the expansion of audio digital distribution channels in the process.
As I had promised I would do, in my earlier article on neighbouring rights, I now turn my attention to how deals are done with digital service providers, in the streaming arena, in relation to the licensing aspects of copyright, in particular performance rights for right owners in the musical composition (as opposed to the sound recording). Here, we focus only on copyright and the situation of right owners in songs and musical compositions – typically, songwriters, composers, music publishers – in films – typically, scriptwriters, film producers – and in books – typically, authors and press publishers.
1. Getting to grips with copyright in the digital era
Copyright was consecrated by law, step by step, in order to ensure that people who create, author and/or produce original content or work (such as authors, writers, composers, songwriters and artists) have exclusive rights for its use and distribution.
Copyright came about with the invention of the printing press and was established first in Britain, as a reaction to printers’ monopolies at the beginning of the 18th century. The English parliament was concerned about the unregulated copying of books and passed the Licensing of the Press Act 1662, which established a register of licensed books and required a copy to be deposited with the Stationers’ Company, thus continuing the licensing of material that had long been in effect.
Copyright has grown from a legal concept regulating copying rights in the publishing of books and maps to one with a significant effect on nearly every modern industry, covering such items as songs, films, photographs, artworks, architectural works, software, etc.
Such exclusive rights granted to content creators are usually for a limited time (in most jurisdictions, the author’s life plus 70 years after the death of the author) and may be limited by exceptions to copyright law, such as fair use in the USA and fair dealing in the UK and Canada. Also, copyright protects only the original expression of ideas, not the ideas themselves, which is referred to as the “idea-expression dichotomy”.
Copyright frequently includes reproduction, control over derivative works, distribution, public performance, transfer of these rights to others, and moral rights, such as attribution.
Copyrights are considered territorial rights, which means that they do not extend beyond the territory of a specific jurisdiction. However, the geographical scope of copyright has been extended thanks to international copyright agreements, such as the 1886 Berne Convention for the protection of literary and artistic works. The Berne Convention introduced the concept that a copyright exists the moment the work is “fixed”, rather than requiring any registration: under the Berne Convention, copyrights for creative works do not have to be asserted, declared or registered, as they are automatically in force at creation. The Berne Convention also enforces a requirement that countries recognise copyrights held by the citizens of all other parties to the convention. Therefore, foreign authors are treated in the same way than domestic authors, in any country signed onto the Berne Convention. The regulations of the Berne Convention are incorporated into the World Trade Organisation’s TRIPS agreement (1995), thus giving the Berne Convention effectively near-global application. These multilateral treaties have been ratified by nearly all countries, and international organisations such as the European Union (“EU“) or World Trade Organisation require their member-states to comply with them.
Since works protected by copyright are consumed more and more online, on digital channels (VOD for video content and streaming and downloads for audio content), a new challenge has arisen to ensure that copyright owners can monetise the exploitation of their works online.
At the EU level, a whole legal framework has been put in place, in order to protect copyright within the 28 member-states and in the digital world. For example, the directive on the harmonisation of certain aspects of copyright in the information society (2001/29/EC) strives to adapt legislation on copyright to reflect technological developments, while the directive 2006/115/EC harmonises the provisions relating to rental and lending rights of works subject to copyright. However, it is mainly the directive 2014/26/EU on collective management of copyright (the “CRM directive“) that reshaped the EU legal framework towards more efficiency in monetising copyright in the digital era.
2. Collecting societies, music copyright and the CRM directive: a step in the right direction for EU right owners
A copyright collecting society, also called copyright collective, copyright collecting agency or licensing agency, is a body created by copyright law or private agreement which engages in collective rights management. Collecting societies have the authority to license works protected by copyright and collect royalties as part of compulsory licensing or individual licenses negotiated on behalf of their respective members. Collecting societies collect royalty payments from users of copyrighted works and distribute royalties back to copyright owners.
Collecting societies are organisations handling the outsourcing function of right management. Copyright owners transfer to collecting societies rights to:
- grant non-exclusive licenses;
- collect royalties on their behalf;
- distribute such collected royalties back to them;
- enter into reciprocal arrangements with other collecting societies around the world and
- enforce their rights.
To understand the role of collective rights management societies, we first need to talk about performing rights. Performing rights represent the greatest source of continuing royalty income. Throughout the world, writers and publishers receive in the area of USD6 billion in royalties each year, from performance rights. The performing right is a right of copyright which applies to the payment of licence fees by music users, when those users perform the copyrighted musical compositions of writers and publishers. This right recognises that a writer’s creation is a property right and that its use requires permission as well as compensation. For example, performances can be songs heard on the radio, underscores in a TV series or music performed live or on tape at a show, an amusement park, a sporting event, a major concert venue, a jazz club or a symphonic concert hall. Performances can be music on hold on a telephone or music channels on an airplane, or digital service providers such as Spotify and Apple Music.
Collecting societies also negotiate license fees for public performance and reproduction and act as lobbying interests groups. They grant blanket licences (i.e. they grant rights on behalf of multiple rights holders in a single blanket licence for a single payment), which grant the right to perform their catalogue for a period of time.
Music users (those that pay the license fees) include the major TV networks, radio stations, pay cable services, digital service providers, websites, concert halls, the hotel industry, nightclubs, bars, theme parks, etc.
Copyright holders will join a collecting society as members and instruct it to license rights on their behalf. The collecting society charges a fee for the licence, from which it deducts an administrative charge before distributing the remainder in royalties. Collecting societies are typically not for profit organisations and are owned and controlled by their members, the right holders.
Most countries in the world have only one collective music rights management society (SACEM in France, SIAE in Italy, PRS in the UK) but the USA have decided to have three organisations, in order to avoid monopolistic and anti-competitive behaviour. Therefore, ASCAP competes with BMI and SESAC, with 96% of the licence fees in performance rights being generated by either ASCAP or BMI in the USA.
For many years, collective rights management societies had a quiet life, apart in the USA where ASCAP, BMI and SESAC fiercely compete with each other, in order to get the best catalogues and music hits in their respective roster.
However, around 2008, quite a few European collective rights management societies were facing serious performance issues, compounded by a highly protective attitude towards other European societies, and an inability to cope with the changes in the way music is getting increasingly distributed online, on the internet.
On 16 July 2008, the European Commission adopted a decision (the “CISAC decision“) prohibiting 24 European collecting societies from restricting competition as regards to the conditions for the management and licensing of authors’ public performance for musical works. The collecting societies were found to have restricted the services they offered to authors and commercial users outside their domestic territory. While the CISAC decision made it easier for authors to select which collecting societies would manage their public performance rights (for example, an Italian author would become able to license his rights to PRS in the UK or SACEM in France), it was deemed to not be enough in order to force European collective rights management societies to make the necessary changes to open themselves up to the market.
Therefore, European institutions stepped up their game and, further to a proposal for a directive on collective rights management and multi-territorial licensing of rights in musical works for online uses, published on 11 July 2012, the EU adopted the CRM directive, the directive 2014/26/EU on collective rights management and multi-territorial licensing of rights in musical works for online uses.
Consequently, in the EU, the conduct of collecting societies is now governed by national regulations which implemented the CRM directive in the 28 member-states by the transposition date of 10 April 2016. Further to the entry into force of the CRM directive on collective management of copyright and related rights and multi-territorial licensing of rights in musical works for online use in the internal market, fairer competition – as well as sound collaboration – have at last arisen between all EU-based collecting societies.
The CRM directive aims to fulfil the following objectives:
- modernise and improve governance, financial management and transparency of the EU collecting societies, in particular ensuring that right holders have more say in the decision making process and receive royalty payments that are accurate and on time;
- promote a level playing field for multi-territorial licensing of online music and
- help create innovative and dynamic licensing structures that encourage the development of legitimate online music services.
EU collecting societies that grant multi-territorial licenses are now required to have “sufficient capacity” to process efficiently and in a transparent manner the data needed to administer multi-territorial licenses. “Sufficient capacity” includes at least capacity to invoice users, collect rights revenue and distribute amounts to rights holders. Also, EU collecting societies must, in response to a “duly justified” request from service providers, rights holders or other societies, provide up-to-date information regarding their online repertoire. Both these requirements are challenges to many EU collecting societies, as timely and accurate invoicing has never been a strong feature of collective licensing in Europe.
For digital service providers that wish to allow users to access easily a vast library of online content, the ability to obtain multi-territorial licenses is the critical factor in enabling service of a pan-European user-base. At a time where digital service providers are not only squeezed by labels, but pressured by authors and publishers to increase royalties, it is not yet clear whether the national transposition regulations of the CRM directive will go far enough to protect digital service providers’ interests.
At least, EU collecting societies are now embarking themselves into pan-European licensing collaborations such as ICE (an online music rights licensing and processing hub formed by three of the EU largest collection societies, PRS (UK), STIM (Sweden) and GEMA (Germany)) and Armonia (another online music rights licensing and processing hub formed by SACEM (France), SGAE (Spain), SIAE (Italy), SACEM Luxembourg, SABAM (Belgium), SUISA (Switzerland), AKM (Austria), SPA (Portugal), Artisjus (Hungary)) which both received clearance from the European Commission to enable faster and simplified rights negotiations for digital service providers operating in the EU. In May 2016, ICE signed its first license deal in the digital market place, partnering with Google Play Music.
3. The master stroke: copyright and the EU digital single market
In July 2014, ahead of his European Commission presidency, Jean-Claude Juncker published his political guidelines for a new Europe. Central to his agenda was a connected Digital Single Market (“DSM“), which triggered proposed EU legislation aimed at making the most out of digital technologies, and at the removal of restrictions to free movement of digital goods and services. Among the reforms, were changes to telecoms regulations (the end of mobile phone roaming charges), data protection (approval of the General Data Protection Regulation) and EU copyright laws.
The EU copyright reforms, in particular, are highly ambitious with a series of key proposals announced by the European Commission in September 2016:
- a EU regulation facilitating broadcasters by requiring only country of origin clearance for ancillary online services (for example, simulcasts, music, e-books, games or catch-up services) which are available across the EU, which was adopted on 8 June 2017;
- a EU directive and a EU regulation to implement the Marrakesh Treaty: the former providing a mandatory exception to facilitate access to published copyrighted works for people who are blind, visually impaired or print disabled, and the latter permitting the cross-border exchange of copies between the EU and other countries that are party to the Treaty and
- a proposal for a EU directive on copyright in the DSM (the “DSM proposal“).
The key provisions of the DSM proposal include:
- providing rights of fair remuneration in contracts for authors and performers;
- creation of an ancillary right for press publishers;
- obligation on online service providers (social networks, platforms, etc) to take measures to prevent infringement;
- new mandatory exceptions to infringement;
- facilitating the use of out-of-commerce works by cultural heritage institutions.
The DSM proposal aims at reducing the differences between national copyright regimes and allowing for wider online access to copyrighted works by users across the EU. It recognises that, despite the fact that digital technologies should facilitate cross-border access to works, obstacles remain, in particular for uses and works where clearance of rights is complex.
As regards audiovisual works, the DSM proposal sets out, despite the growing importance of VOD platforms, EU audiovisual works only constitute one third of works available to consumers on those platforms! Again, this lack of availability partly derives from a complex clearance process. The DSM proposal therefore provides for measures aiming at facilitating the licensing and clearance of rights process, to ultimately facilitate consumers’ cross-border access to copyright-protected content.
In particular, the DSM proposal provides for fair remuneration in contracts of authors and performers, in its articles 14 to 16. Since authors and performers often have a weak bargaining position when licensing their rights, the DSM proposal sets out a “transparency obligation” whereby member-states will be required to ensure that authors and performers shall have the right to information about the exploitation of their works. The obligation may be adjusted where it is disproportionate or disapplied where the contribution of the author is not significant. The provisions go on to provide a “contract adjustment mechanism” so that authors and performers can request additional remuneration from the party with whom they contracted when the remuneration originally agreed is disproportionately low to the subsequent revenues and benefits derived from exploitation of the works or performances. Member-states are also required to provide a voluntary, alternative dispute resolution mechanism. The EU parliament proposes two small amendments: recognising rights to equitable remuneration, and providing authors and performers with the option to appoint representatives for seeking contract adjustments on their behalf.
Another reform set out in article 11 of the DSM proposal, aiming at efficiently monetising copyright in the digital era, is the ancillary right for press publishers. The European commission has said the proposed right aims to address the difficulties faced by press publishers in licensing their publications online: the problem comes from recouping their investment as against those who reproduce their content online for free. Article 11 of the DSM proposal strives to fight this problem by requiring member-states to provide “publishers of press publications” with rights to control the “reproduction” and “making available to the public” rights that are available to authors. This ancillary right is intended to last for twenty years from January 1 in the year following the press publication. A “press publication” is defined as a “fixation of a collection” of journalistic literary works. Similar laws have been introduced in Germany and Spain and it has been reported that these have led to delisting of press publications on news sites, resulting in reduced traffic to publishers’ own sites.
The European Commission proposes to address the so-called “value gap” between licensed streaming services, which pay for the content they host, and intermediaries, such as social media networks (Facebook) and online platforms (YouTube), which host infringing content. The e-commerce EU directive provides a “safe harbour” defence to these intermediaries, with a notice and take-down regime. However, rather than make amendments to the e-commerce EU directive, article 13 of the DSM proposal sets out that “information society service providers that store and provide to the public access to large amounts of works uploaded by their users shall, in co-operation with right holders, take measures to ensure the functioning of agreements concluded with right holders for the use of their works or to prevent the availability on their services of works identified by rightholders through the cooperation with service providers“. The European Commission suggests that such measures may include the use of content-recognition technologies. This article 13 seems at odds with the e-commerce EU directive, its safe harbour provisions and the assurance of no obligation to monitor information transmitted or stored. Therefore, we can expect to see further discussion between the European commission and the EU parliament on how to properly address the “value gap”. One thing that is for sure is that music copyright owners, publishers in particular, are particularly irritated by existing safe harbour laws in place in the EU and the USA and want intermediaries to become fully accountable for the damage that infringement on their platforms causes to copyright owners.
Another notable reform brought by the DSM proposal is the improvement of licensing practices and wider access to content. The European commission puts forward measures to facilitate the digitisation and licensing of out of commerce works. These are works that are not available to the public through customary channels of commerce and which are often held by cultural heritage institutions. The purpose of these provisions is to provide wider access to these materials and to guarantee the cross-border effect of licensing agreements.
Let’s watch the space, as far as the DSM proposal is concerned, but it definitely constitutes a step in the right direction, in order to improve the monetisation of works protected by copyright in the EU single digital market.
4. Technological solutions to better monetisation of copyright in the digital era: a work in progress
Midem 2017 was a whirlwind of fancy technical propositions to tackle transparency, as well as efficient and accurate ways of paying royalties to copyright owners in the digital era.
The creation of a global database of musical copyrights and works was, yet again, envisaged, despite the fact that the Global Repertoire Database (“GRD“) was a resounding failure in 2014 due to a lack of appropriate coordination between, and funding from, various stakeholders such as Universal, EMI Music Publishing, tech companies such as Apple, Nokia and Amazon and collecting societies such as PRS (UK), STIM (Sweden) and SACEM (France).
Other technical suggestions envisaged were the use of sophisticated rights administration and management software solutions such as Counterpoint, the standardisation of data such as streamlining ISWC codes, the improvement of metadata provided to digital service providers by music publishers and labels, and using blockchain to structure a new database, with streamlined ISWC codes and accelerate payment of royalties through smart contracts and bitcoins.
It seems to me that all these technical solutions, in particular the creation of a copyrights’ database and the implementation of clear ISWC codes and sets of metadata will only be implementable when their installation is coordinated by pan-European and mandatory regulations enforceable in the 28 member-states of the EU.
To conclude, while the interests of copyright owners are increasingly being looked after, thanks to both legal and technical processes and tools more adapted to the fluid changes triggered by new means of consumption of copyrighted works in the digital era, it still feels like it is a “touch-and-go” approach that is put in place here. Although both copyright owners and digital service providers have everything to win in increasing transparency and prompt collection of digital royalties, while substantially reducing the value gap which greatly benefits intermediaries protected by safe harbour, I am under the impression that they do not really communicate efficiently together and do not think that their interests are aligned.
Annabelle Gauberti, founding partner of music law firm Crefovi, which specialises in advising the creative industries, out of Paris and London. Having worked with creative clients for more than fifteen years, Annabelle is an avid believer in the importance and value of looking forward, and planning ahead, to thrive in the current music industry and its new paradigm. The work undertaken by her regularly includes advising songwriters and composers on publishing deals; producers and performers on record deals and all of the latter on streaming deals and sync transactions; as well as intellectual property registration and protection, intellectual property and commercial litigation, negotiating merchandise deals and partnerships between brands and bands.
While at the Cannes Film Festival in May 2016, we could not help noticing that one of the hottest topics discussed by all film professionals in attendance was film finance, or lack thereof. Also, Crefovi film clients regularly ask for our input on this touchy subject. How to finance your film production nowadays? What are the best strategies to get your film funded and produced, in this day and age?
Well, here is the lowdown: it’s not easy. You will have to work hard and in an efficient and professional manner to secure the trust and hard-won cash of all those stakeholders who can finance your film project or, at least, allow you to save money while producing your film.
1. What do you need film financing for exactly?
The cost items for a film project are vast, both in numbers and sizes, and can be divided according to the various stages of filmmaking, as follows.
1.1. The idea
All films start with a moment of inspiration. Good ideas and story concepts are the foundation of any solid film project. Screenwriters usually have the initial idea or story but producers, who are in charge of raising money for a film project, frequently come up with ideas as well.
Ideas for films can be original or adapted from plays, novels or real-life events, which make up approximately half of all Hollywood films.
Ideas cannot be protected by copyright – or any other intellectual property right for that matter – because copyright subsists only in the tangible expression of ideas. This is referred to as the idea/expression dichotomy.
Therefore, film makers must take all adequate measures to protect their ideas and stories, by only divulging them after having taken some prior protective measures (such as having the recipient of the information relating to the idea sign a non-disclosure and confidentiality agreement) and/or by even subscribing to producer errors and omissions insurance and multimedia risk insurance which cover legal liability and defence for the film production company against lawsuits alleging unauthorised uses, plagiarism or copying of titles, formats, ideas, characters, plots, as well as unfair competition or breach of privacy or contract.
1.2. Development finance
The next stage in the development of a film project is to turn a rough idea or story into a final script ready for production.
Development money is the financial sum that you need to invest in your idea, until it is in a form suitable for presenting to investors and capable of attracting production financing. Development money is used, for example, to pay the writer, while the script is being written or re-written, as well as the producer’s travel expenses to film markets to arrange pre-sales financing from investors, as well as location scouting and camera tests. It also covers the cost of administration and overheads until the film is officially in pre-production.
Producers typically pitch to secure the money for the development of the script, or, if they can afford it, put up development money themselves.
Indeed, development finance is the most expensive and financiers who put up development money typically expect a 50% bonus plus 5% from the producer’s fees. Bonus payment is usually scheduled to be paid on the first day of principal photography (i.e. the shoot or production), along with the 5% of the producer’s profits as the film starts to recoup.
1.3. Script development
Once development finance is secured, and once a story idea is firmly in place, the negotiation process between the screenwriter and the producer (or production company or film studio) begins.
The writer hires an agent who represents him and plays a critical role in ensuring that the writer’s interests are represented in the negotiation process. The agent also ensures that the writer is paid appropriately in accordance with what the writer’s intellectual property rights may be worth in the future.
The producer has an alternative, in order to move the film project forward on the script development front: either he can buy the rights to the story idea or the material (a novel or play) from which the script was adapted outright, or he can buy an option of the film rights. The first transaction is an assignment of copyright. Buying an option of the film rights means that the producer owns the right to develop the film but only for a certain amount of time, it is therefore an exclusive licence of copyright.
In either cases, the producer is the only person allowed to develop the film idea into a screenplay. He pays the writer in smaller, agreed-upon instalments throughout this period, and may also agree to pay such writer a significant higher amount for all film rights once shooting begins. After the terms are negotiated, the writer can finally start working on the screenplay.
The scriptwriter then enters into action and, if needed, may first write a screenplay synopsis, also called “concept”. Unlike a “treatment”, which is a narrative of everything that happens in a screenplay, a synopsis includes only the most important or interesting parts of the story. A synopsis is a short summary of the basic elements in your story. It describes the dramatic engine that will drive the story in no more than a few sentences.
If the producer likes the synopsis, then the writer will proceed onto drafting the treatment, which, as mentioned above, is a prose description of the plot, written in present tense, as the film will unfold for the audience, scene by scene. A treatment is a story draft where the writer can hammer out the basis actions and plot structure of the story before going into the complexities of realising fully developed scenes with dialogue, precise actions, and setting descriptions. The treatment is the equivalent of a painter’s sketch that can be worked and reworked before committing to the actual painting. It’s much easier to cut, add, and rearrange scenes in this form, than in a fully detailed screenplay.
The author’s draft is the first complete version of the narrative in proper screenplay format. The emphasis of the author’s draft is on the story, the development of characters, and the conflict, actions, settings and dialogue. The author’s draft goes through a number of rewrites and revisions on its way to becoming a final draft, which is the last version of the author’s draft before being turned into a shooting script. The aim of an author’s draft is to remain streamlined, flexible and “readable”. Therefore, technical information (such as detailed camera angles, performance cues, blocking, or detailed set description) is kept to an absolute minimum. It is important not to attempt to direct the entire film, shot-for-shot, in the author’s draft. The detailed visualisation and interpretation of the screenplay occur during later preproduction and production stages.
Once you have completed your rewrites and arrived at a final draft, you will be ready to take that script into production by transforming it into a shooting script. The shooting script is the version of the screenplay you take into production, meaning the script from which your creative team (cinematographer, production designer, etc.) will work and from which the film will be shot. A shooting script communicates, in specific terms, the director’s visual approach to the film. All the scenes are numbered on a shooting script to facilitate breaking down the script and organising the production of the film. This version also includes specific technical information about the visualisation of the movie, like camera angles, shot sizes, camera moves, etc.
Once the script is completed, the producer sends it to film directors to gauge their interest and find the appropriate director for his film project.
The director and the producer then decide how they want to film the movie and who they will employ to support them in achieving this result.
One common way to make the film project more commercial is to attach well-known stars to the script.
In order to turn the film into a proper business proposition, the producer must know how much the film will actually cost to be made.
Potential investors would want to know how the producer plans to raise the money and how the producer plans to pay them back.
Agents and agencies are the lifeblood of the film business. They structure the deals, they hold the keys to each and every gate and often make or break projects. Having strong relationships in this space, for a film producer, is as important as having a strong story on which to base your project.
Agency packaging refers to the fact that an agency will assist in one/all of the following: talent packaging, financing, sales and international representation. Keep in mind that agencies earn their revenue based on a 10 to 15 percent commission of their client’s fees (not only talent, but also writers, producers, directors, etc) and therefore having an agency package an entire project as opposed to having them simply have a single member of their roster involved, will go a long way.
The underlying principle to remember is that agents are looking at each opportunity as a business transaction: regardless of the project, it still boils down to a decision based on the bottom line. As such, finding the right agency (the big agencies are not always the right fit for smaller projects) and incentivising agents by offering full packaging capacities will yield the best results both financially and strategically.
Filmmaking is an expensive business, and the producer must secure enough funding to make the film at the highest possible standards.
To obtain the investment needed to make the film, the producer must travel to, and meet with, potential investors and successfully pitch his project.
The producer’s lawyer will then draw up contracts to seal financing deals between the producer and investors or financiers. Indeed, there are departments of banks that specialise in film finance and offer film production loans.
The producer can also make money from pre-sales, selling the rights to the film before it has even been made. For example, during the Cannes film festival and market 2016, motion picture and television studio STX landed the big prize by plunking down roughly USD50m for international rights to Martin Scorsese’s next film project, “The Irishman”.
Once the financing is in place, the production company hires the full cast and crew and detailed preparation for the shoot begins.
A distinction is made between above-the-line personnel (such as the director, the screenwriter and the producers) who began their involvement during the film project’s development stage, and the below-the-line “technical” crew involved only with the production stage.
It is worth noting that, in France, most film directors do not only direct but also produce, co-produce and almost always write the screenplays for their films. Therefore, their income is made up of a salary, as director-technician, to which is added a minimum guarantee as director and another minimum guarantee as screenwriter of the film, with or without additional screenwriters.
All heads of department are hired, such as the location manager, director of photography, casting director, script supervisor, gaffer, production sound mixer, production designer, art director, set decorator, construction coordinator, property master, costume designer, key makeup artist, special effects supervisor, stunt coordinator, post-production supervisor, film editor, visual effects producer, sound designer. The shooting script is circulated to all of them as pre-production begins.
The casting director, director and producer begin to identify and cast the actors.
Storyboards are made, out of the final script. They are used as blueprints for the film where every shot is planned in advance by the director and director of photography. They have a sequence of graphic illustrations of shots visualising a video production. Most high budget films will have a very detailed storyboard. Those storyboards can really smooth out the post-production process too, when it is time for editing.
The production designer plans every aspect of how the film will look and hires people to design and build each part.
All other heads of department also go through this planning process and hiring process, for their respective department.
Effect shots are planned in much more detail than normal shots and could potentially take months to design and build.
1.7. The shoot or production
Filmmakers and producers must take a careful approach to green lighting the film project and moving forward with production, by requiring unanimous consent from producers, sales agents and board of directors of the film specially-incorporated company, before proceeding.
Shooting starts and funding is released, which is a key stage in filmmaking.
A large film production can involve hundreds of people, and it is a constant struggle to keep up with the shooting schedule and budget. Film productions are ran with strict precision. Production schedules are typically between 9 to 30 days, and you usually spend 12 to 14 hours on set, shooting from dawn to dusk. If film productions fall behind schedule, financiers and insurers may step in.
A 90 page script produced on a 24 day shooting schedule allows the director proper time on set, while keeping overall costs minimum – averaging under 4 pages per day.
The camera department is responsible for getting all the footage that the director and editor need, to tell the story.
Once lighting and sound are set up, and hair and make up have been checked, the shoot can begin.
Every special effect is carefully constructed and must be filmed with minimum risk of injury to cast and crew.
Production is a very intense and stressful process, especially for the producers and film director.
Post production usually starts during the shoot, as soon as the first “rushes” – raw footage – and sound are available. As the processed footage comes in, the editor turns it into scenes and assembles it together, into a narrative sequence for the film.
The editor will read your script and storyboards, and look at the rushes, and from this information, cut the film according to their opinion of what makes the story better.
There are two ways of doing post-production:
- the old way, i.e. celluloid film way. Shoot film and edit, or splice film on film editing equipment. There are few filmmakers who edit this way today;
- the new way is the digital way. You get all your rushes digitised (if shot on film, you will need them telecined, or scanned to a digital format).
The normal schedule for editing a feature is 8 to 10 weeks. During this time, your editor will create different drafts of your film. The first is called the “rough cut”, and last is the “answer print”.
There are two conclusions to an edit, the first when you are happy with the visual images (locking picture) and the second when you are happy with the sound (sound lock).
Once the picture is “locked”, the sound department works on the audio track laying, creating and editing every sound.
Digital effects are added by specialist effects professionals and titles and credits are added.
The final stage of the picture edit is to adjust the colour and establish the final aesthetic of the film.
During that post-production phase, it is also usual to get:
- a digital cinema package – a hard drive which contains the final copy of your film encoded so it can play in cinemas;
- a dialogue script, so that foreign territories can dub or subtitle your film, which has the precise time code for each piece of dialogue so the subtitler or dubbing artist knows exactly where to place their dialogue;
- a campaign image (with titles and credits), which is the first thing a prospective distributor or festival programmer will see of your film and which should let the viewer know exactly what your film is about;
- a 90 to 120 second trailer that conveys the mood and atmosphere of your film, knowing that programming and distribution decisions will be often be based on the strength of your trailer.
While the film is still in post-production, the producer will try to sell it to distributors (if he has not already sold the rights at the financing stage).
Filmmakers and producers must have a pre-sales distribution and market strategy in place, that optimises back end profitability of the film. Targeting major film markets – Cannes, Berlin, Toronto, Sundance, Tribeca, Venice and emerging South by South West – is key to a successful B-to-B marketing strategy, while the same sales agent who packaged the film oversees the final sale.
The film sales world is split up as the domestic market and international market and there are specific sales companies for both specific markets.
Producers tend to work without sales assistance on the domestic deals as it is in the best interest of the producer to form these relationships and close the deal personally, to have an open door for future projects that will need similar distribution.
To help sell the film internationally to distributors, the producer secures the services of a sales agent and markets his film by sending it to film festivals. High profile screenings at top film festivals can be great to generate “clout” for the film.
The trailer is used to show buyers the most marketable aspects of the film.
Distributors are fickle in many senses. The business has changed (think of the recent growth of video on demand streaming services) and international versus domestic deals are becoming challenging. Indeed, being a distributor is still a risky business: if the film is a success, distributors only earn their commissions; while if it is a failure, they lose their minimum guarantees, prints and advertising expenses (P&A). This is why the best way to be a successful distributor, nowadays, is to be also the producer, or at least co-producer because you then earn money on the much higher residuals and international rights, compared to domestic theatrical rights only.
Finding the right distributor takes time. Example of boutique distributors are HBO, IFC, Magnolia, Focus Features or Miramax for broadcast, VOD and content streaming. The search process of the most appropriate distributor for your film project, will give you practice pitching it, as well as the ability to review many different sellers to gauge style, ability and creative fit.
Just as the agencies are self-motivated, so too are sales agents (international film brokers) and distributors (buyers and exhibitors) motivated by the bottom line economics of the deal. Yes, there are buyers and sellers who specialise in content-focused for the art-house driven markets, but they are becoming fewer and fewer.
As the finishing touches are being made to the film, the distributors plan their marketing strategy to “sell” the movie to the public.
Knowing the audience is essential and the marketing team runs test screenings to see how the film is received.
Press kits, posters and other advertising materials are published, and the film is advertised and promoted. A b-roll clip may be released to the press, based on raw footage shot for a “making of” documentary, which may include making-of clips as well as on-set interviews.
Cinema expedition, also called theatrical release, is still the primary channel for films to reach their audiences.
Indeed, box office success equals financial success.
Film distributors usually release a film with a launch party, a red-carpet premiere, press releases, interviews with the press, press preview screenings, and film festival screenings.
Most films are also promoted with their own special website separate from those of the production company or distributor.
For major films, key personnel are often contractually required to participate in promotional tours in which they appear at premieres and festivals, and sit for interviews with many TV, print and online journalists.
The largest productions may require more than one promotional tour, in order to rejuvenate audience demand at each release window.
1.12. Other windows
A successful run in cinemas makes the film a sought-after product, which can be sold through other more lucrative channels such as DVDs and games.
Since the advent of home video in the early 1980s, most major films have followed a pattern of having several distinct release windows. A film may first be released to a few select cinemas (limited theatrical), or if it tests well enough, may go directly into wide release.
A popular option, to develop the domestic sales potential of a film, is to have a first phase initial release on a limited theatrical platform, paired with a joint digital download release on iTunes and Amazon – sales are driven by major market theatre visits and digital downloads in smaller markets. The second phase release via VOD and pay cablers such as HBO, Showtime and potentially Hulu – sales are then driven by word of mouth built from first phase. This is often followed by a third phase, which pairs Netflix and Amazon Prime streaming with a wide DVD release to drive streaming view and build DVD purchases. Finally, in its fourth phase, the film builds upon steady sales and word of mouth audience reception, to gain network television sales and eventual syndication. In broadcasting parlance, syndication is the licensing of the right to broadcast television programs by multiple TV stations, without going through a broadcast network.
Next, the film is released, normally at different times several weeks (or months) apart, into different market segments like rental, retail, pay-per-view, in-flight entertainment, cable, satellite, or free-to-air broadcast television. Indeed, the film may be released in cinemas or, occasionally, directly to consumer media (DVD, VCD, VHS, Blu-ray) or direct download from a digital media provider. Hospitality sales for hotel channels and in-flight entertainment can bring in millions of additional revenues.
Indeed, today, residuals, or neighbouring rights, as those additional revenues are called, bring in most of the profit for the film, not theatrical rights. Those residuals are collected by collection agents, such as Fintage House and RightBack, which adds transparency to the process of collecting revenues generated by the film.
The distributor rights for the film are usually sold for worldwide distribution.
The distributors and the production company then share profits.
As a film producer, you should “trust the shuffler but cut the deck”, by ensuring that you have an audit clause inserted in the distribution agreement, which will allow you to audit the accounts of the distributor in order to check that all collected revenues, from all sources, are indeed included in the residuals statements that you received from such distributor.
It is worth noting that, in at least 10 countries from the European Union, including France, Germany, Spain, Belgium, distributors of pay-TV services and/or operators of VOD services are required by law to contribute to the funding of production, either through contributions to support funds or by means of direct investments in production. The arrangements are generally complimentary to and extend tax law provisions requiring contributions from exhibitors, broadcasters and video distributors: all distribution activities must contribute to the funding of production.
2. How do you finance a film nowadays?
First things first: have you made a business plan? Creating a business plan is almost as important as finding a terrific script. You need to prepare a plan of attack to get the money to shoot your film. Indeed, as a producer or filmmaker, you need to make creating a viable and realistic business plan your first priority. Many filmmakers create an outline business plan first, and then find a script that matches what they think they can raise.
2.1. The studio model
The strategy, here, is to get 3 to 5 films together of a similar genre, and approach investors with a slate of similar films. If one of these films is successful, it will pay off for itself and the other 2 to 4 other film projects on the slate.
While this strategy consisting in hedging your risks by having more than one egg in your basket sounds great, a reality check is necessary: do you really think that you can get more than one project together? You may want to collaborate with some like-minded filmmakers with similar projects.
2.2. Government funding
Many nations now have attractive tax and investment incentives for filmmakers. Individual state and country legislation unable producers to subsidise spent costs for production.
For example, Europe’s MEDIA programme has twenty-odd programmes for media and filmmakers. You need to apply for the funding and lobby decisions makers until you get your soft money.
Many European filmmakers design a business plan around the rules and regulations surrounding the MEDIA money. The same applies for soft money from other countries as well.
Another example is the UK government, which pumps tens of millions of pound sterling into British film every year (using National Lottery funds!). Following the heavily criticised demise of the UK Film Council, UK public money is now distributed by the British Film Institute (BFI). Film London has also put in place a Production Finance Market (PFM), its annual two-day film financing event, run in association with the BFI London Film Festival. PFM encourages new business relationships, between UK filmmakers, producers and investors, attaching international sales companies and securing various forms of investments in companies and film projects.
As soft public money funds are always heavily oversubscribed and lobbied for by competing filmmakers and producers, you should not be over-reliant on getting government funding. In addition, those funds will impose restrictions, that could easily compromise your creative integrity.
Hard cash investments made to your film project by a single investor, a group of investors and personal investments from colleagues, friends and family.
Equity investments require that investors own a stake in the film (i.e. the operating structure, special purpose vehicle incorporated for that particular film project). They also must be paid back (typically on their principal investment plus 20 percent) before profit is seen on the side of the filmmakers and producers.
2.4. Tax finance
It’s all about de-risking your film package.
Through its Enterprise Investment Scheme (EIS) and Small Enterprise Investment Scheme (SEIS), the UK government has created one of the world’s best environments for de-leveraging the risk of investments made in small businesses up to 98 percent (depending on the investors profile). EIS is designed to support smaller higher-risk trading companies to raise finance by offering a range of tax reliefs to investors who purchase new shares in those companies.
Film projects are qualifying business for EIS and SEIS, however we heard that the European Commission has audited the UK EIS and SEIS schemes and only wants long-term UK small businesses to benefit from such schemes, ruling out special purpose vehicles incorporated for each film project. With a Brexit in the works though, it is likely that EIS and SEIS will still be used to finance UK film projects, in the future.
To get all EIS or SEIS up and running, you need to get a strong business plan together with a budget and schedule. Fill in a few online tax forms and get your UK limited company registered for EIS. If you get stuck, phone a really nice lady in Wales who will make sure your secure the paperwork.
While investing in a film is seen as “sexy” by many private investors, the recent economic downturn, Brexit and the competitiveness of securing EIS and SEIS among filmmakers and producers, make investors shy and cautious. It may be worth speaking to UK film financiers, such as the Fyzz Facility (now merged with Tea Shop), who have a pool of private investors who are ready to invest, via gap funding (as this term is defined below in paragraph 2.6 (Gap financing)), through EIS and SEIS.
In France, Sociétés de financement de l’industrie cinématographique et de l’audiovisuel (SOFICAS) are the equivalent tax-wrappers to EIS and SEIS. They are equity funds financed with tax-related money and are allowed to invest in both films and TV productions, on a selective basis. Their money comes from banks which are allowed to collect, from French tax resident private investors who want to pay less income tax in France. As SOFICAS want their money back, they tend to do mostly gap funding (as this term is defined below at paragraph 2.6), providing producers with the last (and most expensive) money. SOFICAS generally stand behind the distributors in the recoupment order. Only part of the SOFICAS money is invested in independent film productions. Each SOFICA can invest 20 percent of its money in foreign-speaking (qualified) co-productions, as long as the film’s language matches the foreign co-producer’s country’s language. In 2015, SOFICAS invested Euros37m in 112 movies, 11 of which were majority foreign co-productions, mostly from British or Belgian producers. A top manager of SOFICAS for the media and entertainment sector in France, is Back-up Media.
Tax incentives require a producer to hire a certain number of local crew employees, rent from local vendors and run payroll through local services. Tax credits are based on an application process and are often lengthy (12 to 18 months) and difficult (as they may involve a substantial amount of tedious paperwork) to procure.
For example, UK film tax relief ensures that, for film spending GBP20m or less, production companies can claim a cash rebate of up to 25 percent of qualifying expenditure. For films spending more than GBP20m, production companies can claim a cash rebate of up to 20 percent of qualifying expenditure. The UK film tax relief is largely responsible for the recent influx of international blockbuster movies into the UK: “Star Wars: the force awakens” (LucasFilm), “Avengers: age of Ultron” (Marvel Studios) and the latest James Bond film “Spectre” (EON) have all been shot in the UK, mostly out of Pinewood Studios.
In France, the Tax Rebate for International Productions (TRIP) concerns projects wholly or partly made in France and initiated by a non-French film production company. It it selectively granted by the French national centre for cinema, CNC, to a French production services company. TRIP amount up to 30 percent of the qualifying expenditures incurred in France: it can total a maximum of Euros30m per project. The French government refunds the applicant company, which must have its registered office in France. “Thor” (Marvel Studios), “Despicable Me” and “the Minions” (Universal Animation Studios) and “Inception” (Warner Bros) have benefited from TRIP.
For French film productions, the Crédit d’impôt cinéma et audiovisuel (CICA) benefits French producers for expenses incurred in France for the production of films or TV programmes. The CICA tax credit is equal to 20 percent of eligible expenses – increased to 30 percent for films for which the production budget is less than Euros4m.
Certain tax credits are sellable, transferable and even trade-able based on the local legislation. US states such as New Mexico, North Carolina, Georgia, New York and Michigan offer the strongest solutions here.
It is really worth for film producers to organise a “competition” between various countries and territories as well, based on available tax rebates and government funding, before deciding in which country to produce and post-produce a film. Indeed, the UK and France are always in rivalry, Film France CEO Valerie Lepine-Karnik noting that “last year (in 2014), American blockbusters spent more than Euros1.6bn in the UK, which is half a million more than the total amount of money invested in French domestic film production in 2014″.
2.5. Pre sales and co-productions
The strategy, here, is to sell your film cheap up front (pre-sales) and hook up with producers in other countries to secure soft public money in other territories. Indeed, by co-producing, you can take advantage of soft money otherwise not normally accessible to your film production.
Pre-sales agreements are pre-arranged and executed contracts made with distributors before the film is produced. These agreements are based on the strength of the project’s marketability and sales potential in each given territory. A distributor will generate a value for your film project, given the script, the attached talent and crew, as well as the marketing approach, and then enable you to take out a bank loan using the pre-sales deal as collateral. Pre-sales can also result in direct payment (at a discounted rate) from the buyer themselves. Pre-sales investments require that the producer pay back the bank its loaned capital before profiting on their respective upside.
Both the UK and France have bilateral co-production treaties in place with certain countries such as:
- Australia, Canada, China, India, Israel, France, Jamaica, Morocco, New Zealand, Occupied Palestinian Territories and South Africa, for the UK;
- and Algeria, Argentina, Australia, Austria, Belgium, Bosnia-Herzegovina, Brazil, Bulgaria, Burkina Faso, Cambodia, Cameroon, Canada, Chile, China, Colombia, Croatia, Czech Republic, Denmark, Egypt, Finland, Georgia, Germany, Greece, Guinea, Holland, Hungary, Iceland, India, Israel, Italy, Ivory Coast, South-Korea, Lebanon, Luxemburg, Morocco, Mexico, New Zealand, Poland, Portugal, Palestinian Territories, Romania, Russia, Senegal, Serbia, Slovak Republic, Slovenia, South Africa, Spain, Sweden, Switzerland, Tunisia, Turkey, Ukraine, United Kingdom, Venezuela, for France.
For example, Ken Loach’s films, mainly produced in the UK, benefit from French funds through French production company Why Not since “Looking for Eric” in 2009. “Mr Turner” by Mike Leigh was co-produced by Diaphana.
Moreover, the European Convention on cinematographic co-productions applies for now, in both countries, although this will cease to be the case for the UK after Brexit.
While co-production can work, it can be difficult to set up co-productions and you will now have financial partners in various territories who will probably all want to exercise creative control. Also, you, the producer, will have to share any revenues generated by your film not only with the distributors, but also with your co-producers scattered in various countries.
2.6. Gap financing
With partial equity raised, you are then able to procure a loan from a bank or a private lender on the unsold territories of the film (and additional elements of collateral, such as the intellectual property or corporate guarantees).
Gap financing is only available when other elements have been assembled and there is adequate security for the investor to “bridge” against.
2.7. Product placement
The strategy is to team up with brands and get cash for including their products on set.
For example, Heineken reportedly paid a third of “Skyfall” ‘s USD150mn budget to turn Daniel Craig’s James Bond into a lager drinker!
Not only do you get some of your film funding through product placement, but the product exposure the brand enjoys may have a far greater value than the cost of the product placement and is generally seen to be cheaper than comparative advertising on TV or print.
However, having a product placement in a film means that you will always be under the scrutiny of brand managers, which may hamper the film creative process. Moreover, few independent filmmakers have the polling power of James Bond! Brands will always want to know what the marketing strategy of your film is, before they invest in, or even allow their products to be used.
Crowdfunding (Kickstarter, IndieGoGo, Ulule, Kiss Kiss Bank Bank, etc.) is now a serious contender to raising finance for your film projects. It enables a contributions-based model for capital to be raised without selling equity.
For example, the “Veronica Mars” Movie project and Spike Lee’s latest film project “Da sweet blood of Jesus”, were all financed through Kickstarter in 2013. Spike Lee raised USD1.4m for his horror flick on contemporary vampires, not a negligible amount by any means.
The strategy is that you get some rewards (such as DVDs, t-shirts, sharing dinner with the famous film director) together and offer them to friends, family and fools, as well as to the crowd, hoping to entice them into making a contribution to your film project. The idea, here, is to build a community who adheres to your story.
Even the studio biggies are using crowdfunding nowadays: Charlie Kaufman, an American screenwriter, producer, director famous for writing “Being John Malkovich” and “Eternal sunshine of the spotless mind”, raised over USD400k for his new project Anomalisa.
This is crowding the pitch and makes it even tougher to get enough noise directed your way. Therefore, you need a really good business plan in order to successfully approach crowd funding.
The strategy is to get everybody to work and be paid later, out of profits if any. Indeed, producers are able to avoid nearly all costs on a project if they are able to negotiate a deferred deal.
Convince everyone that in order to get the film made now, you cannot wait for investment. In exchange, you offer up a percentage of the share of profit, meaning that everyone’s salary could potentially increase depending on the success of the film.
Deferred agreements basically state that crew, cast, vendors, locations and services are all rendered upfront at no cost, until the film generates money upon release.
Deferrals may work but are reliant on the trust the producer has with his team. Often, deferrees are unpaid, even though the film goes on to commercial success. There is also the temptation to overstate the value of the deferment which can lead to bitter arguments if the box office returns do not meet expectations. Moreover, deferred financing is difficult because experienced cast and crew are unwilling to work under these types of structures.
2.10. Self-financed film projects
Self-financed movies mean you do not have to deal with investors. It also does mean that you have to be very careful with the money, which is yours.
For example, Tangerine’s director, Sean Baker, shot his feature film entirely on 2 iPhones and went on to become one of the most hyped film directors in 2015, as Tangerine was reviewed by many critics as one the the best films of 2015. In an interview with Bret Easton Ellis in 2015, 45 years old Sean Baker confessed to still be heavily in debt and reliant on the goodwill and empathy of his parents, to make ends meet.
While getting your film done immediately with your own resources is an enticing prospect and very achievable in today’s digital world, it is worth noting that most of these thousands of self-financed movies fail, mostly due to the fact that their scripts are not good enough. By going the self-financed indie route, filmmakers have side stepped the development cycle and no one has told them that their script sucks.
3. How do you make your film project stand out to financiers?
As mentioned in our introduction, it is tough to get films financed in today’s market. Of course, a strong script, a great team with experience and a game plan for success are prerequisites, but that’s not enough. The key factor to equity investors and debt lenders, is to remove risk, financial exposure and speculation – meaning, when are they going to start earning a return or their money back, and can you guarantee that? The more risk and speculation you remove, by utilising the steps below, the better chance you will have of securing capital in “hard money”.
As mentioned above in paragraph 1.4. (Packaging) above, talent agencies are a difficult nut to crack. They are well-guarded, highly established and protected entities. They are the gatekeepers of taste, talent and possibility – and more than anything they are the lifeblood of the independent producer seeking to put projects together with financing.
Once you have a suitable piece of material, get an agent/agency excited about the project as well. The way forward is approaching the major five talent agencies – William Morris Endeavor, United Talent Agency, Creative Artists Agency, The Gersh Agency and International Creative Management – for the packaging of quality source material – script, paired with proven name talent – actors and directors, under the representation of a successful in-house sales agent.
As with most of the entertainment business, agents think in numbers – how much will my firm/I make from this deal? Incentivize the agency by offering them the ability to package the project – place multiple roles with their roster rather than just one or two roles – which gives them the ability to earn 10 to 15 percent of multiple deals across the board.
Furthermore, offer them the ability to have a first look opportunity for domestic sales representation – again, finding ways to incentivise. By packaging these elements early on, you will be able to bring strong talent to the project and gear up to be more ready to approach equity players.
3.2. Strength of team and experience
A first time producer/director/star is a tough sell for many in the film business. Sales teams are unable to project value (pre-sell), agents are unable to place large name talent (packaging) and financiers are unable to gauge project return on investment (ROI).
Therefore, your best bet is to find a director who has carried a project before, find an agency who is interested in packaging and will keep you/your project in the stratosphere of content that matters and you will be in a great starting position.
The team must bring a wealth of knowledge, experience and relationships to the production phase, in order to properly execute feature film’s full production schedule. All the while, the producers and filmmaker must mindfully nurture the creative necessity, without neglecting the overall commercial nature of the film’s back end.
If you have to utilise unknown talents to make your project, then surround them with experience on all fronts. An unknown star with a strong director, director of photography, producer and writer is a reasonable recipe.
3.3. Soft money options
With your packaged talent signed on, a strong team on board, and a well-developed script, you can now approach “soft money” options, i.e. tax incentives/pre-sales/debt financings.
Tax incentives offer a percentage of the in-state or in-country spend back in rebate form. This means that you can bankroll/cash-flow this piece of financing to offset your investors’ risk.
Pre-sales offer projections of value based on the elements you have brought together. This, in turn, also implies that you can bankroll/cash-flow this piece of financing to offset your investors’ risk.
The same goes for debt options.
As a filmmaker or producer, you need to find ways to cover 50 cent or pence of every euro or pound your investor is putting up before the cameras even turn on.
Shoot in tax incentive rich states, with a strong pre-sold package, and with a great sales team onboard to execute. You can then reduce the level of speculation and guarantee a return of X percent, based on Y investment in a tangible timeline.
3.4. Plan of execution
With these elements onboard, make your investment proposal personable, professional and tailored to your investors specifics. Do not pitch high level equity film financing to first-time entertainment investors. Keep it simple, honest, and remind equity investors that while smoke and mirrors often run throughout the business, you are putting together a basic structure returning X percent on Y investment over Z timeline.
Lastly, look into completion/guarantor insurance guarantees, as a way to assure your equity investors that the project will be completed on time, schedule and budget, and with the elements they have agreed to finance. The liability is now removed via an insurance company and investors’ return is partially guaranteed via tax incentives and additional soft-money.
Pitch smart, often and confidently knowing that you have done your homework and that the investment is well-structured for a return.
On 23 June 2016, during an epic day of flooding in London and South East England, which did not deter a record 72.2 percent of voters to turn out, Little Britain decided to terminate its 43-year membership with the European Union (EU). What are Brexit legal implications that creative industries need to know about?
Now, the United Kingdom (UK) – or possibly, only England and Wales if Northern Ireland and Scotland successfully each hold a referendum to stay in the EU in the near future – will join the ranks of the nine other European countries which are not part of the EU, i.e. Norway, Iceland, Liechtenstein, Albania, Switzerland, Turkey, Russia, Macedonia and Montenegro. Of these, two countries, Russia and Turkey, straddle Europe and Asia.
What are the short-term and long-term consequences, from a legal and business standpoint, for the creative industries based in the UK or in commercial relationships with UK creatives?
The two main treaties of the European Union, which are a set of international treaties between the EU member states and which set out the EU’s constitutional basis, are the Treaty on European Union (TEU, signed in Maastricht in 1992) and the Treaty on the Functioning of the European Union (TFEU, signed in Rome in 1958 to establish the European Economic Community).
The TFEU in particular sets out some important policies which guide the EU, such as:
- Citizenship of the EU;
- The internal market;
- Free movement of people, services and capital;
- Free movement of goods, including the customs union;
- Area of freedom, justice and security, including police and justice co-operation;
- Economic and monetary policy;
- EU foreign policy, etc.
How is the ending of those policies, in the UK, going to change and affect UK creative professionals and companies, as well as foreign citizens and companies doing business in the UK?
1. Brexit legal implications: removal of EU citizenship for UK citizens and of freedom of movement of people coming in and out of the UK
Citizenship of the EU was introduced by the TEU and has been in force since 1993.
EU citizenship is subsidiary to national citizenship and affords rights such as the right to vote in European elections, the right to free movement, settlement and employment across the EU, and the right to consular protection by other EU states’ embassies when a person’s country of citizenship does not maintain an embassy or a consulate in the country in which they require protection.
By voting out of the EU, Little Britain has made it difficult for EU citizens to come to the UK, as a visa or work permit may be required in the future, depending on the agreement that the UK will strike with the EU. However, it will also be much more difficult for UK citizens to travel to EU member states, for work, studies or leisure.
Probably, the majority of people in the UK who voted out of the EU do not travel much out of the UK, either for work or leisure, so there was definitely a class battle going on there, during that Brexit referendum, as high flyers and Londoners (who have to be quite wealthy to live in such an expensive city) wanted to remain in the EU, while the working class population and English & Welsh regions were firmly on the Leave side. That’s democracy for you: one individual, one vote and the majority of votes always has the upper hand!
If we look at the example set by some of the other nine European states which are not part of the EU, we see that several options are available. Although Norway, Iceland and Liechtenstein are not members of the EU, they have bilateral agreements with the EU that allow their citizens to live and work in EU-member countries without work permits, and vice versa. Switzerland has a similar bilateral agreement, though its agreement is slightly more limited. At the other end of the spectrum, the decision about whether to permit Turkish citizens to live and work within member countries of the EU is left to the individual member nations, and vice versa.
So what’s it going to be like, for the UK?
Time will tell but as we now know that David Cameron, a relatively “mild” member of the conservative party, will step down as the UK prime minister in October 2016, we are under the impression that his leadership will be replaced with an atypical and highly-strung right-wing and nationalistic team, probably led by hard-core conservatives such as Boris Johnson. Mr Johnson not being renowned for his subtlety and impeccable political flair, we think that negotiations for new bilateral agreements between the UK and EU as well as non-EU countries will be a difficult, protracted and ego-tripped process which may take years to finalise.
The UK will try to reduce immigration from the EU, probably with a points-based system such as the one in place in Australia. It means giving priority to high-skilled workers and blocking entry to low-skilled ones. But first, the UK will have to clarify the status of the nearly 2.2 million EU workers living in the UK. The rules for family reunions may get tougher. Also, 2 million UK nationals also live abroad in EU countries – so any British measures targeting EU workers could trigger retaliation against UK nationals abroad.
This, of course, may have an extremely negative impact on the freedom of movement of people, in and out of the UK, which may have a catastrophic impact on trade, human rights and political relationships with other states, for the UK.
Article 50 of the Lisbon Treaty, another treaty from the set of international treaties between the EU member states and which sets out the EU’s constitutional basis, relates to the rules for exit from the EU and provides that:
“1. Any Member State may decide to withdraw from the EU in accordance with its own constitutional requirements.
2. A Member State which decides to withdraw shall notify the European Council of its intention. In the light of the guidelines provided by the European Council, the EU shall negotiate and conclude an agreement with that State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the EU. That agreement shall be negotiated in accordance with Article 218(3) of the TFEU. It shall be concluded on behalf of the EU by the Council, acting by a qualified majority, after obtaining the consent of the European Parliament.
3. The Treaties shall cease to apply to the State in question from the date of entry into force of the withdrawal agreement or, failing that, two years after the notification referred to in paragraph 2, unless the European Council, in agreement with the Member State concerned, unanimously decides to extend this period.
4. For the purposes of paragraphs 2 and 3, the member of the European Council or of the Council representing the withdrawing Member State shall not participate in the discussions of the European Council or Council or in decisions concerning it. A qualified majority shall be defined in accordance with Article 238(3)(b) of the TFEU.
5. If a State which has withdrawn from the EU asks to rejoin, its request shall be subject to the procedure referred to in Article 49″.
Therefore, the UK nows needs to notify its intention to withdraw from the EU to the European Council. We understand that such notification will be handed over by the new prime minister in the UK, therefore after October 2016.
The UK will have, at the latest, a period of two years from such notification date to negotiate and conclude with the EU an agreement setting out the arrangements for its withdrawal, taking out of the framework for its future relationship with the EU. After this period of two years or, if earlier, the date of entry into force of the withdrawal agreement, the EU Treaties will cease to apply to the UK.
Let’s hope that the new UK government will have the ability and gravitas to strike a withdrawal agreement with the EU, in particular in relation to free movement of people coming in and out of the UK, which will be balanced and ensure fluid and constructive relationships with its fellow neighbours and main import partners.
Companies which have – or plan to have – employees in the UK, or which staff often travels to the UK for business reasons, should monitor the negotiation of the bilateral agreements relating to the freedom of movement of people, between the UK and EU member-states, as well as non-EU countries, very closely, as costs, energy and time to secure visas and work permits could become a significant burden to doing business in and with the UK, in the next two years.
2. Brexit legal implications: removal of free movement of goods, services and capital?
The EU’s internal market, or single market, is a single market that seeks to guarantee the free movement of goods, capital, services and people – the “four freedoms” – between the EU’s 28 member states.
The internal market is intended to be conducive to increased competition, increased specialisation, larger economies of scale, allowing goods and factors of production to move to the area where they are most valued, thus improving the efficiency of the allocation of resources.
It is also intended to drive economic integration whereby the once separate economies of the member states become integrated within a single EU wide economy. Half of the trade in goods within the EU is covered by legislation harmonised by the EU.
Clearly, the internal market and its wider repercussions have gone totally over the head of Little Britain, who wiped out 43 years of hard-won progress towards economic integration in 12 hours on 23 June 2016! “Put Britain first”, which was what the mentally ill racist and right-wing extremist shouted when he murdered Jo Cox, a Labour politician and campaigner for the rights of refugees, a week and a half ago, summarises what Little Britain had in mind, when they voted out of the EU.
Having said that, it is possible that the internal market remains in place, between the UK and the EU, as such market has been extended to Iceland, Liechtenstein and Norway through the agreement on the European Economic Area (EEA) and to Switzerland through bilateral treaties.
Indeed, the EEA is the area in which the agreement on the EEA provides for the free movement of persons, goods, services and capital within the internal market of the EU. The EEA was established on 1 January 1994 upon entry into force of the EEA Agreement.
The EEA Agreement specifies that membership is open to member states of either the EU or European Free Trade Association (EFTA). EFTA states, i.e. Iceland, Liechtenstein and Norway, which are party to the EEA Agreement participate in the EU’s internal market. One EFTA state, Switzerland, has not joined the EEA, but has a series of bilateral agreements with the EU which allow it to participate in the internal market. The EEA Agreement in respect of these states, and the EU-Swiss treaties have exceptions, notably on agriculture and fisheries.
2.1. Free movement of goods?
Thanks to the internal market, there is a guarantee to free movement of goods.
If the UK decides, during its withdrawal negotiations with the EU, to become a party to the EEA Agreement, then such freedom of movement of goods will be guaranteed.
If the UK decides, during its withdrawal negotiations with the EU, to put in place a series of bilateral agreements with the EU, then such freedom of movement of goods may be guaranteed.
Otherwise, there will be no freedom of movement of goods, between the UK and the EU, and non-EU countries, which would be an extremely perilous commercial situation for the UK. The EU is also a customs union. This means that member-states have removed customs barriers between themselves and introduced a common customs policy towards other countries. The overall purpose of the duties is “to ensure normal conditions of competition and to remove all restrictions of a fiscal nature capable of hindering the free movement of goods within the Common Market“.
Article 30 TFEU prohibits EU member-states from levying any duties on goods crossing a border, both goods produced within the EU and those produced outside. Once a good has been imported into the EU from a third country and the appropriate customs duty paid, Article 29 TFEU dictates that it shall then be considered to be in free circulation between the EU member-states.
Neither the purpose of the charge, nor its name in domestic law, is relevant.
Since the Single European Act, there can be no systematic customs controls at the borders of EU member-states. The emphasis is on post-import audit controls and risk analysis. Physical controls of imports and exports now occur at traders’ premises, rather than at the territorial borders.
Again, if the UK becomes a party to the EEA Agreement, or signs appropriate bilateral agreements with the EU and other countries party to the internal market, customs duties will be prohibited between the UK, the EU, the EEA states and Switzerland. Otherwise, customs duties will be reinstated between the UK and all other European countries, including the EU, which would be again a very disadvantageous situation for UK businesses as the cost of trading goods with foreign countries will substantially increase.
The same goes for taxation of goods and products which will be reinstated if the UK does not manage to become a party to the EEA Agreement or to sign appropriate bilateral agreements with the EU.
This is going to become a major headache for the UK’s new leadership: goods exports of the EU, not including the UK, to the rest of the world, including the UK, are about 1,800bn euros; to the UK, about 295bn euros, or a little under 16 percent. So, in 2015, the UK accounted for 16 percent of the EU’s exports, while the US and China accounted for 15 percent and 8 percent respectively.
The UK would, indeed, become the EU’s single largest trading partner for trade in goods. However, this would probably not be the case for trade overall. Including services would probably reduce the UK’s share somewhat (the EU ex UK exports over 600bn euros in services, while the UK imports only about 40-45bn euros in services from the rest of the EU). Moreover, the US will very probably overtake the UK as the EU ex UK’s largest single export market.
What does this tell us about the UK’s bargaining power with the EU after a Brexit?
It certainly confirms that the UK would become one of the EU’s largest export markets, even if not necessarily the largest. But the UK would still be far less important to the EU than they are to the UK – the EU still takes about 45 percent of UK’s exports, down from 55 percent at the turn of the century. And, if you treat the EU as one country, as this analysis does, “exports” become considerably less important overall (intra-EU trade is far more important to almost all EU countries). Indeed, as this Eurostat table shows, only for Ireland and Cyprus does the UK represent more than 10 percent of total (including intra-EU) exports.
So how important will exporting to the UK be to the EU economy after Brexit? EU exports to the UK would represent about 3 percent of EU GDP; not negligible by any means, but equally perhaps not as dramatic as one might think. The EU, and even more so the UK, would certainly have a strong incentive to negotiate a sensible trading arrangement post-Brexit. But no-one should imagine the UK holds all the cards here.
Bearing in mind that the EEA Agreement and EU-Swiss bilateral agreements are both viewed by most as very asymmetric (Norway, Iceland and Liechtenstein are essentially obliged to accept the internal single market rules without having much if any say in what they are, while Switzerland does not have full or automatic access but still has free movement of workers), we strongly doubt that currently feisty UK and its dubious future leadership (wasn’t Boris Johnson lambasted for being a womanising buffoon by both the press and members of the public until recently?) are cut from the right cloth to pull off a constructive, seamless and peaceful exit from the EU.
Creative companies headquartered in the UK, which export goods and products, such as fashion and design companies, should monitor the UK negotiations of the withdrawal agreement with the EU extremely closely and, if need be, relocate their operations to the EU within the next 2 years, should new customs duties and taxation of goods and products become inevitable, due to a lack of successful negotiations with the EU.
The alternative would be to face high prices both inside the UK (as UK retailers and end-consumers will have to pay customs duties and taxes on all imported products) and while exporting from the UK (as buyers of UK manufacturers’ goods will have to pay customs duties and taxes on all exported products). Moreover, the UK will face non-tariff barriers, in the same way that China and the US trade with the EU. UK services – accounting for eighty percent of the UK economy – would lose their preferential access to the EU single market.
While an inevitably weaker pound sterling may set off some of the financial burden represented by these customs duties and taxes, it may still very much be necessary to relocate operations to another country member of the EU or EEA, to balance out the effect of the Brexit, and its aftermath, for creative businesses which produce goods and products and export the vast majority of their productions.
Fashion and luxury businesses, in particular, are at risk, since they export more than seventy percent of their production overseas. Analysts think that the most important consequence of Brexit is “a dent to global GDP prospects and damage to confidence. This is likely to develop on the back of downward asset markets adjustments. Hence, more than ever, the fashion industry will have to work on moderating costs and capital expenditures“.
2.2. Free movement of services and capital?
The free movement of services and of establishment allows self-employed persons to move between member-states in order to provide services on a temporary or permanent basis. While services account for between sixty and seventy percent of GDP, legislation in the area is not as developed as in other areas.
There are no customs duties and taxation on services therefore UK creative industries which mainly provide services (such as the tech and internet sector, marketing, PR and communication services, etc) are less at risk of being detrimentally impacted by the potentially disastrous effects of unsuccessful negotiations between the EU and the UK, during the withdrawal period.
Free movement of capital is intended to permit movement of investments such as property purchases and buying of shares between countries. Capital within the EU may be transferred in any amount from one country to another (except that Greece currently has capital controls restricting outflows) and all intra-EU transfers in euro are considered as domestic payments and bear the corresponding domestic transfer costs. This includes all member-states of the EU, even those outside the eurozone, provided the transactions are carried out in euro. Credit/debit card charging and ATM withdrawals within the Eurozone are also charged as domestic.
Since the UK has always kept the pound sterling during its 43 years’ stint in the EU, absolutely refusing to ditch it for the euro, transfer costs on capital movements – from euros to pound sterling and vice versa – have always been fairly high in the UK anyway.
Should the withdrawal negotiations between the EU and the UK not be successful, in the next two years, it is possible that such transfer costs, as well as some new controls on capital movements, be put in place when creative businesses and professionals want to transfer money across European territories.
It is advisable for creative companies to open business bank accounts, in euros, in strategic EU countries for them, in order to avoid being narrowly limited to their UK pound sterling denominated bank accounts and being tributary to the whims of politicians and bureaucrats attempting to negotiate new trade agreements on freedom of capital movements between the UK and the EU.
To conclude, we think that it is going to be difficult for creative businesses to do fruitful and high growth business in the UK and from the UK for at least the next two years, as UK politicians and bureaucrats now have to not only negotiate their way out of the EU through a withdrawal agreement, but also to negotiate bilateral free trade deals that the EU negotiated on behalf of its 28 member-states with 53 countries, including Canada, Singapore, South Korea. Moreover, it would require highly-skilled, seasoned, non-emotional and consensual UK leadership to pull off successful trade negotiations with the EU and, in view of the populist campaign lead by a now victorious significant majority of conservative politicians in the UK up to Brexit, we think that such exceptional and innovative UK leaders are either not yet identified or not in existence, at this point in time. The pains and travails of the UK economy may last far longer than just two years and, for now, there is no foreseeable light at the end of the tunnel that all this fuss will be worth it, from a business and trade standpoint. Did Little Britain think about all that, when it went out to vote on 23 June 2016? We certainly do not think so.
In the music ecosystem, the record label is the “facilitator” and the “doer” that produces, manufactures, distributes, promotes and markets music tracks and albums.
The term “record label” derives from the circular label in the centre of a vinyl record, which prominently displays the manufacturer’s name, along with other information. While the label business model has substantially changed, since the day when the term “record label” was spinned, some things are immune to the passing of time: the corporate structure of a record label is still the same, with a president in charge of the business of the whole company at the top, and various vice presidents in charge of different departments such as:
- A&R (artists and repertoire) – in charge of discovering new talent, assisting the artist with song selection, choosing the people who will produce the tracks and deciding where the album will be recorded;
- Art department – in charge of all the artwork that goes along with producing songs (including CD, MP3 and streaming cover art, advertisements and displays at music stores and websites);
- Artist development or Product development – responsible for planning the careers of the artists who are signed to the record label, by promoting and publicizing the artists over the course of their career;
- Business Affairs – which deals with the business side of things such as bookkeeping, payroll and general finances;
- Label liaison – which acts as the liaison, between the label’s distribution company responsible for getting the vinyls, CDs, MP3 files into brick and mortar or online stores or aggregators, and the record company;
- Legal department – responsible for all the contracts that are made between the record label and the artist, as well as contracts between the record label and other companies, and for managing any litigation or legal issues that may arise for the record label;
- Marketing department – which creates the overall marketing plan for every album that the record company will release and coordinates the plans of the promotion, sales and publicity departments;
- New media – in charge of dealing with the newer aspects of the music business, including producing and promoting music videos for the artist, supporting an artist in creating a presence on the internet and dealing with new technologies in which artists can stream music and music videos through the internet (YouTube, Vimeo, etc);
- Promotion department – which main purpose is to make sure that an artist, and in particular his/her new songs, are being played on the radio and the artist’s videos are being played on MTV or VH1 channels as well as video streaming on demand websites (the latter in coordination with the New media team);
- Publicity – which is responsible for getting the word out about a new or established artist, by arranging for articles to be written in newspapers, blogs and magazines, by dealing with radio and television coverage of an artist and
- Sales – which oversees the retail aspect of the record business, working with record store chains and other music stores to get new albums onto retailers’ shelves, in coordination with the efforts of the Promotion and Publicity departments.
As the going got tough, due in part to the rise of music piracy and democratisation of free music online, consolidation of the record labels’ sector occurred: many record companies, now, are huge conglomerates that own a variety of subsidiary record labels. These record corporations are majorly composed of a parent or holding company that owns more than one record label and are, for the most part, located in New York, Los Angeles, London or Nashville. For example, Warner Music Group owns three main labels, Atlantic Records Group, Warner Bros. Records and Parlophone. In turn, Warner Bros. Records owns, among many other record labels, Maverick Records (originally founded in 1992 by Madonna), Sire Records (founded in 1966 by Seymour Stein who went on to sign the Ramones and Talking Heads) and Reprise Records (founded in 1960 by Frank Sinatra to allow “more artistic freedom” for his own recordings).
This ruthless consolidation of the music label industry has now left three major record labels in the playing field, since 2012: Universal Music Group, Sony Music Entertainment and Warner Music Group, which control about 60 percent of the world music market and about 65 percent of the United States music market.
Record companies that are not under the control or umbrella of the big three are considered to be independent, even if they are large corporations with complex structures. The most successful indie record label of all time is, without contest, A&M Records, founded in 1962 by trumpeter Herb Alpert and record promoter Jerry Moss. Over its 37-year run, A&M signed acts such as The Carpenters, Cat Stevens, The Police, Sting, Bryan Adams, Suzanne Vega and Sheryl Crow. Alpert and Moss sold A&M to Polygram in 1989 with the caveat that they would continue to manage it independently. As Polygram was later bought by Universal Music Group in 1998, A&M died the next year as a label and a brand. Today, some successful independent labels that cut out a market share for themselves are Beggars Group (which released Adele’s albums 19, 21 and 25) in the UK and Because Group in France.
A new paradigm is causing a revolution in the music industry, which record labels are desperately trying to grasp and cash in on. Since independent peer-to-peer file sharing service Napster was invented by Shawn Fanning and Sean Parker in 1998, retail consumers have collectively forced and pressured the music and tech industries into re-thinking the offering of music distribution and music consumption tools. This disruption radically and irrevocably annihilates the traditional cash cow music business model, based on physicals (CDs, mini-discs, vinyls, cassettes, etc.), brick and mortar retail points (Virgin, HMV, etc.) as well as paraphernalia to listen to said physicals (CD and cassette players, HI-FI systems, etc.), to trade it for a much more competitive, virtual, lean, complex and data driven music tech business model based on digital revenues (streaming, downloads, internet radio, etc.), online distribution points (Amazon, iTunes, digital service providers such as Spotify and Deezer, etc.) and online consumption (on tablets, laptops, smart phones, ipods, etc.).
After much whining and denial from the vast majority of stakeholders in the music industry, in particular from music top management and acts who are baby-boomers and who differ in their core values from Generation X and Millennials, in that they prefer to “own” things rather than embrace the exponentially successful “sharing” and “access” economy favoured by their juniors, record labels are putting their act together to survive and adapt to this new paradigm.
In this context, I am offering here a snapshot of the most recent and astute evolutions and strategies engineered by record labels to play their cards right. Meanwhile, tech mega-successful and cash-rich multinational corporations such as Google and Apple watch at bay, already going after record labels in order to cut the middle man between precious and highly sought-after musical content and catalogues, and billions of retail customers who stubbornly refuse to fork in any substantial amount of money to listen to said music material.
Record labels and the recording artists: what record deals are on the table today?
Today, more than at any other period historically, a wide range of choices and options is at the disposal of both record labels and talent, to find an agreement on how to make music together, as well as promote, market and distribute it.
1.1. Traditional deal
Recording contracts are legally binding agreements between recording artists and/or bands and record labels, enabling the label to exploit an act’s performance in a sound recording, in return for royalty payments.
Under most exclusive recording and traditional contracts, the recording artist will assign copyright in the sound recordings to the record company. An assignment is an irreversible transfer of ownership for the full life of copyright. In the case of sound recordings, this will be 50 years from release in the UK, and 70 years from release in France. So, even once the artist has repaid all recording costs, the label will still own the masters.
In a traditional deal, exploitation is achieved through physical sales, such as CDs, vinyls and cassettes, the public performance and broadcasting of works, the sale of digital products such as downloads and mobile ringtones and streaming of tracks. The contract will define a record to include audio-visual devices as well, so “Dualdisc”, DVD, online videos and other new technologies will be caught by this definition.
The recording contract will usually require the artist to sign to the label exclusively. As this means that the artist can neither record for another label without permission nor leave the contract if unhappy, record labels justify this exclusivity with the “huge” sums of money invested in breaking an act and by claiming that they need this level of control in order to improve the chances of making a profit or cut their losses. This strategy can backfire though, if record labels cannot justify this exclusivity through factual investments in their acts, as illustrated by the very public showdown between British songstress Rita Ora and Jay Z’s label, Roc Nation.
Major record labels, which are the record companies in the strongest position, and with the strongest inclination to offer traditional deals, will normally sign the act to a worldwide deal. Companies such as Universal and Sony Music Entertainment have offices in all key markets, together with the vast distribution network capable of delivering their latest offerings to a supermarket near you. Split-territory deals are less likely with major record labels, but independent labels may be more willing to agree so such an arrangement.
As far as the term is concerned, it is calculated by reference to an initial fixed period of usually 12 months – when the recording artist will make his first album – followed by further option periods, also usually of 12 months, allowing the labels to extend the contract if they so wish. There will be a minimum commitment within each period, requiring the act to deliver a certain number of tracks, to a releasable standard, with perhaps a total of five or six albums expected under the deal.
Advances are sums of money paid to the recording artist on account of future royalties, in a traditional record label deal. They are paid when the act signs to the label, and again as and when further options are exercised.
If the traditional record agreement is well negotiated by the entertainment lawyer representing the artist, the advances will solely be repaid by the recording act when his record sales generate sufficient royalties to cover them; failing that, the label bears the loss. In a traditional deal, the talent is paid royalties based on record sales. In a typical major-label deal, the artist will earn somewhere between 10 and 25 percent of the record’s dealer price, which may be between GBP6.50 and GBP8.50 a unit. Before they’ll see any money, acts will have to recoup recording costs, advances and usually 50 percent of all video costs. The label will make additional deductions, reducing the real royalty rate still further. Standard deductions include a packaging deduction of 20 to 25 percent on CDs, a reduced royalty rate on foreign sales, budget records and record clubs, a reduced royalty on TV-advertised albums, and often no royalty at all on free goods (records given away to retailers and the media). Overall, an act may only get paid on 90 percent of actual sales, since retailers are able to return records they don’t sell. The record label holds on to a portion of the act’s royalties, usually 10 percent, as a reserve, until all sales are verified. Moreover, the act is expected to pay the producer royalty from their own royalty share: for example, if a producer is paid a 3 percent royalty and the artist 15 percent, then the artist will end up with an actual rate before deductions of 12 percent (the producer, however, will be earning this healthy 3 percent from the first record sold, while the act will only get paid once the deductions and any cash advances have been recouped).
In reality, most “deductions” are artificial and in no way reflect the true cost to the label. Packaging on CDs manufactured in volume is cheap. Similarly, as more records are sold through digital channels, a reserve for breakages and the allocation of free digital goods ceases to make any sense at all, other than boost the label’s profits.
Which means, that today, many acts just refuse flat out to sign what they think is an antiquated and disadvantageous traditional record deal, even with a major, and prefer to either self-release – leveraging social media to target their audience and fans, such as very successful hip hop act Macklemore & Ryan Lewis, whose debut single Thrift Shop peaked at number one on the US Billboard Hot 100 chart in 2014 (the first song since 1994 to reach the top spot without the backing of a major label in the US) – or look at alternative record deals which better match their own expectations, aspirations and sense of fairness.
Reportedly, Macklemore & Ryan Lewis are signed to their own imprint, Macklemore LLC, but have a deal with Warner Bros. Records, which sees the major label take a chunk of their sales in exchange for distribution funding for their debut album, the Heist. Speaking about the deal, Macklemore said at the time “Warner had never done this. That’s the interesting thing about where the music industry is right now: you have major labels that are willing to take unconventional approaches because the old model is crumbling in front of us. They’re open to it”.
Indeed, if major record labels want to keep signing successful new or seasoned acts, they need to become more flexible while negotiating record deals. Also majors need to understand that their strength lies in their global, impactful and far-reaching distribution network as well as in the massive economies of scales that they make, as a result of their conglomerate business model, which is structured around dozens, even hundreds, of subsidiary record labels that share promotion, manufacturing, PR, new media, digital media, sales and marketing services together.
1.2. Net profit deal
Speaking of alternative record deals, this is where the indie record net profit deal comes into play.
As mentioned above, an independent label is a record label that is not affiliated in any way with a major and which uses independent distributors and/or digital distribution methods to get their releases into stores, both online and into traditional brick and mortar music retailers.
The net profit deal, proposed by indie labels, had rapidly increased in use, as an alternative to the traditional type of record deals, at the beginning of the 21st century.
To compute the net profits in a net profit deal, the record company deducts off the top its actual out-of-pocket costs for recording, manufacturing, promotion, marketing, etc. Some labels also deduct a so-called “overhead fee” of 10 to 15 percent of the gross record sales income. After the record company deducts all of these expenses and reimburses itself, the label then pays the recording artists whatever percentage of the profits their contract requires (usually 50 percent of net profits).
Though this percentage is obviously much larger than the 10 to 25 percent royalty range mentioned above for traditional record deals, the recording artist in a net profit deal is getting 50 percent of the income from records sold, but only from what is left after all expenses are paid. In traditional record deals, on the other hand, the act starts getting their artist royalties after the label has recouped the recording costs – and any cash advances to the artist – from the talent’s royalties. Major record labels absorb most other costs out of their own pocket – such as duplication, shipping and staff costs – and those costs do not factor into the calculations of what is to be paid to the artist.
In most net profit deals, a label does not have to pay the artist anything (neither hefty advances nor, under many contracts, any mechanical royalties from internet downloads or physical sales) until the label has recouped all costs fronted by it. This is, of course, appealing to labels, particularly in the current music business climate when the foremost concern of indie labels are front-end costs and just trying to survive financially.
This advantage needs to be weighed against the back end – that is, if the record is successful and the costs relatively small in comparison, then the net profit deal will be less profitable for the label than would be the case with a traditional record deal.
Like in a traditional record deal, the default situation in a net profit deal is that the recording agreement sets out that the record label is the copyright owner of the performances recorded during the term of the recording agreement, by way of assignment of copyright. In cases where the artist is able to cause a reversion of ownership of his recorded performances contractually via negotiation (an occurrence that usually happens only with the biggest superstars or in the case of a licensing of preexisting masters agreement), that right is often subject to the record company having recouped all costs paid on behalf of the artist.
Almost all record labels, when entering into a deal with a recording artist, will insist on the right to handle the artist’s product not just in the physical medium, but also will want to have the right to distribute and sell the artist’s recordings in the digital medium through outlets such as iTunes and YouTube, including downloads to computers and over-the-air downloads to mobile devices for both full track downloads, ringtones, ringbacks and other wireless uses. On a traditional label deal, most labels that work on a royalty basis will try to maintain the payment of just a royalty to the artist in the same way that a royalty is paid on a physical sale, but generally without factoring in packaging deductions and free goods, since these elements are irrelevant. Payment of a 15 percent royalty on a 99 cents download (i.e. 15 cents), plus statutory mechanicals, leaves a nice margin for the label, with the digital music service downloader paying the label 70 cents on the download. However, on a net profit deal, the artist will do much better than a royalty deal of 15 percent. On a 50-50 split of net, the artist will see about 25 cents plus mechanicals, whereas with the royalty traditional deal, the artist will see just 15 cents plus mechanicals.
As digital income is the fastest and exponentially growing area in music revenues, it is likely that more and more acts will be drawn to the net profit deal option, which ensures a 50-50 split on streaming and download revenues, rather than the traditional record deal option.
Recording artists, such as Eminem and “Weird Al” Yankovic, as well as managers, such as 19 Entertainment founded by music mogul Simon Fuller, have swiftly brought this issue relating to the split of earnings on digital revenues to the attention of the general public, by filing high-profile lawsuits against the three majors. The defendants later settled these lawsuits out-of-court, consenting – under confidential terms – to hike up artists’ share of earnings on digital revenues, but their reputation got tarnished in the process.
As there is a clear dichotomy between the labels’ view that royalties for both downloads and streams should be accounted for to the artist as sales, and the point of view of recording artists and their collecting societies which errs on the side of a stream or download being considered as “mechanical reproduction” or as “performance” under a license, it is well worth for labels to make time in order to clarify, and lobby about, the subject matter with the European Union’s Commission and the United States Copyright Office. Indeed, the European Commission currently plans to examine whether action is needed on the definition of the rights of “communication to the public” and of “making available” under copyright law, as well as to assess the role of alternative dispute resolution mechanisms. Both major and indie labels should join forces, in order to lobby the European Commission and other European and US institutions, about that issue of defining what digital revenues are in law, (license or sales or a hybrid of both?) since this single point may seriously impact their future overall revenues, which will increasingly be derived from digital income.
1.3. 360 deal
A 360 deal is a boon for any record label. Mostly favoured by major labels, a 360 deal has two components:
- the first part of the 360 deal contract relates to record sales and contains basically the same terms than those of a traditional record deal and
- the second part of the 360 deal contract gives the label a right to receive a percentage of certain other income streams which labels have not historically shared in, such as artist’s touring and merchandising income as well as the artist’s songwriter and music publishing income (if the recording artist is also a songwriter).
The first reported 360 deal was Robbie Williams’ agreement with now-defunct major EMI in 2002. Acts such as the Pussycat Dolls and Paramore have been reported in the media as having been signed to 360 deals and, in 2007, it was confirmed that Madonna had signed a USD120mn 360 deal with concert promotion company Live Nation. It was reported that in exchange for cash and shares, Madonna gave Live Nation distribution rights for 3 future albums as well as rights to promote live concerts, sell merchandise and license her name and image.
While the sell of a 360 deal to an artist may be a tough call, majors and their affiliates justify their offer of the 360 deal by citing significant investments they make in an artist’s career as well as the dramatic decline in income from sales of recorded music. Factually, it is true that income from sales of pre-recorded music reached its peak in 1999 at approximately USD14.5bn. By 2012, that amount had shrunk to only approximately USD7bn – a decline of more than 50 percent, not accounting for inflation.
Under the traditional paradigm, the label would pay the recording artist a small royalty, which was even smaller after all the deductions. Hence, the artist could expect to receive no recording royalty at all, unless his album was a major commercial success. However, the act got to keep everything else: publishing, merchandising, touring, endorsements, etc.
Since recording artists, especially in the USA where the physical market is moribund and where no neighbouring rights are paid on terrestrial broadcast, often generate more money from other activities than record sales and performance, major and indie labels have insisted on taking a piece of the action, by concocting 360 deals. For instance, Lady Gaga’s Monster Ball Tour grossed over USD227mn of touring income, and 50 Cent’s endorsement deal with Vitamin Water turned golden when he accepted shares in the company in exchange for authorising the use of his professional name in “Formula 50”: when Coca-Cola purchased Vitamin Water’s parent, Glacéau, for USD4.1 bn, 50 Cent’s shareholding became worth over USD100mn.
These developments have spurred labels to seek to participate in all the possible revenue streams generated by the artist. Even small labels, known as production companies, get in on the action and insist that new artists sign 360 deals with them, even if they put little or no money into recording and make no promises in regard to marketing or promotion, while getting an assignment of copyright on the master recordings!
There is no standard 360 deal as the terms vary substantially from deal to deal, and from label to label. A lot depends on the track record and negotiating power of the artist, plus how much of an advance is being paid.
A “full” 360 deal allows the label to share in all entertainment industry income, including touring, music publishing, merchandising, product endorsements, book publishing income (if the artist writes a book), songwriter and music publisher income (if the artist is a songwriter), etc.
Usually, the label’s share of those non-record kinds of income is in the range of 10 to 20 percent, but for new artists if can get as high as 50 percent. A typical 360 deal record agreement would set out the following splits, in relation to the label’s take for various streams:
- 50 percent merchandise;
- 25 percent touring and live performance;
- 25 percent “digital products” such as ringtones and sales from the artist’s fan site;
- 25 percent publishing;
- 25 percent endorsements;
- 25 percent of any other income from the entertainment business including appearances on TV and movies, theatre, book publishing, etc.
Today, all major labels and their affiliates usually demand 360 terms, especially when dealing with emerging artists. So the artist may not have much choice, especially if his strategy is to leverage the formidable distribution channels and economies of scales offered by a major, to achieve wide-reaching and fast success.
1.4. Record deal in the EDM world: still the wild west
In 2010, the acronym “EDM” was adopted by the music industry and music press as a buzzword to describe the increasingly commercial electronic dance music, club music or simply dance, scene.
Major EDM acts, called DJs, such as David Guetta, Deadmau5, Calvin Harris, Steve Aoki, Avicci or Skrillex, often make appearances on main stages during the final nights of high profile festivals such as Lollapalooza or Coachella and, in December 2015, EDM was reported to be a USD6.2bn global industry. In a nutshell, EDM is one of the most lucrative genres in the music industry today.
While top DJs can demand GBP50,000 to GBP200,000 per gig – with hardly any overheads -, record deals relating to some of the EDM tracks that these DJs play during those live gigs are either non existent or incredibly pro-label.
For example, in 1996 artist and songwriter CoCo Star (real name Susan Brice) released a track “I need a miracle” under Greenlight Recordings in the US, which became a club hit. It was then re-recorded and release on EMI’s Positiva imprint in the UK a year later. In 1999, a British DJ mashed up Brice’s vocals from the song with German act Fragma’s track Toca Me. The mash-up was released without Brice’s permission on a bootleg white label for which she was never paid. This sparked a buzz in clubs, and Fragma released their own version of the bootleg, Toca’s Miracle, on Tiger Records in Germany and Positiva in the UK in 2000. It went to N.1 in 14 countries worldwide. While Toca’s Miracle has reportedly sold more than 3 million copies, Brice claims she was never paid for any of these remixes.
While major labels and large indie labels may take a bit of convincing to enter the underground – and drug-fuelled – EDM sector, there is an untapped opportunity here that they can no longer ignore. The public wants and is prepared to pay for EDM, EDM has grown to become a USD6.2bn to USD6.9bn global industry and it is still an Eldorado largely untapped by reputable labels, meaning that the best talent may want to focus on other “more respectable” musical genres for fear of being “screwed” by bootleg white labels which currently populate the EDM scene.
1.5. Label services deal: à la carte and en vogue
At the other end of the spectrum of a 360 deal, lies the label services deal which is a very palatable alternative to business savvy artists. Indeed, the rise of social media, digital distribution, online platforms and direct-to-consumer technology has empowered artists like never before and brought them closer to fans.
The services model sees the record deal flipped on its head: instead of assigning the copyright on their sound recordings for an upfront advance and the label footing the campaign bill, acts will receive the lion’s share of royalties (often 100 percent) from a release and pay a company for a range of services from an à la carte menu of promotion, distribution, marketing, press and a wide range of other essentials.
Interestingly, the services model is not just reserved for artists with enough capital behind them to fund a whole campaign and an already established fanbase likely to ensure a decent return. This services deal is being used by record companies too, as a quick and convenient way to establish an office abroad, push releases into international territories after domestic success, or to simply augment their in-house functionality with new capabilities as and when needed.
Although a relatively new idea in the music industry’s history, the number of companies offering services to both artists and labels has skyrocketed, making the sector fiercely competitive.
PIAS Artist & Label Services, Believe Digital, Republic of Music are some of the most representative label services companies out there, with aggregators, such as the Orchard (now fully owned by the major Sony Music Entertainment), and majors’ owned companies, such as Universal’s Caroline International, Sony RED and Warner’s ADA, very much active in this market.
Even independent rights management groups, such as Kobalt and Fintage House, are widening their services offering, adding label services to their roster. Kobalt in particular, plays the transparency card with brio, by setting out on its website the key characteristics of Kobalt’s “new model” contracts, contrasting them against the key terms of a traditional label deal. For example, as explained on Kobalt’s website, while the term of the label services deal is 3 years with Kobalt, a traditional deal will have a term of 7 years (for a license, a rare occurrence) to the life of copyright. While the talent gives up ownership and control over their recordings, in a traditional deal, Kobalt highlights, on its site, that artists retain full ownership and control of their recordings. While a traditional deal provides for semi-annual accounting with minimal detail, says Kobalt, it commits to provide quarterly accounting with line-by-line detail on every type of income. And the last straw: while a traditional record deal will not cater for any pay-through of neighbouring rights income, Kobalt says that it will collect and pay to artists the label share of neighbouring rights income!
What’s not to like? Of course, major acts are totally smitten with Kobalt’s offering and the likes of 50 Cent, Paul McCartney, Boy George, Busta Ryhmes, Maroon 5, Skrillex, Courtney Love, Dr Luke, Max Martin and Foo Fighters have jumped on the bandwagon of Kobalt’s label services deals.
Personally, I am not surprised that it is a private equity-owned company, such as Kobalt, that is currently delivering some of the act-friendly record deals to the talent, as far as transparency, fairness and redistribution of neighbouring rights and digital revenues are concerned: Kobalt is not managed by “pure” music people!
If majors want to attract legendary artists, nowadays, they must up their game in terms of transparency, redistribution of digital income, auditing and reporting of revenues. Their old ways may work on new talent, who wants to make a fast buck, but seasoned acts will not go anywhere near a 360 or traditional deal those days – especially since they have the cash to auto-finance their distribution and marketing campaigns through label services companies such as Kobalt. What these acts are interested in, is to keep the rights to their recordings and catalogues and monetize those rights to the fullest, through music publishing, neighbouring rights, performance revenues and mechanicals.
Record labels and digital service providers: where the wild things are
As mentioned above, the major beef that artists and their managers have against labels and digital service providers is the lack of transparency, especially as far as digital revenues and neighbouring rights are concerned.
Digital service providers, or “DSPs” are tech companies providing music streaming subscription services. Apple Music, Spotify, Deezer, Tidal, Google-owned YouTube Red are some of the largest DSPs in the music streaming sector.
The stakes are getting higher by the minute, with digital revenues – which comprise income from both digital downloads and streaming –growing by 6.9 percent to USD6.9bn in 2014, and now on a par with the physical sector. Indeed, globally, like physical format sales, digital revenues now account for 46 percent of total music industry revenues. In 4 of the world’s top 10 markets, digital channels (streaming and downloads) account for the majority of revenues (i.e. 71 percent of total 2014 industry revenue in the US; 58 percent of total 2014 industry revenue in South Korea; 56 percent of total 2014 industry revenue in Australia and 45 percent of total 2014 industry revenue in the UK).
In particular, streaming is going from strength to strength, with music digital subscription services – including free-to-consumer and paid-for tiers – growing by 39 percent in 2014, while downloading sales predictably declined by 8 percent but remained nonetheless a key revenue stream as they still account for more than half of digital revenues (52 percent). However, streaming subscription revenues offset declining downloading sales to drive overall digital revenues, pushing subscription at the heart of the music industry’s portfolio of businesses, representing 23 percent of the digital market and generating USD1.6bn in trade revenues.
Music industry analyst Mark Mulligan predicts that streaming and subscriptions will grow by 238 percent from the 2013 levels, to reach USD8bn in 2019, with download revenue declining by 39 percent. He concludes that streaming and subscriptions will represent 70 percent of all digital revenue by 2019.
Universal Music Group is capitalising on the growth of streaming with impeccable flair, naming music and media industry executive Jay Frank, who founded the music and marketing analytics companies DigSin and DigMark, to the newly created role of Senior Vice President of Global Streaming Marketing. His role will be to get UMG acts on playlists, in particular through Digster, a company that creates themed playlists featuring mostly MHG recordings.
While this evolution towards more music streaming is very customer-friendly (who does not want to have the option to select and potentially hear millions of tracks, anywhere in the world, on a device no bigger than the size of a jean’s pocket?), new legal and business issues have arisen as a result.
In particular, right owners in the recorded performance of a composition – typically, the record label, the recording artist-performer and non-featured musicians and vocalists – repeatedly ask themselves how they are financially benefiting from this surge in streaming consumption and income. How do they get paid?
Also, more and more DSPs want to know how they can access high-quality musical content and obtain the right to stream the widest music catalogues on their platforms, at a reasonable price. Since scaling up is the key to success for any technology company, DSPs also want to have the right to stream such musical content all over the world.
Finally, as the surge in musical digital consumption and income is becoming factual evidence, certain categories of income streams are developing and taking more of a preponderant role. For example, sound recording performance rights, or “neighbouring rights”, are a growing source of global revenue for recording artists and record labels. While recorded music sales of physical products have declined 66 percent since their high in 1999, revenues from overall neighbouring rights have increased dramatically, reaching Euros2.034 bn globally in 2013. Musical rights represent around 90 percent of the royalties collected in relation to neighbouring rights. Audio-visual rights are worth around Euros200 mn, benefiting mainly to performers, while the rest of these royalties (around Euros1.834 bn) relate to musical neighbouring rights. Where are these musical neighbouring rights going? How are they collected then distributed?
2.1. Streaming equity
As a preliminary remark, it is worth noting that labels, in particular majors, were very prompt in renewing their grip on music distribution: they invested massively in DSPs, whenever the opportunity was arising.
For example, Warner Music Group acquired up to 5 percent of Soundcloud in October 2014, and Warner, Universal and Sony have quietly muscled out stakes in the hottest digital streaming services, such as Spotify but also in choose-your-own-adventure music video purveyor Interlude and song-recognition giant Shazam – valued at USD1bn in its latest round.
What have the labels been giving the startup DSPs, aside from legitimacy, to secure these “sweet deals”? All-encompassing access to the artists and their songs. As explained in point 2.3. (Neighbouring rights and digital performance of sound recordings) below, the artists derive some minimal amount of royalties from these new distribution channels, but they were not getting any of the ownership.
Until February 2016 at least, when, during his latest investor conference call, Warner Music’s CEO Stephen Cooper announced that the label will pay its recording artists a portion of any income it earns from equity stakes in services such as Spotify and Soundcloud. With Spotify planning on announcing its IPO during the second quarter of 2016, such commitment on Warner’s end is more than a token gesture, as it owns a 2 to 3 percent stake in Spotify’s shareholding, which will probably be valued at around USD200mn.
This is a very smart PR move indeed from Warner because it means that this major understands that it needs to have all its recording artists on board, as far as streaming services are concerned.
Streaming is where consumer behaviour and affinities are going, but currently Google-owned YouTube is growing quicker than everyone else, while labels need premium and freemium services to make up ground fast. Which is why they cannot afford the Black Keys-Taylor Swift-Adele- Coldplay-Radiohead trickle to turn into a free torrent available at will to fans. They need artists to be as vested as they are into streaming and DSPs.
It remains to be seen whether Sony and Universal will follow suit, as far as sharing streaming equity with their respective acts is concerned.
In May 2015, the Verge revealed details of the contract signed between major label Sony Music Entertainment and DSP Spotify, giving the streaming service a license to utilize Sony’s catalogue.
The 42-page licensing agreement was signed in January 2011, written by Sony Music and revealed that Spotify had to pay USD42.5mn in yearly advances to Sony for the two years of the contract. It also detailed the subscriber goals that Spotify had to hit and how streaming rates were calculated. Most interestingly, the contract detailed how Sony used a Most Favoured Nation clause to keep its yearly advances from falling behind those of other music labels, how Spotify could keep up to 15 percent of revenues “off the top” from ad sales made by third parties, and the complex formula that determines how much labels get paid per stream. What the contract between Sony and Spotify did not stipulate was what Sony could and would be doing with the advance money. Did the money go into a pot to be divided between Sony Music’s artists, or did the major keep it to itself?
These revelations sent a shockwave in the music industry, with artists and their managers up in arms because they had already complained that earning on average less than one cent per stream play – between USD0.006 and USD0.0084 according to Spotify Artists – was neither reasonable nor fair. Top talent such as Taylor Swift and Radiohead, in particular, left Spotify with fracas, in 2014 and 2013 respectively, complaining that end-consumers did not pay enough to access their catalogues on Spotify.
But that is just one reason why artists did not get paid much at all per stream, the other reason being breakage: indeed, DSPs, which are always on the lookout for top music catalogues and content to stream to their retail consumers, readily paid hefty “minimum revenue guarantees” to labels, over the past years, to get access to, and be able to license, their music recordings.
For example, French streaming service Deezer, which planned to organize a (later on aborted) IPO from its home city in Paris during the last quarter of 2015, revealed on its “Autorité des Marchés Financiers” registration documents, that it had paid a Euros257mn advance to record companies in instalments over a period of 3 years (2012: Euros57.1mn, 2013: Euros87.4mn and 2014: Euros112.5mn). In 2013, Deezer even had to pay 94 percent of its total revenues to record companies as minimum guarantees (no wonder that IPO went south)! Meanwhile, royalties from subscriptions and ads fell short of this advance payment in 2012, 2013 and 2014 – totally approximately Euros236.4mn. In total, the deficit between the two numbers amounted to Euros20.6mn across the 3-year period (2012: Euros5.4mn; 2013: Euros13.2mn and 2014: Euros2mn). This Euros20.6mn deficit is unallocated “breakage”.
Therefore, while the payment of an advance by a DSP to record companies is justified if the streaming platform then generates the same or even more revenues through subscriptions and ads, the system is inherently flawed if the advance ends up exceeding the annual streaming royalty income. When that happens, the label is inevitably left with a lump sum – in this case over Euros20mn – sitting in record company bank accounts, but which cannot be attributed to any specific artists.
One of the three majors, Warner, feeling the heat, was the first to share this breakage with their acts as standard company policy since 2009, even attributing a line to “breakage” on their artists’ royalty statements. Sony has also agreed to share with its talents proceeds from an upcoming sale of its equity in Spotify. Meanwhile, over 700 indie labels have signed up to the Fair Deal Declaration from the Worldwide Independent Network, which pledges to “account to artists a good-faith pro-rata share of revenue and other compensation from digital services”, and the French ministry of culture issued a voluntary agreement in October 2015 requesting that music industry stakeholders agree to share with artists all income received from online music services and to guarantee them a minimum wage, in return for the digital use of their recordings.
These reactions from both private and public stakeholders in the music industry demonstrate that labels, in particular, majors, will not get away with egotistically keeping all advance income paid by DSPs for themselves. Either the labels self-regulate, and redistribute a portion of this extra income to their recordings artists, or European Union regulators – busy bees with their ongoing general overhaul of copyright law in the 28 member-states of the EU – will eventually make it compulsory, in law, for labels to redistribute a portion of the breakage as well as minimum revenue guarantees to their acts.
2.3. Neighbouring rights and digital performance of sound recordings
Neighbouring rights, also called “related rights”, were consecrated in law, step by step, in order to ensure that people who are “auxiliaries” to the creation and/or production of content (artists, performers, music producers, film producers, non-featured musicians and vocalists, etc.) could have more control over their creative endeavours.
There is no single definition of neighbouring rights, which vary much more widely in scope between different countries than authors’ rights or copyright.
However, the rights of performers, phonogram producers and broadcasting organisations are certainly covered by related rights, and are internationally protected by the Rome Convention for the protection of performers, producers of phonograms and broadcasting organisations, signed in 1961. Aside from the Rome Convention, another international treaty addresses the protection of neighbouring rights in the musical sector: the WIPO performances and phonograms treaty (WPPT) signed in 1996.
At the European Union level, three directives have been instrumental in developing a harmonized legal framework relating to neighbouring rights: the directive of 27 September 1993, relating to the coordination of certain rules on author’s rights and neighbouring rights applicable to satellite broadcasting; the directive of 29 October 1993 – replaced by the directive n. 2006/116/EC of 12 December 2006 – on the term of protection of copyright and certain related rights; the directive n. 2001/29/EC of 22 May 2001 on the harmonisation of certain aspects of copyright and related rights in the information society.
As mentioned above, sound recording performance rights represent the bulk of all neighbouring rights collected worldwide, and they are a growing source of global revenue for recording artists and record labels. For example, in the US, SoundExchange, the organisation responsible for collecting and distributing sound recording performance royalties, distributed USD590mn in 2013, a dramatic increase from the USD3mn the organisation distributed in 2003. In the decade since SoundExchange’s inception, the organisation has generated USD2bn in royalties to artists and record companies.
Out of a total of Euros2.034bn of neighbouring rights collected in 2013, 48.9 percent originate from Europe (Euros1.101bn), 30 percent from North America (Euros681mn), 11.9 percent from South America (Euros268mn) and 8.6 percent from Australasia (Euros192mn).
With a 28 percent share of worldwide royalties, the US is the main market for neighbouring rights, even though the collection of such rights is limited to the public performance of sound recordings on digital medium only (such as online radio like Pandora, satellite broadcasting like Sirius/XM and also online streaming of terrestrial radio transmission like iHeartRadio). Unlike most of the world, the US does not apply sound recordings performance rights to broadcast radio, terrestrial radio and performance of sound recordings in bars, restaurants or other public places.
The market of neighbouring rights is mainly concentrated in 10 countries, which control 82 percent of worldwide royalties, with a strong concentration in Europe. Apart from the US, the United Kingdom (12 percent), France (11 percent), Japan (7 percent), Brazil (7 percent), Germany (7 percent), Argentina (3 percent), the Netherlands (3 percent), Canada (2 percent) and Norway (2 percent), are the top 10 worldwide markets. Outside the US, sound recordings enjoy broader performance rights for broadcast (including terrestrial radio), public performance and so-called communication to the public.
Globally, sound recording performance rights are administered by music licensing companies or collecting societies. These organisations are responsible for negotiating rates and terms with users of sound recordings (e.g. broadcasters, public establishments, digital service providers) collecting royalties and distributing those royalties to performers and sound recording copyright owners, i.e. record labels.
There are around 60 collecting societies around the world focused on sound recording performance royalties. These collecting societies may provide a statutory license to DSPs.
However, neighbouring rights deriving from streaming revenues generated on the DSPs’ platforms are almost always managed directly by the record labels and their representatives. Indeed, it is important to note that statutory licenses do not apply where there is a direct licensing deal between the DSP and the record label. So, for example, the 3 major labels have each directly signed a licensing agreement with each of the DSPs, while other direct deals have been signed between Clear Channel, the owner of digital radio IHeartMedia, and labels such as Glassnote (the label for Mumford and Sons) and Big Machine (Taylor Swift’s label). Independent labels have teamed up to create global digital rights agencies such as Merlin, which offer the attractive option of globally licensing, via a single deal, the world’s most important and commercially successful indie labels to DSPs. Among those that have a license with Merlin, feature Soundcloud, Vevo, Google Play, Deezer, YouTube and Spotify.
In 2014, internet radio Pandora entered its first direct deal with record labels, outside the statutory system, by establishing a partnership with Merlin. Meanwhile, neighbouring rights collection body SoundExchange keeps a tight leash on Pandora, arguing that the USD0.0014 paid by Pandora to record labels for every stream is too low and should be increased to USD0.0025. As a result, in December 2015, the US Copyright Royalty Board increased the basic per-song rates paid by Pandora (and its competitors such as iHeartRadio) to USD0.0017, or slightly more than 20 percent.
While Pandora is now willing to sign direct deals with record labels, as explained above, it does not mean that the cordial relationship is devoid of any strain: the three majors and the RIAA filed several copyright infringement lawsuits against Pandora and its competitors in 2014, for playing pre-February 1972 recordings without making any royalty payments. The labels said both Pandora and competitor SiriusXM took advantage of a copyright loophole, since the master recording for copyright was not created federally, in the US, until 1972. However, the labels claimed that their master recordings are protected by individual state copyright laws and therefore deserve royalty payments. Several court decisions were released since, and the federal courts unanimously found against SiriusXM and Pandora, and for the payment of royalties on play of pre-February 1972 recordings.
Since direct deals are signed between record labels and DSPs, this means that it is down to the parties to organise their licensing contractual agreements as they see fit. These licensing deals between DSPs and labels, which are 3 to 4 years old at best, have so far had almost no impact on the way recording deals signed between label and recording artists, are drafted, as far as digital revenues are concerned.
Indeed, the way the licensing agreement between the DSP and the label is drafted is automatically going to have an impact on the record deal signed between the record label and the recording artist. If a record deal was signed more than 4 years ago, it will most definitely not provide for a clear and transparent redistribution of digital income to the artist, by the label.
As I mentioned in point 1.2. (Net profit deal) above, labels and recording artists are currently fighting hard to establish whether streaming is replacing radio or sales. Currently, labels typically pay artists on either one or the other of those models, and more often on the basis of a stream being a sale. Why are labels most commonly treating streaming as sales (which is rather counterintuitive since streaming is all about “access” not “ownership”)? Because, as explained in point 1.2. above, the percentage that labels have to pay artists is so much lower, often in the 10 to 15 percent range if the artist is signed on a traditional or 360 record deal, rather than around 50 percent for a license. Music industry experts propose to assimilate streaming to a hybrid between sale and license, with a hybrid rate that sits in the middle. Doing so would double the amount of money more artists make from streaming, instantaneously transforming its revenue impact for many.
It is highly probable that new record deals will be negotiated at length, in particular by major acts, as far as digital revenues are concerned, in the very near future, especially in the aftermath of the breakage “scandal” and the controversy over the sale or license nature of a stream.
Record labels and collecting societies: How to collect micro-payments around the world
As mentioned above, there are around 60 collecting societies around the world focused on sound recording performance royalties. These collecting societies may provide a statutory license to public venues, DSPs or radios, etc. from which they later collect neighbouring rights royalties, which are later paid back to record labels, performers and non-featured musicians and singers.
3.1. How are neighbouring rights protected and collected on a territorial-basis?
While it could appear that neighbouring rights are protected and remunerated in a very homogenous way around the world, thanks to the structured international and European legal framework described in point 2.3. (Neighbouring rights and digital performance of sound recordings) above, in fact these related rights and the business practices of collecting societies are very different and vary from territory to territory.
Each of the 60 collecting societies operates in a territory that recognises performances in slightly different ways and has a specific business practice.
For example, the US Copyright act grants owners of sound recordings an exclusive right to “perform the copyrighted work publicly by means of a digital audio transmission“. This right is limited by a statutory license for so-called “non-interactive digital audio transmissions“. Therefore, services which comply with the statutory license may stream sound recordings without permission of the copyright owner, subject only to remitting data and payment to SoundExchange. The US Copyright act specifies how SoundExchange divides and distributes the royalties: 50 percent go to the sound recording copyright owner – i.e. the record label; 45 percent is distributed to the featured recording artist; and 5 percent is sent to an independent administrator which further distributes those royalties to non-featured musicians and vocalists.
In the United Kingdom, the UK copyright, designs and patents act grants sound recording copyright owners exclusive performance rights in their sound recordings. In addition, the UK act gives performers on those sound recordings a right of “equitable remuneration” for a share of the licensing proceeds for uses of the sound recordings. Therefore, when a sound recording is broadcasted in the UK, the performers on those sound recordings have a right against the producer (i.e. the record company) of the recording as to a share of the producer’s revenue from that usage. From a legal standpoint, it is very different from the US statutory license regime where the featured artist’s share is as against the user of the sound recording, not the record company. As mentioned above, the UK is the second largest market for neighbouring rights globally. According to the 2014 financial results of UK collecting society PPL, it collected a total of £187.1mn total license fee income (from broadcast, online, public performance and international revenue sources).
In Germany, the Law on copyright and neighbouring rights similarly grants performers and producers rights to remuneration for the performance of their sound recordings. While this German law grants performers rights of equitable remuneration for the broadcast of communication to the public of their fixed performances (i.e. sound recordings), it grants producers (i.e. record labels) a share of the performer’s proceeds from the licensing of broadcast and communication to the public rights. Therefore, the producers’ revenue from such activity is as against the performer, not the user of the sound recording. This is the exact opposite to the UK regime, and nothing like the US system.
In France, the Intellectual property code also grants sound recording copyright owners exclusive performance rights in their sound recordings, through a statutory license. Like in the US, digital service providers which comply with the statutory license may stream sound recordings without permission of the copyright owners, subject only to remitting data and payment to SCPP (when the record producer is a major), SPPF (when the record producer is an independent label), ADAMI (for performers) and SPEDIDAM (for non-featured musicians and vocalists). The Intellectual property code provides that 50 percent of the royalties go to the sound recording copyright owner (the label), while the other 50 percent go to the performers and non-featured musicians and vocalists.
3.2. How are neighbouring rights protected and collected on a cross-border basis?
One of the recurring questions that artists and labels ask themselves is how they are protected from one territory to the other. Indeed, music is a global business, especially in the digital era: artists successful in one territory often are successful in others.
Worldwide success implies that the sound recordings of artists are going to be performed publicly in other territories than where they reside. How, then, can performers and producers collect sound recording performance royalties in territories where they are not nationals and may not have direct agreements with the relevant societies?
The answers are complex and derive from the application of the provisions set out in the Rome Convention and the WPPT above-mentioned.
Article 2 of the Rome Convention details the level of protection that it grants nationals of contracting states in each others’ territories. In short, contracting states owe nationals of other territories the same level of protection they recognise for their own nationals. This concept of “National Treatment” is key to international copyright treaties and works to ensure that members do not unfairly discriminate against nationals of other contracting states.
Articles 4 and 5 of the Rome Convention specify that sound recordings made by nationals of contracting states, first recorded in contracting states, or first published in contracting states, are eligible for National Treatment. Similarly, a performer’s performance will be granted National Treatment if it was rendered in a contracting state, incorporated in a protected sound recording, or if not recorded, broadcast from a contracting state.
Article 12 of the Rome Convention sets out the equitable remuneration for performers, producers (or both) for secondary uses of their sound recordings (e.g. broadcasting, communication to the public). The US is not a signatory to the Rome Convention because, in 1961, this country did not recognise sound recordings as copyrightable subject matter (only in 1995 were sound recordings granted a limited digital public performance right in the US). Article 4 of the WPPT sets out the treaty’s national treatment requirements. Contracting parties must grant nationals of other contracting parties the same level of protection they grant to their own nationals. Article 3 of the WPPT imports the qualification criteria for performers and producers from the Rome Convention (articles 4 and 5). Thus, performers and producers who would be entitled to National Treatment under articles 4 and 5 of the Rome Convention are entitled to National Treatment under article 3 of the WPPT, as if all members of the WPPT were Rome Convention members. This ensures that US performers and producers eligibility is analysed in the same way, even though the US is not a Rome Convention signatory. Article 15 of the WPPT details the equitable remuneration right of performers and producers and largely follows the provisions of article 12 of the Rome convention. A contracting party may recognise an equitable remuneration right for secondary uses of sound recordings (e.g. broadcast, communication to the public) for performers, producers or both, or may choose not to recognise such a right at all. Contracting parties may choose to limit their application of article 15 by depositing a notification detailing the scope of its limitation. Such notifications may have implications for the level of national treatment member states owe each other’s nationals under article 4.
Article 4 of the WPPT requires contracting parties to provide full national treatment to each others’ nationals. However, article 4(2) states that contracting parties may limit the scope of national treatment to the extent another contracting party has availed itself of a reservation under article 15. For example, because the US does not recognise a terrestrial broadcast right for its own nationals or those of any other country, most WPPT members choose not to grant terrestrial broadcast rights to US nationals, even though they are recognised for their own nationals. This concept of “like-for-like” treatment is often referred to as “reciprocity” and is distinct from “national treatment”.
When seeking to maximise the amount of royalties one collects for artists and record companies abroad, these concepts of “national treatment” and “reciprocity” are critical to keep in mind. Understanding what qualifies for full national treatment and what qualifies for limited reciprocity can have an impact on the amount of neighbouring rights revenue an artist or label realises.
For example, a US performer recording in Europe would be qualified for performer royalties (or a European performer recording in the US). Eligibility for royalties is often a fact-based, case-by-case analysis focused on the nationality of performers and producers, where recordings took place, and where they were first published. Knowing these important facts is crucial to ensuring that artists and labels receive what they are owed.
Collecting societies play an important role here: not only do they collect fees from users in their own territories and distribute those to their domestic royalty recipients, but they often act on behalf of their member artists and labels to collect undistributed royalties abroad.
In particular, PPL in the UK, and SAMI, in Sweden, have a share of international royalties above 20 percent in their respective total amount of royalties collected. This is explained by the fact that both UK and Swedish music are great exports around the world. Consequently, PPL has identified international income as a growing source of revenue and has set up a very dynamic policy of royalties’ collection abroad, signing dozens of reciprocity agreements with sister collecting societies.
3.3. A la carte: how record labels are cherry picking the services that collecting societies will provide them with
In its latest report on neighbouring rights in the digital era, French collecting society ADAMI highlighted that the worldwide market of neighbouring rights in collective management should grow exponentially in the next few years. However, the report noted that the share of sound recording public performance royalties attributed to digital is still quite low, apart in the US where related rights in collective management only come from digital sources (i.e. streaming and digital radio).
As more and more consumers use streaming – as opposed to music downloads and physical formats -, ADAMI forecasts that the share of sound recording public performance royalties deriving from streaming will become an essential part of the income paid to performers and record labels.
As mentioned in point 2.3. (Neighbouring rights and digital performance of sound recordings) above, most labels elect to negotiate the collection of sound recording public performance rights, neighbouring rights, directly from digital service providers.
For now, most of the sound recording public performance royalties collected by collective management societies originates from equitable remuneration, which is in part linked to advertising revenues of commercial radio and TV.
As highlighted by co-founder of the French top indie label Because Group, Emmanuel de Buretel, labels should register directly with foreign collecting societies which manage neighbouring rights in key territories where their sound recordings are played, streamed and used, in order to have quicker and more transparent access to those sound recording public performance royalties. For example, Because Group, which main neighbouring rights collecting society is SPPF, is directly registered with PPL in the UK and SoundExchange in the USA, which are key territories for its acts.
Record labels, brands & ad agencies: let’s synch!
Music is an important part of audio-visual projects such as films, television programs, television or internet advertisements, video games and internet websites. So much so, that Universal Music Group recently named some veteran film producers to lead its development and production of film, television and theatrical projects.
In order to be able to use an existing musical composition and existing sound recording in an audio-visual project, the producer of the project will need to get a license from the people or entities that own or control the rights to that musical composition and that master sound recording.
This is what is called a synchronisation license, or synchronisation and performing rights license, or master use and synchronisation license or just sync license. Such license gives the right to the producer of the project to synchronise the composition and existing sound recording with, or include them in timed relation to, the images in the audio-visual project.
Such use of compositions and master sound recordings in audio-visual projects is not subject to collective or statutory licensing schemes. Each use is freely negotiated between the parties involved: the owners of the musical composition and master sound recording on the one hand, and the producers of the audio-visual project on the other hand.
As sound recordings are usually owned or controlled by record labels, producers of audio-visual projects often negotiate the master use license with them.
4.1. Synch as a viable business model
Master use licenses can be an important source of income and exposure for labels and their recording artists. In an era of shrinking sales of physicals, and still insufficient revenue from downloads and streaming to make up the difference, master use licenses can be welcome and even vital sources of revenue. In particular, unlike sales and neighbouring rights which bring in small amounts of money on a delayed basis, master use licenses often bring in upfront lump sum payments, which can support the labels’ cash flow.
Also, having a placement in a film or television program means that the artist and label can benefit from the promotion and marketing for that project, especially if the artist and label receive prominent written credit within the audio-visual project and in advertisements for the project, and if the sound recording is used in audio-visual ads for the project (such as a film trailer). Such promotion can lead to further physical sales, downloads or streams of the recording. Further, a placement in a successful film or TV show can bolster the credibility of the label and its recording artist, paving the way to obtaining additional master use licenses for that or other sound recordings.
For example, even Adele, who openly said that she will never “sell out” by endorsing consumer goods products, had readily agreed to synch her song Skyfall in James Bond’s movie with the eponymous name in 2012. The song quickly went to the top of the Billboard Hot 100 and it became the first Bond theme to win at the Golden Globes, the Brit Awards and the Academy Awards. It also won the Grammy Award for best song written for visual media.
For bands such as the Rolling Stones, the Beatles and Led Zeppelin, master use licenses of one of their sound recordings into an audio-visual project can reach up to GBP1mn per deal.
Labels are therefore strongly incentivised to have tight links with music supervisors, ad agencies and even music aggregators such as the Orchard, in order to multiply opportunities to place their sound recordings in attractive and cash-rich audio-visual projects.
Labels also need to be reactive and efficient when dealing with sync and master use licensing requests, because brands often contact them at the eleventh hour, sometimes just one or two weeks before the advertising campaign is launched, to negotiate music rights.
4.2. The pros and cons of sound-a-like litigation in the synch context
The other side of the coin of the sync business is that many producers of audio-visual projects do not bother to ask for, and negotiate, a sync and master use license with right owners. In this internet-era, and with a proliferation of user-generated TV channels on platforms such as YouTube, right owners are faced with an ever-increasing number of unlicensed uses of commercial music by brands and individuals.
Often, artists and record labels discover unlicensed commercials via fans who may stumble across them and share via their social networks or even tweet the artist directly. These uses can be incredibly damaging for an act, in particular those who choose not to have their music used in association with brands.
It is not uncommon for a brand or advertising agency based in a country where there is very little IP protection simply to use a sound recording in their advert without asking. Even in the US or the UK it sometimes happens, mainly due to a mistake or simply a misunderstanding of music copyright and sync rights in particular.
Also, there is an increasing use of “sound-a-like” songs in advertising. This is when a brand records a piece of music with the intention of making it sound very similar to an existing – and often famous – song. Ad agencies and brands may think that they will be able to bypass asking for a license to record labels and other right owners of the copied song that way, but recent litigation has proved them wrong. In 2007, for example, Tom Waits objected to the use of a sound-a-like of one of his songs in an advertisement feature Opel cars and successfully settled the claim.
For record labels, non-authorised use of one of its sound recordings or use of a sound-a-like to one of its sound recordings by a brand or ad agency can be a great opportunity to monetise its rights. While this scenario is not for the faint-of-heart though, since it may involve litigation, it is well worth initiating a frank and constructive dialogue with the infringer, in order to assess whether any license – and licensing royalty – may be agreed upon. Since any license would be granted post use of the copyrighted sound recording, labels usually ask for a higher licensing fee, as a penalty for not proactively seeking a licensed use in the first place.
Sometimes these issues cannot be settled out of court, resulting in full-blown litigation which may very well hurt the reputation of the infringing brand, defeating the whole purpose of setting up a marketing campaign in the first place, which is – ultimately – to make more consumers like your brand and its products. Record labels and recording artists are in strong positions, here, because if they have valid evidence to demonstrate the copyright infringement of their sound recordings, they can obtain sizable damages allocated by IP-friendly judges, in court judgments, in particular in jurisdictions such as France, the US and the UK.
To conclude, it is obvious that record labels must reinvent their business models if they are to thrive, in the new paradigm of the music business. While the three majors seem to have the upper hand, at this game of reinvention and first mover’s advantage in tech and streaming services, independent labels can play their cards well by leveraging their existing know-how in proposing innovating label services, monetising their back catalogues through sync and streaming, exploring uncharted EDM waters and maximizing royalties from sound recording public performance by striking advantageous deals with DSPs and collecting societies alike.
 Independent labels trounce UMG, Sony and Warner in US market share, MusicBusinessWorldwide, 29 July 2015.
 Downloaded, 2013 documentary by Alex Winter about Napster and the downloading generation and the impact of file sharing on the internet.
 Rita Ora demands freedom from Roc Nation, citing Jay Z’s new pursuits, Billboard, 17 December 2015.
 Macklemore & Ryan Lewis crash radio with “Thrift shop”, Steven Horowitz, Billboard, 8 January 2013.
 Neighbouring rights in the digital era: how the music industry can cash in, A. Gauberti, July 2015
 What is a music stream? Artists and labels in battle over digital income, The Guardian, Helienne Lindvall, 12 March 2014
 Universal settles influential Eminem digital-revenue lawsuit, Spin, Marc Hogan, 31 October 2012.
 Big shake-up to music licensing regime embraced by US copyright office, The Hollywood Reporter, Eriq Gardner, 5 February 2015.
 Robbie Williams signs GBP80mn deal, The Guardian, Fiachra Gibbons, 3 October 2002.
 Billboard’s top 30 EDM power players list revealed: who rules dance music?, Billboard, 6 December 2015
 EDM’s shameful secret: dance music singers rarely get paid, The Guardian, Helienne Lindvall,6 August 2013
 Electronic music industry now worth close to USD7bn amid slowing growth, Thump, Zel McCarthy, 25 May 2015.
 Labelled with love, Music Week, Tom Pakinkis, May 2015.
 Fintage House launches “full-service” publishing model – including masters, Music Business Worldwide, Tim Ingham, 7 May 2015.
 Kobalt raises USD140mn to scale up its digital collection business, Techcrunch, Ingrid Lunden, 4 June 2014.
 What will record deals look like in the future?, Music Business Worldwide, Tim Ingham, 19 November 2015.
 Neighbouring rights in the digital era: how the music industry can cash in, Crefovi, Annabelle Gauberti, 26 July 2015.
 Revenge of the record labels: how the majors renewed their grip on music, Forbes, 15 April 2015.
 Warner will pay artists Spotify IPO money when it sells its shares, Music Business Worldwide, Tim Ingham, 4 February 2016.
 This was Sony Music’s contract with Spotify, The Verge, Micah Singleton, 19 May 2015.
 Breakage is back: how Deezer paid USD23mn in unallocated advances to labels, Music Business Worldwide, Tim Ingham, 25 September 2015.
 France seeks to tackle music’s digital future, provide artists a minimum wage, Billboard, Andrew Flanagan, 10 May 2015.
 Neighbouring rights in the digital era: how the music industry can cash in, Crefovi.com, Annabelle Gauberti, 26/07/2015.
 Pandora signs first direct deal with Merlin, Billboard, Glenn Peoples, 6 August 2014.
 Pandora forced to pay artists millions more – but fares well in crucial rates decision, Musicbusinessworldwide, Tim Ingham, 16 December 2015.
 Record labels sue Pandora over Pre-1972 recordings, Ed Christman, Billboard, 17 April 2014.
 Neighbouring rights in the digital era: how the music industry can cash in, Crefovi.com, Annabelle Gauberti, 26 July 2015.
 In search of your neighbouring rights abroad, MaMa, 14 October 2015.
 An overview of master use licenses: film and television uses, IAEL book, Licensing of music – from BC to AD, 2014, Bernard Resnick and Priscilla Mattison.
 Music rights without fights, 2016, Richard Kirsten.
 IP Clinic: they’re playing our song. Sue them!, Managing Intellectual Property, 1 September 2014, Tom Foster, Richard Kirstein, Annabelle Gauberti.
 Sync masterclass, MIDEM 2015, Bernard Resnick, Tom Foster, Annabelle Gauberti: https://crefovi.com/media-coverage/london-music-law-firm-crefovi-spoke-sync-license-midem-2015/
ialci and Tranoï become official partners for 2016 trade shows worldwide | London fashion and luxury law firm CrefoviCrefovi : 23/01/2016 8:00 am : Banking & finance, Capital markets, Consumer goods & retail, Copyright litigation, Emerging companies, Employment, compensation & benefits, Events, Fashion law, Fashion lawyers, Gaming, Hospitality, Hostile takeovers, Information technology - hardware, software & services, Intellectual property & IP litigation, Internet & digital media, Law of luxury goods, Litigation & dispute resolution, Mergers & acquisitions, Outsourcing, Private equity & private equity finance, Product liability, Real estate, Restructuring, Tax, Technology transactions, Trademark litigation, Unsolicited bids
ialci, the international association of lawyers for creative industries, and Tranoï, fashion and luxury trade shows’ organiser and platform, partner up on all trade shows for 2016 worldwide.
ialci, the international association of lawyers for creative industries, was founded by Crefovi’s founding partner, Annabelle Gauberti, in 2013.
Today, ialci is a dynamic association, which members are currently drafting a book on the law of luxury goods and fashion (to be released in 2016) and which organises several high-profile seminars from the law of luxury goods and fashion series.
ialci’s president, Annabelle Gauberti, struck a partnership with fashion and luxury goods platform and trade shows’ organiser, Tranoï.
Tranoï is a series of international fashion trade shows as well as an artistic platform with a stern selection of more than 1000 premium designers from all over the world, created for them to meet the most influential fashion ambassadors. As set out on its website, Tranoï is more than trade shows. “It also includes artistic installations, designers exhibitions, catwalk shows, fashion parties and all sorts of events which arouse the dreams and desires inherent to fashion“.
It was founded by the Hadida family, renowned for establishing multi-labels concept stores L’Eclaireur. L’Eclaireur founder, Mr Armand Hadida, is its creative director while his son, Mr David Hadida, is its general director.
The objectives of Tranoï are to:
- Facilitate connections between fashion businesses and the right professionals to support them with their challenges;
- Present highly curated fashion products, sold by the exhibitors, to the most high-profile and sought after multi-label stores, department stores, online stores in the world;
- Showcase the French and international innovations that serve the fashion industry.
ialci’s lawyers will attend all trade shows in 2016, worldwide, in order to provide free legal advice, short one-to-one introductory meetings as well as workshops on hot topics pertaining to the law of luxury goods and fashion, to all Tranoï’s exhibitors and visitors.
With more than 80% of exhibitors at Tranoï New York and Paris coming from Europe, and most visitors to New York and Paris trade shows coming from the US, Japan, Italy, France, Germany and the UK, Tranoï’s clients will benefit from responsive, international and expert legal advice and services provided by several member lawyers of ialci, qualified under English law, French law, New York law, Brazilian law, Belgium law, Italian law and German law.
Already, in September 2015, the lawyers from ialci, including Crefovi’s founding partner Annabelle Gauberti, had a booth at New York trade show at the Tunnel in Chelsea. During that September trade show, ialci lawyers were delighted to have their booth visited by numerous exhibitors and visitors, who asked them many legal questions relating to fashion law and their business affairs and/or were simply curious to know more about ialci.
Exhibitors and visitors also attended with great curiosity and interest ialci’s workshops held at Tranoï New York Show, on 19 and 20 September. These 40 minutes’ seminars focused on which types of intellectual property rights are worth protecting for a luxury and fashion brand, as well as tips to negotiate well an agency or distribution agreement in the fashion sector.
The presence of ialci on the trade show in New York, in September 2015, was duly noticed and even got press coverage!
Now that an official partnership has been signed between ialci and Tranoï, ialci will attend and participate to all trade shows worldwide in 2016, as follows:
- Tranoï Homme and Preview, from 23 to 25 January 2016, at Cité de la Mode et du Design and Palais de la Bourse in Paris ;
- Tranoï New York, from 21 to 23 February 2016, at the Tunnel, Chelsea, in New York City;
- Tranoï Femme, from 4 to 7 March 2016, at Cité de la Mode et du Design, Palais de la Bourse and Carrousel du Louvre in Paris.
In order to organise an appointment with ialci lawyers, please fill out and send us an online contact form.
Crefovi and ialci will revert back to you in due course, with some suggested appointment times, in order to meet up during the trade shows, and with some questions and points about your legal enquiries in order to address them adequately during those appointments.
In addition to being present at ialci booth during the whole duration of each trade show, for free advice and consultations to Tranoï’s exhibitors and visitors, ialci lawyers will also organise various workshops on legal topics of particular interest to the exhibitors and visitors of Tranoï’s trade shows, on intellectual property, fashion finance, agency and distribution agreements, lawful use of social media, etc.
Annabelle Gauberti, founding partner of London fashion and luxury law firm Crefovi, will coordinate ialci’s and her law firm’s presence at Tranoï. She will be present on ialci’s booth at all times.
Tranoï’s goal is to welcome more than 4,000 visitors over three days at its multiple sites in Paris, and more than 1,000 visitors over three days at the Tunnel, Chelsea, in New York.
One of the USPs of Tranoï events is the focus on creating a real dialogue between attendees and speakers, so if you happen to attend some panel discussions or workshops Annabelle is participating in, or if you see ialci’s booths on Tranoï Paris and New York, please don’t hesitate to ask her a question! You can also catch her afterwards if you have anything specific you would like to discuss. See you there!
Highlight trailer of ialci and Tranoi partnership during Paris and New York fashion weeks, in January, February and March 2016
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