26 Mechanical Rights

Compulsory License:

The Copyright Act of 1909 extended the musical works copyright to include the exclusive right to reproduce and distribute those works mechanically. However, in one of most significant legislative decisions in copyright history, the 1909 act also includes a “compulsory license,” allowing for the mechanical reproduction and distribution of musical works by those who do not have any copyright interest in the work. We call this license “compulsory” because the copyright holder(s) cannot opt out of it or otherwise block others from obtaining the license provided they abide by the few requirements. (Note that you may sometimes see the compulsory mechanical license referred to as a “Section 115” license because it can be found in Section 115 of the U.S. Copyright Code.)

Conditions for a Compulsory License:

• A recording of the musical work must have been previously distributed with the consent of the copyright owner(s). In other words, the person seeking to use the compulsory license cannot be attempting to make and distribute the first recording of the work.
• The license includes the right to make an arrangement of the musical work to suit the style of the new performer, but the arrangement “shall not change the basic melody or fundamental character of the work.” There are no hard-and-fast rules about when an arrangement would change the fundamental character of a work. However, we could assume, by way of example, that a “dubstep” EDM version of “My Heart Will Go On” (the theme song from the film Titanic) would alter the fundamental character of the original work, and so would likely not be eligible for a compulsory license if challenged in court.
• The new recording cannot be a duplication of a previously-existing recording (unless specifically authorized by the copyright owner). This is the most obvious requirement: the compulsory license extends only to new recordings of a musical work, not to the duplication of previous recordings.
• Notice of intent to make and distribute a recording of a work under the compulsory license must be given to the copyright owner no later than 30 days after making and distributing the work. If the identification and contact address of the copyright owner are not available in the Copyright Office’s records, then the notice can be made to the Copyright Office itself. (Note that since the passage of the Music Modernization Act of 2018, this notice and record-keeping function will likely be taken over by the newly formed Mechanical Licensing Collective.)
• Payment of all applicable royalties must be made monthly to the copyright holder (see below). If royalty payments are not made, the copyright holder can terminate the license.

Mechanical License Royalties: 

The rates for royalties payable to the copyright owners under a mechanical license are determined by the Copyright Royalty Board (CRB), which is a panel of three copyright royalty judges. The CRB determines the compulsory license rates for 5-year periods, the latest being the period January 1, 2018 through December 31, 2022. The 5-year mechanical license royalty periods are as “Phonorecords I,” “Phonorecords II,” etc. The 2018-2022 5-year period was “Phonorecords III.” The CRB determines the rates for the new period based on public comments and hearings during a review period. The CRB’s rate decisions can be appealed to the United States Court of Appeals, District of Columbia Circuit (see below for a discussion of Spotify’s current appeal of the new streaming rates).

The CRB determines and sets the royalty rates for mechanical licenses based on the type of reproduction and distribution, as follows:

Negotiated Rates:

Before we dive into the complicated methods the CRB uses to set the mechanical license royalty rates, we need to be aware that the licensee and the copyright owner are free to negotiate their own rates and thereby ignore the rates set by the CRB.

Physical phonorecords, permanent digital downloads (PDD), and ringtones

The simplest category of compulsory mechanical licenses involves those used to make and distribute physical phonorecords (including CDs, vinyl records, etc.), mobile phone ringtones, and “permanent digital downloads” (PDDs). PDDs are computer files stored on a computer, iPod, phone, or other device that the user owns and can play from their device whenever desired. PDDs are often protected from copying by digital rights management software (DRM), but the purchaser still owns them and can renew the rights to play them, so they are called “permanent.” Copyright law treats PDDs differently from digital streaming files, which are not stored permanently on a computer or other device and cannot be played by the user other than through requesting a new temporary file from the streaming service such as Spotify. (This is a legally important point: the file that gets downloaded to your device when you stream a song is carefully designed to be temporary — it vanishes from your device once the stream is over or has been interrupted.)

The rates set by the CRB for the 2018-2022 period (Phonorecords III) were as follows:

• • For each copy of a physical phonorecord or permanent digital download, either 9.1 cents or 1.75 cents per minute of playing time or fraction thereof, whichever amount is larger
  • For ringtones, 24 cents for each distributed ringtone.

Note that these rates are the same as the rates that have been in effect since 2006. That is, the CRB chose not to change them for the current 5-year period (Phonorecords III).

In the early spring on 2022, the record companies and publishers submitted a negotiated proposal to CRB that the mechanical royalty for physical and downloads should remain at 9.1 cents for the 2023-2027 period (Phonorecords IV). However, the CRB rejected this proposed settlement because it felt the physical/download rate had been too “static” for too long, a fairly obvious conclusion as it hadn’t changed since 2006. In a surprising response, the parties submitted a new negotiated settlement to the CRB in May of 2022, suggesting a rate of 12 cents for the upcoming 5-year period, with automatic “cost of living” adjustments for each successive year of the period. This represents an immediate 32% increase in royalty payments to songwriters and publishers for physical sales and downloads. In December of 2022, the Copyright Royalty Board formally accepted the 12 cent negotiated rate for the 2023-2027 5-year period (Phonorecords IV). This is nowhere near as significant as the rate for streaming (discussed below), but physical sales of vinyl is an increasing category of revenue.

Interactive Streams and Limited Downloads:

The Music Modernization Act of 2018 created a new blanket mechanical license for interactive music streaming on the internet. Before this act, streaming companies voluntarily paid a royalty on mechanical licenses even though they simultaneously argued that interactive streaming was not technically part of the mechanical license framework due to the ephemeral (temporary) nature of the corresponding computer file. The term “blanket” license means that that it applies to all music streamed, regardless of its ownership by different individuals or companies. In other words, the streaming companies do not have to apply for this license to each copyright holder. The Music Modernization Act codified the applicability of interactive streaming as part of the compulsory mechanical license for musical works by creating blanket licenses for streaming services (such as Spotify and Apple Music).

The CRB’s difficult assignment for the new 5-year term beginning 2018 was to come up with a royalty rate for interactive streaming that would apply to the new blanket streaming licenses. In its decision, the CRB judges chose to adopt what is known as the “All In” rate that streaming services had already been voluntarily paying before 2018. The All In rate strikes a balance between a streaming service’s “percent-of-service revenue” with its “percent-of-TCC” (total cost of content), and the rate paid is based on the greater of those two numbers. Once that total royalty rate is determined for each streaming service, it is allocated among the musical work copyright owners based on the number of streaming plays for each work from that service.

The rate is called an “all in” rate because the streaming services are able to deduct from the mechanical royalties due under this calculation the amount of royalties they also pay to musical works copyright holders as part of the performance right royalties (discussed below). Whatever royalty amount is calculated under this formula includes mechanical and performance royalties as well as royalties paid to record companies for the sound recording license (thus, “all in”) and the other royalties actually paid by the service are then deducted, leaving the effective mechanical royalty payment payable to the musical work copyright holder.

The percentage rates applied for the “greater of” calculation are to be phased in year-by-year during the 5-year period as follows:

The rationale behind this complicated rate formula is as follows: Music streaming services currently operate at a loss because they compete for customers and market share by offering introductory low rates (particularly to students, their biggest audience). Thus, the streaming companies revenues are currently depressed by stiff competition, so basing royalties only on revenues would artificially suppress royalty payments until the revenues begin to rise. So, the royalties are instead based on the “greater of” figure, which balances the total licensing costs against revenues. If a service has very low revenues because it lowers its subscription fee, it will then pay royalties based on a percentage of its costs rather than on a percentage of its revenues. On the contrary, if a service lowers its costs significantly by negotiating very low rates with record companies, it will then pay mechanical royalties based on revenues.

CRB Rate Determination Appeal:

The CRB’s rate determination for this new period was a major victory for songwriters and publishers. The tiered rate increases for streaming shown above represent a 44% increase over the 5-year period. This means that songwriters and their publishers (who typically split the mechanical royalties) will be getting a 44% raise in this period. This might seem like a large increase, but it must be put into the context of changes in the music industry that have been depressing songwriting and publishing royalties since the decline of physical sales and downloads and the subsequent rise of streaming. Streaming royalties amount to approximately ½ of a cent for each stream. Compare that to the royalty payment of 9.1 cents for a downloaded song and you will quickly realize how streaming has resulted in lower royalties to songwriters. 

But the 44% raise being given to songwriters and publishers also represents a corresponding increase in the costs of the so-far unprofitable music streaming business. So, in March of 2019, all streaming services other than Apple Music chose to appeal the CRB’s new rate determinations. This decision to appeal produced a highly accusatory and negative reaction from songwriters (and their publishers) to the streaming industry. This volatile and contentious relationship between songwriters/publishers and streaming companies can be seen in the harsh language used by the outspoken president of the National Music Publishers Association, David Israelite, who publicly asserted that “these big tech bullies do not respect or value the songwriters who make their businesses possible” and vowed that the NMPA would do whatever possible to protect the CRB’s new rates from the appeal.

The fact that Apple Music did not appeal the new rates highlights the difficulty independent streaming companies such as Spotify face when competing against established tech companies such as Apple, Google, and Amazon. The vast majority of Apple Computer’s profits come from the sale of hardware (such as iPhones), and Apple is one of the most profitable companies in the world. Apple uses its music streaming service primarily as a feature to drive hardware sales, not as a primary source of revenue. Apple can thus afford to pay higher royalty rates to songwriters whereas Spotify still struggles to turn a profit under the existing rates. Spotify has had only one profitable quarter (4th quarter of 2019) since its public stock offering in April of 2018. The 44% increase in mechanical royalties will only further delay streaming’s ability to turn a profit. 

The battle between songwriters/publishers and streaming companies has taken on a moral dimension that makes it a public relations minefield for streaming companies. The publishing companies (the largest of which are owned by the major record companies) spin this as a battle between the “little guy” (songwriters) being treated unfairly by the big corporate streaming companies (Spotify, Amazon, Google, etc.). To the average music fan, the unfairness seems obvious as they don’t realize that there are large multinational companies on both sides of the battle, and that streaming is not currently a profitable business.

On August 7, 2020, the U.S. Court of Appeals for the D.C. Circuit issued its opinion in the CRB rate appeal case, remanding (returning) the rate determination back to the CRB for further deliberations. The Court of Appeal agreed with the streaming companies that the CRB had not properly justified its decision to raise the mechanical rate increases and the methods by which they would be determined, nor had it allowed the streaming companies adequate opportunity to argue against those increases. In other words, the Court of Appeal found flaws in the process by which the CRB made its rate decisions.

On July 1, 2022, the CRB announced that after reconsidering its process in the Phonorecords III rate-setting decision, it had decided to stick with the 15.1% of revenue rate that had been appealed. The songwriters and publishers had thus prevailed against the appealing streaming services, even after the decision was remanded for further consideration by the D.C. Court of Appeals. This represents a major victory for songwriters and publishers, though the songwriters are quick to point out that they have only regained their losses from streaming and that there still exists an imbalance in royalty payments between songwriters, on one hand, and the record and streaming companies on the other.

While most industry observers were girding for yet another contentious battle between songwriters and streaming services for the next 5-year period (2023-2027, Phonorecords IV), things took a surprising turn in the summer of 2022. While the CRB has the authority to set the mechanical license rates, the Copyright Act also provides that the parties (songwriters, publishers, streaming and record companies) can also negotiate the rates among themselves and collectively settle on a rate for any future 5-year period. Surprisingly, the parties decided to avoid another costly and protracted legal battle for the Phonorecords IV rate-setting and announced on August 31, 2022 that they had settled on a streaming rate for the upcoming period (2023-2027). The rate they settled on is 15.35% of revenue, a slight rise from the 15.1% rate that ended the Phonorecords III period. The agreement also makes other adjustments to the “total cost of content” (TCC) calculation, and other factors involved in calculating the royalty rate. The negotiated rate was approved and published by the CRB in the Federal Register in December of 2022.