J. Rush Hicks, Jr.
Middle Tennessee State University
The bankruptcy laws were enacted to allow a person a “fresh start” in life by relieving a person of debts which were difficult, if not impossible, to repay. There are certainly pros and cons to the current U.S. Bankruptcy Act and members of Congress have proposed legislation to tighten-up on some of its perceived loopholes. Because of the substantial sums of money an artist can make in a relatively short period of time and the natural desire to live a lifestyle of a celebrity, many artists have found it necessary to ask for bankruptcy relief early in their career. Artists begin questioning why their success at record stores does not translate into substantial royalty payments by the record company and many attorneys and business managers inform their clients about the relatively small royalty payments they receive in proportion to the windfall received by the record company.
Historically, record royalty rates in contracts have been based on the suggested retail price of records but numerous items such as reserves against returns, free goods, foreign royalties, packaging deductions and the recoupment of the costs of the albums and videos are deducted from the artist’s royalty rate. The resulting royalty payment to the artist, who possibly has achieved multi-platinum sales, is usually pennies compared to the profits of the record company. On the other hand, the record company would argue the costs of “breaking” an artist to the public is enormous and the failure rate of most new artists is very high.
Take the scenario of an artist who has struggled for years to break into the music business and finally secures that all-important major label recording contract. The artist knows that success at the record store can translate into opportunities for exposure on television, increased tour dates, merchandise sales, and finally, a six-figure royalty check from the record company. The artist incurs debt almost immediately and does so without a thorough understanding of the deductions the record company will make before payment reaches the artist. The artist commences lavish spending to keep up with other artists because, after all, everyone knows an artist with a hit record will acquire substantial wealth. A year goes by and the artist’s business manager relays the grim news to the artist. You are unable to pay your debts, e.g.,, you are insolvent. The artist, after denying reality, consults an attorney. The attorney examines the artist’s financial condition and recommends filing for bankruptcy. Depending on the particular situation of the artist, the bankruptcy case can be filed as a chapter 7, 11, or 13 and the artist (now referred to as the debtor) will be granted relief from most debts and unsecured creditors (as opposed to secured creditors holding collateral) will generally receive a few pennies on the dollar. A Chapter 7 bankruptcy, called a liquidation, will discharge the debtor from all existing debts while a Chapter 11 bankruptcy called a business reorganization and a Chapter 13 wage-earner bankruptcy petition allows the debtor to repay their debts over time.
Section 365 of the U.S. Bankruptcy Act, however, also provides for relief from executory contracts considered burdensome to the debtor’s estate. Executory contracts are agreements that have obligations remaining to be performed. Artists and their attorneys began looking at the executory contracts provision of the U.S. Bankruptcy Act with the purpose of terminating what the attorney considers a one sided agreement; possibly re-negotiating a new agreement with a different record company who recognizes the value of having this particular artist on their roster; or, as a ploy to re-negotiate the existing deal. Interestingly, some recording artists in the U.K. have been successful in challenging one-sided or unconscionable recording contracts but U.S. civil courts have continued to enforce such agreements. U.S. courts have found that recording artists generally seek legal counsel to negotiate their recording agreements and then enter into these agreements voluntarily and not under duress. Thus, the artist looks to the bankruptcy court for relief and as long as the intent of the artist in requesting bankruptcy protection is to be discharged from debts the artist is unable to pay, a bankruptcy court will not block the debtor’s efforts to be relieved of an executory contract. Compared to litigating the terms of a contract in civil court, which generally is time-consuming, decisions in Bankruptcy Court are typically swift. More importantly, the artist/debtor maintains some leverage over the record company, unlike the realities of the marketplace where artists accept one-sided agreements in the hope of landing a record deal.
A typical recording contract, considered a personal services agreement, provides for the artist to record a minimum number of albums with the record company cross-col-lateralizing the unrecouped recording costs from prior albums with royalties generated from possibly future successful albums. Some record companies also cross-collateralize unrecouped recording costs against royalties earned by the artist/songwriter from the record company’s affiliated publishing company. For years, artists have complained about the relatively small amount of royalties generated by recording artists compared to the sale of their records. Unless an artist reaches superstar status, the record company’s recoupment of production and recording costs make it virtually impossible to earn significant royalties. Record companies have over the years established provisions in record contracts that make it very difficult for the artist to reap the rewards of their sales success. Returns against reserves, packaging deductions, the producer royalty, controlled composition clauses (reduces mechanical royalty income to the artist/songwriter by 25%) and “free” goods are some of the items that have reduced an artist’s anticipated royalty. Combined with recoupment of recording costs, video production costs, tour support, and independent record promotion, the artist will receive only a small portion of the revenue from gross album sales. New artists, unaware of this disparity, dream of the day when they will be offered a recording contract with a major record label. The relationship usually begins to deteriorate shortly after the artist receives the first accounting statement reflecting a substantial unrecouped balance. Even after achieving sales certifying a “gold” record, the artist will barely recoup expenses and must, therefore, depend on other sources of income such as publishing and touring. Record companies believe it is in their best interest to contract with an artist for as many as eight albums to offset the enormous costs of “breaking” an artist in the marketplace. The artist does not have a contractual right to prevent the record company from calling for additional albums or to drop the artist from its roster based on lack of album sales, but it is common for successful artists to attempt to renegotiate the terms of their contract.
Once the artist files for bankruptcy, a court-appointed trustee administers the estate and has the authority under Section 365 to cancel executory contracts. The courts have struggled with defining executory contracts since the Bankruptcy Act does not do so. Black’s Law Dictionary defines an executory contract as a “contract that has not as yet been fully completed or performed. A contract the obligation (performance) of which relates to the future.” The debtor who entered into a recording contract which has obligations remaining, such as delivering future albums, gives the trustee the authority to reject the contract. This allows the artist to possibly re-negotiate the terms of the existing record contract or enter into a new agreement with another record company with larger advances and higher royalty rates. Unfortunately, the record company’s remedy is to be considered an unsecured claim against the debtor with the record company sharing proportionately in whatever monies the debtor’s estate has generated.
If the record company, however, can establish to the satisfaction of the bankruptcy court that the debtor filed the petition with the sole purpose of rejecting an executory contract for the purpose of then entering into a contract with another record company, the Court can dismiss the case. A Chapter 11 bankruptcy petition was filed by an actress on the TV series “General Hospital” who attempted to reject her contract with the network. The Court determined, after reviewing her admission as to why she filed for bankruptcy protection, that her petition was filed in bad faith and subsequently dismissed the case. In Re Carrerre, 64 B.R. 156 (1986). In the case of Delightful Music Ltd. v. Taylor, 913 F.2d 102 (1990), James Taylor, lead singer for the musical recording group “Kool and the Gang,” filed a Chapter 11 bankruptcy petition and promptly moved to reject a recording contract with Polygram Records and Delightful Music. The trial court found that James Taylor had guaranteed certain promissory notes for the members of the group and incurred his own debts totaling in excess of $1,000,000. Additionally, he and the group had an unrecouped balance with Polygram Records of $950,000 and internal loans to their company of $2,000,000. James Taylor listed assets of less than $750,000, the bulk of which constituted his personal residence. Polygram Records and Delightful Music attacked the majority of the debts because they believed guarantees should not be considered debts for filing a petition amounting to bad faith. The Bankruptcy Judge examined the language in the promissory notes and agreed that state law made these guarantees enforceable against the debtor and that future sales of “Kool and the Gang” recordings were speculative and probably not sufficient to recoup the advances. Polygram asserted that the debtor’s purpose in rejecting the recording contract was to allow him to enter into a new recording contract thus concentrating his efforts in generating future income to the detriment of the existing creditors, namely Polygram Records and Delightful Music.
The grunge band “Gruntruck” found themselves in 1993 with an unrecouped balance owing to their record company, Roadrunner Records, totaling $130,000. All Blacks B.V. v. Gruntruck, 199 Bankr. 970 (1996). Because of decreasing record sales, increasing recording costs and tour expenses, all of the members of the group filed Chapter 7 bankruptcy petitions to be discharged from their indebtedness to Roadrunner Records and to terminate their record contract. The U.S. District Court Judge distinguished In Re Carrere because it did not appear to her the members of Gruntruck had been offered another record contract nor filed in bad faith solely to terminate their existing record contract. A similar result occurred in the case, In Re Ferrell v. Robinson Mann Creative Enterprises, Inc., 211, B. R. 183 (1997). Ricardo Brown p/k/a “Kurupt” sought to reject a record contract with his record company, Death Row Records and at the time he filed his bankruptcy petition, Ricardo Brown had assets of slightly more than one million dollars and debts exceeding twenty million. Despite recording with many of the most popular rap artists, Mr. Brown earned less than $200,000 from the record company and had an unrecouped balance in excess of One Million Dollars. The Bankruptcy Court permitted him to terminate his record contract because he was unable to earn any money since he had previously rejected the record contract and was no longer performing under the terms of the agreement. The Court, however, did not rule as to whether he would be entitled to enter into a new agreement with a third party record company which would clearly be in breach of the underlying contractual obligations with Death Row Records. This ruling is limited in scope to the laws of California which generally favor artists over a record company employer.
A recent case underscores the substantial impact a bankruptcy petition can have on the artist and record company. In Re Watkins, Lopes and Thomas, 210 B.R. 394 (1997). The musical recording group, TLC, consists of three female artists who signed with an Atlanta-based record company, LaFace Records. The group achieved multi-platinum sales after some half-dozen radio singles, but found themselves in financial distress and filed bankruptcy asking the court to terminate their record contract. TLC’s contract provided for a relatively low royalty rate of seven percent escalating to nine percent by the eighth album, considerably less than most major recording contracts. LaFace Records argued that because other labels dominate the record distribution channels, independent labels like LaFace are forced to offer lower royalty rates. Most record companies had developed a pattern of re-negotiating recording contracts when the artist achieved significant record sales, but LaFace Records refused to meet the demands of TLC, thus prompting the filing of the bankruptcy petition. LaFace Records argued against terminating the record contract because it claimed there were sufficient royalties in the pipeline to pay the debts of TLC, but that the members of TLC refused to accept advances against those pipeline royalties. The Bankruptcy Court refused to dismiss the case and found the filing to be proper rejecting the argument put forth by LaFace that the bankruptcy filing constituted “bad faith” because TLC wanted to void their record contract. Before, however, the Judge ruled on the request to terminate the record contract, TLC and LaFace reached an agreement which in essence provided for all of the group’s debts to be paid, a significant payment made to the artist and an increase in the royalty terms of their record contract. Shortly after this settlement, LaFace again faced the prospect of an artist being relieved from the obligations of a recording contract. Toni Braxton, whose records reportedly generated more than $170 million in sales, filed a bankruptcy petition claiming she made only 35¢ per album while LaFace and others profited substantially from her creative efforts. She attempted to have her LaFace Records contract discharged according to Section 365 after reportedly refusing an offer of 10 million dollars from her record company. Recently, she and LaFace Records were able to resolve their contractual differences and she entered into a new recording agreement with LaFace which recognizes her value in the marketplace.
Last year, Congress began debate on amending the current bankruptcy law and record companies were quick to encourage the drafters of the Bill to correct the perceived unfairness of Section 365 in regard to recording contracts. The principal debate of the amended Act focuses on “means testing” of filers with the goal of keeping high-income debtors out of Chapter 7 bankruptcy and placing them into Chapter 13 to repay more of their debts. Currently, a debtor can proceed with Chapter 7 bankruptcy unless a court finds “substantial abuse” of the process. The amended Act would replace the substantial abuse standard with a means test focusing on the ability of the debtor to repay debts under Chapter 13. Early drafts of the legislation also contained exemptions for agreements between artists and record companies from the dischargability of executory contracts, but organizations protecting the rights of recording artists became alarmed and language was inserted to alleviate most of those concerns. In the House of Representatives version of the Bill, H.R. 3150, the Recording Industry Association of America (RIAA) was allowed to add a new section 212 to the Bankruptcy legislation that prevented a recording artist from using the bankruptcy laws to terminate a recording contract. Two major artist unions, AFM and AFTRA, criticized the new provision and noted that only recording artists had been singled out for separate treatment in this Bill and that current bankruptcy law allows a court to dismiss a bankruptcy petition filed in bad faith, thus potentially providing relief to a record company. Debate on the floor of the House was led by Representative Scott from Virginia who opposed the insertion of the language protecting record companies. He felt that the legislation singled out recording artists for detrimental treatment and cited a statistic from Billboard Magazine that one percent of all American adults filed for bankruptcy in 1997, but less than one-tenth of one percent of recording artists filed. He further stated that “Section 212 provides a new legal standard which will penalize recording artists for using provisions of the bankruptcy code available without such penalty to all other debtors similarly situated.” He continued saying “Section 212 does not apply to actors, does not apply to athletes, doctors, lawyers, professors, authors or anyone else who signed a personal service contract.” Rep. Tauscher from California, who supported the measure, pointed out that “this provision would not deny anyone access to bankruptcy. It would not deny debtors in genuine economic stress the ability to rehabilitate their finances. And it would not deny or not give recording companies a preferred creditor position.” She characterized her support as good national policy and protection of a home-state economic interest. Cary Sherman, senior VP and General Counsel for the RIAA complained that some recording artists who receive substantial advances from the record company and run up huge debts, then file bankruptcy to walk away from their obligations just when the record company is about to reap the rewards from the artist’s success. Sherman further stated that bankruptcy can be used as a “threat that enables artists to extract money from record companies by threatening something worse.” On June 11, 1998, the United States House of Representatives overwhelmingly passed the draft of the Bankruptcy Reform Bill containing the provision sought by the record companies. The applicable language provided that the rejection by the trustee of a record contract “shall not in any way diminish or impair any applicable nonbankruptcy law rights to enforce noncompetition provisions regarding the rendering of exclusive services as a performing artist that may be contained in such contract.” The RIAA then issued a statement saying the change in the law was necessary to close the loophole being exploited by “increasing numbers of agents and lawyers for popular recording artists who have been misusing the bankruptcy process to get out of long-term contracts in order to sign alternative, more lucrative contracts.”
The U.S. Senate’s version, however, did not contain the recording contract provision and so the RIAA agreed to support a compromise to the House provision. The Trustee will be prevented from terminating a recording contract which provides for future master recordings “if a material purpose for commencing a case is to reject such contract…” unless a bankruptcy court finds it necessary to reject a record contract for the economic rehabilitation of the debtor. The Court will then be required to examine the totality of the circumstances in determining whether the debtor who seeks to reject a personal services contract does so because of the financial need for such rejection. The RIAA and AFTRA released a joint statement agreeing the issue had been resolved which would specifically address the “bad faith” provisions of the reform bill without creating a special rule for recording artists. The Bankruptcy Reform legislation is still pending in Congress, but the effect of the new rule will undoubtedly affect the future relationship between recording artists and their record companies. This Congressional debate will strongly encourage each of the parties and their attorneys to craft language in future recording contracts that recognizes the need to adequately compensate new and successful recording artists while at the same time compensating the record company for the substantial investment needed to “break” that next superstar act.
Brooklyn Law Review 409 (Summer, 1997). “Can Superstars Really Sing The Blues? An Argument for the Adoption of an Undue Hardship Standard When Considering Rejection of Executory Personal Services Contracts in Bankruptcy.” by Alison J. Winick.
Issue Focus: “Lawmakers Hear Record Industry’s Spin on Bankruptcy Reform and Tauscher Croons Bankruptcy Tune, in Lip-Synch with Industry,” by Justin Pritchard, Legi-Slate News, August 10, 1998.
“Does Going ‘Broke’ Mean An Artist Really Doesn’t Have Any Money,” by Anita M. Samuels and Diana B. Henriques, February 5, 1996 issue of The New York Times.
“Bankruptcy Ruling is Half Win for TLC,” by Sonia Murray, April 11, 1996, issue of The Atlanta Constitution, pg. 02C.
“TLC Settles Suit, Setting Aside a Troubling Use of Bankruptcy,” by Beth Burkstrand, November 25, 1996, issue of The New York Times, Section D, pg. 2.
February, 1997, issue of Entertainment Law Reporter, Vol. 18, No. 9. “Artist Bankruptcies Disrupt Record Business.” by Wallace Collins, March, 1997, issue of Entertainment Law & Finance, pg. 3
“Senate Favors Artists in Bankruptcy Bill,” by Bill Holland, October 17, 1998, issue of Billboard Magazine. “Bankruptcy Clause Sweetened,” by Brooks Boliek, October 7, 1998, issue of The Hollywood Reporter.
“Bankruptcy Bill Raises Concern – Musicians Unions Decry RIAA Move On Contract Breaking,” by Bill Holland, May 23, 1998, issue of Billboard Magazine.
“Bankruptcy Bill Talks Hit a Snag – RIAA and Musicians’ Unions to Continue Negotiations,” by Bill Holland, May 30, 1998, issue of Billboard Magazine.
“Bankruptcy Bill Moving Along,” by Bill Holland, June 20, 1998, issue of Billboard Magazine.
“Bankruptcy Bill Racist, Foes Charge,” by Christopher Stern, June 11, 1998, issue of Daily Variety, pg. 6.
“RIAA Wins One on Bankruptcy,” by Brooks Boliek, June 11, 1998, issue of The Hollywood Reporter.
“Putting Back the Bite,” by Michael Higgins, June, 1998, issue of the ABA Journal.
“The Rap On Personal Services Contracts,” by Michael A. Bloom and Ashely M. Chan, May, 1998, issue of The New York Law Publishing Company.
Dr. Rush Hicks, assistant professor of recording industry, received his Bachelor of Music degree from the University of Mississippi. He earned his law degree from Mercer University in Macon, Georgia, and also completed music business courses at Belmont University in Nashville. Hicks worked as an associate for the firm of Johnston & Brannen in Statesboro, Georgia, before moving his entertainment law practice to Nashville to join in a partnership with David Maddox. Currently, Hicks maintains a private practice in Nashville. His clients have included Randy Travis, Restless Heart, John Anderson, Aaron Tippin, Take 6 and Glen Campbell Enterprises. Hicks is a member of the Tennessee and Georgia bar associations. His memberships also include the Country Music Association, the Gospel Music Association, Nashville Songwriters Association and the National Academy of Recording Arts & Sciences.