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Victory in Europe: The Two Years War over the Copyright Directive has Begun

May 30, 2019 Comments off

[This post originally appeared in the MusicTechPolicy Monthly Newsletter.]

If you’ve heard about the new copyright law in Europe, you’ve probably heard that the new rules with either break the Internet or bring Big Tech to heel.  I’d suggest neither proposition is true but not for the reasons you might think.  The reason is that Big Tech has absolutely no intention of complying with the law unless they are made to do so and few-if any- governments have the stomach to make them.

Cynical much, you may think?  Not really.  Hardly a day goes by that some new horror story doesn’t break about some awful business practice at Google, Facebook, Amazon or Twitter.  Lawmakers wring their hands, maybe fine the company concerned and everyone goes back to sleep until the next eruption.  Those fines are in the billions, but the bad behavior continues.

There’s a simple explanation for why.  It should be obvious by now that relying on good corporate citizenship is no more likely to produce a good outcome with Big Tech than it has  been with Big Anything Else.  You can dress them up in hoodies, they can tell you to lean in and that they won’t be evil, but “trust me” has not worked out very well so far.

Not only has “trust me” not worked out in terms of outcomes, it also hasn’t resulted in compliance with the law.  And this is the real reason why the bad behavior continues.  It’s not that these horror stories are “glitches”–no, the platforms that produce the inhuman results are working exactly as they are designed to do.  Do you really think that companies like Google, Facebook and Amazon aren’t able to control their platforms, algorithms and applications?

No, these companies make things that work very, very well.  For them.  They wrap them in extraordinary spin and mythology and deceive their users into increasingly addictive behaviors.  At their core, all these platforms are in two business lines–surveillance capitalism and addiction.  They use access to music and movies and journalism as a honeypot to draw in users whose data they can scrape and resell in an unvirtuous circle.

Face it–the Amazon shopping jones is not that different that a Home Shopping Network addiction, and none of the engineered behavior addictions from Silicon Valley are that different that Brown & Williamson Tobacco chemically engineering their product to be physically addictive to smokers with the messaging to match.

Nowhere is the unvirtuous circle more obvious than in Europe during the run up to and final passage of the new European Copyright Directive.  It cannot be overlooked that the European Commission fined Google billions of dollars twice during the period that overlapped with the ultimate passing of the Directive, for a total of $6.8 billion.  Those fines seem large, but were barely discussed compared to the braying from YouTube over the Copyright Directive.

According to leading European newspapers, Google and Facebook in particular fought the Directive with tactics that are reminiscent of Russia’s Internet Research Agency that we have all become too familiar with.  Bots, spam, interference lobbying and outright threats to Members of the European Parliament, the lot.  YouTube used its platform to spread misinformation about the directive through “YouTube creators” and reportedly targeted the children of MEPs who supported the Directive.

In the end, Google and Facebook were able to turn certain parts of the Directive their way but understand this–the Directive is simply that.  A directive at the “federal” level of the European Union.  That directive now has to be put into national laws by each legislature in the 28 countries that are members of the EU before it has any legal effect.  This can take up to two years  Therein lies the rub.

If past is prologue, Google, Facebook and their Big Tech fellow travelers have absolutely no intention of ever complying with the Directive.  They will lobby away as much of the Directive as possible at the member state level–that effort was already under way before the dust had settled much less the just concluded voting for Members of the European Parliament.

They then will sit back and wait to be sued.  The courtroom is where Big Tech most excels in tying the wishes of voters into knots.  By the time there is a final non appealable judgement from the highest court of competent jurisdiction in each member state including forms of appeal that no one has even thought of yet, Google will have probably backed new legislation and collected political IOUs that Google plans to use to reverse all ground gained in the Directive.

And in the meantime, the greatest income transfer of all time will continue as Google and Facebook suck the life out of creators for their fast buck profits and stock market largesse.

The only thing that will get their attention is action that affects their behavior-breaking up these companies in particular.  But understand that any government that takes them on is essentially going to war with a corporate country that is probably better funded and nastier than any government.

Getting justice from Silicon Valley will be an apocalyptic story worthy of Skynet.  But don’t think you can affect their behavior with your so-called laws that they have no intention of obeying.  Kyle Reese is not coming.

Don’t get me wrong–I’d rather have the Directive than not.  Just don’t deceive yourself into thinking the fight is over.

The fight is just beginning.

Face Force: Facebook’s Secret Foray to Boldly Go Where No Data Miner Has Been Before

May 28, 2019 Comments off

Memorial Day

May 27, 2019 Comments off

The first time I was present at a missing man ceremony was at a “dining out” hosted by Navy Command Center 106 at the Army Navy Club in Washington, DC in August of 2001 to which I was invited as a personal guest.  The guest speaker was Commander Kirk Lippold who was CO of USS Cole.

The missing man table is a moving memory of the evening’s ceremonies, particularly because a few weeks later Navy Command Center 106 took their share of the direct hit when the Pentagon was attacked.  These shipmates were awarded a Meritorious Unit Commendation for actions during and following September 11 in the finest traditions of the Naval service.  Twenty nine were lost.

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20 Questions for New Artists Part 5: Pre-Existing Contracts and Sound Recording Aggregators

May 26, 2019 Comments off

Pre-existing Contracts:

Ask your band mates for copies of any music industry contracts the band, or any of you, have previously signed before you formed or joined the band. Whether it be a credit card, management agreement, publishing deal, previous band agreement or a production agreement, it is important to understand the band’s current rights and restrictions. If any of the members are still tied to an exclusive recording agreement from a prior band, or has credit card debt from a prior band, that needs to be cleared up sooner rather than later. Extracting the artist from a prior agreement may not be quick or even possible.

Sound Recording Aggregators:

It is almost required that an independent artist sign up with an aggregator in order to have your works serviced to many online outlets–some aggregators service hundreds of different retailers.  (So one example of a pre-existing contract may be a band member’s contract with a sound recording aggregator.)

It is important to remember that without marketing and promotion, a new artist is simply a needle in an even bigger digital haystack. Do not expect the aggregator to do any significant marketing or promotion, much less guarantee it.  This is the primary difference between a traditional distributor and an aggregator, but even traditional distributors may have a shakey ability to do marketing and promotion.

Given that there are so many potential digital outlets, it is important for an artist to be able to decide on a case by case basis whether they want to be included and preserve the right to opt-in to any retailer or to opt-out at any time.

Artists should also be able to terminate the aggregator deal on short notice for any or no reason (e.g., 30-60 days). If you are asked to sign a deal with an indie label or with a major label, these labels may well require that you give them exclusive distribution rights–including the digital rights you have already granted to the aggregator. That means that you need to have the ability to terminate your aggregator deal and transfer digital distribution to the new label, often as part of an exclusive bundle of rights. There have been instances where digital distributors tried to hold up artists from signing to a label with the previously released recordings–a problem solved by the payment of money. Keep an eye on that issue.

How the aggregator is compensated is also an issue of concern. In the traditional model, the aggregator took a percentage of sales as their compensation. This meant that the aggregator only made money if the artist made money. (This is similar to a traditional distributor model.) Some aggregators charge a flat fee on some basis (such as a per-retailer basis) instead of a percentage.

Each model has its strong and weak points. The percentage model pays the aggregator regardless of whether they are making an effort to stimulate sales (which few of them do in any event). However, under the percentage model the aggregator only makes money if you make money, so the incentives are aligned. The percentage should be lower that the traditional 12-25% to take into account that the aggregator has lower incremental costs over time of maintaining content in their catalog.

The flat fee model has the artist pay the aggregator a fee for distribution instead of paying the distributor a percentage. While this is attractive from the point of view that the artist knows what their distribution costs will be up front, it also transfers much if not all of the financial risk of distribution to the artist.

In order to determine which is the better model, the artist should compare their most favorable percentage based offer to the flat fee model and see what the breakeven point will be. Try using a formula like this:

[Flat Fee]/[percentage] = Gross Income Required to Equal Aggregator Payment

Gross Income/wholesale price = breakeven units

or, for example, if the flat fee charged is $100 compared to a distribution fee of 10% for the same services, a distribution fee of 10% will equal a flat fee payment of $100 if you earn $1,000 of gross income.

Said another way, the 10% model is better for the artist for the first $1,000 of income

$100/.10 = $1,000 (Gross Income)

How many units would you have to sell in order to reach $1,000 of gross income?

$1,000/$0.70 = 1428 units (rounded down) for a download.

Now let’s pick the Spotify and Apple streaming rates:

 

$1,000/$0.00397 = 251,889 Spotify streams to earn back either a $100 flat fee or 10% distribution fee, or

$1,000/$0.00783 = 127,714 Apple Music streams (roughly half what it costs on Spotify).

This means at breakeven, you will be indifferent between the two deals.  But it also means that if in reality you sell less than the breakeven numbers, you will be better off under the distribution fee model.  If you sell more, you will be better off under the flat fee model.

From the distributor’s point of view, on flat fee distribution deals they will make more profit from artists who sell less than artists who sell more than the theoretical break even.

In any of these examples, you will need to use your own projections on sales, wholesale price and configurations in order to get a projection that is relevant for your own use.

Also, the aggregator need not collect SoundExchange monies and should not be able to list itself as the sound recording copyright owner in order to receive statutory royalties.  The artist need only sign up with SoundExchange in order to collect statutory royalties.  SoundExchange has an entire artist relations staff to help you with registering and becoming a member.  We will go into the benefits of SoundExchange membership in the SoundExchange topic, but highly recommend becoming a SoundExchange member rather than just registering for U.S. collections.

It may not be that obvious from the click through aggregator agreement that the company intends to collect Soundexchange royalties.  Look for words like “non interactive statutory royalties” which means royalties collected by SoundExchange.

It must also be said that no digital aggregator should be able to enter into any agreements on behalf of the artist/copyright owner that allows the aggregator to waive any rights (such as litigation rights) or to settle any claims or audits.

Another big problem with flat fee aggregators is that you have no idea what their deals with their accounts may be and you are betting on their ability to both negotiate a favorable deal and also pass those benefits along to you directly including audit recovery (especially since you may not have the right to audit them).

 

20 Questions for New Artists Sidebar: The Economic Reality of Streaming

May 16, 2019 Comments off

Streaming is all the rage.  But–it is cannibalizing higher margin goods, even digital goods.  Because of the industry standard revenue share method of dividing up royalties, all artists essentially get a market share allocation of streaming service revenue based on the number of streams.  Plus, with some exceptions, your royalty rate is dependent on factors you have no control over.  What this means in simple math is that streaming royalties on a per-stream basis will always decline over time (see also Malthusianism).

 

Artists’ dismal streaming royalties on music subscription services are largely based on a simple calculation:  A per-stream payment derived from a share of the service’s revenue prorated by number of streams.  Artists get a portion of a service’s monthly revenue (at least the revenue the service discloses) based on a ratio of your plays to all the plays.  Your plays will always be a lot smaller than the total plays.  (This is essentially what Sharky Laguana referred to as the “Big Pool.”)

Sounds simple, but mixed with the near-payola of Spotify’s playlist culture and Pandora’s “steering” deals, it’s really not.  Negotiating leverage allows big stakeholders to tweak the basic calculation with royalty floors, advances (aka breakage), nonrecoupable payments that help cover accounting costs, and other twists and turns to avoid a pure revenue share.  All of which approximate a per-stream rate on a Rube Goldberg level, by the way, which is one thing these services seem to resist.

Cartoonist Rube Goldberg’s Automatic Back Scratcher

It’s pretty safe to say that all new artists get hosed on streaming royalties.  Setting aside the fact that your distributor will never get all the goodies that the big labels get in their deals, this is because even if a fan listens to your tracks only for a month, well over 90% of that fan’s subscription payment is allocated to artists she didn’t listen to and may not even like.  Of course all these machinations happen behind the scenes.  Fans are not usually not aware that their subscription pays for music they don’t listen to and artists they never heard of or don’t care for.   Plus, it’s virtually impossible for any label, digital distributor or publisher to tell an artist or songwriter what their per-stream rate is or is going to be.

Revenue share deals for big stakeholders have some bells and whistles that leverage can get you, like per-subscriber minimums, conversion goals, top up fees, limits on free trials, cutbacks on “off the top” revenue reductions, and the percentage of revenue in the pool (50%—60%-ish).  Even so,  the basic royalty calculation in a revenue share model is essentially this equation calculated on a monthly basis:

(Net Revenue * [Your Streams/All Streams])

Or ([Net Revenue/All Streams] * Your Streams)

In other words all the money is shared by all the artists.

Sounds fair, right?

Wrong.  First, all artists may be equal, but on streaming services, some are more equal than others.  Regardless of the downside protection like per-subscriber or per-stream minima, the revenue share model has an inherent bias for the most popular getting the most money out of the “Big Pool.”  (This is true without taking into account the unmatched.)

And of course it must be said that the more of those artists are signed to any one label, the bigger that label’s take is of the Big Pool.  So the bigger the label, the more they like streaming.

Conversely, the smaller the label the lower the take.  This is destructive for small labels or independent artists.  That’s why you see some artists complaining bitterly about a royalty rate that doesn’t have a positive integer until you get three or four decimal places to the right.  Why drive fans away from higher margin CDs, vinyl or permanent downloads to a revenue share disaster on streaming?  Because it’s all the rage.

Yet it increasingly seems that we are all stuck with the nonsensical streaming revenue share model with ever-declining per-stream rates.  Why is the rate guaranteed to decline?

If the month-over-month rate of change in revenue (the numerator) is less than the month-over-month rate of change in the total number of streams or sound recordings streamed on the service (the denominator), the per-stream rate will decline over those months.  This is because there will be more recordings in later months sharing a pot of money that hasn’t increased as rapidly as the number of streams.

As the number of recordings released will always increase over time for a service like Spotify that licenses the total output of all major and indie labels (and independent artists), it is likely that the total number of recordings streamed will increase at a rate that exceeds the rate of change of the net revenue to be allocated.  If there are more recordings, it is also likely that there will be more streams.

So streaming royalties in the Big Pool model will likely (and I would say necessarily will) decline over time.  That’s demonstrated by declining royalties documented in The Trichordist’s “Streaming Price Bible” among other evidence.

 

There is a move afoot to switch to a “user centric” model of revenue share allocation that rewards the artist with a share of everyone who listens to them.  I have a version of that concept I call the Ethical Pool.  But the simplest approach would be to abandon the revenue share model altogether and negotiate a per-stream royalty–unfortunately, no one seems to be interested in the simplest approach.

For our purposes, just understand that regardless of what you hear about streaming saving the industry, streaming is unlikely to save you.

 

20 Questions for New Artists Part 4: Band Administrator, Split Sheets and Co-Writer Agreements

May 15, 2019 Comments off

For the next few weeks, we’re going to post sections from the article “20 Questions for New Artists” by Chris Castle and Amy Mitchell some of which has been posted various places. This doesn’t constitute legal advice, or any intent to form the attorney-client relationship. Chris, Amy and others will also be publishing occasional excerpts from the “Artist Glossary of Industry Terms” as a companion guide.

Band Administrator

It is a good idea for one band member to take responsibility for keeping track of the papers and information relating to the band’s business, such as receipts, bank statements, credit cards, payments, approvals for licenses, etc. This is especially important if there is no manager involved with the band.

It’s a bad idea if this “managing member” has too much latitude to go off the rails–which in this case means run up bills, take on other debt, disappear with the money.   The “managing member” must keep the other band members informed, and should not be able to assume any liabilities or sign any contracts on behalf of the band without written consent of the other members and giving them a chance to read and understand what it is they are signing up to.

The duties and authority of this person need to be clearly spelled out and understood.    This is the kind of thing that is addressed in a band partnership, shareholder or LLC operating agreement (and you may well be forming a “de facto” partnership as it is), so we will reiterate the importance of having the band agreement drafted by a lawyer.

Split sheets

Song splits are probably the most sensitive conversations that the band has together. Some professional songwriters take split sheets into each writing session and at least get all the co-writers to sign off on the split sheet and  at least register the song with their PRO when the song is completed. This is another one of those discussions that are better had before the band is making money to avoid the “selective memory disease” and can help if the band (or any member-writer) is ever accused of copyright infringement in connection with a song.

Song splits become especially important if you are writing with “outside writers” such as a record producer who may bring beats or a singer who brings a top line, or even just a producer who helps to shape the song as well as the recording.

Whenever you co-write with someone not in your band (which could be a producer or another songwriter) there are some issues you have to be concerned about. Some of this may be a little too complex legally for most people to try on their own, but we will assume that if you have a record deal (which is when most of these issues come up) you will already have a lawyer or manager to help you. These are not all the issues involved, but if you cover all of them you will avoid a good deal of agita later on.  Your lawyer should be able to help you get song split agreements drafted.

1. Splits: It seems obvious, but make sure there is no dispute about who wrote how much of the song.

2. Videos: You will need to be sure that the co-writer agrees to whatever terms are in your record deal that cover the synchronization license for promo music videos that are in your recording agreement. Assume that you’ll need to get a free sync license for promo music videos. “Promo music videos” can include YouTube which is technically a commercial exploitation but which throws off so little revenue that is may as well be promotional. You do not want to wake up and find out that you have to pay a sync license for a promo video.  One way to refer to this is “a free sync license for promotional or “YouTube-style” music videos”.

3. Controlled Compositions:

Record companies must license the right to sell reproductions of songs in records (or what the Copyright Act defines as “phonorecords”).  The Music Modernization Act’s revisions to the mechanical licensing section of the Copyright Act now treats record company mechanical licensing differently than digital music service mechanical licensing but does not change the rules applicable to controlled compositions.

Record companies (and I use the term broadly to include any distributor of phonorecords) typically will negotiate the maximum mechanical royalty rate that they must pay on records they release. These terms apply to songs written, owned or controlled by the recording artist.

These special terms are found in a clause in the recording artist agreement which is called the “controlled compositions clause.” The terms typically will include a maximum cap, a reduced mechanical rate applied as a percentage of a fixed rate and a limitation on the types of records for which a mechanical is paid. For example, a maximum album rate of 10 times ¾ of the minimum statutory rate on the date of delivery of the record concerned applied to sales of records for which an artist royalty is also paid would be a fairly customary (and low) controlled compositions rate.  (These reductions typically do not apply to digital reproductions.)

Very often digital distributors and some indie distributors will require that gross monies paid for digital downloads or physical record sales are inclusive of mechanical royalties.  This is not true of streaming, where the streamer (like Apple Music) pays the mechanical separately.  The Music Modernization Act created a blanket license for streaming mechanicals and gave the streamers a retroactive safe harbor on unlicensed uses that were the subject of David Lowery and Melissa Ferrick’s class action lawsuit against Spotify and David Lowery’s separate class action against Rhapsody over unlicensed songs and unpaid mechanicals.

Controlled compositions clauses do not apply to sales in the world outside of the United States and Canada, and even in the United States and Canada there have been developments that reduce the effects of certain controlled compositions clause provisions, especially for digital sales.  Controlled compositions clauses must be carefully negotiated.

If you are an artist signed to a recording agreement with a controlled compositions clause, you want to be sure that your co-writer accepts all the terms that apply to you. If you are the unsigned co-writer, be sure you understand all the terms of the controlled comp clause that apply to your song. You can ask for a copy of the “redacted” clause from the artist contract (and artists who do a lot of co-writing should have a digital copy of this clause ready to send out as it is a fair request).

4. Demo Ownership: Make sure you are clear about who owns the copyright in demo recordings. Remember—there are two copyrights in each sound recording, the sound recording itself (the demo) and the song that’s recorded (that you are co-writing). If you are the featured artist, you want to own 100% of the sound recording copyright in the demo. The percentage ownership of the demo and the percentage ownership of the song are two very different things and the ownership shares are independent of each other. Just because your cowriter owns 50% of the song doesn’t mean the cowriter owns 50% of the recording. This will become important if you use a pitching service for film and TV placements (“syncs”) and the licensee wants to use the recording of the cowrite. If you are signed to a record company, the record company will technically own the demo (or will take the position that they do).

5. Other Sync Licenses and Pitching: Aside from music video syncs, there is a whole world of film and TV licensing as well as advertising opportunities. These often require servicing a recording of your song to the film and TV supervisors or creatives at advertising agencies.

There are people who operate these pitching services, and major labels (at least theoretically) do it themselves. If you co-write with a writer who either has a pitching deal or a record deal, you need to have an understanding of who can pitch the song and who can approve synchronization licenses. If you are the featured artist, you will want to have some control over who is pitching the song because if your co-writer pitches the song for a use you do not want to approve, that can create confusion in the film and TV licensing community and may result in your not getting considered for future syncs that you do want. (The conversation with the co-writer will go something like this: “Want do you mean the artist won’t approve it? YOU PITCHED IT TO ME!”)

You will also need to have a clear understanding with any outside writers of  how pitching services your co-writer has contracted are compensated.  This can involve “retitling” or giving up a share of publishing.  Your share of songs should not be subject to those pitching agreements unless you separately decide to accept the terms, but you must, of course, know what the terms are before the fact.  We’ll cover these agreements separately.

6. Creative Commons: As usual, you have to be very careful not to write with anyone who intends to make your co-written song available under any kind of a “Creative Commons” license. The “CC” license does not work very well for professional songwriters, mostly because it is very poorly drafted and it is effectively irrevocable. See “Carefully Co-Writing Without Creative Commons” (by Chris Castle), Public Licenses: The Gift that Keeps on Giving (by Prof. Jane Ginsburg), Common Understanding (by ASCAP’s Joan McGivern)

 

See also:  20 Questions for New Artists Sidebar: The Importance of Metadata

 

 

 

 

 

 

Where Was the Board? Some Thoughts on Potential Legal Issues in Pledge Music “Administration” Bankruptcy–Artist Rights Watch

May 13, 2019 Comments off

[This post first appeared on Artist Rights Watch]

We’ve had a lot of questions about what is going on with the Pledge Music crowdfunding platform which appears to be either on its way or already in a bankruptcy filing according to reports.  This post will be a few thoughts about the current situation which is evolving.  This is not intended as legal advice and if you’re involved in the Pledge situation you need your own lawyers and you need them right now.  Consult your local state bar association (in Texas, that would be www.texasbar.com)  Don’t ask me questions in the comments as I won’t be able to answer them, so I’m afraid this is a one-way communication.

If this is all news to you, that’s understandable because if you go to the company’s website, there’s no indication that anything is amiss, which I find to be just downright bizarre in and of itself.  Normally what one would expect is that there would be some conclusive message blazoned across the landing page, but there’s nothing.

There certainly would not be testimonial endorsements from artists who are blasting the company which arguably qualifies as false advertising even if the site as a whole does not.

Pledge Landing Page 5-11-19

This lack of communication is, unfortunately, fast becoming what I find to be the hallmark of Pledge Music’s waning days, days which have been waning for a long time now.  I’m not a bankruptcy expert but one thing I can say from experience is that companies typically do not get into bankruptcy overnight and the seeds of their destruction often go back many months if not years.  In fact, those seeds are often found in the basic business plan.  So don’t let nostalgia allow you to let anyone out of their responsibilities and don’t let anger cloud your judgement.  Easy for me to say, I know.

Which Kind of Bankruptcy

Bankruptcy in a common language sense comes in two flavors:  liquidation and reorganization.  In liquidation bankruptcy the company ceases operations, the company’s assets are sold off, the proceeds used to pay creditors (including employees in some cases), and that’s the end of it.

In reorganization, it’s literally what it sounds like.  The company intends to keep operating (often with the same management as incredible as that may sound) and it reorganizes its finances, pays off creditors as best it can, and then re-emerges on the other side with a new balance sheet and having dealt with (some might say shirked) its obligations.  iHeart is a prime example of how artists and songwriters get screwed in reorganization bankruptcy.

It would be nice if Pledge had at least made a clear statement about what its future intentions are–like you know, on its website–but I don’t think we know definitively today.  It sounds like they’re liquidating.  I saw a lot of that in the Dot Bomb era when “entrepreneurs” burned through the investors money, ran the company into the wall at 100 mph and then flipped the keys to the first bum on the street.  A bit harsh, but that’s essentially what was happening all the time in the Silicon Valley testing range.

The difference is that they did it with the investment from sophisticated investors.  It’s looking more and more like Pledge did it with the artists and fans’ money at least in part.

Creditors

Creditors also come in two flavors and this is important:  secured and unsecured.  An example of a secured creditor is a bank that lends money to the company.  It appears that Pledge had a loan from one Sword, Rowe & Co. that may be secured.  There may be others.  We don’t know, but based on open source materials, it appears to be at least one entity that could be a larger secured creditor.  If it’s this Sword Rowe & Co., they are based in New York and Nashville and specialize in music industry lending.  The Bloomberg profile on a Sword Rowe & Company appears to be the same company, and it is a successor to Sword & Company, a New Jersey based investment bank of long standing.

Secured creditors typically will be ahead of practically everyone in the bankruptcy pecking order, and sometimes can essentially wipe out any available assets.

Another attribute of a secured lender is that they typically have the benefit of loan applications and due diligence to have a good look at the financial condition of who they are lending to.  So in the “what did they know and when did they know it” race of the rats running for the door, we have to think that a sophisticated lender would know or should have known of the company’s financial condition whenever they made the loan.  Of course, investment banks sometimes have private equity arms, so it may not be the case that Sword is a secured lender.  It seems inconceivable, however, that they did not know what was going on with the company at some point.

When is a Creditor Not Creditor

The big difference–at least to me–between the kind of creditor relevant to bankruptcy and the artists whose fans pledged money is that the fan did not intend to give money to Pledge for its own use.  I think it’s fair to say that the fan paid money to Pledge to hold the money in trust, deducting solely the agreed 15% commission to Pledge, conditioned on Pledge fulfilling all of its obligations.  Given the reaction online so far, I think that the reality bears this out.  Like I said, I’m not a bankruptcy expert, but I don’t know of any rule that allows a company or its officers and directors to take money “pledged” to a third party and paid to the company in trust, spend it on themselves without authorization from anyone, and then declare bankruptcy to get out of paying it back.

There is, of course, the practical question of where the money comes from to pay the artists as originally intended, refund pledges to the fans who paid the money in the first place, and also refund all or part of any commissions taken by Pledge.  Not an easy answer, but this is why “what did they know and when did they know it” becomes an important question in my view.  If it turns out–and I can’t see how it couldn’t–that someone in a position of authority at the company like an officer or director, or perhaps even a secured creditor, knew that the money was improperly handled and spent–much less even co-mingled with the company’s own money–that person may have the responsibility to pay it back 100 cents on the dollar to either the artist or the fans.

This is one reason why you have directors and officers liability insurance.  That insurance arguably provides another pool of money (assuming Pledge had the insurance coverage).  Crimes are excluded, of course.  It’s worth asking if the coverage was in place (sometimes required by investors or lenders) and explore if one could make a claim against it in good faith.

On the other hand, bankruptcy can be a complex and confusing process that has its own set of rules, so artists and fans may wish to determine how they can perhaps argue in the alternative that they can claim creditor status if they initially take a position that they are not creditors.  That status issue likely would have to be ruled on by a court, so getting the issue in front of a judge quickly will likely be of critical importance.

This is a complex area, so if you’re involved you need to get to a lawyer quickly.

Credit Card Refunds

Fans may be able to pursue a refund through their bank or credit card company.  There are often limitations on how long a card holder can wait to make a claim for an improper charge, sometimes 90 days.  This may explain why one of the few public statements that Pledge made was to ask for 90 days to put its house in order.  By delaying any refund requests for 90 days, the company may have hoped to preclude anyone seeking a refund.

However, consumers might be able to successfully argue to their bank or credit card company that they did not know conclusively that their funds were being misused until the day that Pledge announced it was going into bankruptcy in the UK, which was last week.  One could argue that the clock to disallow the charge did not start running until that time as the company’s public statements indicated that they might ultimately fulfill their obligations to the fan (or “pledger”).

If it turns out that there was fraud involved, the credit card company may actually become your ally as they will have been duped as well.

Law Enforcement Agencies

The scope of this meltdown suggests that law enforcement agencies may at least investigate what happened.  It may turn out that there’s no criminal dimension to the situation, but I don’t think it can be ruled out at this point.

If Pledge violated state consumer protection laws, federal bank or wire transfer rules, mail fraud rules or other criminal statutes, this could be a 51 jurisdiction issue in the U.S. regardless of the choice of law provisions in a click through agreement.  I suspect that law enforcement agencies may be reviewing the situation now.

Artist Rights Groups

So far the only artist rights groups to jump in on the Pledge situation are UK Music and the UK Musicians Union.  I know the Musicians Union has been monitoring the Pledge situation for quite a while to their everlasting credit.

The silence is deafening.

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