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CORPORATE RESTRUCTURING AND BANKRUPTCY Monday, March 5, 2007 Recording Artists, Beware! A recent ruling permits sale of copyrights free and clear of royalty obligations. BY BRIAN S. HERMANN being divorced from the obligation to pay In March 1996, the bankruptcy court AND JUSTIN G. BRASS the artist royalties. And, it is for that very approved Luke Records’ and Campbell’s reason that Thompkins is of such interest and joint plan of reorganization. Pursuant to this ECORD COMPANIES have long potential significance to record labels and plan, Luke Records sold certain specified despised the use of bankruptcy by their artists. assets, including “[a]ll worldwide rights to Rrecording artists seeking to redo their the masters…owned or controlled by Luther record deals or to sign new ones with competing The Facts in ‘Thompkins’ Campbell or Luke Records” and “[a]ll worldwide labels by rejecting their existing deals or copyrights and/or publishing interests held by In 1989, Jeffrey J. Thompkins, a rap artist Luther Campbell, Luke Records, Inc., or Pac threatening to do so. Well, bankruptcy just got know as “JT Money,” signed a five-year Jam Publishing” to Lil’ Joe Records, Inc. and more appealing to those same record companies, exclusive recording agreement with the its owner, Joseph Weinberger.3 as a result of the Eleventh Circuit’s recent predecessor to Luke Records, Inc., a rap label Significantly, the assets, which included decision in Thompkins v. Lil’ Joe Records, founded by a member of the South Florida- Luke Records’ rights in and to Thompkins’ recordings, were sold “free and clear of any Inc., et al.1 based rap group 2 Live Crew. Pursuant to the recording agreement, and all liens, claims, encumbrances, charges, Thompkins, among other things, conveyed setoffs, or any recoupments of any kind, and… In Thompkins, the Eleventh Circuit to Luke Records “exclusive, unlimited and free and clear of any interest in such property concluded that, through a bankruptcy perpetual rights throughout the world” to of an entity other than [Luke Records].”4 of an artist’s record company, the artist’s the copyrights “in sound recordings (as The joint plan further provided that all copyrighted materials that were owned by distinguished from the musical compositions executory contracts that were not otherwise the record company—e.g., recorded music embodied thereon) recorded by [Thompkins] disposed of prior to confirmation of the joint and related music publishing rights—could during the [t]erm.”2 plan were deemed rejected, pursuant to §365 of be sold by the record company free and clear In exchange therefore, Luke Records agreed the Bankruptcy Code. Luke Records’ exclusive of any obligation to pay the artist royalties to pay Thompkins royalties according to recording agreement with Thompkins was for the buyer’s ongoing exploitation of the certain specified rates. During the five-year among the contracts that were rejected. copyrighted materials. term of the contract, Thompkins recorded Pursuant to the bankruptcy court’s order We suspect it is antithetical to many in three albums as part of the group called approving the joint plan, counterparties to the music industry that the right to exploit “Poison Clan.” rejected contracts, including Thompkins, were an artist’s copyrighted materials is capable of On March 28, 1995, after the term of the given 30 days to file a claim for damages in recording agreement expired, an involuntary Luke Records’ Chapter 11 case. Thompkins bankruptcy petition was filed under Chapter 7 never filed such a claim. of the Bankruptcy Code against Luke Records. Almost six years later, on March 5, 2002, Brian S. Hermann is a partner and Justin The case was subsequently converted to Thompkins sued Lil’ Joe Records, Lil’ Joe Wein G. Brass is an associate in Paul, Weiss, Chapter 11 and procedurally consolidated Music, Inc., and Weinberger (collectively, Rifkind, Wharton & Garrison’s bankruptcy and with the Chapter 11 case of Luke Records’ “Lil’ Joe”) in the U.S. District Court for the corporate reorganization department. founder, Luther Campbell. Northern District of Georgia for, among NEW YORK LAW JOURNAL MONDAY, MARCH 5, 2007 other things, copyright infringement, or order directing the receiver to reassign the The implications of the Thompkins decision alternatively, breach of contract.5 copyrights to them, or, in the alternative, to from the record label’s perspective can be Specifically, Thompkins asserted that, as sell the copyrights subject to the plaintiffs’ summed up as follows: a result of Luke Records’ rejection of the continued right to receive royalties. (1) A record label that suffers from exclusive recording agreement almost six On appeal from the district court’s financial distress and its creditors should years earlier, ownership of the copyrights decision to rescind the publishing contracts carefully consider bankruptcy as a means of he transferred to Luke Records under and reassign the copyrights to the plaintiffs, maximizing value through a sale of the label’s that agreement reverted back to him; the Second Circuit ruled that a recision was music catalogue free and clear of claims for consequently, Lil’ Joe’s exploitation of inappropriate. The court further concluded ongoing artist royalties; and those copyrights infringed on Tompkins’ that the receiver or trustee in bankruptcy (2) An acquisitive music label may use rights therein. was authorized to sell the copyrights for the bankruptcy opportunistically to acquire and In the alternative, Thompkins asserted benefit of the bankrupt’s creditors. subsequently exploit copyrighted music free that Lil’ Joe’s ownership of the copyrights Importantly, though, the Second Circuit and clear of the obligation to pay royalties. brought with it an obligation to pay royalties to held that “while the copyrights may be sold by Of course, many record labels may be Thompkins for Lil’ Joe’s ongoing exploitation the trustee, they should be sold subject to the reluctant not to pay royalties out of concern of those copyrights. By failing to pay right of the composers to have them worked in for artists or for reputational or other practical such royalties, Thompkins asserted that their behalf and to be paid royalties according business reasons. Nevertheless, one can Lil’ Joe was in breach of its obligations to the terms of the contracts.”8 In other words, imagine a situation in which the acquiring to Thompkins. the buyer of the copyrights would have to label is interested solely in an artist’s prior work them and pay over to the composers recordings or circumstances involving so- any royalties accruing after the sale. called “one-hit wonders,” where the benefits Eleventh Circuit Affirmed Why the divergence between the Eleventh of acquiring the artist’s existing repertoire free The Eleventh Circuit affirmed the and Second Circuits? Because, according to the of any obligation to pay royalties outweighs the district court’s summary judgment grant Eleventh Circuit, the court in Waterson was reputational or other costs of doing so. in favor of the defendants. concerned that, unless the artist’s royalty rights Additionally, a record label could use the The court easily dismissed Thompkins’ first travelled with the copyrights, the artist would specter of a “free and clear” transaction to point—that copyright ownership reverted be deprived of the only means of compensation renegotiate the terms of the artist’s existing to him upon Luke Records’ rejection of the he had been promised. recording contract. recording agreement—because it is well In the Eleventh Circuit’s view, what By providing record labels with this established that rejection, while a material differs in Thompkins is that the Bankruptcy flexibility and leverage,Thompkins represents breach, is not the functional equivalent of a Code, which did not exist in its present form a clear bankruptcy win for the labels. recision. Where property—here, copyrighted until 1978, well after Waterson was decided, ••••••••••••• ••••••••••••• material—is acquired by a bankrupt debtor expressly provides the artist with the right ••• to assert a pre-petition damage claim against pursuant to a pre-bankruptcy executory 1. 2007 WL 316302 (11th Cir. Feb. 5, 2007). contract, rejection “does not obligate the the bankrupt recording company for unpaid 2. 2007 WL 316302 at *1. debtor to return the property.”6 future royalties. Thus, according to the 3. 2007 WL 316302 at *3. What is more significant, though, is the Eleventh Circuit, “the author-assignor is 4. Id. at *4, n.18. 5. The case was subsequently transferred to Eleventh Circuit’s ruling on Thompkins’ not left completely without recourse in the the U.S. District Court for the Southern District second point—that is, that a buyer cannot event that his original copyrights, transferred of Florida. purchase a copyright without assuming the in consideration of future royalties, are later 6. 2007 WL 316302 at *8. concomitant obligation to pay royalties for sold to a third party out of the debtor-assignee’s 7. 48 F.2d 704 (2d Cir. 1931). 8. 48 F.2d at 710 (emphasis added). its use of the copyright. Here, the Eleventh estate, free and clear of royalty obligations 9. 2007 WL 316302 at *12. Of course, in the many Circuit held that in bankruptcy it is possible due to the rejection of the original copyright cases where unsecured creditors receive only cents on to sever the obligation to pay royalties from transfer/royalty agreement.”9 the dollar for their claims, the damage claim is worth far less than the ongoing right to receive royalties the ownership of the copyright. Unfortunately for Thompkins, he did not avail from a third-party buyer of the debtor’s assets. This latter holding in this case stands in himself of the right to file a damage claim. stark contrast to the Second Circuit’s much earlier decision in Fain v.

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