5 Reasons Why Artists and Creators Fail to Secure Royalties in Distribution Agreements
Why do artists, entrepreneurs, and other creatives fail to secure their fair share of royalties in agreements with distributors? Here are 5 reasons.
Distributors include record labels, movie studios, art galleries, and anyone else tasked with distributing your creative projects, products, or services to the public.
distribution agreements
Inside of the contracts between creators and distributors, there are often provisions saying that the creator and the distributor will divide the profits in accordance with a formula. The formula usually provides for (A) a definition of “Net Profits” and (B) a percentage of the “Net Profits” that will go to the creator.
You may be surprised to find out that the definition of “Net Profits” used for purposes of calculating royalties to artists, entrepreneurs and creators is totally different from the definition of “Net Profits” used by the same distributor for purposes of reporting profits to lenders, shareholders, and/or the IRS.
Below are five typical forms of bogus accounting that cause artists to lose royalties.
How Artists Lose Royalties
Excessive Service Fees.
Distributors often deduct expenses from “Net Profits” for services provided by the distributor, without using a fair metric such as (a) actual cost of providing the services or (b) the fair market value of the services. Unfortunately, distributors often deduct absurd amounts from “Net Profits” for services provided by the distributors to distribute your project.
Misallocated Expenses.
Distributors often make the “innocent mistake” – almost always in their favor – of misallocating expenses from unprofitable projects to profitable projects. Because there is no benefit to maximizing expenses on projects where there is no income to offset, a distributor can dupe you by shifting expenses from the distributor’s unprofitable projects to the distributor’s profitable projects.
Misallocated Revenues.
Similar to example (2) above, distributors often misallocate revenues from profitable projects that will likely pay out large commissions or royalties to failed projects that have no chance of earning a profit. By doing so, the distributor reduces the total amount of revenue that is subject to commissions or royalties, keeping more cash for themselves and less for you.
Reimbursements.
Distributors often fail to account for tax credits – or other reimbursements – that distributors receive as a direct result of expenses they incur to distribute your project. Therefore, certain “expenses” are not true expenses to the extent that (a) such expenses are reimbursed and (b) such reimbursement is not counted as revenue to your project.
Books and Records.
Distribution agreements often fail to include a provision giving you broad rights to (a) audit the distributor’s books and records and (b) force re-calculations if necessary. You will want both rights in most deals.
Best Ways to Preserve Royalties
The best way to preserve royalties is to not rely on a definition of "Net Profits" at all. Rely instead on a definition of “Gross Revenues” or something to that effect. Definitions of gross revenues should not include any deductions for expenses, because they are merely a measurement of money coming in and not a measurement of profits.
By using a gross revenues metric instead of a net profits metric, you leave your distributors without any opportunity to deduct expenses. As a result, your distributors will find it harder to cook the books.
Of course, the percentage of commissions or royalties will (and should) decrease when you switch from net profits to gross revenues. But the good news is that certainty of payment will increase, because you will have decreased the risk of bogus accounting by the distributor. And, most importantly, actual royalties or commissions paid out to you by the distributor should increase.
Bottom line:
Unfortunately, many creators cannot negotiate for a percentage of gross revenues and must instead settle for a percentage of net profits. If you cannot negotiate for gross revenues in lieu of net profits, you should focus instead on: (a) instructing your lawyer to limit the damage as much as possible and (b) relying instead on large upfront payments that are not dependent on a shaky definition of net profits.
Adam Yohanan represents entrepreneurs, investors, freelancers, startups, small businesses, artists, and entertainers in a wide variety of transactional and regulatory matters, with an emphasis on complex commercial contracts, business formations, corporate governance, M&A, finance, intellectual property, and entertainment law. His office can be reached at 212-859-5041.
This guide is meant for educational and informational purposes only and should not be considered legal advice. It is essential to consult with an attorney or other advisors regarding all legal and other important matters.
