COLUMN: My previous post on sales of Beatles albums in the U.S. seems to have precipitated a lot of interest so I thought I'd briefly discuss the history of the Beatles contracts. If you're interested in reading them, copies of the pertinent agreements are posted at deconstructingpopculture.com. These are a matter of public record having been filed in litigation actions in both London and New York.

First a little bit about Capitol Records, which released (most of) the Beatles' recorded musical work. Capitol was incorporated in 1942. Its stock was publicly offered in 1946. In 1955 EMI acquired 96.4% of the shares outstanding. On January 1, 1956 Capitol and EMI entered into the first of a series of what they called Matrix Exchange Agreements (“MEA”), subsequently renewed and amended. Pursuant to the MEA EMI undertook to supply masters to Capitol and Capitol to EMI in consideration for a license fee equal to a percentage of the retail sales price in the country of manufacture. Because each company had rights of first refusal to the other's product the MEA was the foundation of the operating relationship between Capitol and EMI.

June 4, 1962

The Beatles contracted with Parlophone Co., Ltd. (a subsidiary of EMI) on June 4, 1962 through their manager, Brian Epstein (NEMS Enterprises, Ltd.). This simple four-page contract granted EMI options to extend it for three consecutive one-year periods, all of which EMI exercised. It did not provide for an advance against royalties. The royalty initially payable to the Beatles was one old British pence per song on 85% of gross sales and half that rate outside of the U.K. To give you an idea of what this was worth in contemporary terms there were 240 old British pence per British pound. One British pound now is worth about $1.50. $1.50 * .85 / 240 = a little bit more than ½ cent per song. If there were 12 songs on an album that would be around six cents royalty. On top of this EMI's obligation to pay royalties (but not its ownership of the masters) expired on June 4, 1987. [Both these features of the June 4, 1962 agreement later were amended.]

As is well known Capitol initially rejected the Beatles. It declined to exercise its first-refusal rights pursuant to the MEA thereby activating EMI's rights to seek an alternative source of distribution. Transglobal Music Co., Inc. (an affiliate of EMI) contracted with Vee Jay Records, Inc., a label based in Chicago. See Mike Callahan's excellent article “The Vee-Jay Story” which appeared in the May 1981 issue of Goldmine Magazine. Needless to say Capitol regretted this decision after the Beatles began selling records. Capitol exercised its option to acquire new Beatles masters from EMI under the MEA and commenced an unprecedented promotional campaign. It also filed a lawsuit against Vee Jay on the grounds it lacked rights and had failed properly to account and pay royalties. This dispute eventually was resolved when Capitol granted Vee Jay a limited license to manufacture and distribute records derived from the masters which Vee Jay contended it controlled, expiring on October 15, 1964.

After it started selling records Capitol paid artist royalties to EMI (plus a 5% override or licensing fee). EMI then accounted for them to the Beatles as foreign sales (thus attracting a lower rate). Capitol paid mechanical royalties (those attributable to the song, not the master sound recording) directly to the applicable music publishers. Masters recorded by the Beatles pursuant to the 1962 agreement and distributed by Capitol include “I Want to Hold Your Hand,” “She Loves You,” “Can't Buy Me Love” and “Ticket to Ride.”

January 26, 1967 Agreement

Meanwhile the Beatles' agreement with Parlophone expired according to its terms on June 3, 1966. It was not until January 26, 1967 that a new agreement was concluded, this one for a period of nine years. [Masters recorded between June 3, 1966 and January 26, 1967 were accommodated by a series of letter agreements.] Capitol continued to derive its rights to manufacture and distribute in the U.S. under the MEA (though the internal royalties override that EMI received for licensing the Beatles masters to Capitol was reduced from 5% of the retail price to 2.2% of the retail price, payable on 90% of sales, less a fixed packaging fee; there also were several other technical nuances).

Royalties payable to the Beatles for new material were substantially increased. The 1967 agreement later became the source of considerable confusion because instead of being payable on “retail” price the royalty became payable on a “wholesale” price, which was incompletely defined. This probably was due to a misapprehension by Alan Livingston, then Capitol's President. Livingston had negotiated separate terms for the U.S., Canada and Mexico and most likely got them confused because the sales base for each territory was expressed differently.

Masters recorded by the Beatles pursuant to the 1967 agreement and distributed by Capitol include “Help,” “Yesterday,” “We Can Work It Out,” “Nowhere Man” and “Eleanor Rigby.”

On April 19, 1967 the Beatles formed Apple Corps, their internal partnership. Sometime in 1968 the Beatles became interested in having their own label and producing product by artists other than themselves. They also would have liked to get out of their artist contract with EMI (which ran until January 27, 1976) so they could record for their own company, but of course EMI didn't want to release them. The outcome was that on July 1, 1968 Capitol entered into a separate contract with Apple, which covered the “non”-Beatles records such as Mary Hopkin, James Taylor, Badfinger and Billy Preston. Imagematically Capitol also agreed that it would use the “Apple” label on new Beatle releases. This non-Beatles contract ran until June 30, 1973.

September 1, 1969 Agreements

Allen Klein appeared on the scene in March of 1969 and several months later took over completely as manager for Apple and three of the individual Beatles (everybody but Paul). At his instigation the relationship between the Beatles, EMI and Capitol was substantially revised on September 1, 1969.

The Beatles had fulfilled the requirement that they deliver a certain number of master sound recordings under the January 26, 1967 contract and were not obligated to deliver anything further during the remaining years of the contract (though they could not record for another label). Klein said that since the delivery requirements had been met the Beatles would not record anything further under this contract. They would however be willing to negotiate a new contract in which, for an increase in the royalty rate on everything released under this and the previous contracts (both old and new masters) they would guarantee delivery of a certain number of masters, with the increase in the royalty rate dependent upon how the new records sold. Klein also added that he felt that Capitol had underpaid the Beatles in the neighborhood of $2 million through use of the wrong “wholesale” price. Capitol obviously wanted to keep the Beatles so it too had an incentive to reach an agreement.

One of Klein's major points was that he wanted to deal directly with Capitol in North America instead of going through EMI. The reason why is because he wanted to keep the Beatles royalties in the U.S. in a U.S. corporation rather than sending them off to the U.K. Insofar as I have been able to discern this strategy was invented by Lew Wasserman of MCA (at least he's the one who popularized it). See Dennis McDougal's book “The Last Mogul,” p. 162. Rather than being taxed at “ordinary income” rates as and when earned, royalties could be accumulated in a corporation and the corporation later could be sold. The resulting tax would be at the much-lower capital gains rate. Also, they would be treated as “domestic” royalties and thus payable at full rate rather than being subjected to the typical abatement for foreign royalties.

For these reasons (among others) the new contract took the form of a “buy-sell” agreement. Here's how it worked. By-passing the MEA, EMI licensed to Apple the exclusive right to manufacture and distribute records in North America, at the same time requiring Apple to enter into a series of agreements with Capitol to perform those functions on its behalf. Under this format Apple was charged a manufacturing fee (the “buy” price) and was paid a “sell price” on the amount of records actually sold. The “sell price” was greater than the “buy” price and Apple retained the spread in lieu of actual royalties. This satisfied Klein's desire to accumulate royalties in what was for all intents and purposes a domestic shell corporation. Apple had very little in expenses. Royalties were payable monthly instead of quarterly, giving Apple better float on interest. From Capitol's perspective, in economic effect the new agreement was just a variation of a conventional artist-royalty contract. The Beatles, for example, still did not own their masters.

Again there were many complicated nuances to how this all worked which are set forth in the agreement. Klein contended (and Capitol basically agreed) that the 1968 contract for non-Beatles releases was unworkable. It too was revised, mainly to retain royalties in the domestic corporation as set forth above. Apple also received a large settlement to cover items then in dispute.

Status after April 30, 1976

The Apple buy-sell agreements ran from September 1, 1969 through April 30, 1976. At that point EMI's license to Apple thereupon terminated (and with it, Apple's manufacturing and distribution commitments with Capitol). Both EMI and Capitol still retained the right to commercially exploit Beatles masters that had been delivered up to that point (and were obligated to pay royalties to the Beatles). However the Beatles, both individually and collectively, now were free to enter into contractual relationships to record and deliver new masters for other labels. Since the agreements had expired, after April 30, 1976 Capitol's rights to Beatles masters once again were derived from the MEA.

The Beatles dissolved as a group in 1970 shortly after the Apple agreements were in place (though the dissolution was not formalized until December 19, 1974, at which time each individual Beatle became responsible for his individual recordings and royalties on those recordings were paid directly to each individual Beatle). Those agreements mainly applied, then, to sales of records derived from Beatles masters already recorded: the “Abbey Road” and “Hey Jude” albums, released in October 1969 and February 1970, respectively; and to masters recorded by the individual Beatles.

Both parties wanted to renegotiate all of these contracts long before the original expiration dates. There were almost day-to-day renegotiations to settle arguments and open issues. Capitol's original intention in signing the 1969 contract was to get additional records in consideration for paying an increased royalty and to avoid further trouble over Livingston's mistake in not defining “wholesale price.” Capitol acquiesced in Klein's buy-sell arrangement to accommodate Apple, but it was to be purely a royalty deal as far as other factors were concerned.

Klein on the other hand was determined that Apple really should be the manufacturer of Beatles (and non-Beatles) records. He wanted to control all activities that a manufacturer possibly could control. The 1969 agreements went further than most royalty contracts in that they gave approval of product, packaging, pickup albums, etc. to the Beatles. Klein not only wanted to keep those features but also add release dates, pricing, approval and placing of advertising, promotion, publicity, etc. Essentially he wanted to reduce Capitol's position from that of a partner to that of a distributor (with a small distribution margin). Klein achieved some of these objectives in the 1969 agreements, others he did not, and many remained unclear. Ironically Klein's objectives later were unambiguously realized by acts such as Madonna, Garth Brooks and Metallica.

There were many pros and cons on both sides resulting from omissions, ambiguous statements, and negotiating power. The stage was set for a fusillade of litigation, the basic themes of which I will cover in another post.