Penalty Default Licenses: A Case for Uncertainty

Abstract

Research on the statutory license for certain types of copyright-protected content has revealed an unlikely symbiosis between uncertainty and efficiency. Contrary to received wisdom, which tells us that in order to increase efficiency, we must increase stability, this Article will show that uncertainty can actually be utilized to increase efficiency in the marketplace. In the music industry, the battle over terrestrial performance rights – that is, the right of a copyright holder to collect royalties for plays of a sound recording on analog format radio – has raged for decades. Last summer, in a deal that circumvented – for the first time ever – the statutory license for sound recordings, broadcasting giant Clear Channel granted the elusive terrestrial performance right to a small, independent record label named Big Machine, and agreed to pay royalties where no such legal obligation exists. This result not only improves upon many of the statutory license’s inefficiencies but is also the opposite of what we would expect given both the tumultuous history surrounding the rights at issue, and the respective parties’ bargaining positions, and suggests an underexplored mechanism at play: uncertainty. Using the statutory license for sound recordings and the Clear Channel-Big Machine deal to motivate the analysis, this Article argues that bounded uncertainty – such as uncertainty about the future legal status of terrestrial performance rights – converts a statutory license into a penalty default license. Just as penalty default rules encourage more efficient information exchange between asymmetrical parties, penalty default licenses encourage more efficient licensing among otherwise divergent parties by motivating them to circumvent an inefficient statutory license in favor of private ordering. While not without its drawbacks – previous work identified, and ameliorated, some of the adverse selection and distributive justice concerns – private ordering improves upon the statutory approach, resulting in greater efficiency not only for the parties involved, but for society overall. Recognition of the role that uncertainty plays in converting an inefficient statutory license into a penalty default license that improves market efficiency while mitigating inequality has implications beyond the statutory licensing context. Importantly, it suggests a revision in the way we view the relationship between uncertainty and efficiency. Specifically, it shows that when coupled with a penalty default, uncertainty can bring greater efficiency to the marketplace by encouraging private ordering, with its tailored terms and responsiveness to rapid legal and technological change, while mitigating concerns about equality and gamesmanship.

Keywords: intellectual property, copyright, licensing, statutory licensing, contract, default, penalty default, uncertainty, behavioral economics, efficiency, distributive justice, law and economics

JEL Classification: D61, D63, D81, D82, D80, K00, K10, K12, K39