Tag: entertainment

Multi-Club Ownership – For the Good of the Game?

Alongside the rise of investment from sovereign wealth and private equity funds, sport has also seen an increase in multi-club/franchise ownership groups. These groups, often spanning across different sports, leagues, countries, and continents, allow investors to diversify their portfolios and spread their risks.

However, in football, the rise of the Multi-Club Ownership (MCOs) model poses a challenge for how the sport is governed and has implications on current and future financial regulation. MCOs acquire multiple football clubs, building a network of related teams in the process. This, consequentially, has a knock-on effect on player transfers, commercial opportunities, and the overall competitive balance of football across the globe.

In this article, we discuss the benefits of MCOs for both clubs and owners, the potential competitive advantages clubs can gain through MCOs, and whether the existing financial regulations are fit for purpose given the increasing number of MCOs within the sport.

Governance

One of the key benefits for clubs under an MCO structure is the ability to leverage centralized governance infrastructure and apply lessons learned from across the group. By centralizing key departments at the portfolio level, and incentivizing knowledge sharing within the group, MCOs can apply synergies and implement best practices with each new acquisition, leading to a more effective and efficient operation. Additionally, the centralized governance structure within an MCO brings with it opportunities for financial benefits in the form of cost savings and potentially increased revenues.

Sponsorships and Commercial Deals

Operating under an MCO allows clubs to benefit from sponsorships and other commercial deals negotiated at the group level, while also increasing individual brand awareness for each respective club. For example, an MCO could negotiate a group sponsorship agreement with a kit manufacturer or shirt sponsor covering a number of teams within the group, including the flagship club.

Agreements of this kind would be beneficial for all parties involved. The sponsor increases its own profile by being associated with the flagship club, while also getting instant access to a variety of markets through the other clubs in the agreement. At the group level, the homogeneity created by having clubs within the group playing in similar kits creates a stronger brand identity, whilst also boosting the brand profile for the smaller clubs by further associating them with the flagship club. Additionally, a group agreement would allow the MCO to secure a competitive rate that may have been unattainable for a solitary club.

Player Scouting, Acquisition, and Development

The other major financial benefit for clubs in an MCO structure relates to how players are scouted, acquired, and developed. A common feature of MCOs is the application of a uniform strategy, across all portfolio clubs, set at a group level by a Sporting/Technical Director. When trickled down to each club, this results in a global scouting network, acquiring local talent with the group’s playing style in mind. These players will then be brought into an academy, through which they will be developed to play in the MCO’s preferred playing style.

While this does not represent an immediate cost saving, this network of local scouting and academies at the club level can lead to a significant competitive and financial advantage as players move within the group from smaller clubs to the flagship club. By transferring or loaning players “in-house”, MCOs can ensure that a player’s development is not hampered by being played in an unfavorable position, or by being asked to perform a different role, protecting their value.

Additionally, by acquiring players from within the group, clubs save both time and money on scouting, as players are already a known quantity within the network. Furthermore, the receiving club acquires a player tailor-made to their playing style, reducing the time required to bed them in.

“In-house” Transfer Agreements

As exemplified by the transfer of Hassane Kamara between Pozzo family-owned clubs Watford and Udinese, “in-house” transfers can be leveraged to alleviate financial constraints for clubs within the group. Kamara, initially purchased by Watford in January 2022 for £4m, and who went on to be Watford’s player of the season, was subsequently sold to Udinese in August 2022 for £16m.

However, Kamara was then loaned straight back to Watford for the 2022/23 season. Although prima facie, this transfer does not benefit Udinese, it allowed Watford to recognize an £8m profit on Kamara while retaining his services, and strengthening their cash flow at a time when they were negotiating contracts with other star players. While “in-house” transfers of this kind raise questions regarding their fitness and propriety, they also have implications on competitive balance.

Parent Feeder

The most recognizable transfer strategy within MCOs is the feeder club model. This can be mutually beneficial to both clubs, with the best-performing players transferring to the “parent” clubs” and the “feeder” club receiving transfer income, as well as occasional loan transfers of youth team players to develop while remaining in the MCO structure.

Such a relationship can be seen between Red Bull owned, RB Leipzig (RBL) and FC Red Bull Salzburg (FCS). Since 2015, twelve players have transferred directly from FCS to RBL, with transfer fees totaling £119.75m. Eight of these players, bought for a total of £73.85m have subsequently been sold for a total of £117.50m, generating £43.65 profit RBL. The cumulative market value of the four players still playing for RBL has risen by £26.32m since their relevant transfers. For perspective, there have only been four transfers from RBL to FCS in the same period. [i]

Competition Integrity

Although centralized governance structures provide a wealth of benefits to clubs and owners within MCOs, there is a regulation to limit the effects of centralized governance on the integrity of competition.

UEFA’s regulations on common ownership prohibit teams from competing in the same competition where a single person or entity has a de facto control over both clubs. For clubs under common ownership to compete in the same competition, they must demonstrate that there are disparities within the clubs’ corporate matters, financing, personnel, and sponsorship arrangements.

On only one occasion since 2002 has UEFA’s rule on common ownership been considered. RBL and FCS both qualified for the 2017/18 Champions League and had to make significant structural changes in order for both teams to be admitted to that season’s edition. Therefore, as long as MCOs are willing to sacrifice centralized operations to an extent satisfactory to UEFA regulations, mutual competition is allowed. However, while many smaller clubs within more centralized MCO structures may not have short-term goals of European Football, UEFA regulations do raise questions over the investor’s long-term footballing ambitions for those clubs.

Financial Sustainability Regulations

In addition to the on-field benefits, being part of an MCO also provides opportunities for clubs to improve their financial position, and potentially exploit loopholes in existing financial regulation. UEFA’s recently introduced Financial Sustainability Rules (FSR) are built upon three pillars: solvency, stability, and cost control. The new cost control regulation, known as the squad cost ratio, states that a club’s outlays on wages, agents’ fees, and amortization costs must be less than 70% of club revenues. [ii]

In a scenario where an MCO owned club requires to decrease their squad cost ratio, it is possible that group sponsorship agreements and in-house transfers could be used to achieve this. By selling players within an MCO, and then receiving those players back on loan, clubs will recognize a profit on the sale for the purposes of FSR and bring down their squad cost ratio.

When considering group sponsorship agreements in respect of FSR, it is also possible that the accounting treatment of this contract at the club level could be engineered to assist a club in complying with the squad cost ratio. The allocation of revenue from a group-level sponsorship to each of the clubs under the agreement is not required to be split evenly, which provides MCOs with an opportunity to funnel revenues from group sponsorships to their clubs complying with FSR. With no current guidance or regulation on how group sponsorships should be treated from an accounting perspective, group sponsorships are another tool that can be utilized to improve their squad cost ratio.

Fair Value Regulations

Although MCOs bring opportunities to improve squad cost ratios, the FSR regulations also require all transactions to be made at “fair value”. This means that financial arrangements for sponsorships and player transfers must be accounted for on an “arm’s length” basis. Where there are doubts amongst the Club Financial Control Body (CFCB) board, it can request an adjustment of the proceeds resulting from the transfer of a player, or the allocation of sponsorship monies.

However, there is currently no precedent or evidence to indicate how UEFA would view the accounting treatment for a club under a group sponsorship agreement or the transfer of players within MCOs. Furthermore, while there is a clear means to value a sponsorship agreement, this is considerably more difficult with regard to transfers, specifically the valuation of a player.

While age, injury record, marketability, and contract length, are all attributable factors, a player’s worth comes down to how much the selling club desires weighted against how much the buying club is willing to pay. An MCO structure circumvents this issue and allows for “in-house” transfers at an inflated value stipulated by the shared owner/s. Given the regulations, it is unlikely any club would want to pique the interests of the CFCB by hyper-inflating the value of a transfer, but whether MCOs will be deterred from increasing the value of in house transfers by smaller, nominal values remains to be seen.

The Future of MCOs

Recent trends have shown that the existence of MCOs will be sustained over the coming years. Sport has developed alongside the increasingly commercialized world, resulting in significant growth in investor interest across multiple clubs and sports. However, how the governance and regulation of MCOs evolves will define their development in the long term. Another factor that must be considered is whether investors will prefer multi-sport ownership (MSOs), which bring with them their own regulatory considerations, particularly in relation to conflicts of interest. Nonetheless, in the immediate future we expect continued investment in Football, the question is whether they remain satisfied with just one club, or one sport.

[i] All figures have been taken from https://www.transfermarkt.co.uk/

[ii] A full copy of UEFA’s new regulations can be found here

Kurun Bhandari (Director) and James Michaels (Associate) at Ankura authored this article.

For more entertainment, art, and sports legal news, click here to visit the National Law Review.

Copyright © 2023 Ankura Consulting Group, LLC. All rights reserved.

Bad Faith Games – Hasbro Rolls and Loses

For EU and UK trademarks, there is a five-year grace period following the issuance of a registration, during which the trademark owner must use the mark in connection with the goods and/or services covered by the registration before it can be challenged (and potentially ultimately revoked) for non-use with such goods and/or services. Some trademark owners have tried to take advantage of this by re-filing their previously registered trademarks for exactly the same goods and/or services just before the five-year grace period ends as a means of extending this grace period. This is commonly referred to as “evergreening.”

In Hasbro v EUIPO1, the General Court has upheld the EUIPO Board of Appeal’s decision that repeat filing of trademarks can result in bad faith applications. While it is true that evergreening doesn’t always mean bad faith, where it can be demonstrated that an applicant’s intention for filing a trademark application is to dodge showing genuine use of a mark more than five years old, then bad faith may be established.

Bad faith?

In legal terms, “bad faith” goes back in time and considers a trademark owner’s intention at the time it applied for the trademark. If the intention was to weaken the interests of third parties or obtain a trademark registration for reasons that are unrelated to the trademark itself, then this might result in bad faith. In Hasbro, the question of whether the board game conglomerate acted in bad faith hinged on whether Hasbro’s repeat filings of the MONOPOLY trademark, to avoid showing genuine use of the mark, amounted to bad faith.

Hasbro v EUIPO

When Hasbro filed its MONOPOLY trademark yet again, specifying goods and services near-identical to its earlier filing, the General Court said the application was made in bad faith, as Hasbro’s intention was to prolong the five-year grace period allowed for establishing use.

Although the case was initially rejected by the Cancellation Division of the EUIPO, the EUIPO Board of Appeal partially invalidated Hasbro’s EU Registration for the MONOPOLY mark. A key factor of the General Court’s decision supporting the EUIPO Board of Appeal’s verdict was Hasbro’s admission that its motivation for re-filing was to avoid potential costs that would be incurred to show genuine use of the MONOPOLY trademark.

Impact

The Hasbro case is setting precedent in both the European and UK courts. Although the Hasbro case came along post-Brexit, it is still considered “good law” in the English courts.

In a recent dispute between the two supermarket chains Tesco and Lidl2, Tesco argued that Lidl’s wordless version of its logo should be invalidated, as the mark had never been used and Lidl was periodically re-filing it to avoid having to prove genuine use. Tesco’s counterclaim was struck out in the High Court as Tesco had not made a clear-cut case for bad faith. However, the Court of Appeal allowed Tesco’s appeal and maintained that it was possible bad faith had occurred. This forced Lidl to explain its intentions when filing the mark, which is consistent with the Hasbro case. Tesco’s bad faith allegation will now be assessed at the substantive trial later this year. This will be watched closely by brand-owners and practitioners hoping for further guidance on evergreening and specifically where re-filings amount to bad faith.

In Sky v SkyKick3, the Court of Appeal said that a trademark applicant can have both good and bad reasons for applying to register trademarks. However, trademark filings that are submitted underhandedly, particularly where dishonesty is the main objective of filing the application in the first place, should be invalidated.

Bad faith beware!

The Hasbro v EUIPO decision has resulted in brand owners and trademark lawyers taking greater care when re-filing trademarks. It is important to highlight though, that re-filing a trademark is allowed. It is only when it can be established that an applicant’s intention at the point of re-filing the mark was to skirt use requirements, that bad faith can be found.

Brands looking to file new, or re-file existing, trademarks, should ensure they have a clear trademark strategy. Also consider retaining and recording: (1) evidence of genuine use of your marks; and (2) your reasons for re-filing any existing trademarks.

1 21/04/2021, Case T‑663/19, ECLI:EU:T:2021:211 (Hasbro, Inc. v European Union Intellectual Property Office)

2 Lidl Great Britain Limited v Tesco Stores Limited [2022] EWHC 1434 (Ch)

3 Sky Limited (formerly Sky Plc), Sky International AG, Sky UK Limited v SkyKick, UK Ltd, SkyKick, Inc [2021] EWCA Civ 1121, 2021 WL 03131604

Article By Sarah Simpson and Tegan Miller-McCormack of Katten. To read Kattison Avenue/Katten Kattwalk | Issue 2, please click here.

For more entertainment, art, and sports legal news, click here to visit the National Law Review.

©2023 Katten Muchin Rosenman LLP

Could Leagues and Teams be Joint Employers Before the NLRB?

The National Labor Relations Board (NLRB) has released a Notice of Proposed Rulemaking to change the standard for determining if two employers may be joint employers under the National Labor Relations Act (NLRA). The proposed rule, expected to become effective sometime in 2023, could make it more likely that professional and collegiate leagues would be found to be joint employers of any unionized professional players or collegiate student-athletes who play for teams that are members of those leagues.

As a joint employer of unionized players of member teams, a league could be jointly responsible for unfair labor practices committed by the teams or the team’s supervisors or managers (i.e., coaches and administrators), be required to participate in collective bargaining negotiations with the teams concerning the wages and other terms and conditions of employment of the players, and picketing directed at the league would be considered primary and therefore permissible (rather than secondary and subject to injunction).

Currently, the NLRB will find two or more employers to be joint employers if there is evidence that one employer has actually exercised direct and regular control over essential employment terms of another employer’s employees. An employer that merely reserves the right to exercise control or that has exercised control only indirectly will not be found to be a joint employer. The NLRB has proposed that the Browning Ferris standard be restored. Under the proposed rule, two or more employers will be found to be joint employers if they “share or codetermine those matters governing employees’ essential terms and conditions of employment.” Importantly – and the critical import of the proposed rule – the NLRB will consider both evidence that direct control has been exercised and that the right to control has been reserved (or exercised indirectly) over these essential terms and conditions of employment when reviewing two or more employers for status as joint employers.

Professional athletes are employees under Sec. 2(3) of the NLRA, of course. As for collegiate student-athletes, NLRB General Counsel Jennifer Abruzzo issued a memorandum, GC 21-08, announcing the intention to consider scholarship athletes at private colleges and universities to be employees because, as she wrote, they “perform services for their colleges and the NCAA, in return for compensation, and subject to their control.” Stating in summation “that this memo will notify the public, especially Players at Academic Institutions, colleges and universities, athletic conferences, and the NCAA, that [she] will be taking that legal position in future investigations and litigation” under the NLRA, Abruzzo signaled that conferences, leagues, and the NCAA will face joint-employer analysis in an appropriate case.

The “essential terms and conditions of employment” will translate to the sports workplace in the nature of game, practice and meeting times, travel and accommodation standards, equipment and safety standards, conduct rules and disciplinary proceedings, the length of a season, the number of games and playoff terms, and numerous other areas. Professional leagues may already coordinate with their member teams on a number of employment terms for players. For collegiate conferences and leagues, this may be new. Under the current standard, a league could better insulate itself from the decisions made by its members’ coaches and administrators by not exercising direct involvement in those matters. Under the proposed rule, a league or conference that merely has the power (even if reserved and unexercised) to make decisions affecting the “work” conditions for student-athletes could be jointly liable along with the institution for decisions made solely by the institution’s agents.

Consequently, conferences and leagues should consider training managers on their responsibility under the NLRA to private sector employees. They should also consider the role they want to play in collective bargaining should any of the student-athletes at their member institutions unionize.

Article By Patrick L. Egan of Jackson Lewis P.C.

For more labor and employment legal news, click here to visit the National Law Review.

Jackson Lewis P.C. © 2022

Update Alert on Mickelson v. PGA Tour, Inc.

On August 16, 2022, we prepared an alert discussing Mickelson v. PGA Tour, Inc. and the claims made by suspended PGA Tour players (“Player Plaintiffs”) against PGA Tour, Inc. (“Tour.”) Quite a bit has transpired in the past three weeks both in and out of the courtroom. This alert highlights new developments that stem from an amended complaint that was filed in the US District Court, Northern District of California on August 26, 2022 (the “Amended Complaint.”)

The Amended Complaint can be found here and the original alert can be found here.

The Amended Complaint removes several Player-Plaintiffs listed as plaintiffs in the original complaint. Originally, the Player Plaintiffs were comprised of the following eleven golfers: Abraham Ancer, Bryson DeChambeau, Taylor Gooch, Matt Jones, Jason Kokrak, Phil Mickelson, Carlos Ortiz, Pat Perez, Ian Poulter, Hudson Swafford, and Peter Uihlein. Per the Amended Complaint, four of the original Plaintiff Players have been removed as plaintiffs, namely: Abraham Ancer, Jason Kokrak, Carlos Ortiz, and Pat Perez.[1] As a result, only seven of the eleven original Player Plaintiffs remain as Player Plaintiffs.

Perhaps the most significant development in the case is that LIV Golf has been added as a Plaintiff in the Amended Complaint. The Amended Complaint generally reiterates allegations made by the Player Plaintiffs (together with LIV Golf, collectively, the “Plaintiffs”) in the original complaint and incorporates LIV Golf’s alleged harm, mainly, that the Tour’s efforts made to prevent LIV Golf’s entry into the elite professional golf market forced LIV Golf to delay and restructure its 2022 launch plans and required LIV Golf “to pay excessively higher guaranteed payments to recruit a number of marquee players than would be required in a competitive market.”

Three more claims were added to the Amended Complaint, for a total of eight claims brought by the Plaintiffs. The first new claim alleges that Tour has violated Section 2 of the Sherman Antitrust Act by monopolizing the market for promotion of elite professional golf events (which is in addition to the Section 2 claim in the original complaint that alleges that the Tour maintains a monopoly on elite event services.) In addition to the now three antitrust claims brought in the Amended Complaint, LIV Golf also brought separate tortious interference claims of contractual relationships and prospective business relationships. The antitrust claims and the tortious interference claims are based on the premise that the Tour’s exclusionary actions: (i) prevent competition for the promotion of golf entertainment among stakeholders, such as broadcasters, players (via the Media Rights Regulation), vendors, sponsors, advertisers, partners, and agencies, and (ii) interfere with LIV Golf’s ability to negotiate and enter into contracts with those stakeholders.

Key Observations

Although more than one-third of the original Player Plaintiffs have withdrawn from Mickelson v. PGA Tour, Inc., the addition of LIV Golf as a plaintiff elevates the lawsuit because it brings the very public rivalry between the Tour and LIV Golf to the courtroom. The circumstances surrounding the case are also rapidly evolving. Since the order denying Player Plaintiffs Talor Gooch, Hudson Swafford, and Matt Jones’s motion for temporary restraining order (“TRO”) issued on August 9, 2022, six Tour members (most notably world number 2 Cameron Smith) have joined LIV Golf, which amounts to nearly half of the major winners since 2016 and 26 of the world’s top 100 golfers that have now signed with LIV Golf. In addition, the Tour announced various rule changes for the 2023 PGA Tour season, including increased purse winnings, bonus pools, and elevated events. It remains to be seen whether these circumstances will materially alter the arguments made throughout the TRO proceedings.

The tentative date to hear dispositive motions (such as summary judgment) has been scheduled for July 23, 2023, and the jury trial date is expected to begin on January 8, 2024.

FOOTNOTES

[1] Pat Perez was the only player who directly provided the reason for his withdrawal: “I didn’t really think it through… I did it to back our guys,” he reportedly said. He also said that he does not have “ill will” towards the Tour and emphasized his content of playing for LIV Golf.

Article By Richard L. Brand, Thomas R. Castiello, Brian D. Schneider, and Anjelica L. Fuccillo of ArentFox Schiff LLP

For more entertainment, art, and sports legal news, click here to visit the National Law Review.

© 2022 ArentFox Schiff LLP

By Law, Everything Is Possible In California

The California Civil Code includes a number of decidedly gnomic provisions.  Section 1597 is one of these.  It purports to answer the question of what is possible:

Everything is deemed possible except that which is impossible in the nature of things.

The problem with the statute is that it doesn’t fully answer the question because to know what is possible, one must know what is impossible and the statute doesn’t provide a definition of impossibility.  In this regard, I am reminded of the following lines from James Joyce’s Ulysses: 

But can those have been possible seeing that they never were?  Or was that only possible which came to pass?

But why define what is possible?  The reason is that Civil Code requires that the object of a contract must, among other things, be possible by the time that it is to be performed.  Cal. Civ. Code § 1596.  When a contract that has a single object that is impossible of performance, the entire contract is void.  Cal. Civ. Code § 1598.

Happy Bloomsday!

Today is Bloomsday.  Joyce chose June 16, 1904 as the day on which most (but not all) of the action in Ulysses takes place.  It is called Bloomsday because the hero of the novel is Leopold Bloom.  It was on June 16, 1904 that Joyce and his future wife, Nora Barnacle, had their first date (and intimate contact).

1C8E1253-FA65-4ED3-B026-ABF4D9098AAC

Finn’s Hotel in Dublin, where Nora worked in 1904

Article By Keith Paul Bishop of Allen Matkins Leck Gamble Mallory & Natsis LLP

For more legislative legal news, click here to visit the National Law Review.

© 2010-2022 Allen Matkins Leck Gamble Mallory & Natsis LLP

“Levitating” Lawsuits: Understanding Dua Lipa’s Copyright Infringement Troubles

Even global stardom will not make copyright woes levitate away from British superstar Dua Lipa. The pop icon is making headlines following a week of back-to-back, bi-coastal lawsuits alleging copyright infringement with her hit “Levitating.” First, on Tuesday, March 1st, members of reggae band Artikal Sound System sued Dua Lipa for copyright infringement in a Los Angeles federal district court1. Then, on Friday, March 4th, songwriters L. Russell Brown and Sandy Linzer filed their own copyright infringement lawsuit against the pop star in a New York federal district court2. Both lawsuits were filed claiming violations of the Copyright Act, 17 U.S.C. §§ 101 et seq.3

The Artikal Sound System lawsuit is short and alleges that Dua Lipa and the co-creators of “Levitating” copied Artikal Sound System’s 2017 song “Live Your Life.”4 The lawsuit does not provide any details in the allegation, other than explaining that “Live Your Life” was commercially released in 2017, was available during the time Dua Lipa and her co-creators wrote “Levitating,” and that because the two songs are substantially similar “Levitating” could not have been created independently.5 As a remedy, Artikal Sound System seeks actual damages, a portion of Dua Lipa’s profits stemming from the alleged infringement, the cost of the lawsuit, and any additional remedies the Court sees fit.6

Similarly, the Brown and Linzer lawsuit alleges that Dua Lipa and her “Levitating” co-creators copied their works “Wiggle and Giggle All Night” and “Don Diablo.”7 More specifically, the Brown and Linzer lawsuit alleges that “Levitating” is substantially similar to “Wiggle and Giggle All Night” and “Don Diablo.”8

Accordingly, the lawsuit claims that the defining melody in “Levitating,” the “signature melody,” is a direct duplicate of the opening melody in “Wiggle and Giggle All Night” and “Don Diablo,” and therefore appears in all three songs.9 As additional support, the lawsuit points to professionals and laypersons noticing a similarity between the three songs, and Dua Lipa previously admitting that she “purposely sought influences from past eras for the album Future Nostalgia.”10

As for a remedy, Brown and Linzer request full compensatory and/or statutory damages, punitive damages, an injunction on “Levitating,” a portion of Dua Lipa’s profits stemming from the alleged infringement, the cost of the lawsuit, and any additional remedies the Court sees fit.11

The copyright infringement legal framework

A general overview of the copyright infringement legal framework is helpful in assessing the potential outcomes of the “Levitating” lawsuits. Specifically, the legal framework from the 9th Circuit, where one of the “Levitating” lawsuits was filed, provides great guidance.

In order to establish copyright infringement, one must prove two elements: owning a valid copyright and copying of “constituent elements of the work that are original.”12 Importantly, when there is no direct evidence of copying, but rather circumstantial evidence, plaintiffs must show that:

  1. the accused infringers had access to the copyrighted work, and

  2. the infringing work and the copyrighted work “are substantially similar.

Plaintiffs can easily show access to the copyrighted work, but “substantial similarity” is harder to show.

2-Part Test

Luckily, the 9th Circuit devised a 2-part test to prove “substantial similarity.”13 Under the test, there is sufficient copying, and therefore “substantial similarity,” if an infringing work meets an “extrinsic” and “intrinsic” prong.14 The intrinsic prong is met if there is “similarity of expression” between the works, as evaluated from the subjective standpoint of an “ordinary reasonable observer.”15 The extrinsic prong is objective and requires comparing the “constituent elements” of the copyrighted and infringing works to see if there is substantial similarity in terms of the “protected” elements in the copyrighted work.16

As such, if the commonality between the copyrighted and infringing works is not based on “protected” elements, then the extrinsic prong is not met, and there is no “substantial similarity” between the works for purposes of a copyright infringement action. It must be noted that the 9th Circuit recognizes that, in certain situations, there can be a “substantial similarity” even if the constituent elements are individually unprotected, but only if their “selection and arrangement” reflects originality.17

To understand “substantial similarity” one must define what is “protectable” under copyright law. Copyright protection extends only to works that contain original expression.18 In this context, the standard for originality is a minimal degree of creativity.19 According to the Copyright Act, protection does not extend to ideas or concepts used in original works of authorship.20 In the musical context, copyright does not protect “common or trite musical elements, or commonplace elements that are firmly rooted in the genre’s tradition” because “[t]hese building blocks belong in the public domain and cannot be exclusively appropriated by any particular author.”21

Katy Perry “Dark Horse” case and an ostinato

While the “Levitating” lawsuits are still young, a recent decision by the 9th Circuit in the infamous Katy Perry “Dark Horse” case is a good example of how courts conduct legal analyses in copyright infringement cases. The precedential ruling (Gray v. Hudson), released on March 10th, affirms a U.S. District Judge’s decision to vacate a jury verdict that awarded US$2.8 million in damages to a group of rappers who claimed Katy Perry’s “Dark Horse” copied their song “Joyful Noise.”22

The 9th Circuit’s opinion cogently applies copyright law to hold that the plaintiffs in the original lawsuit did not provide legally sufficient evidence that “Joyful Noise” and “Dark Horse” were “extrinsically similar” in terms of musical features protected by copyright law.23

Specifically, the Court reasoned that while “Dark Horse” used an ostinato (a repeating musical figure) similar to the one in “Joyful Noise,” the resemblance in the ostinatos stemmed from “commonplace, unoriginal musical principles” and made them uncopyrightable.24 Without the ostinatos, the plaintiffs could not point to any “individually copyrightable” elements from “Joyful Noise” that were “substantially similar” in “Dark Horse.”25

Additionally, the Court held that the “Joyful Noise” ostinato was not original enough to be a protectable combination of uncopyrightable elements.26 In turn, under the legal framework for copyright infringement the plaintiffs failed to meet their burden.27 The Court put it best by opining that:

“[a]llowing a copyright over [the] material would essentially amount to allowing an improper monopoly over two-note pitch sequences or even the minor scale itself, especially in light of the limited number of expressive choices available when it comes to an eight-note repeated musical figure.”28

“Levitating” lawsuits likely outcomes

Applying the copyright infringement framework to the “Levitating” lawsuits allows us to understand the likely outcomes. First, the Artikal Sound System lawsuit does not allege any direct evidence of copying. As such, Artikal Sound System must show that Dua Lipa had access to “Live Your Life” and that “Levitating” is “substantially similar” to their song under the 2-prong test. Access is easily proved, as “Live Your Life” was commercially available on multiple streaming services when Dua Lipa wrote “Levitating.”29

However, the Artikal Sound System lawsuit does not provide enough information to pass the 2-prong “substantial similarity” test. The lawsuit only alleges that “Levitating” is “substantially similar” to “Live Your Life,” but does not detail any similarities much less provide any evidence that there is similarity of expression between the works from the point of view of a reasonable observer, as required by the intrinsic component of the test.30

More importantly, the lawsuit does not even mention any protectable elements from “Live Your Life” copied in “Levitating” and would, therefore, fail the extrinsic prong of the “substantial similarity” test.31 In turn, as submitted, the Artikal Sound System lawsuit fails to make a prima facie case of copyright infringement by Dua Lipa’s “Levitating.”

The story may be different for the Brown and Linzer lawsuit. Like the first suit, the Brown and Linzer lawsuit does not provide direct evidence of copying and will therefore only succeed if it passes the circumstantial evidence requirements of 1) access and 2) “substantial similarity.” Unlike the first suit, however, the Brown and Linzer complaint includes comparisons of the notes in “Levitating” to the notes in “Wiggle and Giggle All Night” and “Don Diablo” as support for the allegation of “substantial similarity.”

The 2nd Circuit, where the lawsuit was filed, held that a court can determine as a matter of law that two works are not “substantially similar” if the similarity between the two works concerns non-copyrightable elements of the copyrighted work.32 In practice, this means that the 2nd Circuit can apply the 2-prong “substantial similarity” test. Brown and Linzer can easily prove access to “Wiggle and Giggle All Night” and “Don Diablo” since both songs are internationally popular.33

Brown and Linzer can also meet the intrinsic prong of the test because, as they point out, “laypersons” (ordinary reasonable observers) have noticed the commonality between their copyrighted works and “Levitating,” as supported by widespread postings on mediums like TikTok.34 The extrinsic prong of the test is more uncertain.

In their lawsuit, Brown and Linzer point to a “signature melody” that repeats in “bars 10 and 11 of all three songs… [and] with some slight variation, in bars 12 and 13.”35 The court may find that this “signature melody” is not protected by copyright if it reasons that a melody is a basic musical principle, much like the 9th Circuit did for ostinatos in the Katy Perry “Dark Horse” case.

At its core, it seems like Brown and Linzer will have to convince the court that a melody, which they define as “a linear succession of musical tones,” qualifies as copyrightable because it is an original creative expression. Conversely, Brown and Linzer can concede that a melody is not copyrightable, but that their original arrangement and use of the melody in their copyrighted songs is copyrightable. In the end, it will be up to whether or not a court finds that the “signature melody” is copyrightable. As such, the outcome of Brown and Linzer’s action for copyright infringement is uncertain.

Nonetheless, one thing is for sure, copied or not, “Levitating” will continue powering gym visits and nights out dancing.

Footnotes

  1. See Complaint, Cope v. Warner Records, Inc., Case 2:22-cv-01384 (C.D. Cal. 2022).

  2. See Complaint, Larball Publ’g Co., Inc. v. Dua Lipa, Case 1:22-cv-01872 (S.D.N.Y. 2022).

  3. See Complaint at ¶ 7, Larball Publ’g Co., Inc. v. Dua Lipa, Case 1:22-cv-01872 (S.D.N.Y. 2022); Complaint at ¶ 12, Cope v. Warner Records, Inc., Case 2:22-cv-01384 (C.D. Cal. 2022).

  4. See Complaint at ¶ 17, Cope v. Warner Records, Inc., Case 2:22-cv-01384 (C.D. Cal. 2022).

  5. See Complaint at ¶ 15-18, Cope v. Warner Records, Inc., Case 2:22-cv-01384 (C.D. Cal. 2022).

  6. See Complaint at ¶ 19-22, Cope v. Warner Records, Inc., Case 2:22-cv-01384 (C.D. Cal. 2022).

  7. See Complaint at ¶ 2, Larball Publ’g Co., Inc. v. Dua Lipa, Case 1:22-cv-01872 (S.D.N.Y. 2022).

  8. See Complaint at ¶ 2, Larball Publ’g Co., Inc. v. Dua Lipa, Case 1:22-cv-01872 (S.D.N.Y. 2022).

  9. See Complaint at ¶ 3, Larball Publ’g Co., Inc. v. Dua Lipa, Case 1:22-cv-01872 (S.D.N.Y. 2022).

  10. See Complaint at ¶ 49, Larball Publ’g Co., Inc. v. Dua Lipa, Case 1:22-cv-01872 (S.D.N.Y. 2022).

  11. See Complaint at 13-14, Larball Publ’g Co., Inc. v. Dua Lipa, Case 1:22-cv-01872 (S.D.N.Y. 2022).

  12. Feist Publ’ns, Inc. v. Rural Tel. Serv. Co., 499 U.S. 340, 361 (1991).

  13. Apple Comput., Inc. v. Microsoft Corp., 35 F.3d 1435, 1442 (9th Cir. 1994).

  14. Id.

  15. Id.

  16. Swirsky v. Carey, 376 F.3d 841, 845 (9th Cir. 2004).

  17. Satava v. Lowry, 323 F.3d 805, 811 (9th Cir. 2003).

  18. See 17 U.S.C. § 102(a); Feist, 499 U.S. at 345.

  19. See Feist, 499 U.S. at 345.

  20. See 17 U.S.C. § 102(b); Skidmore as Tr. for the Randy Craig Wolfe Tr. v. Led Zeppelin, 952 F.3d 1051, 1069 (9th Cir. 2020) (en banc).

  21. Skidmore, 952 F.3d at 1069.

  22. Gray v. Hudson, No. 20-55401, slip op at 26 (9th Cir. Mar. 10, 2022).

  23. Id.

  24. Id. at 14-21.

  25. Id. at 17.

  26. Id. at 22.

  27. Id. at 26.

  28. Id. at 24.

  29. See Complaint at ¶ 16, Cope v. Warner Records, Inc., Case 2:22-cv-01384 (C.D. Cal. 2022).

  30. See Complaint at ¶ 18, Cope v. Warner Records, Inc., Case 2:22-cv-01384 (C.D. Cal. 2022).

  31. See Complaint at ¶ 18, Cope v. Warner Records, Inc., Case 2:22-cv-01384 (C.D. Cal. 2022).

  32. Peter F. Gaito Architecture, LLC v. Simone Dev. Corp., 602 F.3d 57, 63-65 (2d Cir. 2010).

  33. See Complaint at ¶ 35, Larball Publ’g Co., Inc. v. Dua Lipa, Case 1:22-cv-01872 (S.D.N.Y. 2022).

  34. See Complaint at ¶ 4, Larball Publ’g Co., Inc. v. Dua Lipa, Case 1:22-cv-01872 (S.D.N.Y. 2022).

  35. See Complaint at ¶ 38, Larball Publ’g Co., Inc. v. Dua Lipa, Case 1:22-cv-01872 (S.D.N.Y. 2022).

Article By Adrian Gonzalez Cerrillo and Sana Hakim of K&L Gates

For more intellectual property legal news, click here to visit the National Law Review.

Copyright 2022 K & L Gates

SCOTUS Shelves Request to Review 11th Circuit Dark Tower Decision, Ending Copyright Saga

The Supreme Court’s refusal to review the Eleventh Circuit’s decision in DuBay v. King marks an end to a 4-year copyright battle concerning the lead character of Stephen King’s acclaimed series, The Dark Tower.  The Eleventh Circuit’s decision affirmed that the King’s anti-hero, Roland Deschain, is not substantially similar to William DuBay’s The Rook comic book character, Restin Dane. The decision illustrates the complexity of literary copyright infringement disputes, where a claim is brought based on a mix of original and stock character elements.

In 2017 William DuBay’s heir, Benjamin DuBay, sued novelist Stephen King, Marvel Entertainment, Sony Entertainment, and others for various counts of copyright infringement, alleging that King copied DuBay’s artistic expression based on purported similarity between lead characters of The Rook (Restin Dane) and The Dark Tower (Roland Deschain). The district court granted summary judgment to King, determining (1) that any similarities between the characters comprise unprotectable general ideas and scènes à faire elements; and (2) that the protectable original character elements in dispute are different, such that “no reasonable jury…could find the works substantially similar.” DuBay appealed.

The principal issue on appeal was whether the district court erred in assessing substantial similarity.  DuBay argued that the characters were substantially similar based on several shared characteristics, including: (1) similar names; (2) interaction with time-travel related towers; (3) having a bird as a companion; (4) having knightly characteristics; (5) wearing Western-style clothing; (6) surviving a fictionalized interpretation of The Alamo; (7) the use of knives; and (8) traveling back in time to save a young boy who becomes a gunslinger. DuBay also argued that the unique combination of these elements made Dane a distinctive character, and that Deschain is a copy of DuBay’s artistic expression in that character.

The Eleventh Circuit addressed DuBay’s contentions in two parts.

First, the court assessed whether each of the claimed character elements merit copyright protection. The court affirmed the district court’s holding that “character names do not merit copyright protection,” since mere words and short phrases cannot be protected under copyright law.  The court reiterated that only original elements of a copyrighted work can be afforded protection, and that certain claimed elements (i.e., “knightly heritage,” time travel to “different times and parallel worlds,” “western attire,” “fictionalized Alamo histories,” and “knife wielding”) are merely general ideas or scènes à faire that are “too general to merit copyright protection.”  The court then reviewed the remaining elements to determine whether the shared characteristics rendered the characters substantially similar.  Although both characters may be broadly similar in having bird companions, a relationship to towers and tower imagery, and past time travel experiences involving the rescue of a young boy, the court found that the depiction of these elements was different in each work.  For example, whereas Dane lives in and travels via tower shaped structures shaped like the namesake chess piece, Deschain embarks on an endless mission to find an elusive Gothic tower that connects parallel worlds and time periods.  Because the portrayals of each original element are distinguishable, the court determined that no reasonable jury could have concluded that the works were similar.

Second, the court examined whether the characters are substantially similar based on each character’s combination of the claimed elements (or the “look and feel” of the characters).  The Court recognized of the potential dangers of comparing works based on individual similarities alone because an original combination of unoriginal elements can potentially sustain a claim of copyright infringement.  However, the court found that any similarities of combined elements were “superficial” at best, and that the “look and feel” analysis actually hurt, rather than helped, DuBay’s case by highlighting differences in expression of shared original character elements.

Takeaway:

The Supreme Court’s refusal to hear Dubay reinforces the basic tenet of copyright law that general ideas or scènes à faire cannot be protected by copyright.  It also reminds litigants that although a combination of original and non-original elements can be protected under copyright law, broad similarities are usually insufficient to sustain a copyright infringement claim.

The case is DuBay v. King, 844 Fed. Appx. 257 (11thCir. 2019), cert. denied, 142 S. Ct. 490 (2021).

Article By Spencer K. Beall and Margaret A. Esquenet of Finnegan

For more intellectual property legal news, click here to visit the National Law Review.

© 2021 Finnegan, Henderson, Farabow, Garrett & Dunner, LLP

In the Coming ‘Metaverse’, There May Be Excitement but There Certainly Will Be Legal Issues

The concept of the “metaverse” has garnered much press coverage of late, addressing such topics as the new appetite for metaverse investment opportunities, a recent virtual land boom, or just the promise of it all, where “crypto, gaming and capitalism collide.”  The term “metaverse,” which comes from Neal Stephenson’s 1992 science fiction novel “Snow Crash,” is generally used to refer to the development of virtual reality (VR) and augmented reality (AR) technologies, featuring a mashup of massive multiplayer gaming, virtual worlds, virtual workspaces, and remote education to create a decentralized wonderland and collaborative space. The grand concept is that the metaverse will be the next iteration of the mobile internet and a major part of both digital and real life.

Don’t feel like going out tonight in the real world? Why not stay “in” and catch a show or meet people/avatars/smart bots in the metaverse?

As currently conceived, the metaverse, “Web 3.0,” would feature a synchronous environment giving users a seamless experience across different realms, even if such discrete areas of the virtual world are operated by different developers. It would boast its own economy where users and their avatars interact socially and use digital assets based in both virtual and actual reality, a place where commerce would presumably be heavily based in decentralized finance, DeFi. No single company or platform would operate the metaverse, but rather, it would be administered by many entities in a decentralized manner (presumably on some open source metaverse OS) and work across multiple computing platforms. At the outset, the metaverse would look like a virtual world featuring enhanced experiences interfaced via VR headsets, mobile devices, gaming consoles and haptic gear that makes you “feel” virtual things. Later, the contours of the metaverse would be shaped by user preferences, monetary opportunities and incremental innovations by developers building on what came before.

In short, the vision is that multiple companies, developers and creators will come together to create one metaverse (as opposed to proprietary, closed platforms) and have it evolve into an embodied mobile internet, one that is open and interoperable and would include many facets of life (i.e., work, social interactions, entertainment) in one hybrid space.

In order for the metaverse to become a reality, that is, successfully link current gaming and communications platforms with other new technologies into a massive new online destination – many obstacles will have to be overcome, even beyond the hardware, software and integration issues. The legal issues stand out, front and center. Indeed, the concept of the metaverse presents a law school final exam’s worth of legal questions to sort out.  Meanwhile, we are still trying to resolve the myriad of legal issues presented by “Web 2.0,” the Internet we know it today. Adding the metaverse to the picture will certainly make things even more complicated.

At the heart of it is the question of what legal underpinnings we need for the metaverse infrastructure – an infrastructure that will allow disparate developers and studios, e-commerce marketplaces, platforms and service providers to all coexist within one virtual world.  To make it even more interesting, it is envisioned to be an interoperable, seamless experience for shoppers, gamers, social media users or just curious internet-goers armed with wallets full of crypto to spend and virtual assets to flaunt.  Currently, we have some well-established web platforms that are closed digital communities and some emerging ones that are open, each with varying business models that will have to be adapted, in some way, to the metaverse. Simply put, the greater the immersive experience and features and interactions, the more complex the related legal issues will be.

Contemplating the metaverse, these are just a few of the legal issues that come to mind:

  • Personal Data, Privacy and Cybersecurity – Privacy and data security lawyers are already challenged with addressing the global concerns presented by varying international approaches to privacy and growing threats to data security. If the metaverse fulfills the hype and develops into a 3D web-based hub for our day-to-day lives, the volume of data that will be collected will be exponentially greater than the reams of data already collected, and the threats to that data will expand as well. Questions to consider will include:
    • Data and privacy – What’s collected? How sensitive is it? Who owns or controls it? The sharing of data will be the cornerstone of a seamless, interoperable environment where users and their digital personas and assets will be usable and tradeable across the different arenas of the metaverse.  How will the collection, sharing and use of such data be regulated?  What laws will govern the collection of data across the metaverse? The laws of a particular state?  Applicable federal privacy laws? The GDPR or other international regulations? Will there be a single overarching “privacy policy” governing the metaverse under a user and merchant agreement, or will there be varying policies depending on which realm of the metaverse you are in? Could some developers create a more “privacy-focused” experience or would the personal data of avatars necessarily flow freely in every realm? How will children’s privacy be handled and will there be “roped off,” adults-only spaces that require further authentication to enter? Will the concepts that we talk about today – “personal information” or “personally identifiable information” – carry over to a world where the scope of available information expands exponentially as activities are tracked across the metaverse?
    • Cybersecurity: How will cybersecurity be managed in the metaverse? What requirements will apply with respect to keeping data secure? How will regulation or site policies evolve to address deep fakes, avatar impersonation, trolling, stolen biometric data, digital wallet hacks and all of the other cyberthreats that we already face today and are likely to be exacerbated in the metaverse? What laws will apply and how will the various players collaborate in addressing this issue?
  • Technology Infrastructure: The metaverse will be a robust computing-intensive experience, highlighting the importance of strong contractual agreements concerning cloud computing, IoT, web hosting, and APIs, as well as software licenses and hardware agreements, and technology service agreements with developers, providers and platform operators involved in the metaverse stack. Performance commitments and service levels will take on heightened importance in light of the real-time interactions that users will expect. What is a meaningful remedy for a service level failure when the metaverse (or a part of the metaverse) freezes? A credit or other traditional remedy?  Lawyers and technologists will have to think creatively to find appropriate and practical approaches to this issue.  And while SaaS and other “as a service” arrangements will grow in importance, perhaps the entire process will spawn MaaS, or “Metaverse as a Service.”
  • Open Source – Open source, already ubiquitous, promises to play a huge role in metaverse development by allowing developers to improve on what has come before. Whether or not the obligations of common open source licenses will be triggered will depend on the technical details of implementation. It is also possible that new open source licenses will be created to contemplate development for the metaverse.
  • Quantum Computing – Quantum computing has dramatically increased the capabilities of computers and is likely to continue to do over the coming years. It will certainly be one of the technologies deployed to provide the computing speed to allow the metaverse to function. However, with the awesome power of quantum computing comes threats to certain legacy protections we use today. Passwords and traditional security protocols may be meaningless (requiring the development of post-quantum cryptography that is secure against both quantum and traditional computers). With raw, unchecked quantum computing power, the metaverse may be subject to manipulation and misuse. Regulation of quantum computing, as applied to the metaverse and elsewhere, may be needed.
  • Antitrust: Collaboration is a key to the success of the metaverse, as it is, by definition, a multi-tenant environment. Of course collaboration amongst competitors may invoke antitrust concerns. Also, to the extent that larger technology companies may be perceived as leveraging their position to assert unfair control in any virtual world, there may be additional concerns.
  • Intellectual Property Issues: A host of IP issues will certainly arise, including infringement, licensing (and breaches thereof), IP protection and anti-piracy efforts, patent issues, joint ownership concerns, safe harbors, potential formation of patent cross-licensing organizations (which also may invoke antitrust concerns), trademark and advertising issues, and entertaining new brand licensing opportunities. The scope of content and technology licenses will have to be delicately negotiated with forethought to the potential breadth of the metaverse (e.g., it’s easy to limit a licensee’s rights based on territory, for example, but what about for a virtual world with no borders or some borders that haven’t been drawn yet?). Rightsholders must also determine their particular tolerance level for unauthorized digital goods or creations. One can envision a need for a DMCA-like safe harbor and takedown process for the metaverse. Also, akin to the litigation that sprouted from the use of athletes’ or celebrities’ likenesses (and their tattoos) in videogames, it’s likely that IP issues and rights of publicity disputes will go way up as people’s virtual avatars take on commercial value in ways that their real human selves never did.
  • Content Moderation. Section 230 of the Communications Decency Act (CDA) has been the target of bipartisan criticism for several years now, yet it remains in effect despite its application in some distasteful ways. How will the CDA be applied to the metaverse, where the exchange of third party content is likely to be even more robust than what we see today on social media?  How will “bad actors” be treated, and what does an account termination look like in the metaverse? Much like the legal issues surrounding offensive content present on today’s social media platforms, and barring a change in the law, the same kinds of issues surrounding user-generated content will persist and the same defenses under Section 230 of the Communications Decency Act will be raised.
  • Blockchain, DAOs, Smart Contract and Digital Assets: Since the metaverse is planned as a single forum with disparate operators and users, the use of a blockchain (or blockchains) would seem to be one solution to act as a trusted, immutable ledger of virtual goods, in-world currencies and identity authentication, particularly when interactions may be somewhat anonymous or between individuals who may or may not trust each other and in the absence of a centralized clearinghouse or administrator for transactions. The use of smart contracts may be pervasive in the metaverse.  Investors or developers may also decide that DAOs (decentralized autonomous organizations) can be useful to crowdsource and fund opportunities within that environment as well.  Overall, a decentralized metaverse with its own discrete economy would feature the creation, sale and holding of sovereign digital assets (and their free use, display and exchange using blockchain-based payment networks within the metaverse). This would presumably give NFTs a role beyond mere digital collectibles and investment opportunities as well as a role for other forms of digital currency (e.g., cryptocurrency, utility tokens, stablecoins, e-money, virtual “in game” money as found in some videogames, or a system of micropayments for virtual goods, services or experiences).  How else will our avatars be able to build a new virtual wardrobe for what is to come?

With this shift to blockchain-based economic structures comes the potential regulatory issues behind digital currencies. How will securities laws view digital assets that retain and form value in the metaverse?  Also, as in life today, visitors to the metaverse must be wary of digital currency schemes and meme coin scams, with regulators not too far behind policing the fraudsters and unlawful actors that will seek opportunities in the metaverse. While regulators and lawmakers are struggling to keep up with the current crop of issues, and despite any progress they may make in that regard, many open issues will remain and new issues will be of concern as digital tokens and currency (and the contracts underlying them) take on new relevance in a virtual world.

Big ideas are always exciting. Watching the metaverse come together is no different, particularly as it all is happening alongside additional innovations surrounding the web, blockchain and cryptocurrency (and, more than likely, updated laws and regulations). However, it’s still early. And we’ll have to see if the current vision of the metaverse will translate into long-term, concrete commercial and civic-minded opportunities for businesses, service providers, developers and individual artists and creators.  Ultimately, these parties will need to sort through many legal issues, both novel and commonplace, before creating and participating in a new virtual world concept that goes beyond the massive multi-user videogame platforms and virtual worlds we have today.

Article By Jeffrey D. Neuburger of Proskauer Rose LLP. Co-authored by  Jonathan Mollod.

For more legal news regarding data privacy and cybersecurity, click here to visit the National Law Review.

© 2021 Proskauer Rose LLP.

Federal Courts Side With Strip Clubs in Opposing the SBA’s Ineligibility Rules for the Paycheck Protection Program, Possibly Signaling a Broader Trend

Recent rulings from federal courts enjoined the US Small Business Administration (SBA) from applying its April 2, 2020 Interim Final Rule (April 2 IFR) to limit the types of businesses that can participate in the Paycheck Protection Program (PPP) under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Some of these rulings are expressly limited to the named plaintiffs that had been denied PPP loans and do not directly impact any other businesses that have or might apply for a PPP loan. Irrespective of any limitations in these cases, such decisions may signal a broader trend. In increasing numbers, federal courts are agreeing with arguments made by small businesses facing COVID-19-related challenges that the SBA’s PPP business eligibility limitations are inconsistent with Congress’ intention to help “any business concern” during this unprecedented time.

Financial services businesses that are deemed ineligible under the April 2 IFR need to pay close attention to cases that challenge the SBA’s incorporation of its existing list of “prohibited businesses” into eligibility requirements for a PPP loan. Even without court rulings, it also is possible (although not likely) that Congress or the SBA could suspend or revise the April 2 IFR to broaden PPP eligibility to include some or all of the currently designated “prohibited businesses.”

This advisory will explore:

  • the SBA’s April 2 IFR restricted eligibility in the PPP to certain financial services businesses that were ineligible for SBA-guaranteed loans under existing federal programs;

  • a recent Sixth Circuit ruling challenging the April 2 IFR as well as other federal court cases may signal a trend by federal courts to adhere to the text of the CARES Act; and

  • whether other federal courts will follow the Sixth Circuit’s view, or whether Congress or the SBA will suspend or revise the April 2 IFR to broaden PPP eligibility.

The April 2 IFR and Subsequent SBA Rules and Guidance

The PPP was one of several measures enacted by Congress under the CARES Act to provide small businesses with support to cover payroll and certain other expenses for an eight-week period due to the economic effects of the COVID-19 pandemic. As noted in a prior Katten Financial Markets and Funds advisory, the SBA published the April 2 IFR on the evening before lenders could accept PPP applications, determining that various businesses, including some financial services business, were ineligible to apply for PPP loans under the CARES Act.1

The April 2 IFR limited the types of businesses eligible for the PPP by specifically incorporating an existing SBA regulation and guidance document that lists the types of businesses that are ineligible from applying for Section 7(a) SBA loans. In particular, the April 2 IFR provides, in part, that: “Businesses that are not eligible for PPP loans are identified in 13 CFR 120.110 and described further in SBA’s Standard Operating Procedure (SOP) 50 10, Subpart B, Chapter 2.”2

Some of the ineligible financial services businesses listed in the SBA’s Standard Operating Procedure 50 10 (SOP) include, without limitation:

  • banks;
  • life insurance companies (but not independent agents);
  • finance companies;
  • investment companies;
  • certain passive businesses owned by developers and landlords, which do not actively use or occupy the assets acquired or improved with the loan proceeds, and/or which are primarily engaged in owning or purchasing real estate and leasing it for any purpose; and
  • speculative businesses that primarily “purchas[e] and hold[ ] an item until the market price increases” or “engag[e] in a risky business for the chance of an unusually large profit.”

With respect to last category in this list, the SBA provided further clarity regarding certain investment businesses and speculative businesses that were applying for PPP loans. In an April 24, 2020 Interim Final Rule (April 24 IFR), the SBA expressly clarified that hedge funds and private equity firms are investment and speculative businesses and, therefore, are ineligible to receive PPP loans.3 However, the April 24 IFR created an exception for portfolio companies of private equity firms, which were deemed eligible for PPP loans if the entities met the requirements for affiliated borrowers under the April 2 IFR.4

Recent Sixth Circuit Case

As noted above, the SBA’s SOP did not only deem financial services businesses ineligible to receive PPP loans. Other types of businesses, including without limitation, legal gambling businesses, lobbying firms, businesses promoting religion and businesses providing “prurient sexual material” also were deemed ineligible. Believing that these limitations were inconsistent with a plain reading of the text of the CARES Act, some of these businesses have challenged the SBA’s restrictions imposed pursuant to the April 2 IFR.

On May 11, 2020, the US District Court for the Eastern District of Michigan preliminarily enjoined the SBA from enforcing the April 2 IFR to preclude sexually oriented businesses from PPP loans under the CARES Act.5 Plaintiffs were primarily businesses that provided lawful “clothed, semi-nude, and/or nude performance entertainment,” which were considered ineligible businesses for the PPP under the April 2 IFR due to their “prurient” nature.6 The district court found that the CARES Act specifically broadened the class of businesses that are PPP eligible,7 determining that it was clear from the text of the statute that Congress provided “support to all Americans employed by all small businesses.”8 The district court, however, limited the injunction to the plaintiffs and intervenors in the case, noting that it was “not a ‘nationwide injunction’ and did not restrict any future action the SBA may take in connection with applications for PPP loans.”9 The SBA appealed to the US Court of Appeals for the Sixth Circuit and requested a stay of the injunction.10

The Sixth Circuit ultimately denied the SBA’s stay, and agreed with the district court’s interpretation of the CARES Act’s eligibility requirements.11 Specifically, the Sixth Circuit held on May 15 that the CARES Act conferred eligibility to “any business concern,” which aligned with Congress’s intent to provide support to as many displaced American workers as possible. The SBA pointed out that the CARES Act explicitly listed “nonprofit organizations” as eligible for PPP loans, even though “they are ineligible for ordinary SBA loans.”12 The SBA argued that if Congress wanted to include previously ineligible businesses for PPP loans, like sexually oriented businesses, the CARES Act would have listed such entities.13 The Sixth Circuit stated that it was “necessary to specify non-profits because they are not businesses,” which further supported the district court’s expansive interpretation of the CARES Act.14

The Sixth Circuit’s opinion only requires the SBA to issue loans to the businesses that were a party to the underlying lawsuit. The ruling does not require the SBA to make PPP loans to any other businesses that are defined as ineligible in its April 2 IFR. However, as a practical matter, this opinion could be used to support a small business located in Ohio, Pennsylvania or Michigan (i.e., the states within the jurisdictional reach of the Sixth Circuit) in a federal court proceeding initiated prior to the submission of a PPP application requiring the SBA to defend its eligibility criteria in connection with such small business’s specific facts. (Note that an application should not be made without first obtaining a similar legal result as the small business applicant would not otherwise be able to make the certifications necessary to apply for a PPP loan.)

Cases in Other Circuits

In addition to the Sixth Circuit, several other federal courts have struck down the SBA’s imposition of its ineligibility criteria on PPP applicants engaged in sexually oriented businesses. For example, the US District Court for the Eastern District of Wisconsin on May 1 preliminarily enjoined the SBA from enforcing the April 2 IFR to preclude “erotic dance entertainment” companies from obtaining a PPP loan.15 The SBA argued that because Congress removed some conditions that would ordinarily apply to Section 7(a) SBA loans (such as the PPP eligibility for non-profits), “it must have intended for the SBA to enforce all other conditions.”16 Similar to the Sixth Circuit, the district court found the SBA’s interpretation “highly unlikely” given “Congress’s clear intent to extend PPP loans to all small businesses affected by the pandemic.”17 Additionally, the SBA failed to identify any purpose of either the CARES Act or Section 7(a) that is furthered by the SBA’s exclusion of sexually oriented businesses.18 The SBA appealed to the US Court of Appeals for the Seventh Circuit and requested a stay of the injunction pending appeal. The Seventh Circuit denied the request for a stay on May 20, 2020, but has yet to rule on the merits of the appeal.19

Implications

As of May 21, 2020, roughly $100 billion PPP funds are still available.20 In its recent statutory amendments to the PPP, Congress decided not to address PPP eligibility issues.21 Notwithstanding Congress’s decision not to take action on these issues more recently, financial services businesses deemed ineligible under SBA regulations for PPP loans under the CARES Act should still pay close attention to these cases and whether federal court rulings influence Congress or the SBA to revisit the April 2 IFR.22

1 See US Small Business Administration, Interim Final Rule: Business Loan Program Temporary Changes; Paycheck Protection Program, 85 Fed. Reg. 20811, (Apr. 15, 2020).

2 See Interim Final Rule at 8, citing 13 C.F.R. § 120.110 and Small Business Administration Standard Operating Procedure 50 10 Subpart B, Chapter 2.

3 See US Small Business Administration, Interim Final Rule: Business Loan Program Temporary Changes; Paycheck Protection Program – Requirements – Promissory Notes, Authorizations, Affiliation, and Eligibility, __ Fed. Reg.___, available.

4 According to the April 24 interim final rule, the affiliation requirements are waived if “the borrower receives financial assistance from an SBA-licensed Small Business Investment Company (SBIC) in any amount. This includes any type of financing listed in 13 CFR 107.50, such as loans, debt with equity features, equity, and guarantees. Affiliation is waived even if the borrower has investment from other non-SBIC investors.” Id.

5 DV Diamond Club of Flint, LLC, et al. v. SBA, et al., No. 20-1437 (6th Cir. Apr. 15, 2020).

6 Id. at 2.

7 DV Diamond Club of Flint LLC v. SBA, No. 20-cv-10899 (E.D. Mich. May 11, 2020), at 2. The district court stated that 15 U.S.C. § 636(a)(36)(D) of the CARES Act specifically “broadened the class of businesses that are eligible to receive SBA financial assistance.” Id. at 9. This section provides, in relevant part, that “‘[d]uring the covered period, in addition to small business concerns, any business concern . . . shall be eligible to receive a covered [i.e., SBA-guaranteed] loan’ if the business employs less than 500 employees or if the business employs less than the size standard in number of employees for the industry,” which is established by the SBA. Id. See also 15 U.S.C. §§ 636(a)(36)(D)(i)(I)-(II).

8 DV Diamond Club, No. 20-cv-10899 (E.D. Mich. May 11, 2020), at 2.

9 Id. at 45.

10 DV Diamond Club, No. 20-1437 (6th Cir. Apr. 15, 2020), at 1.

11 Id. at 4. The Sixth Circuit interpreted the CARES Act under the Supreme Court’s ruling in Chevron, U.S.A., Inc. v. Natural Res. Defense Council, Inc., 467 U.S. 837 (1984). Id. In Chevron, the Supreme Court stated that if a federal statute can be facially interpreted, “the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress.” Chevron, 467 U.S. at 842–43.

12 DV Diamond Club, No. 20-1437 (6th Cir. Apr. 15, 2020), at 5.

13 Id.

14 Id. US Circuit Judge Eugene E. Siler Jr. dissented, stating that the CARES Act was ambiguous and the district court’s injunction should be stayed to give time to decide on the merits. Id. at 6. He noted that the CARES Act requires “PPP loans to be administered ‘under the same terms, conditions and processes’” as the SBA’s section 7(a) loans, which would exclude sexually oriented businesses from PPP eligibility. Id. See also 15 U.S.C. § 636(a)(36)(B).

15 Camelot Banquet Rooms, Inc., et al. v. SBA, et al., No. 20-C-061 (E.D. Wis. May 1, 2020), at 27-28. A similar case, filed early May 2020, is currently pending in the US District Court for the Northern District of Illinois. See Admiral Theatre Inc. v. SBA et al., No. 1:20-cv-02807 (N.D. Ill May 8, 2020).

16 Camelot Banquet Rooms, No. 20-C-061 (E.D. Wis. May 1, 2010), at 15.

17 Id. at 16. In contrast to the Eastern District of Michigan, the Wisconsin federal court did not explicitly limit its injunction to the parties. In light of the potentially serious penalties for ineligible applicants, businesses that are ineligible for the PPP under the April 2 IFR should be cautious about applying for a PPP loan without exploring all options and consequences with counsel.

18 Id.

19Camelot Banquet Rooms, Inc., et al. v. SBA, et al., No. 20-1729 (7th Cir. May 20, 2020). In contrast to the Sixth and Seventh Circuit rulings, the US District Court for the District of Columbia denied an injunction to enjoin the SBA from making an eligibility determination for the PPP under the CARES Act. Am. Ass’n of Political Consultants v. SBA, No. 20-970 (D.D.C. April 21, 2020). Plaintiffs, a trade association of political consultants and lobbyists, argued that the denial of PPP loans under the SBA’s April 2 IFR due to the political nature of their businesses violated plaintiffs’ First Amendment rights. Id. at 1-2. The district court ruled that it was constitutionally valid for the SBA to decide “what industries to stimulate” with PPP loans. Id. at 11. The plaintiffs filed a notice of appeal on April 22, 2020. Am. Ass’n of Political Consultants, Notice of Appeal, ECF No. 22 (D.D.C. April 22, 2020).

20 Kate Rogers, More than half of small businesses are looking to have PPP funds forgiven, survey says, CNBC News (May 21, 2020), available at https://www.cnbc.com/2020/05/21/more-than-half-of-small-businesses-are-looking-for-ppp-forgiveness.html.

21 On June 3, 2020, Congress passed the Paycheck Protection Program Flexibility Act (“PPP Flexibility Act”), which modified certain provisions of the PPP. H.R. 7010, 116th Cong. (2020), available at https://www.congress.gov/bill/116th-congress/house-bill/7010/text?r=12&s=1. At a high level, the PPP Flexibility Act: 1) extends the PPP to December 31, 2020; 2) extends the covered period for purposes of loan forgiveness from 8 weeks to the earlier of 24 weeks or December 31, 2020; 3) extends the covered period for purposes of loan forgiveness from 8 weeks to the earlier of 24 weeks or December 31, 2020; 4) increases the current limit on non-payroll expenses from 25% to 40%; 5) extends the maturity date on the portion of a PPP loan that is not forgiven from 2 years to 5 years; and 6) defers payroll taxes for businesses that take PPP loans.

22 IFRs are subject to public comment under the Administrative Procedures Act. The particular comment period of the April 2 IFR expired on May 15, 2020.

©2020 Katten Muchin Rosenman LLP

For more on business’ PPP loan eligibility, see the National Law Review Coronavirus News section.

DOJ Seeking to End Movie Studio and Theater Antitrust Decrees amidst Streaming Competition – A New Opportunity in Theatrical Distribution?

For the film and media distribution industries, this year has been action-packed.  Production budgets are skyrocketing and new digital services have been announced or are launching with each passing month. The streaming wars are upon us. Moreover, the FCC recently voted to treat streaming services as “effective competition” to traditional cable providers (or MVPDs), thereby triggering basic cable rate de-regulation in parts of Hawaii and Massachusetts.

The distribution landscape took yet another unexpected legal twist this week. On November 18, Assistant Attorney General Makan Delrahim announced that the Antitrust Division of the Department of Justice would ask a federal court to terminate the “Paramount Consent Decrees” (the “Decrees”), which have prohibited movie studios from engaging in certain distribution practices with movie theaters since the 1940s. The DOJ filed a motion to terminate the Decrees in federal court in the Southern District of New York on November 22, 2019.  Notably, the DOJ cites streaming services and new technology as a few of the many reasons that the Decrees may no longer be necessary in what the DOJ official sees as today’s highly competitive, consumer-driven content market. Given the volatility of the content licensing space, film licensors and licensees will have to carefully consider how the DOJ’s actions will affect their content rights and options going forward.

By way of background, the Decrees emerged out of the landmark 1948 Supreme Court antitrust case, United States v. Paramount Pictures, Inc. Prior to the case, top Hollywood studios frequently owned movie theaters (thus, owning both the means of production and distribution). This vertical integration led to lower distribution costs for the studios and gave them pricing power and the ability to discriminate about which theaters distributed their films. Not surprisingly, smaller, independent theaters struggled to survive.  The problem was exacerbated by studios engaging in practices such as “block-booking” (requiring theaters to distribute all or none of the studio’s slate of films) and overbroad “clearances” (restrictions on the time which must elapse between particular runs of a film), as well as alleged horizontal conspiracies between the studios and theaters on matters like minimum ticket pricing. As part of the Decrees, the defendant studios were restricted or prohibited from engaging in these practices and were required to divest certain interests in their theaters.

The DOJ’s November 22nd motion may not come as a surprise, as the DOJ first announced that the Decrees were under review in August 2018, after which several industry players, including the National Association of Theatre Owners (NATO), submitted comments. In particular, NATO argued, despite how streaming and technology might increase competition, that block-billing would still adversely impact independent or local chains that exhibit fewer films and may not be able to afford larger blocks of films.

Delrahim summed up the DOJ’s position, stating, “the [D]ecrees, as they are, no longer serve the public interest, because the horizontal conspiracy – the original violation animating the decrees – has been stopped. […] Changes over the course of more than half a century also have made it unlikely that the remaining defendants can reinstate their cartel.” In particular, the DOJ argued that the competitive concerns of the 1940s no longer exist because the movie marketplace has changed so drastically, citing how film distributors have become less reliant on theatrical distribution with the advent of streaming. According to the DOJ, colluding to limit theatrical film distribution in today’s market “would make no economic sense.”  In addition to streaming services, Delrahim also cited new theatrical release business models (such as flat-fee multi-ticket pricing) as increasing competition and innovation in film distribution.

The DOJ acknowledged NATO’s concerns in part and asked the court to implement a two-year sunset on block-booking and circuit dealing (licensing to all theaters under common ownership, as opposed to on a theater-by-theater basis). Whether terminating the Decrees would decrease innovation, neither the motion papers nor Delrahim venture to guess. Delrahim noted that antitrust enforcers need not predict the future but need only recognize that changes are occurring. He added that practices covered by the Decrees would not become per se lawful, but would rather be subject to review under the rule of reason standard.

Commentators are split on whether termination of the Decrees that have shaped Hollywood for decades will lead to any significant change for the movie business. One thing that is important to note is that the Decrees did not outright prohibit vertical integration of studios and theaters – the defendant studios could (and did) acquire theaters after proving that such acquisitions would not unreasonably restrain trade. Further, only those studios party to the Decrees remain subject to their restrictions, meaning many of today’s top studios (that now typically own a vast portfolio of traditional and digital entertainment properties) were non-existent or much smaller in the 1940s and have not been subject to the Decrees.

While it remains to be seen how this development will play out, it is noteworthy for digital providers because it may breathe extra life back into the theatrical release window. With mammoth streaming deals inked every week, the value of the theatrical release window was seemingly diminishing for some films. But now that many studios are forgoing third-party licensing fees and instead retaining their content for their own streaming platforms, studios may begin to ask whether added revenues from ownership of a theater chain could be a potential new source of revenue and a way to gain additional control of the theatrical window. Meanwhile, the effect of lifting the Decrees may not necessarily lead to a flurry of acquisitions, as other studios involved in direct-to-consumer streaming campaigns may not have the capital or desire to exploit the termination of the Decrees. Major theater chains will likely seek to strengthen relationships with studios, while independent theaters will look for ways to succeed despite potentially rising costs.

With all of these developments, studios and media platforms will also need to carefully consider how to protect their interests when handling their licensing arrangements, given the volatility in this space and keeping in mind the two-year sunset (assuming the DOJ succeeds) on block-booking and circuit dealing. While some distributors may be looking for long-term, exclusive content deals as they roll-out their streaming services, studios and content providers may seek flexibility as their distribution options are changing day-to-day.

© 2019 Proskauer Rose LLP.

More on entertainment distribution on the National Law Review Entertainment, Art & Sports law page.