The Oracle: Deciphering American contracts

A – Don’t all lawyers use language to baffle us mere ordinary folk? Those who draw up recording contracts are no different and they contain some of the most baffling of terms such as cross-collateralization, controlled compositions, synchronisation licences, inducement letters and so on.
The basic deal between any record company and an artist is that royalties will be paid on recordings that are sold to the public. But this does not mean that the record company will pay a royalty on records that are manufactured, shipped but eventually returned to them. So for example, if the record company manufactures 50,000 albums but only 10,000 are actually sold in the shops, with the remainder being returned to the record company, then the artist will only get a royalty on the 10,000 actually sold.
There are always going to be returns, regardless of who the artist is, and these returns can take many months and sometimes years to come back, so record companies will withhold a certain percentage of an artists royalties in anticipation of these returns. Using the example above, if the record company ships its 50,000 albums to the shops, the initial sales figures will show that 50,000 albums were sold. But let’s assume that over the next year to 18 months 40,000 of these albums are returned because they couldn’t be sold. If the record company had paid a royalty on the initial 50,000 it would have overpaid the artist on 40,000 albums.
To protect themselves against this type of thing, record companies insert a “reserve clause” into the recording contract and this allows them to hold back a certain percentage of the artist’s royalties. I’m not aware of an industry standard of how much the record company is allowed to hold back, so each record company operates differently. Certainly you would expect them to use lower percentages for established artists and higher percentages for newer artists. It’s been known for record companies to withhold as much as 50% of the royalties due to new artists until they know how the record has sold. An average percentage would be something in the region of 20% to 40% depending on the artist’s track record. It is also worth noting that the reserve percentage for albums will be lower than that for singles or EPs.
As you can see, reserve funds are solely for the benefit of the record company, with absolutely no benefit for the artist as it reduces their royalty payments and postpones the payment of royalties due to them. Indeed an artist could be seriously out of pocket in the situation where the reserve percentage is say 40% and returns were only 20%.