Personal bankruptcy filings have reached epidemic proportions in the United States. Unfortunately, the music business is finding that it is not immune and bankruptcy filings by recording artists are spreading like a virus and disrupting business for many record labels. More and more prominent recording artists are filing bankruptcy petitions in order to be released from what they perceive to be unfair recording contracts, production deals, and management contracts in order to enter into more lucrative deals with rival record labels - and this has serious implications for the record industry.

Section 365 of the Federal Bankruptcy Code allows the court to free debtors from burdensome or onerous contracts that impair their ability to make a fresh financial start if the court deems it fair to do so. The process is basically simple and the repercussions for the artist can be fairly mild. Some debtors need only file a simple form, and those declaring bankruptcy can then shed their debts and avoid contractual commitments and still end up keeping some of their assets including in some cases their homes and their cars.

The problem for the record industry is that the advance/recoupment structure of most record contracts makes them especially vulnerable to termination in bankruptcy proceedings. Most record contracts are structured as ongoing recording commitments whereby the record label agrees to pay for the production of one album with options to require additional albums from the artist at the label's discretion. The record label pays an advance to the artist for the cost of producing the album and the artist then records and delivers the album to the record label. The record company agrees to pay the artist a royalty on sales of the album based on a complex calculation involving numerous variables. However, the royalty is not actually paid to the artist until after recoupment by the record label of all advances out of the artist's royalty. These advances often include not only the cost of the recording but also the cost of video production, tour support and independent promotion.

Ultimately, although the artist pays for the cost of producing an album by way of recoupment, the album becomes an asset of the record company pursuant to the terms of the contract. Since most of the artist's advances are used to pay for recording costs and other expenses, the artist ends up with no asset and very little money in his or her pocket. Since the record label can cross-collateralize unrecouped advances from one album against royalties payable from any other album, an artist could conceivably sell hundreds of thousands of albums and still be in an unrecouped position with its record label.

In fairness to record labels, since the record business is a high stakes business and, more often than not, record labels end up with albums that do not sell, this advance/recoupment system protects them from the high number of failures that occur. However, an artist's substantial unrecouped balance is considered a debt in the eyes of the bankruptcy court which makes the record contract, and the commitment of the artist to record additional albums for the label, subject to termination by the court if an artist's efforts at renegotiating the terms of its deal are thwarted.

Although a new, unknown artist is often unsophisticated in the ways of the business and unwilling to refuse the chance at stardom when a contract is initially offered, once an artist attains a modicum of success the artist often attempts to renegotiate his deal. However, an artist's efforts at renegotiation frequently degenerate into bitter contract disputes that drag on for months since the record label exerts the greater economic advantage. It is at this point that several prominent recording artists like "TLC" and "RUN-DMC" have found that the way to a fresh start in the 90's is one that celebrities like Kim Basinger and Micky Rooney, big corporations like Macy's and The Daily News, and entertainment companies like Wherehouse and Camelot have used to get out of contracts that were a burden to their operations: commencing a Chapter 7 or Chapter 11 bankruptcy proceeding.

Artists are finding that, when all else fails, a bankruptcy filing gives the artist greater leverage at the bargaining table to redress the imbalance of economic power in the record industry. In order for this tactic to work, a debtor must prove that he or she is insolvent under the terms of the law since the courts can dismiss bankruptcy filings that are made for the sole purpose of breaking a contract. So far, however, no artist in a substantially unrecouped position with its record label has had a hard time proving that its debts exceed its income and that it is sufficiently insolvent to merit the protections established by the Federal Bankruptcy Code.

This bankruptcy ploy can backfire on an artist, however. In one recent instance, an artist with only one hit song and marginal name recognition filed a bankruptcy petition in order to get leverage in renegotiating his contract. The tactic so alienated the president of the particular record label that, in a settlement, he dropped the artist from the record label. The artist has been unable to get another record deal since then.

The overall solution for avoiding the pitfalls posed by the threat of a bankruptcy filing by a prominent artist is painfully obvious for the record labels: offer the artist fairer contract terms. A successful artist, even if contractually unrecouped, has usually made substantial profits for the record label. It is unwise to force such an artist into bankruptcy and run the risk that a long-term recording commitment will be terminated.

The proliferation of artist bankruptcy proceedings is a double-edged sword: it threatens to substantially disrupt the standards and practices of the record industry while it simultaneously levels the playing field and forces record companies to pay their artists more. Record companies would be well advised to share more of the financial rewards with even a marginally successful artist at the appropriate time so that the artist's debts do not exceed its income. Otherwise, they run the risk of having their artist's record contract terminated prematurely in bankruptcy court and finding that the artist that they worked so hard to develop is reaping the benefits of the first label's efforts making records for a second record label under a lucrative new contract.


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Wallace Collins is a New York attorney specializing in entertainment and intellectual property law. He was a recording artist for Epic Records before attending Fordham Law School.