Steve Gillen (photo right) is a partner in the intellectual property firm of Wood, Herron & Evans L.L.P. and has focused his practice on publishing and media matters for 30 years. To reach him, email sgillen@whepatent.com or call 513-241-2324.

Electronic rights and corresponding royalty rates have been the subject of much passionate discussion on both sides of the author-publisher divide for more than a decade. Until now, that discussion has been largely academic, as the technology was nascent and the business models and markets were unsettled and evolving.

But a predominating platform has emerged in the hands of a powerful market force—the Kindle by Amazon. Pulling a few others along with it, the Kindle, and e-books generally, appear finally to have a toehold.

As you may be aware, sales of e-books surged exponentially in the first quarter of 2010, although still from a small base. The International Digital Publishing Forum reported first quarter domestic e-book sales approaching $100 million (more than three times that of the corresponding period in 2009). And according to the Book Industry Study Group, e-book sales jumped to 5 percent of the total book market in the first quarter, up from just 1.5 percent in 2009.

As a result, language in your existing publishing contracts may be suddenly out of step with your intentions.

A Revenue Stream Divided

In the relationship between publisher and author, the author’s role has historically been to provide a publishable manuscript and, upon publication, to participate at some level in promotion. What the author receives in return is a royalty on the publisher’s proceeds from commercial exploitation of the work.

The publisher’s role has been to provide editorial guidance, book development and production, publication, printing, promotion, and sales support and distribution. To protect the publisher’s significant, front-loaded commitment of resources to these obligations, it generally gets from the author a broad and exclusive grant of rights in the work.

Some of those rights, the publisher exploits directly—principally publication and sale of the domestic edition of the printed book. Other rights, the publisher may exploit only indirectly (and with a less significant commitment of resources) through subsidiary rights licenses—a licensed French translation or an adaptation for television, for example.

Reflecting the very different economics of these two revenue sources, the royalties on each have historically been calculated very differently. On direct sales, the publisher generally paid a royalty in the range of 5 to 15 percent based on copies sold. On the proceeds from subsidiary rights transactions (proceeds that are themselves a royalty on retail sales), the publisher has generally split revenue with the author, most commonly on a 50/50 basis.

Therein lies the rub. Is an e-book transaction effected through an e-book distributor more like the sale of a hardcopy of a book, or is it more like a subrights license? The answer, as you can see, makes a big difference in the author’s royalty.

For the answer, we can look to the language of two contracts—one between publisher and the e-book distributor, and the other between publisher and author.

In the E-Book Distribution Agreement

Because the publisher will be granting the distributor the right to make and deliver a digital copy of the work to the end purchaser, the agreement between them will almost certainly have license language in it, tending to support the argument that it is akin to a subrights deal.

The relevant clause may look something like this:

You hereby grant to us, throughout the term of this Agreement, a nonexclusive, irrevocable, right and license to distribute Digital Books as described herein, directly and through third-party distributors, in all digital formats by all digital distribution means available.

Although there may be other ways to structure the e-book distribution agreement to avoid the need to grant a license to the distributor (for instance, an agency agreement like the one several large publishing houses recently made with Apple), legal ramifications from such a fundamental change in structure make any such cure worse than the disease.

Moreover, the kind of contract we’re focusing on will almost certainly have been drafted by the e-book distributor rather than the publisher, and it isn’t likely that any single publisher will have the market power to insist on a materially different deal structure.

So, if the solution isn’t likely to be found in the e-book distribution agreement, can you find it in the language used in your publishing contracts? Unfortunately, this is language that was probably written before the Kindle was even a gleam in some inventor’s eye.

In Your Publishing Contract

The royalty section in most book-publishing contracts speaks first about the royalty on sales of copies of the printed book. The rates (expressed as a percentage of cover price or as a percentage of net receipts) will typically vary from 5 to 15 percent, depending upon (among other things) the distribution channel through which the book is to be sold and the market into which it is to be sold.

The language may look something like this:

Except as otherwise provided below, the Publisher will pay to the Author a royalty of 10% based upon the Publisher’s net receipts from sales by it of copies of the Work [italic added], revisions thereof, or reprints of all or portions thereof.

A royalty at one half the aforementioned rate will be applied to the Publisher’s net receipts:

(a) from sales by it in foreign markets of special editions, adaptations, or regular editions of the Work . . .

Even if the language has been updated to specify a special higher rate on the exercise of electronic rights—often 25 percent of net receipts—it probably speaks in terms of sales effected directly by the publisher.

Typically, the royalty rates for subrights transactions have been handled at the end of the royalty section, with language that might look something like this:

The Publisher will pay to the Author 50% of the Publisher’s net proceeds from agreements that license others the right to [italic added] reprint all or portions of the Work, to include the Work in an electronic database, or to make visual or sound reproductions or adaptations, motion pictures, educational and commercial television versions, Braille and large-type editions, microfilm, or microfiche editions, microcomputer adaptations, electronic versions, translations, or foreign editions or adaptations either in English or in foreign languages.

Simplistically, the first provision deals with the direct sale of hard copies by the publisher; the second deals with the publisher’s grant of a third-party license.

Originally written in the days before End User License Agreements for all things digital, provisions like these were drafted when a sale was a sale, and a license was a license, and there was no overlap between the two.

Now, the world is more complex. Digital works that can be easily, inexpensively, and perfectly replicated are “licensed” rather than “sold,” and the “copy” that a publisher delivers may fly noiselessly through the ether instead of rattling through the press and bindery and down the road in a semi-tractor-trailer.

It’s time, then, for publishers to have a fresh look at the royalty language in their form contracts and to amend them if necessary to avoid confusion about whether the 50/50 subrights split is to be applied to the proceeds from e-book sales.

Consider adding a clause about an exception to the subrights provision to make it clear that the sale or license of a copy of the Work in any format under any name or imprint of the publisher is deemed to be a publication by the publisher subject to the copy-sold rate and not the subrights-license rate.

Revising the form contracts may avoid misunderstandings going forward. How to deal with existing author contracts is another matter. One thing is certain, though: the issue will not become easier to address as time goes on.