Napster Files for Chapter 11

SAN FRANCISCO (AP) _ Napster Inc sought bankruptcy protection Monday as part of a financial housecleaning mandated by Bertelsmann AG, the music industry heavyweight that hopes to buy and then revive the idle Internet music-swapping service.

Redwood City-based Napster filed the Chapter 11 bankruptcy case in a Delaware court to meet the terms of a sales contract it signed late last month with Germany-based Bertelsmann, according to documents filed Monday.

After agreeing to buy most of Napster's remaining assets for $8 million in a contract signed May 24, Bertelsmann gave the company until Monday to file for bankruptcy to reshape its balance sheet, according to court documents.

The bankruptcy "marks a new beginning for Napster," said Konrad Hilbers, the company's chief executive. "It is clear the demand for an Internet-based music file sharing community that benefits artists and consumers is as strong as ever."

It remains unclear whether Napster will be able to resurrect a once wildly popular renegade music service and transform it into an industry-sanctioned subscription business, industry analysts said Monday.

"I think it's a long shot," said Sean Badding, a senior analyst with the Carmel Group. "They haven't been able to figure out a profitable business model yet and time is running out on them. They need to get back online soon to restart an engine that has been cold for too long."

Napster shut down its music-sharing service last July after losing a series of legal battles with the world's major recording labels, who accused Napster of trampling on copyrights by setting up a revolutionary system that enabled millions of people to make copies of songs stored on computer hard drives.

With Bertelsmann's financial backing, Napster has been trying to develop a subscription service that licenses songs from the same music labels that crippled the company. The efforts have been stalled since March when the costs of developing the new service and defending against the music industry lawsuits resulted in a "liquidity crisis," Napster said in court documents.

While Napster has been in hibernation, the music labels have been building their own online services, pressplay and MusicNet.

As part of its survival efforts, Napster began laying off most of its work force in March, paring its payroll from 91 employees to as few as 11 employees last month. Napster employed 18 workers as of Monday and hopes to rehire 28 more workers during the bankruptcy proceedings, according to court documents.

Bertelsmann wants its proposed purchase approved within the next 60 days, according to court documents. The bankruptcy filing will allow other bidders to submit offers for Napster.

Industry analysts said it's unlikely other suitors will emerge, given that cash-starved Napster tried to raise more money from investors for at least two months before Bertelsmann _ the company's biggest creditor _ agreed to the last-minute bailout.

Bertelsmann is owed $91 million of the $101 million in liabilities that Napster listed in its bankruptcy filing. The Bertelsmann debt has grown since October 2000, when the music company first agreed to loan Napster $50 million while it battled the music industry's lawsuits.

Napster's assets totaled just $7.9 million, reflecting how far the company has fallen since it arrived online in 1999 with a file-swapping service developed by former Northeastern University student Shawn Fanning.

At its peak, Napster boasted 60 million users, prompting the music industry to launch the legal attack that nearly broke the company.

With the bankruptcy filing, Napster may try to minimize any possible damages that it faces in the music industry suits. Although the courts have ruled against Napster in most key decisions so far, no determination has been made on how much money, if any, the company owes the music labels for its past actions.

"We look forward to Napster becoming a legitimate online music service in which artists and record companies are fairly compensated for the use of their works," said Cary Sherman, president of the Recording Industry Association of America, the music trade group marshaling the Napster lawsuit.

Even if the bankruptcy case ends up limiting the amount the music industry can collect for past damages, it won't necessarily stop the recording labels from demanding steep licensing fees from Napster in the future, analysts warned.

"The liabilities may be gone, but they won't be forgotten," predicted P.J. McNealy, an online media analyst with GartnerG2.