A federal appeals court in New York ruled that a Yahoo Inc Internet radio service is not required to pay fees to copyright holders of songs it plays, a defeat for Sony Corp's BMG Music.

In a case closely watched by the recording industry, the U.S. Second Circuit Court of Appeals upheld a 2007 jury verdict that Launchcast, a webcasting service run by Yahoo's Launch Media Inc unit, did not give listeners enough control to be an interactive service that would require the fees.

The three-judge panel said the service is required only to pay licensing fees set by SoundExchange, a nonprofit that collects royalties on sound recordings. It was the first federal appeals court to decide the issue.

Friday's ruling is a setback for record producers that have struggled with slumping sales as customers increasingly obtain music online or through other means.

It's an immediate loss for the recording industry, said Rey Sanchez, chairman of the department of music, media and industry at the University of Miami and a voting member of the National Academy of Recording Arts and Sciences.

If the service had been deemed interactive, Yahoo would have to negotiate fees with every record label to use their songs. Instead, it only has to pay licensing fees.

He added that the dispute signals a shift in the culture of how people access music, and how to monetize that access.

A Sony representative declined to comment. A lawyer for the recording companies did not immediately return a call seeking comment. A lawyer for Sunnyvale, California-based Yahoo had no immediate comment.

Other recording companies involved in the case included Capitol Records Inc, Motown Records Co and Virgin Records America Inc, among others, court papers show.

NOT ENOUGH CONTROL

Launchcast lets users create individualized radio stations that play songs in a particular genre, or which are similar to their favorite artists or songs.

Sony, whose labels also include Arista, Bad Boy, and Zomba, sued Launch Media in a 2001 for copyright infringement, saying it failed to obtain licenses to play its songs.

The law at issue defines an interactive service as a service that enables a member of the public to receive a transmission of a program specially created for the recipient, or on request, a transmission of a particular sound recording ... which is selected by or on behalf of the recipient.

In his 42-page opinion for the appeals court, Judge Richard Wesley said the U.S. Congress enacted the law because previous laws did not do enough to protect sound recording copyright holders from falling record sales.

Yet he found that Launchcast does not provide sufficient control to convince listeners to choose to listen to music on the Internet, instead of buying music.

The user has control over the genre of songs to be played for 5,000 songs, the judge wrote, but this degree of control is no different from a traditional radio listener expressing a preference for a country music station over a classic rock station.

Sanchez, the professor, explained: The record labels argued that the ability of listeners to skip songs they don't like made the service interactive. The court disagreed.

The appeals court also criticized trial judge Richard Owen for giving potentially misleading jury instructions in the case, but said it did not need to address the issue.

In afternoon trading, Sony shares were up 8 cents at $26.58 on the New York Stock Exchange, and Yahoo shares were up 3 cents at $14.80 on the Nasdaq.

The case is Arista Records LLC et al v. Launch Media Inc, U.S. Second Circuit Court of Appeals, No. 07-2576.

(Reporting by Jonathan Stempel, Additional reporting by Yinka Adegoke; editing by Matthew Lewis)

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