You've been lucky since you neither went to jail nor did you have to pay 50 million in damages.

While it is a big deal, I just want to clarify that, copyright infringement is civil law not criminal law, and almost certainly (to the best of my limited non-lawyer knowledge) not result in prison time, nor in $50 million in damages. To be forced to pay $50 million, the people he infringed upon would have to be able to prove (with the burden of proof on them), that he caused $50 million worth of damages for a judge to order someone to get reimbursed for the damage. There's punitive damages, but $50,000,000 punitive damages on only $10,000 worth of actual damages would be 'excessive'.

The RIAA would likely use the threat of such fees (which they have no control over, and is ultimately decided by a judge) to force the infringer to sign an agreement saying that he promises not to infringe in the future and for the infringer to agree to pay a decent, but much more reasonable, settlement fee (a few thousand or in the low tens of thousands). This has been their modus operandi in the past.

Many parts of law that most citizens are familiar with, attempt to codify morals - for example, murder and theft most people and most cultures inherently know is wrong (at least according to some views). Copyright law on the other hand, is an artificial system invented fully by humans from the ground up only a few hundred years ago, to serve a particular purpose - benefiting consumers by encouraging business competition and the sharing of information in the long term while also providing encouragement of creativity by making creativity profitable in the short term.

It's fully understandable to not be aware of copyright law, so people shouldn't be vilified or made to feel like scum for not being familiar with an artificial human invention. Though if someone is getting into business (i.e. wanting to make any amount of money from games) they'll need to learn the basics of it.

Until recently, consumers didn't need to even understand or know of the existence of copyright law. Copyright law merely provided a framework for publisher and content-creator relationships (especially protection from government-controlled monopolies of printing presses). But with the advent of computers able to copy things in a single click, decentralizing "copying" (instead of only a few hundred large printing buildings), and with the advent of the internet allowing mass sharing, decentralizing "distribution" to billions of users (instead of a merely tens of thousands of retail stores), suddenly the average consumer is unknowingly participating in what used to be solely an area of business that has legal rules and regulations already in existence.

Copyright laws are actually a good thing for consumers - they benefit the public. But the existing laws need to be updated (and timeframes shortened) to give more freedom to consumers and content creators, being too heavily slanted towards businesses at present.

[I am not a lawyer. Below (and in the post above) is my layman understanding of copyright law]

Additional artwork were fan art (or traces) of famous animes that were also used with permission. I don't understand why they may remix original content with no issues, but when i used (already altered) content by themselves with permission i may

It's like when you are driving down the highway, and you see twenty cars going over the speed limit - some of them significantly more over the speed limit than you are - but you happen to be the one the police pull over and issue a ticket to.

Here we have to separate what people are doing (speeding, or making fan art) from what they have permission to do. I don't need permission to take a physical action, but if I don't have permission there can be repercussions if I'm the one getting caught. That is to say, the natural laws of physics don't prevent me from taking physical action, but the laws of men may attach legal ramifications to those actions.

If I wasn't aware of the driving laws in the USA, and I saw a huge number of people driving over the speed limit, it's fully understandable that I'd assume it's okay to do so. But that's why they make you learn the driving laws in the USA before getting a license.

If I wasn't aware of copyright laws (which apply to Europe and the USA and many other countries), and I saw thousands of people making fan art on the internet, I'd assume it was okay. The artists themselves are assuming it's okay. But that assumption doesn't actually make it okay according to our legal system.
If you're getting into business, or using property (characters, music, worlds) that belong to a business, you need to learn the laws that govern the creation, duplication, and distribution of created content.

I know this can sound really weird. "What the heck do I mean that fan art is 99.99% of the time in violation of copyright laws?!" (0.0005% of the time it's fair use*, and 0.0005% of the time they have permission**).

*Everyone claims fair use, but all the people claiming "fair use!" have no idea what that actually means.
**Percentages made up, but are within the right ballpark. Seriously, it's probably 99.999% that are in violation.

"How can someone "own" Mickey Mouse?! Well, I mean sure Disney created that character, so okay, maybe only they should be able to profit off it. But if I wanted to draw Mickey Mouse for free... why the heck shouldn't I? And then if I want to sell copies that artwork to a few friends... or take donations so I can continue to make free stuff... or put ads on my site to pay for hosting... or trade the artwork for some physical possession... or maybe just a digital possession... or maybe I should just take the latest Disney movie, and recreate my own version of it and release that for free... sure they're losing movie tickets because my Mickey Mouse movie is free and theirs isn't, but I'm not making any money... or maybe I can use Mickey Mouse, for free, to promote my favorite political candidate... or to promote my next non-Mickey Mouse commercial project... or just to earn me more Twitter followers... surely Disney shouldn't be able to stop me from making Mickey Mouse porn, right? I mean, sure it causes damage to their brand and intellectual property, but I am releasing it for free after all..."

If you create a character, or a game, or a movie, or music, or whatever... our laws grant you exclusive control over everything that is made with that character. You have the 'copyright' to that character. People can make similar characters, or use similar ideas, but you have control over your characters. That control lasts for only "X" years, afterward it becomes public property. Officially "X" is your entire lifetime plus 70 years* (which is far too long, but that's currently the law).

*Unofficially, it's basically infinite, because major corporations keep on getting the government to push the duration farther back, so no copyrights have been expiring.

Now let me quickly talk about derivative works. If I draw a picture of Mickey Mouse, it's a derivative work. It's my work, but it's using someone else's work. I own the parts that are mine (for example the background scenery, the pose I put him in, the lighting and camera angle, the composition, the outfit he's wearing, etc...), but they own the parts that are theirs (the character 'Mickey Mouse', which arguably is the most important part of the picture - people aren't fawning over the artwork because of my fantastic background scenery). My work is derived from their work. I own my part - my creation, but they own their part - their creation, which I was merely 'copying'. But they have exclusive control (for Walt Disney's lifetime plus 70 years) over the 'right' to 'copy' (duplicate, recreate, or otherwise use) their work (their character).

If I wanted to publicize my Mickey Mouse drawing (for example, by posting it for free on the internet) , I'd need Disney's permission (a license) to use their part of the work, and I'd need my own permission to use my part of the work. But if I made my own mouse-related character, that wasn't an obvious knock-off*, then I'd only need my own permission, because it's 100% mine.

*'moron in a hurry' applies to trademark law, but I think it's a good early-warning system for copyright infringement also.

Finally, back to your original question, if a music composer makes an original piece of music, he owns that music. If you want to use it in a game, you need a license from him (some recognizable form of permission). This can be as simple as an email saying, "Yep, you can use my music in your game".

The reason why licenses get more complicated than that, is to avoid misunderstanding (ironically ). You may think he means, "Yes, you can use my music in your game [without paying me]", and he may think he means, "Yes, you can use my my music in your game [in exchange for 50% of all the profits]". So people write out large more specific contracts that are seemingly nitpicky and pointless, but that actually spell out in detail what is actually being agreed to.

Time to throw you another potential curveball: You know how Disney owns some undefined portion of my fictional Mickey Mouse fan art? And how my art is 'derivative' and I need Disney's permission/license to use publicly their portion of my artwork?
Well, the actual real-life composer who's music you are actually wanting to use, who is giving you actual permission to use his work... his song contains Mickey Mouse in that song, and you also need Disney's permission to use his song in your game, because his song makes use of Disney's property.

Okay, slight exaggeration. His 100% original song doesn't use Disney's work, but it does use someone else's work other than his own, and you need that other person's permission. His song (likely) makes use of drum beats, flutes, or whatever else noises he used, that he then assembled into a musical melody. His composition is his work - but the sound "samples" (as they are called by composers) are owned by the people who recorded the sound. And if that recording is of a real person (say, a violinist, or a voice-actor), then they also own a piece of that work that needs to be licensed.

Okay, so now we're in a big muddy swamp of a problem here. Luckily, the solution is really simple.
The violinist gives permission (license) to the sound recorder to sub-license/re-license the sound to other people to make music with.
The sound-recorder gives permission (license) to your composer to re-license the sounds

When you license the composer's song, part of the license is (if it is written out in the license) a promise that he has permission to let you use whatever licenses are necessary for you to use the music in your game. This includes some several dozen different licenses from people you've never met and who he's never met. He's licensing not only his own work to you, but also (almost invisibly) re-licensing the components he used to make the music. He likely never met these people either - unless he's using live music, most likely he just downloaded some Creative Commons-licensed sound samples from some website like freesound.org. Those Creative Commons licenses (depending on the specific license) give him permission (license) to use that recorder's work in his work and re-license that work to you so you can re-license it to your users.

Eventually, your completed game is being licensed (and the music sub-licensed, and the sounds that make the music, sub-sub-sub-sub-licensed) to Valve so Valve's Steam service can copy your game (with your permission, since you have the exclusive 'right to copy' it) onto user's computers to play, and also your game is being licensed to the end users (EULA = End User License Agreement) so they can play your game, that contains the music, composed from sounds samples, that record a violinist.

You don't need to understand all of this immediately. Just pick up bits and pieces of it as you go, and you'll learn the important parts.

Really, all you need to understand (for the time being) is this: If you are going to release anything, free or not, make sure you have permission to use any components you use to make your game - and make sure the person who made the components has permission to use the sub-components he used.
He doesn't need custom permission - things like stock Creative Commons licenses work fine. If he's knowledgeable about his line of work (composing), he already knows all this. This is likely what he was trying to convey to you. If he's knowledgeable about his business, all you have to worry about is getting his permission for his composition, and he'll be taking care of the licenses for the sounds he used (that he likely already got before using them).

Here endeth my walls of text. Good luck on your development!

While it is a big deal, I just want to clarify that, copyright infringement is civil law not criminal law

For the USA, you are (as far as I know) right. In the EU, on the other hand, things like copyright infringement and plagiarism are under criminal law (with penalties going from fees in the 10k-100k range to prison, depending on what exactly you're found guilty of). That may not be the case in the USA, but considering the sheer cost of a typical US lawsuit (and the totally irrational sums that are being asked in the US) it doesn't make much of a difference, civil law is equally devastating (maybe even more so).

Youtube may get away with it and no one here seems to complain about the ethics of that, but they do have more lawyers.

In Germany, they just recently (last week or so) lost the 2nd instance on yet another lawsuit against GEMA. After already having been forced take down tens (hundreds?) of thousands of videos which "infringe artist rights" because some youtuber has the radio on while recording his self-made video they are now being taught that it is illegal to state "This video has been taken down because GEMA didn't give permission". Because, hey, that statement is unfairly misleading. The guys at GEMA are the good guys after all who are only making sure that nobody uses any music (even accidentially) without paying them.

Law, copyright in particular, is soooooo perverse...

It is a tricky thing, and law varies by location.

On the one hand, it is correct that people creating content should be allowed to charge for the thing they create. That is long accepted as a short-term right for books, music, and art.

On the other hand, there are organizations that are self-serving and exist only to extract money from people, claiming that they represent those who society has deemed have a legitimate right to compensation, and whose purpose may or may not be evil.

And on the gripping hand, it is difficult to build comprehensive creative stuff without relying on IP of others, unless you are perhaps doing nature photography or similar, or you have a very large budget for creating assets. Even in a simple photograph you have clothing cuts and stitching patterns, cloth designs, you've got distinctive watches and rings and jewelry, you've got distinctive furniture, and even distinctive named shades of wall paint.

Trying to balance all of those with people's natural rights can be hard for policy.

It is a tricky thing, and law varies by location.

It does depend where, here are the rights to use content from Soundcloud:

http://creativecommons.org/licenses/by-nd/3.0/

and from Deviantart:

http://about.deviantart.com/policy/copyright/

The terms & conditions weren't violated for the game.

These are examples of the same rights used to allow users to alter content and generate Fan Arts, Remixes & famous lets players like Pewdiepie to monetize other video games. What this game did is very much like what Equals3, Pewdiepie & other famous Youtube celebrities did. The only difference? They actually made a profit from altering content.

I wouldn't even use the .mp3 format unless I get a license from them regardless of it being shown to millions or a few kids.

For the USA, you are (as far as I know) right. In the EU, on the other hand, things like copyright infringement and plagiarism are under criminal law

Not true at least in middle europe law. Unless the plagiating suspect is found guilty of cheating, legal documents falsing, false testimonies, intentional large financial losses (not potentional), no civil law comes in.

Youtube may get away with it and no one here seems to complain about the ethics of that, but they do have more lawyers.

On youtube, general agreement an uploader makes when uploading content to them is, that very youtube can use your video, not another subject, and, you must be an owner/author/licensed subject to make this agreement plausible, else - if you are not, all violations are on you, not youtube legal body.