First Sale, Software, and eBay

The question whether a transaction in which a copy of software is transferred for a set price to end users is a sale or license is long-standing. It has been raised again in a suit brought by Timothy Vernor against Autodesk, in which he is now represented by Public Citizen. Here is a link to their press release about the suit (including a link to the amended complaint), and a short excerpt from that release:

The lawsuit ... was filed in federal court in Seattle and contends that the software company’s actions are abusive and lead to higher prices for consumers. ... eBay vendor Timothy Vernor picked up his first used copy of Autodesk’s “AutoCAD Release 14” at a tag sale. Autodesk sells this product new in a shrink-wrapped box that contains a “license agreement” that the company claims prohibits the purchaser from reselling the software. Public Citizen argues that this contract language is unlawful under the Copyright Act, which guarantees that the owner of a copyrighted product can resell that product without permission.

The complaint seeks declaratory relief that no infringement occurred and has a count for unfair and deceptive practices arising out of the DMCA take down notices sent to eBay. Within the Ninth Circuit, Adobe has made some law on the question, although the courts are split. In the first case, Adobe Sys. Inc. v. One Stop Micro, Inc., 84 F.Supp.2d 1086 (N.D. Cal. 2000), Adobe distributed software to the educational market through authorized distributors who in turn transferred copies to authorized resellers. Those authorized resellers had an agreement with Adobe limiting sale to end users in the educational market. Defendant, a company not an educational end-user, bought a copy in the "open market," as the court described it. While the court found some ambiguity in the agreement on the question whether the parties intended a sale or license, using extrinsic evidence, it held that a license was intended due to the presence of restrictions on the types of sales, and expert testimony that software is generally licensed, not sold. This testimony was of course conclusory in nature; that is, it stated an opinion on the law, masked as testimony about facts. The court dismissed the language "purchase and sale" in the agreement as "convenient and familiar," but meaningless in light of the custom of licensing it found. The custom was, however, in how the industry wants such agreements to be legally construed, and not how they may be factually. For example, Adobe did not, I believe, require return of a copy. Characterizing such transactions as sales does not leave Adobe and others high and dry; rather, they still have available a breach of contract action against the party who breached the resale agreement.

In the next case, Softman Products Co. LLC v. Adobe Sys., Inc., 171 F. Supp.2d 1075 (C.D. Cal. 2001), the court reached the opposite result, disagreeing with the earlier decision, and noting that the industry's preference for describing the transactions as licenses ""does not alter the Court's analysis that the substance of the transaction at issue here is a sale and not a license."

Finally, in Adobe Sys., Inc. v. Stargate Software, Inc., 216 F. Supp.2d 1051 (N.D. Cal. 2002), the court agreed with the One Stop Micro court and disagreed with Softman, which it lamely attempted to distinguish as involving the disaggregation of a compilation of products.

In many ways, the debate hearkens back to Judge Easterbrook's ProCD case and his concerns about arbitrage, the effort to develop a market that impedes the copyright owner's efforts to market the work in a discrete way. In the Adobe cases, Adobe was targeting the educational market and perhaps offering terms different (and hopefully more favorable) than those it offered to the commercial market. One would want to encourage such efforts; yet, the question is how, consistent with the statute and the actual facts of the transaction. If, as the Softman court held, the substance of the transaction is a sale, calling it a license shouldn't change matters and copyright owners should be left to pursue contract remedies. If the substance is a license as that term is used in other fields of law, then there is no first sale. The type of restrictions pointed to by some courts -- restrictions on whom copies may be sold to -- is no different than any agreement where a sale is commonly found: you can sell copies of a CD in the U.S., but not Canada for example. It is unthinkable that this last agreement would be deemed a license. So too an agreement that says you can sell the software to the educational market but not the general market.

Promos CDs and First Sale

Of all the things to occupy record labels’ time, I wouldn’t have thought any would be devoted to tracking down the sale of lawfully made Promotional CDs on eBay. I’m wrong. There have been a number of such suits (two of whom are against the same individual), but in one the EFF has taken up defendant’s cause. Here is a link to EFF’s site, which contains a press release, the complaint, and the answer.

It is not only Promo CDs that are getting cracked down on; inexplicably, there has been an increase on so-called state “pawn shop” laws, most recently in Florida. In Florida, stores buying second-hand merchandise for resale must apply for a permit, thumb-print CD sellers and get a copy of the seller’s driver's license. Stores are limited to issuing store credit, and furthermore must hold the merchandise for 30 days before re-selling them. Not surprisingly, this has resulted in the closure of a number of such stores or in stores ceasing the sale of used CDs. (See this article in Ars Technica). And copyright owners wonder why they have a bad reputation among consumers.

In the promo CD case, the first sale doctrine will be a key element of the defense. The record label does not dispute that the promo CD was lawfully made but contends that a legend stating it was given under a license prevents application of that doctrine since the license terms prohibited resale. I have a few of these promo CDs, bought in second hand stores (in NYC, not Florida). I have always regarded efforts to make a sale (or in the case of promos, a gift), into a license just by saying so, is legally deficient. Putting a license label on something but treating in every other way as a sale, doesn’t seem to me to represent the strongest position, as the 2001 Softman/Adobe case showed. Yet, there is the Seventh Circuit’s ProCD versus Zeidenberg going the other way. Perhaps the promo CD case will distinguish ProCD by considering the effort to make the promo a license to be ineffectual in comparison, but all such analyses point out an Achilles heel in first sale: a federal defense is subject to the vagaries of state law.

What Did the 4th Circuit Eat for Breakfast?

Jerome Frank (Second Circuit 1941-1957), an echt Legal Realist (see Brian Leiter, "Legal Realism and Positivism Reconsidered," 111 Ethics 278 (2001)), is reputed to have remarked that a court's decision might turn on what the judge had for breakfast. This led litigants to have a generous morning repast waiting for him at the Plaza Hotel. Eventually, Judge Frank ballooned to 450 pounds and burst like the Stay-Puft Marshmellow Man in the movie Ghostbusters. Judge Alex Kozinski of the Ninth Circuit, while a bon vivant, is nevertheless more careful about breakfast, as he detailed in his March 19,1993 speeech, "What I Ate for Breakfast and other Mysteries of Judicial Decision Making," available here.

All this is by way of background to wondering what a panel of the 4th Circuit had for breakfast when it decided, yesterday, Christopher Phelps and Associates, LLC v. Galloway; whatever it is was, I earnestly pray it is never served again. (HT to LKB for letting me know about the opinion).

The case, while possessed of some factual interest, is, in its legal essence, simple: an individual (Galloway) had an unauthorized copy of architectural plans made and then built a house based on them. The building design firm plaintiff sued for infringement. There was a jury trial; the jury awarded plaintiff its lost fees for use of the plans ($20,0000). The trial court denied plaintiff's motion for a new trial on damages and refused to order an injunction barring the future lease or sale of the house or mandating destruction or return of the infringing plans. Since there was no registration for the architectural plans, the lost fee award can be justified only as a value of use award for infringement of an architectural work.

But, alas, the Fourth Circuit issued a 22-page opinion. The opinion is a maddening mixture of getting some things right and some things very very wrong. The court's holding on how the first sale doctrine works applies across all subject matter, and bears no resemblance to how copyright law has worked since its inception centuries ago. Let's work through the issues methodically, though, since there is error built on error, which must be peeled back.

The first error, and it is a common one, is in fixing the proper measure of damages for infringement of architectural plans. Architectural plans have been protected since the 1909 Act; architectural works only since 1990. Because of their historically different roots, great care should be taken to ensure that the proper remedies are awarded for the particular type of work sued upon. This is more of a problem than one would think, given the failure of many plaintiffs to obtain a registration for both types of work, even if that party is the creator and owner of both. Copyright Office regulations are crystal clear that two separate registrations are required, one for the architectural plans and one for the architectural work. If plaintiff has failed to obtain both registrations, the court lacks subject matter jurisdiction of the work for which registration has not been obtained and obviously has no power to award any relief for such a work.

In the typical case, plaintiffs obtain a registration for architectural plans, but not for the architectural work, and yet attempt to claim remedies for infringement of the architectural work, that is, they seek defendant’s profits from sale of infringing houses. Such claims must be rejected. Assuming there are proper registrations for both types of works, what are the available monetary remedies? For architectural plans, a common measure is the fee the architect or building designer charges for use of his or her plans. One may never obtain damages for infringement of architectural plans measured by profits made from sale of infringing homes; such damages are proper only for infringement of architectural works, although courts with a disturbing regularity overlook this critical distinction. For infringement of architectural works, a common remedy is either the profit plaintiff would have made but for the infringement from sale of the house, or the profits defendant made from the same sale. In the case of the profits plaintiff would have made, one might ask why isn't this the fee the architect would have charged? This would, of course, justify the jury's award under a different theory.

In the Christopher Phelps case, plaintiff only sued on (I believe) infringement of the architectural work. The only remedies the jury could award, therefore, was damages from violation of the architectural work copyright. In an ordinary case, looking at defendant's profits, this would be calculated by the profit the builder made from selling the house(s), reduced by expenses and things like the value of the land, the location, and many other features, like the comps in the neighborhood. For plaintiff's losses, it seems a stretch to claim plaintiff suffered losses calculated by the value of the house: if authorized plaintiff's don't charge that way. Rather they charge either a flat fee for use of the plans or a percentage of the construction costs (in the case of skyscrapers, this is no small amount). In Phelps, though, defendant didn't sell the house: it was his dream house, which he built and still lives in. I don't disagree that in such circumstances, it might be possible to award the fair market value of the infringing house, apportioned by non-infringing elements of the design, and deducting for other non-infringing things like the construction costs, the value of the land, the value of the location etc. This may be a speculative task, although not impossible. More straightforward, however, is the fee the architect would have charged if authorized, in Phelps, $20,000.

On to injunctions. The court of appeals, citing eBay, rejected the argument (if it was made), that plaintiff was entitled to a permanent injunction since it prevailed on the merits. Since it was very unlikely defendant (an individual building his "dream" house) would do anything else with the plans, an injunction was unnecessary, although plaintiff was entitled to get the infringing copy back (on this point, the court of appeal remanded and hopefully the district court will order return of the copy, although for reasons given at the end of this posting, I don't see how it can). Plaintiff, though, asked for an injunction against defendant leasing or selling the house. The argument was based on the radical view that there can be a distribution of a house within the meaning of the Copyright Act merely by selling it. I disagree: there can only be a distribution by physical transfer of the copy, not by transfer of the title to the copy. In the case of an architectural work, that means selling it and moving it to a different location.

The Section 106(3) right is: "to distribute copies or phonorecords of the copyrighted work to the public by sale or other transfer of ownership, or by rental, lease, or lending." There is no definition of "distribution" but one thing is clear: the operative terms are not, as plaintiff asserts, "by rental, lease or lending," but instead to "distribute copies." Whatever distribute means, it means distributing a copy, not title to the copy, and that's all that happened in Christopher Phelps.

Now on to the real La-La-Land. In rejecting plaintiff's argument, the court of appeals didn't focus on the statutory language, and instead found for defendant on a ground not briefed or argued (I am told). That ground was the first sale doctrine, in Section 109. At this point, I expect readers to say, "huh?" What does first sale have to do with it; the first doctrine states, in Section 109 that it is limited to lawfully made copies. An infringing copy is by definition, not lawfully made. Yes, but the 4th Circuit panel clearly had something very very bad for breakfast. The panel holding is that when the jury awarded plaintiff the $20,000 for the use fee for the plans, plaintiff was made whole-- and this is the kicker -- the infringing copy magically became a lawfully made copy.

In reaching this result, the court cited to the 1976 House committee report; that report, however, refers to copies made under a compulsory license; that is, by a congressional act, not a judicial act. The court also cited to the Second Circuit's decision in Platt and Munk Co. v. Republic Graphics, Inc., 315 F.2d 847, 854 (2d Cir. 1963). Platt was allegedly construing the the term "vend" under that Act, and in doing so, inquired into whether the copyright owner had received its "reward" for transfer of the copies. This passage was external to the statutory provision at issue, and indeed to the facts of the case, which involved a dispute between the copyright owner of games and the manufacturer thereof over quality deficiencies. When the copyright owner refused to pay for defective goods, the manufacturer sold them. Those facts have nothing to do with a first sale since the copyright owner never took possession of the copies and the initial distribution (by the manufacturer) was, in any event, unauthorized by the copyright owner. Platt and Munk was bad law under the 1909 Act and has not been followed in the Second Circuit under the 1976 Act.

If I read the 4th Circuit opinion correctly, defendant now owns an authorized copy of the plans and can sell them; why then remand to the district court for a possible return or destruction order under Section 503(b)? That section only covers infringing copies, and of course, that paradox points out another fatal flaw in the court's first sale holding: all of the post-judgment remedies are now impossible, including an injunction. But beyond this case, are we now in a situation in the 4th Circuit where copyright owners have to elect between damages and all other remedies, on pain of infringing copies being deemed lawfully made if monetary relief is granted?