I drafted this piece in preparation for my ABA-sponsored speaking engagement in Washington, D.C. on June 10, 2011.  If you’re going to be in the DC area on that day, please consider joining us.  In addition to the Vernor case analyzed below, my panel will also address the Ninth Circuit’s opinion in UMG v. Augusto and the future of the first sale doctrine in the wake of these two significant cases.  There will also be panels on topics relating to trademarks, patents and trade secrets.  To register for the event, click here.

The first sale doctrine entitles “the owner of a particular copy . . . lawfully made under this title” to “sell . . . that copy.” 17 U.S.C. § 109(a).  The Supreme Court first recognized this doctrine in 1908 in Bobbs-Merrill Co. v. Straus, 210 U.S. 339 (1908).  In that case, a book publisher sold copies of a book to the wholesale trade bearing a notice stating that the book could not be sold for a retail price of less than $1.  There was no license agreement between the book publisher and wholesale purchasers.  The defendants bought copies of the book and resold them at retail for less than $1 per copy.  The Supreme Court held that the Copyright Act did “not create the right to impose, by notice . . . a limitation at which the book shall be sold at retail by future purchasers, with whom there is no privity of contract.”  Bobbs-Merrill, 210 U.S. at 350. “[O]ne who has sold a copyrighted article, without restriction, has parted with all right to control the sale of it. . . . [T]he books sold by the appellant were sold at wholesale, and purchased by those who made no agreement as to the control of future sales of the book, and took upon themselves no obligation to enforce the notice printed in the book, undertaking to restrict retail sales to a price of one dollar per copy.”   Because the Copyright Act did not grant the publisher the right to control the pricing of downstream sales, and there was no privity of contract between the publisher and the defendants, the defendants were free to resell the books as they saw fit.

Over the last 100 years, the first sale doctrine has furthered the dual purposes of the U.S. Constitution’s Copyright Clause by acting as a limitation on the copyright owner’s monopoly and providing a corresponding benefit to the public’s interest in access to creative works.  In June 2010, the Ninth Circuit dealt a significant blow to the applicability of the first sale doctrine to software when it ruled that a downstream purchaser had obtained a mere license to the software and could not resell his copy of it.  Vernor v. Autodesk, 621 F.3d 1102 (9th Cir. 2010) (“Vernor II”).  Timothy Vernor, an eBay reseller, purchased several copies of Autodesk’s AutoCAD software from CTA, one of Autodesk’s direct customers, and sought to resell them on eBay.  Vernor succeeded in selling some copies, but after Autodesk served eBay with repeated DMCA takedown notices accusing Vernor of copyright infringement, eBay eventually terminated his account, effectively prohibiting him from selling his remaining copies.

District Court proceedings and opinion

Vernor brought an action for declaratory relief, seeking a declaration that his sales of AutoCAD were noninfringing because he was an “owner” of the “particular copy” of each software package pursuant to §109.  Vernor also claimed immunity under §117 of the Copyright Act, which authorizes the “owner of a copy of a computer program” to make a copy of the program if doing so is an “essential step in the utilization of the program.”  This provision exempts from liability the copying of a software program into a computer’s memory as part of the program’s normal operation.
Autodesk argued that though it transferred possession of the software to CTA, its license agreement (“License”), which imposed a variety of limits on CTA’s ability to use and dispose of the software, did not transfer ownership of the software to CTA.  The License reserved title and copyright in the software to Autodesk.  Moreover, the License allowed CTA to install the software on only two computers at a time, and prohibited CTA from using the software simultaneously on those computers.  The License forbade CTA from modifying or reverse engineering the software, and from using or transferring the software outside the Western Hemisphere.  It likewise barred any transfer of the software without Autodesk’s written permission.  And it provided that if CTA obtained the software as an upgrade from an earlier version of the software, CTA must destroy its copies of the earlier version.  When CTA purchased the software packages at issue, however, it did not agree to destroy them if it later upgraded to a subsequent version.

The District Court ruled in Vernor’s favor, finding that Autodesk transferred ownership of the AutoCAD packages to CTA, which in turn transferred its ownership interest to Vernor.  In so doing, the District Court made an important distinction: that although there was no dispute that Autodesk licensed the software itself to CTA, “the use of software copies can be licensed while the copies themselves are sold.”  Vernor v. Autodesk, 2009 U.S. Dist. LEXIS 90906 (W.D. Wa. Sept. 30, 2009)(“Vernor I”).

In order to determine who was the “owner” of the AutoCAD copies, the District Court attempted to reconcile four apparently conflicting Ninth Circuit opinions.  United States v. Wise, 550 F.2d 1180 (9th Cir. 1977), involved movie prints distributed by studios to theaters for display, or to various “V.I.P. licensees” like the actress Vanessa Redgrave for personal use.  The Wise panel looked to the terms of the applicable transfer agreements to assess whether the studios had transferred ownership of the prints or merely licensed them.  The transfer agreements contained a variety of contradictory terms; some suggested a transfer of ownership, while others suggested a mere license.  Thus, the Wise panel considered whether an agreement contained a clause reserving title in the transferred work to the copyright owner; whether the transferee made a single, up-front payment; whether the agreement required the transferee to return or destroy the transferred copy after a certain period of time; and whether the agreement imposed restrictions on the use or subsequent disposition of the copy.  The Vernor I court found that none of these terms was dispositive of the issue, with one exception: the Wise panel found a transfer of ownership in each agreement which allowed the transferee to retain possession of the transferred copy indefinitely, and gave the copyright owner no right to reclaim the copy.  By contrast, the Wise panel construed as a license each agreement which gave the copyright holder the right to regain possession of the transferred copy.

The Vernor I court concluded that, under Wise, Autodesk had transferred ownership in AutoCAD to CTA.  Though the License purported to reserve title in the software to Autodesk, and imposed restrictions on the use and disposition of the transferred copy, it did not allow Autodesk to regain possession of the copy. “In [the District Court’s] view, retaining title in a copy is meaningless unless the copyright holder has some means to regain possession of the copy.”

The Vernor I court then turned its attention to a trio of Ninth Circuit opinions issued long after Wise, in the digital era: MAI Sys. Corp. v. Peak Computer, Inc., 991 F.2d 511 (9th Cir. 1993); Triad Sys. Corp. v. Southeastern Express Co., 64 F.3d 1330 (9th Cir. 1995); and Wall Data Inc. v. Los Angeles County Sheriff’s Dep’t, 447 F.3d 769 (9th Cir. 2006).  Each of these cases addressed whether a licensee was an owner entitled to invoke the “essential step” defense in §117.  In MAI, the Ninth Circuit addressed whether a computer repair service that serviced computer systems containing licensed software made unauthorized copies of that software when they operated the computers that they were servicing.  In a footnote, the court noted, “Since MAI licensed its software, [its] customers do not qualify as ‘owners’ of the software and are not eligible for protection under §117.”  Consequently, those customers could not authorize the repair service to make repairs to the computers, since doing so necessarily involved the making of a copy of the software in the computer’s memory.

Triad also involved software and a computer repair service.  The software in Triad was distributed pursuant to three different agreements.  The first sold the software outright; these transferees were owners under §117.  The second licensed the software but restricted duplication and third-party use, and the third added a requirement that licensees pay a transfer fee to sell computer systems on which the software had been installed.  Transferees under these agreements were licensees, not owners, and could not authorize repairs pursuant to §117.

Finally, in Wall Data, the Los Angeles County Sheriff’s Department purchased software pursuant to a license which (1) prohibited the department from installing the software in “multiple computer” or networked arrangements; (2) restricted transfers of the software between computers to once every thirty days; and (3) limited the department to installing the software on 3600 machines.  The license did not, however, prohibit resale of the software.  The department proceeded to install the software on more than 6000 machines, but configured it so that no more than 3600 users could access it at any given time.  The Wall Data panel held that “if the copyright owner makes it clear that she or he is granting only a license to the copy of software and imposes significant restrictions on the purchaser’s ability to redistribute or transfer that copy, the purchaser is considered a licensee, not an owner, of the software.”  As in MAI, the Wall Data licensing agreement “imposed severe restrictions on the Sheriff’s Department’s rights with respect to the software.  Such restrictions would not be imposed on a party who owned the software.”  Thus, the Sheriff’s Department did not own its copies of the software, and could not rely upon the essential step defense.  The panel also denied §117 protection to the Sheriff’s Department because copying the software to the additional computers was not an “essential step” in the operation of the software.

The Vernor I court concluded that if it were to follow the MAI trio, “Autodesk would prevail.”  Under MAI and Triad, “the mere labeling of an agreement as a license is sufficient to ensure that the licensee does not have ownership of any copy of the software.”  The Wall Data holding, while “more flexible” according to the Vernor I court, nonetheless provided that “if the copyright owner makes it clear that she or he is granting only a license to the copy of software and imposes significant restrictions on the purchaser’s ability to redistribute or transfer that copy, the purchaser is considered a licensee, not an owner, of the software.”

The Vernor I court found Wise and the MAI trio in irreconcilable conflict with each other.  Under the reasoning of Wise, Vernor should prevail, because the Autodesk License allowed CTA to retain possession of the copy of the software indefinitely.  Under the MAI trio, Autodesk should prevail, because the licenses in question unequivocally provided that they were licenses, and reserved ownership to the copyright holder.  When precedent conflicts, the court must follow “the oldest precedent among conflicting opinions from three-judge Ninth Circuit panels.”  Consequently, the Vernor I court applied Wise and ruled in favor of Vernor.

Ninth Circuit opinion

The Ninth Circuit reversed, finding that Autodesk’s direct customers were licensees, not owners, and therefore could not transfer ownership rights to Vernor.  The Vernor II court found no conflict between Wise and the MAI trio.  It reasoned that under Wise, the Ninth Circuit considers all of the provisions of a transfer agreement to determine whether it constitutes a license or a transfer of ownership, including “(1) whether the agreement was labeled a license and (2) whether the copyright owner retained title to the copy, required its return or destruction, forbade its duplication, or required the transferee to maintain possession of the copy for the agreement’s duration.”  Vernor II rejected Vernor I’s interpretation of Wise as holding that “a transferee’s right to indefinite possession itself established a first sale.”  To the contrary, no one factor is dispositive, and each transfer agreement must be examined in its entirety.

The Vernor II court characterized the MAI and Triad agreements as “restrictive license agreements,” and thus their customers were licensees who could not qualify for the essential step defense.  Finally, the Vernor II court interpreted Wall Data as holding “that the essential step defense does not apply where the copyright owner grants the user a license and significantly restricts the user’s ability to transfer the software.”  Thus, the Vernor II court read “Wise and the MAI trio to prescribe three considerations that we may use to determine whether a software user is a licensee, rather than an owner of a copy.  First, we consider whether the copyright owner specifies that a user is granted a license.  Second, we consider whether the copyright owner significantly restricts the user’s ability to transfer the software.  Finally, we consider whether the copyright owner imposes notable use restrictions.”

The Vernor II court went on to hold that “a software user is a licensee rather than an owner of a copy where the copyright owner (1) specifies that the user is granted a license; (2) significantly restricts the user’s ability to transfer the software; and (3) imposes notable use restrictions.”  It found that Autodesk’s agreement was a license rather than a sale.  “Autodesk retained title to the software and imposed significant transfer restrictions: it stated that the license is nontransferable, the software could not be transferred or leased without Autodesk’s written consent, and the software could not be transferred out of the Western Hemisphere.”  Moreover, the License “imposed use restrictions against the use of the software outside the Western Hemisphere and against modifying, translating, or reverse-engineering the software.”  The License provided for termination “upon the licensee’s unauthorized copying or failure to comply with other license restrictions.  Thus, because Autodesk reserved title to [AutoCAD] copies and imposed significant transfer and use restrictions, we conclude that its customers are licensees of their copies . . . rather than owners.”  As licensees, Autodesk’s direct customer thus could not transfer ownership to Vernor.  In turn, Vernor could not invoke the first sale doctrine or the essential step defense.

Implications

Vernor II raises the question whether and to what extent the first sale doctrine will retain its vitality in the digital age.  It vests software developers with tremendous power to restrict downstream uses of their products.  Purchasers of software rarely – if ever – have the opportunity to negotiate the licenses that come with the products they think they are “purchasing.”  Under Vernor II, saying it makes it so – the opinion makes it all too easy for owners of all types of digital content to include restrictive language in their licenses and strip §109 of any applicability to digital technologies.  Nor is it too great a stretch to imagine Vernor II being extended to other, traditional, contexts.  Imagine, for example, a print book purchased pursuant to a shrink-wrap license that prohibits the purchaser from reselling it on eBay or outside the United States.

Vernor II also appears to conflate the important distinction between a copyrighted work and the tangible medium in which it is reproduced.  In Vernor, the copyrighted work was the AutoCAD software program, but that program was reproduced and distributed on a physical object – a disc. “Ownership of a copyright . . . is distinct from ownership of any material object in which the work is embodied.”  17 U.S.C. § 202.  Transferring a copy does not necessarily transfer the copyright, and vice versa.  As the Vernor I court noted, “the use of software copies can be licensed while the copies themselves are sold.”  Yet nowhere did the Vernor II court explicitly address the issue of ownership of the physical discs as distinct from the copyrighted AutoCAD program.  Consider a printed book: the purchaser obtains no rights in the words printed on the pages of the book (the intellectual property), but the purchaser plainly owns the paper upon which the words are printed.  The same rationale can be used to distinguish software code from the disc on which it is embedded.  Of course, as commerce and digital products increasingly move into the cloud, where products are simply downloaded rather than distributed in a physical medium, this distinction may likewise lose relevance.

On the other hand, the software industry has built itself and its various business models on the foundation that software is licensed, not sold.  A ruling in favor of Vernor could upset settled expectations in an industry with a significant impact on the economy.

Vernor’s deadline to seek certiorari to the Supreme Court was May 18, 2011.  It remains to be seen whether he can defy the very slim odds of winning Supreme Court review.  Until then, the continuing applicability of the first sale doctrine in the context of digital technologies will remain in flux.