Are First Sales Final?

If you’re in the business of software creation and distribution, a current California case is worth paying attention to. In Adobe Systems Inc. v. Hoops Enterprise LLC, the U.S. District Court for the Northern District of California held on February 1, 2012, that Adobe’s distribution of certain software to original equipment manufacturers (OEMs) was a license, not a sale of the software. The Court found that the “first sale” doctrine was unavailable as a defense to Adobe’s claims of copyright infringement against third parties who subsequently resold the software without authorization.

Does that sound complicated? Let’s take a few steps back in order to understand the impact of this ruling. What is the “first sale” doctrine? The doctrine is one of the specific statutory restrictions that Congress has placed on the exclusive rights of copyright owners. The “first sale defense” is an affirmative defense to infringement codified under the Copyright Act, 17 U. S. Code 109(a). The idea is that a person who buys a legally produced copyrighted work (e.g. a book or a DVD) may “sell or otherwise dispose” of the work as he or she sees fit, subject to a few conditions and exceptions. If I walk over to Barnes & Noble and buy a copy of Richard Polenberg’s The World of Benjamin Cardozo (my favorite Supreme Court Justice), I can loan that book to my friend without having to pay any sort of licensing fee to Mr. Polenberg or his publisher. Libraries could not exist without the protection of the first sale doctrine; otherwise, all sorts of licensing fees would cripple them.

Like many copyright doctrines, the logic of first sale became strained as society moved from the tangible world of books and DVDs to the digital world of files and code. Is it still okay for me to “loan” (i.e. e-mail) a PDF e-book I bought online? Rather than being a single, transferable item, “my” legally purchased copy can be infinitely reproduced. I could enjoy that copy at the same time as my friend, indefinitely. Those sorts of basic questions needed to be sorted out by courts during the e-explosion of the 1990s.

An important caveat to the first sale defense is that, as stated in 17 U.S.C. § 109(d), the defense does not “extend to any person who has acquired possession of the copy or phonorecord from the copyright owner, by rental, lease, loan, or otherwise, without acquiring ownership of it.” Most software is distributed through the use of licensing agreements. Thus the copyright holder retains ownership of all distributed copies—even though a purchaser (i.e. user) of the software has physical possession of the physical CD, the software, and the computer that runs the software. For this reason, alleged infringers cannot claim that copies of software should be permitted under first sale. In other words: No, I can’t just burn you a CD of my Microsoft Office for you to install even though I legally bought that CD at the Apple Store.

So back to the Adobe case. Adobe distributed the OEM software in a bundle with approved hardware components, subject to restrictive licensing agreements that did not transfer title to the software. Hoops Enterprises LLC and the other defendant bought computer hardware from Dell and Hewlett-Packard and resold OEM-installed Adobe software on eBay, unbundled from the hardware. (Obviously Adobe had not given permission to make or distribute copies of its software).

The key issue before the district court was whether Adobe’s distribution of certain software to OEMs was a license or a sale. If the copies of the software were licensed, then the copyright first sale doctrine did not protect third parties who subsequently unbundled the software and resold it without Adobe’s authorization from a claim of copyright infringement. If the software were sold, then it would be the opposite result.

Central to this case was the Ninth Circuit’s decision in Vernor v. Autodesk, which held that the first sale doctrine does not apply to the resale of software by users that are licensees of a copy, rather than owners. According to Vernor, a user is a licensee and not an owner where the copyright owner 1) Specifies that the user is only granted a license, 2) Significantly restricts the user’s ability to transfer the software, and 3) Imposes notable use restrictions.

Adobe did enter into license agreements with the OEMs, but the defendants argued in a counterclaim that those agreements failed to create significant restrictions on transfer, nor did they impose use restrictions, and therefore Adobe did not retain sufficient control over the copies, making the agreement an effective sale rather than a license agreement.

The court disagreed, applying the Vernor factors and finding that Adobe’s license agreement did 1) specify that it grants a license and requires the OEMs to obtain a similar agreement with any third parties before authorizing or sublicensing the software to them; 2) Imposes significant transfer restrictions, and 3) Imposes significant use restrictions. Because the transfer of the OEM software was subject to a license and did not constitute a sale, the first sale defense could not protect the defendants.

What’s the “takeaway” from this recent decision? If you are a software vendor or a company that licenses third-party software, the distinction between a sale and a license is very significant. A resale of a licensed copy of the software is not protected by the copyright first sale doctrine. Abode was fortunate to have had a carefully drafted agreement to which the court could apply the Vernor factors.

With all of this said, remember that this has only been examined at the district court level. The issue seems likely to come upon appeal, which will hopefully clarify the scope of first sale doctrine—a doctrine that is equally important in the digital copyright world as it is the old fashion world of my Benjamin Cardozo biography.

Brian Farkas