The copyright-innovation tradeoff: property rules, liability rules, and intentional infliction of harm.

• Author: Oliar, Dotan

INTRODUCTION I. CONTENT AND TECHNOLOGY: A DYNAMIC OF CONFLICT AND LEGAL UNCERTAINTY A. Innovators' Secondary Liability for Copyright Infringement B. Innovators' Liability Under Other Doctrines C. Taking Stock: Law Has Not Struck the Copyright-Innovation Tradeoff According to Any Clear or Consistent Logic or Policy II. A FRAMEWORK FOR APPROACHING THE COPYRIGHT-INNOVATION TRADEOFF: INCENTIVES TO INVEST UNDER DIFFERENT RULES A. The Framework: Assumptions and Setup B. Protecting Copyright Owners with a Property Rule 1. Efficient coexistence 2. Revolutionary technology 3. Harmful technology 4. Taking stock: investments under a property rule in copyright owners C. Protecting Copyright Owners with a Liability Rule 1. Efficient coexistence 2. Revolutionary technology 3. Harmful technology 4. Taking stock: investments under a liability rule in copyright owners D. Protecting Innovators with a Property Rule: Innovators' Incentives to Generate Harm 1. Efficient coexistence 2. Revolutionary technology 3. Harmful technology 4. Taking stock: investments under a property rule in innovators E. Protecting Innovators with a Liability Rule 1. Efficient coexistence 2. Revolutionary technology 3. Harmful technology 4. Taking stock: investments under a liability rule in innovators F. Summary: Copyright Owners' and Innovators' Incentives to Invest Under Property Rules and Liability Rules III. ANALYSIS: HOW THE FRAMEWORK CAN BE USED TO PREDICT CREATORS' BEHAVIOR AND TO MAKE BETTER LAW A. Descriptive Payoffs: The Framework Gives Insight into How Different Entitlements Affect Copyright Owners' and Innovators' Incentives to Create and to Minimize Their Mutual Interference 1. Integrating a multiplicity of viewpoints into one coherent whole 2. Breaking clown the particular tradeoffs associated with alternative rules 3. Understanding copyright owners' and innovators' behavior 4. Understanding the tradeoffs associated with Grokster B. Prescriptive Payoffs 1. Choosing among possible rules 2. Modifiable entitlements: a proposal to improve incentives to invest 3. Understanding Sony and Grokster 4. Coordination of ex post precautions in an efficient-coexistence setting 5. When the interference approaches zero IV. LIMITATIONS AND EXTENSIONS OF THE ANALYSIS A. Relaxing Assumptions 1. Allowing for externalities 2. Relaxing the assumption of predictability of scenario type 3. Relaxing the assumption of equal bargaining power 4. Varying the relative likelihood of the three scenarios 5. Decreasing ex ante transaction costs below a prohibitive level 6. Increasing ex post transaction costs above zero 7. Different entitlements B. Optimal Timing of Modification CONCLUSION INTRODUCTION

Should copyright law impose liability on innovators of technologies used to copy, manipulate, or disseminate protected content? Intellectual property law's goal, and constitutional mandate, (1) is to promote both authorship and invention. (2) Often, each of these goals can be pursued independently. (3) Sometimes, however, they conflict. New technologies--such as record players, radio, motion pictures, photocopiers, VCRs, MP3 players, and file-sharing networks-often weaken copyright owners' control over content. As the Supreme Court observed, imposing copyright liability on technology companies would promote authorship but chill innovation, while immunizing innovators from liability would promote innovation but chill authorship. (4) How should the law balance these two interests? (5)

This question has been asked respecting each of the technologies above and many others. Each time, however, courts and Congress have struck the balance differently. The law has alternated over time between protecting copyright owners and innovators by either property rules or liability rules. The copyright-innovation conflict is one of the most important and recurring themes in copyright law's evolution, and it has been studied extensively. (6) Unfortunately, despite much congressional, judicial, and scholarly attention, the law has not treated content-technology conflicts coherently.

This Article takes a first-principles approach to content-technology conflicts. It views authorship and innovation as two economic activities that interfere. It conducts a systematic analysis of how allocating property rules and liability rules to copyright owners and innovators would induce each group to invest both in pursuing its own trade and in minimizing the copyright-innovation interference. (7)

For example, a property rule in innovators--an entitlement allowing them to manufacture any technology regardless of harm to copyright owners--may drive some of them to produce harmful technologies and to actively promote their use for infringement. Such inefficient investments in technology creation and harm generation may allow some innovators to extract value from copyright owners in return for shutting down. Imagine, for instance, an innovator contemplating a technology--such as an online file-sharing network--that creates a small value of 10 but that also harms copyright owners by 100. Backed by a right to market this technology, an innovator would produce it. The innovator and copyright owners would quickly realize that all can be made better off by shutting down the technology. In negotiations, the innovator would not accept anything less than 10 to shut down while copyright owners would pay 100 at most. Under equal bargaining power, the innovator would shut down in return for 55. Assume, however, that when the innovator creates the new technology, he can invest an extra 5 to increase the technology's harmful effect to 200. While a net loss in social welfare, this investment in harm exacerbation would pay off for the innovator, because it would increase the copyright owners' maximal willingness to pay to 200, thus increasing the innovator's settlement amount to 105. This is just one effect of one legal rule--this Article provides a comprehensive analysis of the incentives generated by each of the four classic entitlements. (8)

Charting the incentive effects of alternative legal rules can explain observed phenomena and predict future ones. For instance, before the rise of file-sharing networks over the past decade, the relevant Supreme Court precedent, Sony Corp. of America v. Universal City Studios, Inc., (9) was largely understood as vesting a property rule in innovators. Several courts found that file-sharing networks actively induced infringement by end users, a behavior consistent with the predicted behavior of the similarly protected innovator in the numerical example in the preceding paragraph. Also consistent with that example were the negotiations between Napster, the file-sharing network, and music labels, pursuant to which Napster would shut down its harmful technology in return for value. (10)

A major cost of legal rules is that they may drive protected parties to make clearly inefficient investments. For instance, the innovator in the numerical ex ample above found it privately profitable to invest in a socially harmful technology. When it comes to technological change, lawmakers often cannot predict the nature of future technologies before they are invented. Their choice is often limited to allocating background entitlements under limited information regarding the future. Although lawmakers cannot observe the nature of the parties' investments in real time, they might still be able to verify their type (socially beneficial or harmful) once a content-technology conflict occurs. A legal system that, upon observing a protected party who invested inefficiently, reallocates the entitlement to its counterpart, will provide the parties with improved incentives to invest. Contrary to conventional wisdom regarding content-technology conflicts, this prescription holds true even if the parties can transact costlessly at the time a conflict occurs. (11) The purpose of this prescription is not to overcome transaction costs after the parties' activities already conflict. In such a case, under costless bargaining, the efficient result will happen regardless of the applicable entitlement, as the example above shows. (12) Rather, this prescription seeks to make the parties invest efficiently at an earlier time when they cannot yet transact, a time when improved incentives to invest may prevent a future conflict from arising. (13)

The Supreme Court's decision in MGM Studios Inc. v. Grokster, Ltd. (14) suggests that the legal system is at times capable of verifying the nature of the parties' earlier investments during a conflict, and of reallocating entitlements accordingly. In Grokster, the Ninth Circuit allowed the technology company to rely on the background entitlement from Sony to manufacture its harmful technology. The Supreme Court likely believed that the technology was harmful (i.e., it was of little or no independent value yet created great harm to copyright owners (15)) and so the Court reallocated the entitlement to copyright owners. Doctrinally, it did so by crafting a new theory of liability--intentional inducement--that led to a reversal of the outcome below. (16) Providing improved investment incentives therefore requires mechanisms to reallocate entitlements from innovators to copyright owners in certain cases (such as by way of the Court's doctrinal innovation in Grokster), but also from copyright owners to innovators in other appropriate cases. The fair use doctrine is one major way in which the latter reallocation can be done, and indeed Sony can be read as having used the doctrine in this way.

This Article proceeds as follows. Part I reviews the historical cycle of technological disruption of copyright owners' business models, ensuing copyright litigation, and systemic doctrinal uncertainty and unpredictability. Part II presents a framework modeling how different property rules and liability rules affect copyright owners' and innovators' incentives to invest in their respective...