Selling the right to license: examination of the first sale doctrine through the lens of UMG Recordings & Quanta Computer.

• Author: Newman, Joshua W.

1. Introduction II. Background A. Origin of the First Sale Doctrine B. License Agreements Limit the First Sale Doctrine's Application C. UMG Recordings & Quanta Computer: Changing the Landscape of Ownership and the Ability to Contract Around Intellectual Property Protections 1. The Court's Findings in UMG Recordings 2. The Court's Finding in Quanta Computer III. Analysis A. Sale Versus License: UMG Recordings & Quanta Computer Encourage Proliferation of Intellectual Property 1. Quanta Computer: Leaving the Door Open for Conditional Sales 2. Sale Versus License: UMG Recordings Recognizes Importance and Value of Secondary Markets B. The Implications of UMG Recordings in the Digital Arena IV. Recommendation A. First Sale Legislation: Backward- and Forward-Looking 1. The Necessary Amendment to Section 109 2. Preempting Quanta Computer Conditional Sales B. License Agreements: Courts Should Adopt the FTC Approach V. Conclusion I. INTRODUCTION

   Despite ongoing attempts by intellectual property owners to extend control over their creations, the first sale and patent exhaustion doctrines in United states copyright and patent law are still salient today. These doctrines, which allow consumers who buy copies of a protected work to resell, rent, or lend those copies, are important tools that help maximize public access to intellectual property and preserve consumer rights. However, the advent of digital technologies has begun to change the environment in which the first sale doctrine operates. No longer is the exchange or sale of physical goods the predominant form of transacting, but rather, digital transmissions are becoming more commonplace. This, in turn, has raised issues about the need and practicability of extending the first sale doctrine into the digital arena.

   In 2001, the U.S. Copyright Office submitted a report to Congress highlighting the potential effects that technology and e-commerce would have on the first sale doctrine. (1) Although the U.S. Copyright Office recommended a wait-and-see approach at the time, (2) recent court decisions suggest that this approach is no longer viable. (3) Such decisions represent an important victory for consumer rights regarding the first sale doctrine; however, unless Congress now intervenes, contract law may improperly usurp intellectual property law, leading to the erosion of consumer privileges.

   This Note suggests that the wait-and-see approach is no longer the most suitable alternative to protect consumer rights. Rather, Congress should embrace the recent decisions that extend the first sale doctrine and legislatively revise those principles to protect consumer privileges. Part II discusses the first sale doctrine's origins, its operation in physical goods markets, and how two recent cases, UMG Recordings and Quanta Computer, may affect the doctrine's future. Having identified the manner in which the first sale doctrine functions, Part III addresses how UMG Recordings and Quanta Computer both positively and negatively affect consumer rights. In particular, this discussion analyzes whether the principles set forth in UMG Recordings and Quanta Computer, which seem to stand for added consumer protections, actually provide intellectual property owners with a broader possibility to exploit consumer rights. Finally, having considered the impact that UMG Recordings and Quanta Computer may have on consumer rights, Part IV examines how to resolve the policy inconsistencies between the two cases. In short, this Note demonstrates why the time is right for Congress to intervene to ensure the first sale doctrine's survival and prevent the erosion of consumer rights.

2. BACKGROUND

   Since Congress adopted the Copyright Act of 1790, copyright owners have had the exclusive right to print, publish, and vend "copies" of their works. (4) Yet, these protections are neither limitless nor specifically designed to provide a private benefit to the copyright owner. (5) Rather, as the Constitution mandates, Congress's role is to enact copyright laws that strike a proper balance between fostering incentives for the creation of original works and disseminating knowledge by granting the public sufficient access to these works. (6)

   1. Origin of the First Sale Doctrine

      The first sale doctrine is one of the primary mechanisms limiting copyright owners' exclusive right to distribute. (7) The Supreme Court originally recognized and upheld the doctrine in Bobbs-Merrill Co. v. Straus. (8) Specifically, the Court held that although a copyright owner has the exclusive right to distribute an original work, that right does not permit imposition of price limitations on secondary sales. (9) One year after this decision, Congress codified the first sale doctrine in section 27 of the Copyright Act of 1909, (10) recognizing that failure to divest copyright owners of control over post-sale disposition could cause interference with otherwise efficient markets. (11) Section 109(a) of the Copyright Act of 1976 "carried forward the existing federal policy of terminating a copyright owner's distribution right as to a particular lawfully-made copy or phonorecord of a work after the first sale of that copy." (12) Additionally, section 109 sets forth a two-prong test outlining eligibility for first sale protections. (13)

      First, an individual must "own" the tangible object in which the copyrighted work is fixed. While sales are one common way to acquire ownership, other transfers of title, such as gifts or bequests, will also suffice. (14) Yet, courts will not grant first sale protections based solely on mere possession, "regardless of whether that possession is legitimate, such as by rental, or illegitimate, such as by theft." (15) For instance, an individual who sells a rented videotape, though lawfully coming into possession of the copy, would nevertheless infringe the owner's copyright.

      Second, section 109 mandates that acquired copies must have been lawfully made--meaning that either the law or a copyright owner must have authorized a particular copy's reproduction. (16) Consequently, unlawful copies, regardless of whether the owner is aware of the piracy, are unprotected under the first sale doctrine. (17) Thus, "an unsuspecting holder of a pirated CD, therefore, cannot legally resell it to a used CD store without violating the copyright owner's distribution right." (18)

   2. License Agreements Limit the First Sale Doctrine's Application

      In what has become a highly digital era, intellectual property owners have become increasingly concerned about the erosion of their rights. In an effort to more effectively protect both their investment and expected returns, many have turned to contract law to supplement intellectual property protections. (19) In particular, intellectual property owners are commonly utilizing licensing agreements whereby they retain ownership but authorize a third party to carry out certain acts, usually for a limited duration. (20) While such agreements may serve pro-competitive ends, (21) copyright owners have attempted to use such agreements to achieve two primary objectives. First, copyright owners have sought to use licensing as a vehicle to increase available remedies--for instance, contract remedies, when users pirate or make unauthorized copies. (22) Second, copyright owners have used license agreements as a weapon to eradicate the first sale doctrine. "By reducing a copyright user's status from that of owner to a mere possessor," copyright owners have made it impossible for users to meet the first sale doctrine's ownership requirement. (23) Consequently, copyright owners have mitigated their concerns that used copies in secondary markets will displace the purchases of new works. (24)

      However, the strategic manner in which intellectual property owners have attempted to use licensing agreements has not gone unnoticed. In 1997, members of Congress proposed the Digital Era Copyright Enhancement Act, which sought to make nonnegotiable license terms unenforceable where such terms abrogated consumer rights or limited the reproduction or distribution of uncopyrightable material. (25) Though Congress did not enact the bill, such initiatives illustrate the ongoing debate about the extent to which copyright owners should be able to use license agreements to reduce fair use and first sale privileges. (26)

   3. UMG Recordings & Quanta Computer: Changing the Landscape of Ownership and the Ability to Contract Around Intellectual Property Protections

      The music industry has long offered free promotional CDs to radio stations, music critics, distributors, and other individuals to generate interest in new artists or music. (27) These CDs, which are not counted as part of an artist's calculation of sales or royalties, are typically stamped with a "promotional" label, indicating that the CD is licensed for personal use only and is subject to copyright law. (28) Nevertheless, recipients often give away such materials or, alternatively, sell them to third parties. (29)

      Recently, in UMG Recordings, Inc. v. Augusto, a California district court controversially diminished copyright owners' protections, holding that the first sale doctrine governs the distribution of promotional CDs. (30) UMG distributed promotional CDs affixed with a restrictive label to music insiders. (31) Augusto, a non-music insider, who acquired the promotional CDs from online auctions and various record stores, advertised and sold the aforementioned CDs as rare collectibles on eBay. (32) Subsequently, UMG filed suit, alleging that Augusto had infringed upon UMG's copyright. (33) In resolving the dispute, the court noted that Augusto's entitlement to first sale protections hinged on a single issue: did UMG transfer title to music insiders when it mailed the promotional CDs? (34)

      1. The Court's Findings in UMG Recordings

         In deciding this question, the court first had to determine whether the promotional CDs constituted a sale or a license...