The Future of Software Licensing

Posted By Derick Choi, Apr 22, 2014

Introduction

Copyright is a bundle of rights given to the creators of “original works of authorship”. It is a legal concept designed to grant the creator of an original work the exclusive right to create and distribute copies.[1] Copyright law has often grappled with the conflict between the rights of the copyright owner and the rights of the consumer of the copyrighted work. Under § 106, copyright owners have the exclusive rights to make and distribute copies of a copyrighted work. However, the right to copy and distribute said works is limited by §§ 106-122. Such limitations include but are not limited to fair use reproduction by libraries, and special limitations for computer programs.

The shift towards an all-digital model of distribution for software has only made the conflict between copyright holders and copy holders worse. The rapid growth of the digital economy has helped spur technological innovation and create new global markets. The rise of the digital revolution also comes with its costs. The software industry faces issues of piracy, where users distribute illegal software that could account for approximately 40 per cent of the global market.[2] Software companies that own the copyrights should be and are understandably concerned. One method that copyright holders have adopted to protect their rights is the use of licenses. Virtually all software is licensed to end users so they do not own the copy of software in question but merely have a right to use it.[3] Given the relative ease of copying programs, this issue has enormous importance to software companies. It is in the interest of the companies to restrict distribution in order to protect their copyrights. On the other hand, users have as much of an interest to distribute programs to each other without paying software owners. Fortunately, copyright law also grants the software users some rights against the software companies.

First Sale Doctrine and Exhaustion

Under the “first sale” doctrine enshrined in §109(a), the sale of a lawful copy terminates the copyright holder’s right to interfere with subsequent sales or distribution of that copy.[4] The first sale deals with the distribution rights of the user for that particular copy. Once the first sale is completed, the copyright owner’s §106(3) exclusive distribution right is “exhausted” and subsequent owners of the copies are free to dispose of it in the manner they choose. The owner of the copy cannot reproduce the work. For example, a book publisher has the right to produce copies and prevent anyone else from making those copies. He sells a book to a customer. Once a publisher sells that book, he cannot prevent the customer from disposing of it however they wish; selling it; leasing it; or simply throwing it away. However, with the emergence of the digital era, distribution is no longer as simple as selling a book to another person.

Court Interpretations of Licensing

The emergence of software technology, especially software produced by videogame publishers, has produced problems for copyright. Companies have sought to protect against users transferring the software to other users primarily through contract such as End User License Agreements (EULA). For example, a provision in Electronic Art’s Battlefield 4 EULA states:

Through this purchase, you are acquiring and EA grants you a personal, limited, non-exclusive license to install and use the Software for your non-commercial use solely asset forth in this License and the accompanying documentation. Your acquired rights are subject to your compliance with this Agreement. Any commercial use is prohibited. You are expressly prohibited from sub-licensing, renting, leasing or otherwise distributing the Software or rights to use the Software. The term of your License shall commence on the date thatyou install or otherwise use the Software, and shall end on the earlier of the date that: (i) you dispose of the Software, (ii) your subscription to the Software is terminated, cancelled, or expires, or (iii) EA terminates this License. Your license will terminate immediately if you attempt to circumvent the technical protection measures for the Software.[5]

However, state contract law is preempted by the federal Copyright Act and therefore limited to the extent that the provisions under Title 17 allow. If the Copyright Act allowed users to lease, license or distribute their copy, the license agreements such as the EULA above would not be able to prevent them from doing so. Consequently, if the doctrine of the first sale allows owners of copyrighted work to distribute said work as they saw fit, restrictions on distribution in the EULA would not be enforceable.

There is no bright-line rule that the courts uniformly apply in determining whether a sale has occurred or not. Court decisions have not provided clear instructions on how to approach the license/owner issue. Some courts have analyzed the agreements themselves to determine whether it would be a sale. Others courts have taken a simplistic approach in judging whether there was a sale or not. In MAI Systems Corp. v. Peak Computers, the Ninth Circuit stated that because there was a license agreement that prohibited the copying or use of MAI’s software, Peak could not copy it.[6] The court did not look at the specific terms of the license agreement in its determination. However, a subsequent decision by the Federal Circuit advocated a more nuanced interpretation. In DSC Communications Corp. v. Pulse Communications, Inc., Judge Bryson rejected the Ninth Circuit’s characterization of all licensees as non-owners.[7] Bryson disagreed with the ruling in MAI because it failed to distinguish between the ownership of a copyright and ownership of copies of the copyrighted software.[8] This distinction is important because copy owners may have distribution rights after the “first sale” and are not subject to inference by the holder of the copyright.[9] The court acknowledged that whether right of possession is perpetual or the possessor’s rights were obtained through a single sale were relevant factors in considering software ownership.[10] However, the court still found that Pulse was a licensee because of other restrictions that were inconsistent with the status of owner.[11] However, the legal importance of the court’s interpretation is that labeling a particular transaction as either a sale or license agreement within a contract is not necessarily determinative. The Second Circuit went to apply these factors in Krause v. Titleserve, Inc. By looking at Titleserve’s degree of ownership, the court determined that there was a sale. The court considered the following factors to be relevant: Titleserve paid Krause substantial consideration; Krause never reserved the right to repossess the copies used by Titleserve; Titleserve had the right to continue to possess and use the program forever regardless of its relationship with Krause; and Titleserve could discard or destroy the copies any time it wished.[12] As a result of all of those factors, the court held that Titleserve was an owner of a copy under §117.[13] The court also ruled on the question of formal title. The court stated that the absence of a formal title is a factor but it may be outweighed by evidence that the possessor of the copy enjoys “sufficiently broad rights over it to be sensibly consider its owner.”[14] Justifying the description as a sale, Judge Leval stated:

It seems anomalous for a user whose degree of ownership of a copy is so complete that he may lawfully use it and keep it forever, or if so disposed, throw it in the trash, to be nonetheless unauthorized to fix it when it develops a bug, or to make an archival copy as backup security.[15]

Looking back at the Electronic Art’s EULA for Battlefield 4, the Second Circuit may have determined it was a sale. Looking at the factors considered in Krause, the Battlefield 4’s EULA does not reserve a right to repossess the software. It does not indicate a time limit for owner’s use of the software in relation to EA, it implies that the users may dispose of the software if they wish. It is likely that the user paid for the software, so there was consideration. The Second Circuit’s decision is not binding on other circuit courts. The court precedent on this issue has been unclear and has not provided a clear guideline for courts debating the issue today.

Current Status

Courts, even within the same circuit, have been inconsistent in deciding whether the purchase of software constitutes a sale, which is subject to the first sale doctrine, or a license, which is not. One of the Ninth Circuit’s more recent cases reflects the prevailing approach of the courts. In Vernor v. Autodesk, the Ninth Circuit took an approach similar to the MAI and DSC Communications cases. The court rejected the district court’s classification of the transfers of AutoCAD copies as sales. The court singled out three considerations to determine whether a software user is a licensee or an owner of a copy. First, whether the copyright owner specified that the user is granted a license. Second, whether the owner significantly restricts the user’s ability to transfer the software. Finally, whether the owner imposes notable use restrictions.[16] Vernor incorporates the MAI face value interpretation of license with the various factor test advocated under DSC Communications. But the stance taken by the Ninth District is in no way set in stone. The factors that courts consider to be dispositive vary from court to court. For example, the Ninth Circuit thought that the transferee’s ability to possess a print indefinitely was not dispositive. In contrast, the Second Circuit placed strong emphasis on the ability of the user to “lawfully use…and keep forever…”[17] Clearly, American courts are having difficulty in generating a consistent approach for addressing what combinations of factors are dispositive in determining a sale or a license.

An Alternative Approach

The current debate on what factors determine whether a software company is licensing or selling copies may not produce the best solution to this problem. A recent court case in the EU may have come up with a novel way of handling this dilemma. The Court of Justice of the EU found that the right to distribute computer software is “exhausted” when the program is downloaded. In UsedSoft v. Oracle, the court took novel yet balanced approach to the issue of software sales. Echoing the 2nd Circuit Court’s opinion, the court noted the awkwardness of granting a customer the right to use a copy for an unlimited time, in return for a fee, would be classified as a license as opposed to a sale.[18] Recognizing the concern of illicit reproduction, the court stated that a user who resold the copy of the software in question must make his own copy unusable when he/she re-sells or distributes it to someone else.[19] This alleviates some of the concern of software companies who would be afraid of their software being copied in violation of their copyright during subsequent distributions of the copy. On the other hand, it preserves the right of the user to distribute the good.

If courts begin taking the approach that the EU may be moving towards, a potential secondary market could emerge. Users who have programs that they no longer use will be able to sell their copies to other users. The benefits are clear to the users who will not necessarily have to buy directly from the software owners. Copyright holders are still able to control the amount of a program distributed through market since users are required to disable their own copy upon transferring it to another user. While the requiring the owner to disable their own copy may be difficult, the use of registration and online authentication upon use may overcome that technical issue. The EU’s new approach to software sales may be the solution that finally ends the ongoing debate.

Conclusion

The consensus on whether software license agreements are sales remains elusive. As noted by the EU Court of Justice, it is a legal fiction to call the transfer of software a license as opposed to a sale. The fiction may be necessary to protect software creators because copying software and distributing illegal copies is now relatively easy. On the bright side, courts are beginning to move beyond simply accepting the agreements as licenses at face value. As courts continue to grapple with the use of license agreements regarding software transfers, the ease of distributing copies of software continues to dramatically increase. Several industries have even begun to shift towards solely using digital distribution. Within the videogame industry, which adapted quickly to online distribution, Valve’s Steam and Electronic Art’s Origin are amongst the most prominent of the distribution systems. Steam alone boasts over 2,000 games that can be downloaded directly to one’s computer.[20] Basing entire economies on agreements that may not be valid is a major concern to all parties. It is not an exaggeration to say that entire markets such as the secondary market for software could emerge if the courts ruled in a certain way. Therefore, it is imperative that either the courts or the legislature provide clear guidance to both companies and users as to software purchases.


[1] 17 U.S.C.A. § 106(1).

[2] International Telecommunication Union, Intellectual rights in Today’s digital economy, available at http://www.itu.int/net/itunews/issues/2011/07/38.aspx

[3] Fishman, Stephen. Why Use a License to Sell Software?, available at

http://www.nolo.com/legal-encyclopedia/why-use-license-sell-software.html-0.

[4] See 17 U.S.C.A. § 117(b).

[5] Electronic Arts Software End User License Agreement, Battlefield 4, available at

http://eacom.s3.amazonaws.com/EULA_BF4_ROW_PC+8+6+13.pdf

[6] See generally MAI Systems Corp. v. Peak Computer, Inc., 991 F.2d 511 (9th Cir. 1993)

[7] DSC Communications Corp. v. Pulse Communications, Inc., 170 F.3d 1354, 1363. (Fed. Cir. 1999)

[8] Id. at 1360.

[9] See generally Parfums Givenchy, Inc. v. Drug Emporium, Inc., 38 F.3d 477, 480 (9th Cir. 1994).

[10] DSC Communications Corp., 170 F.3d at 1362.

[11] Id.

[12] Krause v. Titleserve, Inc., 402 F.3d 119, 123 (2d Cir. 2005).

[13] Id.

[14] Id. at 124.

[15] Id. at 123.

[16] Vernor v. Autodesk, Inc., 621 F.3d 1102, 1111.

[17] Krause, 402 F.3d at 123.

[18] UsedSoft GmbH v. Oracle International Corp., Case C-128/11, E.C.J. 49 (2012).

[19] Freshfields Bruckhaus Dringer LLP, EU landmark decision opens way to second-hand software market, available at http://www.freshfields.com/uploadedFiles/SiteWide/Knowledge/34097%20final.pdf.

[20] http://store.steampowered.com/about/.