Wednesday, January 5, 2011

From the Ninth Circuit: Giving CDs Away for Free Is a "Sale," But Selling Software for Money Isn't a "Sale"

While the title of this post perhaps gives away the answer, I thought I'd start the post with this quiz.  Which of the following is a "sale" of the goods involved?

A.  A record company gives promotional CDs away for free, with no right to get the CDs back once the recipient is done with them. 
B.  A software company sells software for money, with no right to get the software back once the buyer is done with the software. 

If you thought that "B" was a sale and "A" was not a sale, you're not alone (based on the unscientific home survey I did last night).  But based on two cases from the Ninth Circuit, you have it completely backwards.

The first case, decided in September 2010, was Vernor v. Autodesk.  The case involved Autodesk's sale of computer software; the Ninth Circuit opinion was the inspiration for my starting this blog.  My post on Autodesk was entitled, "The Ninth Circuit on first sale: "'If it looks like a duck, and quacks like a duck, and flies like a duck . . . it's a CHICKEN!'" Read that post for the background of the "first sale" doctrine, which in summary says that once a copyright owner sells a physical copy of a work, the buyer can resell the physical copy without implicating the copyright laws.  In Autodesk, the Ninth Circuit held that certain restrictions in Autodesk's end user agreements meant that even though its customers bought copies of the software for a one time fee and got permanent possession of the software (that is, Autodesk had no right to regain possession of the copies), the transaction was a license, not a sale, and the "first sale" doctrine didn't apply.  I commented that putting a "license" label on the transaction, which Autodesk did, didn't make the economic realities of the transaction a license instead of a sale, any more than calling a duck a "chicken" makes it a chicken.

Two other cases were argued before the Ninth Circuit the same day as Autodesk.  One of them, MDY v. Blizzard, was decided in December and only peripherally involves the first sale doctrine.  The other one, UMG v. Augusto, was decided yesterday.

Augusto involved UMG's distribution of promotional CD's.  UMG would give the CD's to disc jockeys and the like for marketing purposes.  UMG did not charge money for the CD's and gave them away unsolicited.  UMG marked the discs either "Promotional Use Only--Not for Sale" or with a promotional statement saying that the transaction was a license.  Augusto obtained copies of the CD's and tried to sell them on eBay; the lawsuit ensued.

Well, if the transaction in Autodesk wasn't a sale because Autodesk sold its software under a "license" agreement, then surely UMG's giving CD's away for free under a license agreement can't be a "sale" either, right?  In other words, the UMG CD's are even more of a "chicken" than the Autodesk software.

Not according to the Ninth Circuit, which ruled in favor of Augusto under the first sale doctrine (and also a Postal Act statute on unordered merchandise).  The Court stated:

We conclude that, under all the circumstances of the CDs’ distribution, the recipients were entitled to use or dispose of them in any manner they saw fit, and UMG did not enter a license agreement for the CDs with the recipients. Accordingly, UMG transferred title to the articular copies of its promotional CDs and cannot maintain an infringement action against Augusto for his subsequent sale of those copies.
. . .
It is one thing to say, as the [promotional] statement does, that “acceptance” of the CD constitutes an agreement to a license and its restrictions, but it is quite another to maintain that “acceptance” may be assumed when the recipient makes no response at all. This record reflects no responses. Even when the evidence is viewed in the light most favorable to UMG, it does not show that any recipients agreed to enter into a license agreement with UMG when they received the CDs.  Because the record here is devoid of any indication that the recipients agreed to a license, there is no evidence to support a conclusion that licenses were established under the terms of the promotional statement.

It's hard to disagree with any of this.  Except, of course, that most of the above applies equally to the software sales in Autodesk.  About the only difference is that buyers of mass-marketed software find when they open a shrink-wrapped package that there is a "license" agreement inside.  But otherwise, software buyers can dispose of the software as they see fit, and don't make a "response" to a shrink-wrapped license.

The Ninth Circuit says that software is different, though, to explain the different result in the two cases.  Its Augusto opinion says that its Autodesk "formulation, however, applies in terms to software users," and not to UMG's customers.  At least one problem with this is that the first sale statute itself makes no distinction between software and other works of authorship. 

Perhaps the Ninth Circuit will rehear Autodesk en banc, or perhaps the Supreme Court will review one of these cases.  In the meantime, it's hard to tell the ducks apart from the chickens in that Circuit.

Here is additional commentary by the EFF, Eric Goldman, and Techdirt.



A Tale of Two Experts

Yesterday the Federal Circuit decided Uniloc USA, Inc. v. Microsoft Corp.  The case is very interesting because of the holding on patent damages, but is personally interesting because it involved two experts I worked with at various times while in private practice.  The technical expert was vindicated in this opinion, while the damages expert -- who wasn't even involved in the case -- saw the Court disapprove a widely-adopted damages theory he had used for many years.

The Technical Expert

I worked with Uniloc's technical expert, David Klausner, in a number of cases starting in the late 1990's.  I liked David and enjoyed working with him.  In April 2009, David told me about a patent case where his side, plaintiff Uniloc, won a big patent verdict against Microsoft.  David provided testimony about how Microsoft's products infringed Uniloc's patent, and the jury agreed with him.  I congratulated David on this good result.  However, several months later, the trial judge threw out the verdict and entered judgment for Microsoft.  The judge's opinion was quite critical of David's testimony.

The case went up on appeal, and in yesterday's opinion, the Federal Circuit sided with Uniloc and David on infringement.  The Court found that David's testimony provided "substantial evidence" to justify the jury's verdict.  In particular, the Court addressed the trial court's criticism of David: "the district court improperly rejected Klausner’s testimony as 'incomplete, oversimplified and frankly inappropriate.'"  Rather, the Federal Circuit stated that "Klausner’s testimony was certainly a simplification of the functioning of MD5, but neither the district court nor Microsoft demonstrate why it was 'oversimplified,' Uniloc II, 640 F. Supp. 2d at 171 n.21, or even why it was inaccurate."

So good news for David Klausner and his client on the infringement issue.

The Damages Expert

Not such good news for a damages expert I once worked with, who didn't even testify in the case.  By way of background, in the late 1980's and 1990's I worked with Robert Goldscheider,  Bob was an impressive and knowledgeable licensing expert.  When I first met him, he told me about a theory of his that could be used to determine a reasonably royalty in patent case, which is now known as the "25 percent rule."  Bob's theory was that a reasonable patent royalty would be 25% of the licensee's expected profits for the product that uses the patent.  The theory is that the licensee gets to keep 75% of the profit (it builds the product, after all), and the patent owner gets the other 25%.  The Federal Circuit describes Bob as the "leading proponent" of the 25% rule, and discusses it at length (see pages 35-38 of the opinion).

Since the time Bob first told me about his theory, it had gained wide acceptance as at least a starting point in calculating a reasonable royalty.  Many other licensing or damages experts considered it.  The Federal Circuit's opinion lists quite a few cases using the 25% rule (see pages 39-41 of the opinion).  Uniloc's damages expert, Mr. Gemini, had used the rule to calculate his royalty rate, which the jury's damage award reflected (perhaps with a reduction).

In its decision, for the first time the Federal Circuit disapproved the 25% rule:

This court now holds as a matter of Federal Circuit law that the 25 percent rule of thumb is a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation.  Evidence relying on the 25 percent rule of thumb is thus inadmissible under Daubert and the Federal Rules of Evidence, because it fails to tie a reasonable royalty base to the facts of the case at issue.
. . .

. . . there must be a basis in fact to associate the royalty rates used in prior licenses to the particular hypothetical negotiation at issue in the case. The 25 percent rule of thumb as an abstract and largely theoretical construct fails to satisfy this fundamental requirement. The rule does not say any-thing about a particular hypothetical negotiation or reasonable royalty involving any particular technology, industry, or party.

Thus, although Bob didn't even get a chance to defend his theory in the Uniloc case, it has now been disapproved after decades of use.

In another part of the damages discussion, the Court disapproved the use of the "entire market value" rule by  Uniloc's expert.  The accused product was a software registration system for Microsoft's other products (such as Office and Windows), but Uniloc's expert also calculated damages as a percent of the sales of those larger products -- not just the registration system.  The Court disapproved this use of the "entire market value" analysis:

This case provides a good example of the danger of admitting consideration of the entire market value of the accused where the patented component does not create the basis for customer demand. As the district court aptly noted, “[t]he $19 billion cat was never put back into the bag even by Microsoft’s cross-examination of Mr. Gemini and re-direct of Mr. Napper, and in spite of a final instruction that the jury may not award damages based on Microsoft’s entire revenue from all the accused products in the case.” Uniloc II, 640 F. Supp. 2d at 185. This is unsurprising. The disclosure that a company has made $19 billion dollars in revenue from an infringing product cannot help but skew the damages horizon for the jury, regardless of the contribution of the patented component to this revenue.

Microsoft therefore got a new trial on damages.

This decision might yet be reviewed further by the entire Federal Circuit, or by the Supreme Court.  If the opinion stands, it operates as a substantial limitation on patent damages in future cases.
Here is further analysis by Patently-O.  UPDATE:  Here is an article by Joe Mullin.

Sunday, January 2, 2011

Oh Darn, I Named This Blog Incorrectly

I called this blog "IPDuck" with the "IP" short for "Intellectual Property."  Well, "Intellectual Property" is really just a shorthand for patents, copyrights, trademarks, and trade secrets (and maybe other things).  It's cumbersome to list all four of those things when you can abbreviate them to "Intellectual Property" or even shorter, "IP."

Only problem is the use of the word "property."  "Property" usually means things like your house (real property) or valuable possessions, like jewelry (personal property).  But patents, copyrights, trademarks, and trade secrets aren't really like that, for a bunch of reasons.  For example, patents, copyrights, trademarks, and trade secrets are legal rights only to exclude others from doing things -- patents in particular don't give you the right to practice your own invention.  (Imagine owning a house where you didn't have the legal right to live in it yourself, but only had the right to exclude other people from staying there.  Not much of a house, eh?)

In a blog post last week, Mike Masnick's blog points out that the term "Intellectual Property" is misleading in its use of the term "property."  See "Exposing the False Sanctity of Intellectual Property."   In a post later that same day, Masnick further points out that the term "Intellectual Property" is a relatively recent term.  Masnick's solution?  Call it "Intellectual Pooperty."

So maybe I misnamed this blog.  At least, keep in mind that I'm using a shorthand for convenience, and not asserting that there are any "property" rights in "IP."

Dave Barry's 2010 Year In Review

Has arrived.