Stopping Digital Copyright Infringement Without Stopping Innovation[1]

Mark A. Lemley[2] & R. Anthony Reese[3]

Suing actual infringers is passé in copyright law. In the digital environment, the real stakes so far have been in suing those who facilitate infringement by others. Copyright owners tend not to sue those who trade software, video, or music files over the Internet. Indeed, such suits are so rare that the RIAA’s recent announcement that it would sue some actual infringers sent shock waves through the legal community. Instead, copyright owners sue direct facilitators like Napster,[4] makers of software that can be used to share files,[5] those who provide tools to crack encryption that protects copyrighted works,[6] search engines that help people find infringing material,[7] and quasi-ISPs like eBay or Yahoo Auction.[8] All of these suits rely on theories of secondary liability, focusing on those who provide services or write software that can be used in an act of infringement.[9]

In addition, there is a new theory of what might be called “tertiary” liability that seeks to reach those who help the helpers. Cases in this vein include lawsuits filed against those who help others crack encryption, for example by providing links to software that can be used to crack encryption,[10] the copyright lawsuit against backbone providers for providing the wires on which copyrighted material flows,[11] the claims filed against the venture capital firm of Hummer Winblad for its role in funding Napster,[12] and (with an unusual twist) the malpractice suit against the law firm of Cooley Godward for advising mp3.com that it could assert defenses to copyright infringement.[13] The anticircumvention provisions of the Digital Millennium Copyright Act (DMCA) provide for one particular type of tertiary liability (for providing tools that circumvent encryption protecting a copyrighted work and that can be used to infringe the work’s copyright),[14] and there have even been suggestions that there should be a new tort of contributory violation of the DMCA’s anticircumvention provisions, which should perhaps be termed quaternary liability for copyright infringement.[15]

Further, a number of doctrines that were designed to protect these secondary and tertiary “facilitators” – the “safe harbor” for online service providers,[16] the restrictive standard for contributory copyright infringement for equipment providers announced by the Supreme Court in the Sony Betamax case,[17] and the requirement that vicarious infringement be limited to cases of direct financial benefit[18] – are under attack. The ALScan and Perfect 10 cases undo much of the benefit of section 512’s protection for Internet service providers.[19] Napster rewrites the rule of Sony in a way that significantly limits its application.[20] And both Napster and Fonovisa have all but eliminated the requirement of direct financial benefit in vicarious infringement.[21] It’s also worth noting that the doctrine of the corporate veil, which protects investors from liability in most areas of law, appears not to function in copyright.[22] And proposed legislation would go even further in regulating the behavior of those who do not themselves infringe, injecting Congressional oversight into how software and consumer electronics are built[23] and permitting content owners to unleash destructive hacks of computer networks without fear of liability.[24]

There is of course a good reason copyright owners are filing such suits. They see themselves as under threat from a flood of cheap, easy copies and a dramatic increase in the number of people who can make those copies. The high volume of illegal uses, and the low return to suing any one individual, make it more cost-effective to aim litigation at targets as far up the chain as possible. From the perspective of the music industry, it’s easier and more effective to shut down Napster than to sue the millions of people who traded files illegally on Napster. So far, the courts have been largely willing to go along, shutting down a number of innovative services in the digital music realm, though refusing to ban the provision of peer-to-peer (p2p) software by Streamcast and Grokster.

In this article, we focus on one strand of these cases against those who allegedly facilitate copyright infringement – those dealing with distribution of digital content over p2p networks. We argue that unrestricted liability for anyone who is in any way involved with copyright infringement is a bad idea. Indirect liability is a continuum, in which acts most closely related to infringement and with the fewest affirmative benefits are the easiest to condemn. Napster was a relatively easy case for liability, because the service was limited to trading music files and virtually all of the files actually traded were illegal. The Grokster case is a substantial step further removed from infringement, both because the defendants’ involvement is less (indeed, resellers like Grokster are arguably merely conduits for providing software, an activity which should be legal under most circumstances)[25] and because the noninfringing uses of KaZaA and similar software involved in the case are greater. Lawsuits against ISPs, search engines, telephone companies and other indirect providers, while not the focus of our attention here, are even more problematic because of the many legal uses of these services. The key policy point is that going after makers of technology for the uses to which their technologies may be put threatens to stifle innovation. Similarly, going after necessary third parties like investors and law firms will stifle investment in innovation. The fundamental difficulty is that while courts can make decisions about direct infringement on a case-by-case basis, lawsuits based on indirect liability necessarily sweep together both socially beneficial and socially harmful uses of a program or service, either permitting both uses or condemning both.

A middle ground has so far largely been lacking in this debate. Our aim in this article is to seek such ground.[26] Optimal digital copyright policy with respect to p2p networks would do two things: stop deterring innovators, and permit cost-effective enforcement of copyright in the digital environment.[27] Economically, one can estimate the cost to society from enforcement of the indirect liability rules against p2p providers as a function of the legal uses that that law effectively forbids, plus the foregone efficiency of the p2p distribution mechanism relative to industry-driven distribution of copyrighted content, plus the social value of foregone innovation that results from deterring would-be innovators. If we compare this cost to the benefits accrued by giving digital copyright owners another, more convenient forum to sue, it is not at all clear that the benefits of the new, expanded indirect liability rules exceed the costs in most cases.

Moreover, we need not make this difficult tradeoff at all unless it is clear that copyright owners have no effective alternatives to suing facilitators.[28] The basic economics of copyright enforcement, however, do suggest alternative approaches. It is not currently cost-effective for copyright owners to sue individual infringers, because there are tens of millions of them, because lawsuits are expensive, and because many infringers would only be liable for (or able to pay) minimal damages. Copyright owners are happy to sue facilitators instead, because there are fewer of them and both damages and the benefits of injunctive relief are substantial. Copyright owners have no incentive to permit optimal innovation by facilitators, because they do not benefit from that innovation except indirectly. Individual infringers in turn have no incentive to change their behavior or to subscribe to fee-based services, because they suffer none of the costs of infringement. In this paper, we suggest three possible alternatives that might provide ways out of the digital copyright morass.

One solution is to change the incentives of individuals potentially engaged in copyright infringement. Because individual users of p2p networks know that it is extremely unlikely they will be sued, economic theory suggests that the only way to effectively deter infringement is to increase the effective sanction substantially for those who are caught.[29] Were the government to criminally prosecute selected users of peer-to-peer services, or were copyright owners to sue those users and obtain extremely large monetary judgments, we suspect it could have a substantial deterrent effect on many illegal users. Selective enforcement has other advantages as well – the suits could target the relatively few keystone providers of illegal files on p2p sites, and those are precisely the users whose activities are most likely infringing. While particular prosecutions won’t stop illegal file trading altogether, copyright owners have never been able to prevent all piracy. All they need to do is reduce piracy enough that they can make a return on their investment.

Another solution is to change the incentives for copyright owners to pursue individual infringers by reducing the cost of such enforcement. One such approach would be a levy system of the type proposed by Neil Netanel.[30] Levies on equipment or services have the virtue of permitting automatic collection of royalties, reducing the enforcement cost dramatically, but at the cost of taxing legal as well as illegal uses. A levy solves the enforcement problem at the front end, but as with the current approach of suing facilitators, it imposes the costs of copyright enforcement on innovators. The main difference is that under a levy system the copyright owner is protected by a compulsory license rather than a property rule.

A second way to reduce the cost of enforcement is to create some sort of quick, cheap arbitration system that enables copyright owners to get some limited relief against abusers of p2p systems. The existing domain name trademark arbitration system is a model in some respects – its speed and low cost -- but a cautionary tale in others – its lack of due process protections.[31] Digital copyright law also differs in some significant ways from the law governing domain names, and the design of a private arbitration system would have to reflect those differences. One way to design this system is not to mandate it, as ICANN does for domain name registrants, but to offer a safe harbor to any intermediary that requires its users to participate in the system. Once users have registered and agreed, they could be challenged by copyright owners if they are uploading (not just downloading) copyrighted files. The system could also be designed to improve accuracy relative to the binary choice the courts face in indirect infringement cases today. We could design the system so that it is limited to "clear cases" – say uploading of more than 10 files to a network in a one-week period. We could also build in a defense for arguable fair uses, so that a user who could prove she was uploading only out-of-print works or that she was space-shifting CDs she already owns might have a defense.[32] Such a system would permit low-cost enforcement of copyright infringement against direct infringers, reducing the need for content owners to sue facilitators. Relative to levies, an arbitration system would trade off some increase in cost for accuracy, targeting only those making illegal uses rather than all users of computers or p2p networks. It would be more fair than selective criminal or civil prosecution, because the burden of paying the penalty for infringement would fall more evenly on each wrongdoer, rather than imposing stark punishment on a few in order to serve society’s interest in deterring the rest.

None of these approaches is perfect. Each has its advantages and disadvantages, and is likely to work better in some contexts than in others. But it is clear that something must be done to escape the current linkage between stopping copyright infringement over p2p networks and stopping innovation. The economics of copyright enforcement suggest two basic types of alternatives – raising the cost of direct infringement, or lowering the cost of suit. Pursuing a combination of these approaches—selective enforcement, levies, and an arbitration safe harbor—is preferable to the status quo.

In Part I, we make the case that there has been a seismic shift in copyright infringement in the digital environment, away from suing direct infringers and towards suing facilitators with less and less connection to the act of copyright infringement. Our discussion in this part focuses on issues relating to p2p networks, though these cases are part of a broader trend towards suing facilitators rather than direct infringers online. In Part II, we examine the economics of digital copyright infringement. This part explains why copyright owners are suing facilitators, why doing so is bad for society, and outlines the possible alternatives at a theoretical level. Part III makes those alternatives more concrete by applying them to the problem of infringement over p2p networks. Section III.A explores how a system of criminal prosecution of, or severe civil penalties against, high-volume uploaders might work and discusses its likely consequences. Section III.B evaluates the pros and cons of a p2p levy system and proposes an additional alternative: a safe harbor for p2p facilitators who agree to implement an arbitration system designed to stop digital piracy. Part III also discusses the limitations and potential problems of these approaches. We conclude that implementing a combination of these strategies may offer copyright owners effective protection without unduly hampering innovation in p2p networks.

I. Suing Facilitators

Suits seeking to hold someone other than a direct infringer liable for copyright infringement are not new. Although the Copyright Act throughout the twentieth century was essentially silent on the issue of liability for anyone other than a direct infringer, courts read the statute as imposing such liability in certain circumstances, and Congress endorsed that view in the 1976 Act.[33] Two doctrines of secondary liability have emerged in copyright law: contributory infringement and vicarious liability. With respect to contributory infringement, “one who, with knowledge of the infringing activity, induces, causes or materially contributes to the infringing conduct of another, may be held liable as a ‘contributory’ infringer.”[34] With respect to vicarious liability, “one may be vicariously liable if he has the right and ability to supervise the infringing activity and also has a direct financial interest in such activities.”[35]

The digital era has so far seen an expansion of secondary liability in two main ways. First, producers and suppliers of technology that has both infringing and noninfringing uses have increasingly been held liable for infringements committed by their users. Second, the directness of the financial interest in infringing activity required before a defendant is held vicariously liable for that activity has been significantly loosened. And although Congress has provided some limitations on the liability of online service providers, those limitations have not significantly cut back on secondary liability, and in any event are often a poor fit for the activities of p2p providers.

A. Indirect Liability and “Dual-Use” Technologies

The impact on innovation of imposing indirect liability for copyright infringement is particularly important with respect to what might be called “dual use technologies.” These are products or services that can be used by the consumer in noninfringing ways, but that can also be used to infringe copyright. The phenomenon of dual-use technologies is not a new one. After all, musical instruments can be put to both non-infringing uses—such as performances of the performer’s own musical works or uncopyrighted works, as well as private performances (or licensed public performances) of copyrighted musical works—and infringing uses, such as unlicensed public performances of copyrighted musical works. So can typewriters, printing presses, and photocopy machines. But the question of whether the developer or supplier of such dual-use technology can be held liable for copyright infringements committed by a purchaser of the technology has attracted substantial legal attention only in the last 25 years or so, and the principal precedent on the question is the Supreme Court’s 1984 decision in Sony Corp. v. Universal City Studios, Inc.[36]

That decision imposed an important limit on secondary liability in the context of the manufacture and sale of dual-use devices. Universal and Disney, which own copyrights in many motion pictures and television shows, sued Sony over its manufacture and sale of videocassette recorders (VCRs), alleging that people who bought VCRs and used them at home to tape broadcasts were engaged in copyright infringement, and that Sony was liable for contributing to that infringement. The Court, by a 5-4 vote, declined to impose secondary liability on Sony, announcing a test borrowed from patent law for holding liable those who manufacture and market devices that buyers might use to infringe copyright: “[T]he sale of copying equipment, like the sale of other articles of commerce, does not constitute contributory infringement if the product is widely used for legitimate, unobjectionable purposes. Indeed, it need merely be capable of substantial noninfringing uses.”[37] Because the Court determined that a VCR was capable of substantial noninfringing use, Sony was not liable for the infringing uses committed by VCR owners merely because it sold the machine.

The substantial noninfringing use test was designed to reconcile the need to give copyright owners effective protection for their works and “the rights of others freely to engage in substantially unrelated areas of commerce.”[38] The Court’s concern, easily discernible in its analogy to the “staple article of commerce” doctrine in contributory patent infringement cases, was that copyright owners not be allowed to control the development of new technologies used in connection with copyrighted works. Although the issue directly before the Court in Sony was a claim of contributory infringement,[39] the opinion strongly suggested that its analysis applied to secondary liability for copyright infringement generally, and that the principles in its decision would bar using copyright’s vicarious liability doctrine to hold Sony liable for infringements committed by VCR users.[40]

The Sony doctrine clearly provides significant protection for innovation in technologies that are related to the use of copyrighted material. Where such innovation leads to a dual-use product or service—that is, a product or service capable of substantial noninfringing use—the innovator can generally rely on Sony for assurance that she will not be held liable for those infringements that consumers commit using the new technology.

In the context of peer-to-peer networks, however, lower court decisions have called into question the protection that the Sony doctrine offers developers of dual-use technologies, though the courts’ opinions leave some uncertainty about how far the cutback goes. The Ninth Circuit’s decision in A&M Records, Inc. v. Napster[41] is emblematic of this trend. Music copyright owners sued Napster, charging that users of the Napster network were infringing their copyrights and that Napster was liable for the users’ infringements. Napster argued that its software and network were capable of substantial noninfringing use and that Sony therefore shielded it from liability for users’ infringements. The Ninth Circuit, however, read Sony narrowly. The Sony opinion, the Ninth Circuit concluded, merely barred a court from imputing to a defendant constructive knowledge of another party’s infringement if the defendant was the maker of copying equipment that was “capable of substantial noninfringing use.”[42] Thus, making and selling equipment capable of noninfringing use could still lead to secondary liability for users’ infringements if a copyright owner could establish by other means that the maker knew, or perhaps should have known,[43] of the users’ infringements and materially contributed to them. The Ninth Circuit found that Napster had actual knowledge that infringement had occurred on its network and that Napster provided the facilities for that infringement, so Napster could be liable for contributory infringement.[44]

It is worth noting that it is not clear that Sony itself would have escaped secondary liability under the Ninth Circuit’s reading of the Supreme Court’s test. The Napster court based its finding of actual knowledge on notices provided by copyright owners to Napster, charging specific past instances of infringing uses of Napster. It seems quite likely, however, that Disney and Universal would have been able, in the wake of the Sony decision, to provide notice to Sony alleging specific infringing uses by particular VCR owners. Survey evidence in the case indicated that “a substantial number of [survey respondents] had accumulated libraries of tapes,”[45] and the Supreme Court’s opinion did not address the question of whether library building was a noninfringing fair use. It therefore seems likely that the studios could have given Sony actual knowledge of infringing use of its VCR by some users and thus, under Napster’s reading, perhaps overcome the Sony court’s limitation on secondary liability. Since making and selling a VCR seems likely to be a material contribution to the infringing recording of television broadcasts, the consumer-electronics maker might well have been liable under Napster’s interpretation of Sony.[46]

The Napster court also limited the protective reach of Sony by holding that a product’s capability for substantial noninfringing use was entirely irrelevant to the issue of vicarious liability. As noted above, the Supreme Court’s opinion in Sony suggested that the maker of a product capable of substantial noninfringing use would not be indirectly liable for user’s acts of infringement under either a contributory infringement or a vicarious liability theory. The Napster opinion, however, suggests that the noninfringing uses to which an innovator’s technology can be put are irrelevant to the question of vicarious liability.

Post-Napster decisions on peer-to-peer systems have taken conflicting approaches in applying Sony to those systems.

1. Aimster

Aimster provided a file-sharing service over the instant messaging (IM) networks of AOL, ICQ, and Yahoo!. The IM networks allow users to share files with select lists of “buddies,” by providing connections to openly available files and by allowing users to send specific files to one another. Aimster built upon this capability by allowing users to designate all Aimster members as “buddies,” thus allowing users to search for files available on any Aimster member’s open space. In 2001, Aimster began offering an additional fee-based service that provided lists of popular downloaded songs without any additional requests by the user.

Following the Napster decision, Aimster filed for declaratory relief in 2001; and the RIAA and record companies filed suit for copyright infringement. Aimster filed for bankruptcy in May 2002, and the bankruptcy court ordered an immediate decision on the copyright owners’ pending motion for a preliminary injunction. In October 2002, the court allowed Aimster to continue operations, but ordered it to refrain from allowing any downloading of the record company plaintiffs’ works, and to post a $500,000 bond.[47] In a December follow-up order, the court ordered Aimster to disconnect its website and servers entirely, and gave the RIAA permission to request Aimster’s ISPs to disconnect service if Aimster did not do so voluntarily.

The District Court Decision

Aimster argued that the Sony doctrine shielded it from liability because the Aimster software could be used for noninfringing purposes, including transferring noncopyrighted files (or presumably files in which the transferring party owned the copyright) to other users. The district court rejected the argument, advancing several grounds for distinguishing Sony and concluding that the doctrine did not prevent Aimster from being held liable for infringements committed using its software.

First, the court found that even though the Sony court had framed the question as whether a product was “capable of substantial noninfringing uses,” the actual facts in Sony established that the VCR’s “principal use” was noninfringing, whereas there was no evidence before the court that any Aimster user had actually used the software for any of the potential noninfringing uses that Aimster identified. And the court stated that such evidence would have to establish not merely that Aimster was capable of such use, or that it had actually been used for noninfringing purposes, but that such use “constituted Aimster’s primary use.”[48] In essence, the District Court read the Sony majority to embody an even stricter view of when makers of copying equipment are protected against claims of secondary liability than that held by the Sony dissenters, who would have ruled that “if a significant portion of the product’s use is noninfringing, the manufacturers and sellers cannot be held contributorily liable for the product’s infringing uses.”[49] None of the verbal formulations used in either Sony opinion indicated that secondary liability could be imposed so long as a product did not have a primary noninfringing use.

In addition, the court suggested that Sony only immunized a supplier of copying equipment against private, home-use copying done using its equipment, and not against the “widespread distribution of infringing works.”[50] The court also suggested that Sony did not apply when a product was “specifically manufactured for infringing activity,” even if the product did have noninfringing uses, and the court found that Aimster’s service was in fact specifically designed to assist users in infringement.[51]

Next, the court ruled that Sony applied only to a “staple article of commerce,” and Aimster was not such an article. A VCR was a “discrete product” that was sold to a buyer who then used the machine as she saw fit. The court viewed Aimster not as such a product but as an ongoing service that involved an ongoing relationship between Aimster and its users.[52] Finally, the court read Sony as applying only if the defendant did not influence or encourage the infringement by the users of its product, and found that Aimster did both.[53]

The district court’s reading of Sony in Aimster narrowed even more substantially than did the Napster court the space that the doctrine would provide for developers of new technologies that have both infringing and noninfringing uses to produce and market those technologies without being held liable for copyright infringement committed by the technologies’ users. A technology’s capability for substantial noninfringing uses would appear to be irrelevant to the innovator’s secondary copyright liability if the product’s principal actual use was infringing.

The Seventh Circuit’s Decision

The Seventh Circuit affirmed the preliminary injunction, but on substantially narrower grounds. The Seventh Circuit expressed concern about the impact of secondary liability on the development of new online services. It held that in applying the Sony doctrine to the provider of an ongoing service (rather than a discrete product), the service provider’s ability “to prevent its customers from infringing is a factor to be considered in determining whether the provider is a contributory infringer.”[54] But the court recognized that ability to prevent infringement should not in itself determine liability because such a rule would have “alarming” adverse consequences for the provision of “dual use” services:

If a service facilitates both infringing and noninfringing uses, … and the detection and prevention of the infringing uses would be highly burdensome, the rule [that imposes liability whenever the service provider knows of infringing activity and could prevent it] could result in the shutting down of the service or its annexation by the copyright owners (contrary to the clear import of the Sony decision), because the provider might find it impossible to estimate its potential damages liability to the copyright holders and would anyway face the risk of being enjoined.[55]

The Aimster court also expressed disagreement with the Ninth Circuit’s position in Napster, which it characterized as “suggesting that actual knowledge of specific infringing uses is a sufficient condition for deeming a facilitator a contributory infringer.”[56]

The court did not, however, merely reaffirm the Sony opinion’s language that secondary liability would not be imposed on the supplier of a technology that is “capable of substantial noninfringing use.” Rather, it held that in order to determine whether the supplier of a dual-use service was liable for user’s infringements, “some estimate of the respective magnitudes of [noninfringing and infringing] uses” must be made.[57] The court made clear that it was not enough for Aimster to show that “its file-sharing system could be used in noninfringing ways.”[58] The fact that a product or service is capable of noninfringing uses would not exempt the supplier from liability if the product or service “in fact is used only to infringe.”[59] Because there was evidence that Aimster’s system was in fact being used for infringing purposes, the court said that the burden shifted to Aimster, at least at the preliminary injunction stage, “to demonstrate that its service has substantial noninfringing uses.”[60] It turned out, however, that the court did not in fact think that it was sufficient that Aimster service had noninfringing uses. What the court actually required was that Aimster quantify how much of the use of its system was noninfringing. Thus, although the court itself explained several possible noninfringing uses of the Aimster system, it concluded that “[i]t is not enough … that a product or service be physically capable, as it were, of a noninfringing use. Aimster has failed to produce any evidence that its service has ever been used for a noninfringing use, let alone evidence concerning the frequency of such uses.”[61] This lack of evidence relieved the court from having to decide how frequent noninfringing uses would have to be for the service provider to escape liability for infringing uses of the service, though it quoted the district court’s language on Aimster’s failure to show that the “primary” use of the system was noninfringing.

The court further suggested that even if a new technology was not only capable of substantial noninfringing use but was in fact used in noninfringing ways, that would not in itself be enough to avoid secondary liability for actual infringements:

Even when there are noninfringing uses of an Internet file-sharing service, moreover, if the infringing uses are substantial then to avoid liability as a contributory infringer the provider of the service must show that it would have been disproportionately costly for him to eliminate or at least reduce substantially the infringing uses.[62]

The requirement, at least in the context of peer-to-peer services, that a supplier design her service to prevent or reduce infringement unless it is excessively costly to do so appears to go beyond what Sony required: although the dissenters in Sony discussed design alternatives available to Sony that would have reduced infringement, the majority made no mention of those possibilities as relevant to the question of Sony’s liability for its users’ infringements.[63]

While the Seventh Circuit’s Aimster decision preserves more of the Sony doctrine’s protection for innovators of dual-use technology than does the Ninth Circuit’s Napster opinion, Aimster’s interpretation of Sony does pose significant challenges to innovation. Someone who develops a new dual-use technology must be concerned about whether noninfringing use of that technology will not only be “substantial,” but perhaps whether it will be the primary use, as well as whether she will be able to prove that substantial or primary use in court. Perhaps more significantly, even if the innovator is confident as to how the technology will be used, she will have to consider, at least in the case of services, whether she can design the technology to reduce or eliminate the possibility of infringing uses of the technology, what the costs of doing so are, and whether a court will decide that those costs are “disproportionate” and so need not be expended.

2. Grokster

Yet another approach to applying Sony to peer-to-peer services emerged in the decision of the district court in California against Grokster Ltd. and StreamCast Networks, providers of peer-to-peer software. Record and movie studios sued several defendants, alleging that users of their software infringed on the plaintiffs’ copyrights and that the defendants, as providers of the software, were secondarily liable for that infringement. In April 2003, the district court granted summary judgment to two of the defendants, Grokster and StreamCast, which disseminate the “Grokster” and “Morpheus” software, respectively.[64] The Grokster decision follows Napster in reading Sony as only barring the imputation of constructive knowledge to a defendant who has supplied a product or service that is capable of substantial noninfringing use. But in applying the principles announced in Napster to the providers of peer-to-peer software, the Grokster court appears to have given innovators of dual-use technologies more breathing room.

The court described the operation of the Grokster and Morpheus networks as follows:

Although novel in important respects, both the Grokster and Morpheus platforms operate in a manner conceptually analogous to the Napster system …

In both cases, the software can be transferred to the user’s computer, or “downloaded,” from servers operated by Defendants. Once installed, a user may elect to “share” certain files located on the user’s computer, including, for instance, music files, video files, software applications, e-books and text files. When launched on the user’s computer, the software automatically connects to a peer-to-peer network … and makes any shared files available for transfer to any other user currently connected to the same peer-to-peer network.

Both the Morpheus and Grokster software provide a range of means through which a user may search through the respective pool of shared files. … Once a search commences, the software displays a list (or partial list) of users who are currently sharing files that match the search criteria…

The user may then click on a specific listing to initiate a direct transfer from the source computer to the requesting user’s computer. When the transfer is complete, the requesting user and source user have identical copies of the file, and the requesting user may also start sharing the file with others. Multiple transfers to other users (“uploads”), or from other users (“downloads”), may occur simultaneously to and from a single user’s computer. [65]

Finding no dispute that at least some users of the defendants’ software engaged in direct copyright infringement, the court turned to the question of whether Grokster and StreamCast could be liable as contributory infringers.

With respect to the defendants’ knowledge of end-user infringement, the court followed the Ninth Circuit’s Napster decision in reading the Supreme Court’s Sony opinion as addressing only the knowledge required for a finding of contributory infringement where a product is capable of substantial noninfringing use. The court found that the defendants’ software is capable of such use, including dissemination of works with the consent of the copyright owner and dissemination of works not protected by copyright, and the defendants offered evidence of such actual use by its customers.[66] As a result, the court applied the standard announced in Napster, which it read as prohibiting the court from imputing knowledge to a defendant based on the fact that its software could be used to infringe copyrights. The district court, however, focused on the timing of a indirect-liability defendant’s knowledge of infringing activity:

Rather, liability for contributory infringement accrues where a defendant has actual—not merely constructive—knowledge of the infringement at a time during which the defendant materially contributes to that infringement.

In other words, as the Ninth Circuit explained, defendants are liable for contributory infringement only if they (1) have specific knowledge of infringement at a time at which they contribute to the infringement, and (2) fail to act upon that information.[67]

The court noted evidence (including internal documents and searches by company executives) that showed that Grokster and StreamCast “clearly know that many if not most of those individuals who download their software subsequently use it to infringe copyrights.”[68] In addition, the court noted that the plaintiffs had sent defendants thousands of notices of claimed infringements. But in the court’s view the crucial question was whether the defendants had “actual knowledge of infringement at a time when they can use that knowledge to stop the particular infringement”[69]—that is, “whether actual knowledge of specific infringement accrues at a time when either Defendant materially contributes to the alleged infringement, and can therefore do something about it.” [70]

With respect to the defendants’ material contribution to their users’ infringements, the court framed that question as “whether Grokster and StreamCast do anything, aside from distributing software, to actively facilitate—or whether they could do anything to stop—their users’ infringing activity.”[71] Neither Grokster nor StreamCast operated the network over which the users of their software connected and exchanged files, and the court emphasized the decentralized nature of those networks: when users search for and initiate file transfers, no information is transmitted to or through any computers owned or controlled by the defendants.[72] Further, the court explained that when a user wishes to connect to the Grokster or Morpheus P2P networks, the user must locate another user to whom to connect, but emphasized that neither defendant was involved in the process that allows a user to locate a network connection. The court sharply contrasted Grokster and StreamCast’s operations with Napster’s:

Plaintiffs appear reluctant to acknowledge a seminal distinction between Grokster/StreamCast and Napster: neither Grokster nor StreamCast provides the “site and facilities” for direct infringement. … Users connect to the respective networks, select which files to share, send and receive searches, and download files, all with no material involvement of Defendants. If either Defendant closed their doors and deactivated all computers within their control, users of their products could continue sharing files with little or no interruption.

In contrast, Napster indexed the files contained on each user’s computer, and each and every search request passed through Napster’s servers. Napster provided the “site and facilities” for the alleged infringement, affording it perfect knowledge and complete control over the infringing activity of its users. If Napster deactivated its computers, users would no longer be able to share files through the Napster network.[73]

The court therefore concluded that Grokster and StreamCast did not provide active and substantial contribution to end-user infringements[74] in a way that justified holding the companies liable as contributors to those infringements:

Defendants distribute and support software, the users of which can and do choose to employ it for both lawful and unlawful ends. Grokster and StreamCast are not significantly different from companies that sell home video recorders or copy machines, both of which can be and are used to infringe copyrights. While Defendants, like Sony or Xerox, may know that their products will be used illegally by some (or even many) users, and may provide support services and refinements that indirectly support such use, liability for contributory infringement does not lie “merely because peer-to-peer file-sharing technology may be used to infringe plaintiffs’ copyrights.”[75]

The Grokster decision thus offers innovators of dual-use technologies substantially more protection against the danger of secondary liability for their users’ acts of copyright infringement than do the Napster or Aimster opinions, at least where the innovator creates a dual-use product and does not have an ongoing service relationship with the user. Whether this approach will continue, however, will depend on the Ninth Circuit, as the plaintiff copyright owners have appealed the decision.

B. Expansion of Vicarious Liability and The “Direct” Financial Interest Requirement

While the Sony doctrine’s protection of developers of dual-use technologies has been interpreted so as to make it of uncertain use to innovators of peer-to-peer technologies, the doctrine may be undermined entirely by recent developments in the law of vicarious infringement. Vicarious liability for infringement committed by a third party has expanded in recent years, offering another possible approach for copyright owners to hold peer-to-peer developers liable for infringement committed by users of their technologies. The basic rule is that “one may be vicariously liable if he has the right and ability to supervise the infringing activity and also has a direct financial interest in such activities.”[76] In recent years, courts have substantially expanded what constitutes a sufficiently “direct financial interest” in an infringers’ activity to hold a third party liable for that activity. The result is that ever more parties are potentially subject to vicarious liability for others’ copyright infringements, including innovators who may be deterred from pursuing innovations because of such potential liability.[77]

Vicarious liability in copyright originated from the doctrine of respondeat superior, holding employers liable for infringements committed by their employees. The doctrine expanded to hold defendants liable for infringements committed by independent contractors as well. The seminal case of Shapiro, Bernstein and Co. v. H.L. Green Co.,[78] involved a department store whose record departments were operated by an independent concessionaire. Green received ten to twelve percent of the concessionaire’s gross receipts from record sales. The concessionaire sold infringing recordings, and Green was held liable. The court found that Green had “an obvious and direct financial interest in the exploitation of copyrighted materials” by the concessionaire—indeed, the court viewed Green as having “a most definite financial interest in the success of [the] concession; 10% or 12% of the sales price of every record sold by [the concessionaire], whether ‘bootleg’ or legitimate, found its way … into the coffers of the Green Company.”[79]

In recent years, the doctrine has far outgrown the employment and independent contracting contexts, and the financial interest that a defendant must have in a third party’s infringing activities in order to be held liable has become more attenuated. The Ninth Circuit’s 1996 decision in Fonovisa, Inc. v. Cherry Auction, Inc.,[80] is generally viewed as a major case in the expansion of vicarious liability. The defendant in that case operated a flea market where it rented space to third-party vendors; Cherry Auction advertised the flea market to the public and charged customers for parking, admission, and food sold at the market.[81] Fonovisa sued, seeking to hold Cherry Auction liable for sales by one of its vendors of infringing recordings. Under the doctrine of vicarious liability, the Ninth Circuit held that Cherry Auction “reap[ed] substantial financial benefits from admission fees, concession stand sales, and parking fees, all of which flow directly from customers who want to buy the counterfeit recordings at bargain basement prices,” and that this was sufficient for the imposition of vicarious liability.[82] For the court, because the infringing activity “enhance[d] the attractiveness of the venue to potential customers” or served as a “draw” for customers, the venue operator could be held liable for the infringing activity.

Fonovisa’s interpretation of the “direct financial interest” standard for vicarious liability allows imposing liability for what seems to be a somewhat indirect financial interest. The flea market earned nothing directly from the sale of infringing recordings by one of its vendors. Instead, the court assumes that the vendor’s offering of infringing recordings attracted to the flea market customers who otherwise would not have attended, and those additional customers would result in revenues to the flea market not from their purchase of infringing material but from ancillary fees. This financial connection seems fairly clear in the traditional “dance-hall” cases, which hold the operator of a dance hall vicariously liable for infringing public performances of copyrighted musical works committed by a band that the operator hired to play in the dance hall. Most customers pay admission to the dance-hall operator largely because they wish to hear music performed. Thus, the operator’s financial interest in the infringing performances seems fairly direct. It seems far less clear that most flea market shoppers pay admission to a flea market largely because they wish to purchase infringing recordings. But the existence of infringing activity is assumed to draw customers in greater numbers than noninfringing activity, and any money those customers pay to the defendant appears to count as revenue “directly” related to the infringing activity for purposes of vicarious liability.

In Napster, the Ninth Circuit in a single paragraph loosened the “direct financial interest” requirement even further. The court followed Fonovisa in ruling that the availability of infringing music on the Napster system served as a “draw” for users. But because Napster disseminated its software to users, and permitted them to use its system to list and locate titles, at no charge, it did not, unlike Cherry Auction, make money off of the customers attracted by the infringing material. Indeed, it did not even make money indirectly, by selling advertising to users of the service. The Ninth Circuit concluded, however, that because Napster would likely charge users in the future, and because that “future revenue is directly dependent upon ‘increases in userbase,’” Napster had a sufficiently direct financial interest in infringement committed by its users to warrant holding the company vicariously liable for that infringement. Thus, not only can a defendant be held liable if it earns money from ancillary services to customers attracted by infringement, it can be held liable if it is likely to earn such money in the future.

As a result of the loosened requirement for direct financial interest, innovators are more likely today to be found vicariously liable for copyright infringement committed by users of their innovations.

C. Statutory Safe Harbors for Internet Service Providers

For innovators who are also Internet service providers, the Sony doctrine is only one source of limitation on liability for copyright infringement. In 1998, Congress enacted, as part of the Digital Millennium Copyright Act, statutory limitations on the liability of those who provide online services. Essentially, Congress provided online service providers (OSPs) with several safe harbors: if an entity qualifies as an OSP[83] and meets two basic eligibility requirements,[84] then it is exempt from all monetary relief and most injunctive relief for copyright infringement with respect to four specified categories of activities if specific conditions (which vary with the type of activity) are met. If an OSP fails to qualify for the safe harbor on any basis, then its liability for copyright infringement is to be determined by ordinary principles of copyright law.

Congress enacted the safe harbors in 1998 as part of the Digital Millennium Copyright Act in response to concerns expressed by online service providers about their potential overwhelming liability for copyright infringement committed by their users. These statutory safe harbors, however, have not provided significant protection from indirect liability to innovators of dual-use technologies, particularly in the peer-to-peer context. The main reason for this is that the most relevant safe harbor for peer-to-peer systems primarily protects service providers against liability for acts of direct copyright infringement committed by the provider. The safe harbor largely preserves the availability of relief against service providers on the basis of secondary liability for infringement committed using the service, though the safe harbors may somewhat heighten the requirements for holding the provider secondarily liable. In addition, judicial interpretation of the safe harbors has curtailed the usefulness of their protection for P2P innovators.

The safe harbors apply to any “provider of online services or network access, or the operator of facilities therefor.”[85] Some innovators whose products involve copyrighted works in digital format will likely not meet this definition and therefore not be eligible for the safe harbors at all. A company that distributes peer-to-peer software, for example, may be disseminating a product that its customers use over an online network, but the company itself may not be providing (or operating any facilities for) online services or network access. Similarly, a company that merely makes a digital video recorder capable of automatically skipping commercials would not necessarily be a service provider within the scope of the safe harbors. Other innovators, however, will likely qualify as service providers eligible for safe harbor protection. Napster and Aimster, for example, seem at least to have offered their users “online services;” a Napster user would connect over the Internet to Napster’s own computers in order to identify music files available for copying.

The safe harbors protect service providers from copyright infringement liability for four kinds of activity. The first harbor, in § 512(a), essentially protects against liability for merely transmitting or retransmitting someone else’s material over a computer network—that is, essentially for serving as a mere conduit for Internet transmissions, as ordinary Internet service providers such as Earthlink do when they transmit a customer’s e-mail message over the Internet to its addressee or when they retrieve a Web page from a third-party’s computer and transmit it to a customer’s at that customer’s request.[86] The second safe harbor protects a service provider who temporarily caches or stores online material on its own system or network in order be able to transmit that material at a later time to other of the provider’s users who request it.[87] A third safe harbor limits the liability of a service provider that stores information on its own system or network at the direction of a user, such as an ISP that hosts a user’s Web site on the ISP’s computers or an online auction Web site such as eBay that hosts a customer’s auction information on its computers.[88] Finally, a fourth safe harbor shields service providers who offer “information location tools.”[89] These include not only directories, indices and search engines that direct users to information on the Internet, but also any “reference, pointer, or hypertext link” to such information.[90]

For peer-to-peer service providers that meet the statutory definition of “service provider,” the § 512 safe harbors may offer little protection from liability for copyright infringement committed by the service’s users. The first court to address this issue in any depth is the district court in the Napster case.[91] That court ruled that Napster was not protected from liability for its users’ copyright infringements under the § 512(a) “conduit” safe harbor. It reasoned that the safe harbor only protects a service provider against liability for the provider’s “transmitting, routing, or providing connections for, material through a system or network controlled or operated by or for the service provider.”[92] Because any infringing transfer of files in Napster’s system occurred directly between two Napster users over the Internet and not through Napster’s own system, the court concluded that the secondary liability claims against Napster were not based on the activity shielded by Section 512(a) and thus were not precluded by the safe harbor. The district court in the Aimster case reached the same conclusion about that company’s system.[93] Given that peer-to-peer services, by their very nature, involve decentralized transmissions directly between users, the § 512(a) safe harbor, at least as interpreted by the Napster court, seems likely to offer little protection against secondary liability claims.

The safe harbors in Sections 512(b) and 512(c) will generally not offer peer-to-peer innovators protection against secondary liability claims because those provisions cover infringeme