WAKE FOREST JOURNAL OF BUSINESS AND INTELLECTUAL PROPERTY LAW
VOLUME 16 NUMBER 2 WINTER 2016
COULD A LACK OF STRONG PATENTS SPUR THE NEXT GLOBAL MARKET COLLAPSE? Nicholas Tsui 182
AN ECONOMIC ANALYSIS OF MARKET FAILURES IN COPYRIGHT LAW: IATROGENESIS AND THE FAIR USE DOCTRINE Colin Kennedy 209
THE NEED FOR COMPULSORY LICENSING OF ANTIRETROVIRAL DRUGS: THE INDIAN PERSPECTIVE Ambika Sahai & Kruthika N. S. 241
USEDSOFT AND ITS AFTERMATH: THE RESALE OF DIGITAL CONTENT IN THE EUROPEAN UNION Sven Schonhofen 262
ABOUT THE JOURNAL
The WAKE FOREST JOURNAL OF BUSINESS AND INTELLECTUAL PROPERTY LAW is a student organization sponsored by Wake Forest University School of Law dedicated to the examination of intellectual property in the legal context. Originally established as the Wake Forest Intellectual Property Law Journal in 2001, the new focus and form of the Journal, adopted in 2010, provides a forum for the exploration of business law and intellectual property issues generally, as well as the points of intersection between the two, primarily through the publication of legal scholarship. The Journal publishes four print issues annually. Additionally, the Journal sponsors an annual symposium dedicated to the implications of intellectual property law in a specific context. In 2009, the Journal launched an academic blog for the advancement of professional discourse on relevant issues, with content generated by both staff members and practitioners, which is open to comment from the legal community. The Journal’s student staff members are selected for membership based upon academic achievement, performance in an annual writing competition, or extensive experience in the field of intellectual property or business. The Journal invites the submission of legal scholarship in the form of articles, notes, comments, and empirical studies for publication in the Journal’s published print issues. Submissions are reviewed by the Manuscripts Editor, and decisions to extend offers of publication are made by the Board of Editors in conjunction with the Board of Advisors and the Faculty Advisors. The Board of Editors works closely and collaboratively with authors to prepare pieces for publication. Manuscript submissions should be accompanied by a cover letter and curriculum vitae, and may be sent electronically to [email protected] or by mail to:
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ISSN 2164-6937 (Print) ISSN 2164-6945 (Online)
BOARD OF ADVISORS
DANNY M. AWDEH BARBARA LENTZ Finnegan Henderson Farabow Professor, Wake Forest Garrett & Dunner LLP University School of Law Washington, DC Winston-Salem, North Carolina
CHARLES W. CALKINS JAMES L. LESTER Kilpatrick Townsend & Stockton MacCord Mason PLLC LLP Greensboro, North Carolina Winston-Salem, North Carolina JUSTIN R. NIFONG KENNETH P. CARLSON Olive Law Group Constangy, Brooks & Smith, LLP Cary, North Carolina Winston-Salem, North Carolina MICHAEL S. MIRELES TRIP COYNE Professor, University of the Williams Mullen Pacific, McGeorge School of Law Wilmington, North Carolina Sacramento, California
RODRICK J. ENNS ALAN PALMITER Enns & Archer LLP Professor, Wake Forest Winston-Salem, North Carolina University School of Law Winston-Salem, North Carolina EDWARD R. ERGENZINGER, JR., PH.D. ABBY PERDUE Ward & Smith, P.A. Associate Professor, Wake Forest University School of Law Raleigh, North Carolina Winston-Salem, North Carolina JASON D. GARDNER Kilpatrick Townsend & Stockton COE W. RAMSEY LLP Brooks Pierce
Atlanta, Georgia Raleigh, North Carolina
STEVEN GARDNER T. ROBERT REHM, JR. Kilpatrick Townsend & Stockton, Smith, Anderson, Blount, LLP Dorsett, Mitchell, & Jernigan, Winston-Salem, North Carolina LLP
ROB HUNTER Raleigh, North Carolina The Clearing House Payments SIMONE ROSE Company, LLC Professor, Wake Forest Winston-Salem, North Carolina University School of Law Winston-Salem, North Carolina
Editor-in-Chief TIMOTHY M. MCLISTER Managing Editor ELI M. MARGER Marketing Editor Manuscripts Editor JOSEPH GREENER ANASTASIA E. FANNING Symposium Editor Executive Articles JAIME C. GARCIA Editors CAMERON J. BROWN Development Editor JANE C. GARRITY KATHERINE S. OTT COLIN T. KENNEDY Senior Notes and Comments Editor Articles Editors MAGGIE H. DICKENS BRITTANY P. COLTON Notes and Comments Editors SARAH A. GALLAS EMILY G. MORRIS KAYLA M. FREDERICKSON EMILY A. SINGER S. BLAYDES MOORE
Editorial Staff ANDREW M. ADAMS CHRISTIAN C. DORISMOND ALEC C. ROBERSON ISSAC B. ALLMAN DANIEL P. GALYON ELIZABETH RUOCCO MITCHELL H. BLANKENSHIP CALEB J. HOLLOWAY RACHEL M. SHIELDS ALEXANDRA C. BRAVERMAN TYLER S. HOOD JONATHAN D. SILVER KEES C. BURNS AFZAL KARIM TALIS TREVINO BRANDY L. DAVIS JAMES C. WYATT
Staff Members RYAN BOWERSOX THOMAS M. GAFFNEY NICOLE REGNA CHRIS CHOE LAUREN HENDERSON SARAH REMES AMANDA MICHELLE BRAHM MATTHEW KERSCHNER ZACHARY RHINES LAURA BROWDER LUKE E. KRAUS DIANNA SHINN JENNA B. COOGLE JAMES LATHROP MATTHEW W. SILVERSTEIN ETHAN CLARK AMELIA E. LOWE DANA SISK MARIA COLLINS DRAKE MASON DAVID A. SWENTON CANDICE A. DIAH MOLLY MCCARTNEY CARA VAN DORN KELLY DONIGAN RACHEL OPLINGER KAITLIN G. WESTBROOK LAUREN N. FREEDMAN MOLLY D. PEARCE SARAH WESLEY WHEATON
Faculty Advisors BARBARA R. LENTZ ALAN R. PALMITER ABBY PERDUE SIMONE A. ROSE OMARI S. SIMMONS
WAKE FOREST JOURNAL OF BUSINESS AND INTELLECTUAL PROPERTY LAW
VOLUME 16 WINTER 2016 NUMBER 2
COULD A LACK OF STRONG PATENTS SPUR THE NEXT GLOBAL MARKET COLLAPSE?
Nicholas Tsui†
I. INTRODUCTION ...... 184 II. FINANCIAL INDUSTRY BENEFITS FROM MARKET RESTRAINTS ...... 185 III. PATENTS ARE BUYER-SIDE MARKET RESTRAINTS 190 IV. AN EMPIRICAL LOOK AT PATENTS IN REGULATING THE COMMERCIALIZATION OF FINANCIAL INNOVATION ...... 195 A. METHODOLOGY ...... 196 B. FINANCE PATENTS DURING THE GLOBAL FINANCIAL MELTDOWN ...... 196 V. CONCLUSION ...... 205
† Associate in the Intellectual Property Litigation Group at Alston & Bird LLP in the Atlanta office ([email protected]); J.D. from Stanford University, a Ph.D. from MIT, and a B.S.E. from the University of Pennsylvania. I would like to thank Mark Lemley and Shawn Miller at Stanford Law School for each's review and support during the writing of this manuscript. 2016] COULD A LACK OF STRONG PATENTS 183 SPUR A GLOBAL MARKET COLLAPSE?
ABSTRACT
The purpose of the patent is to encourage potential inventors to undergo the risky venture of innovation. Since an issued patent then stands in the way of competition and follow-on innovation, it is generally thought desirable only to grant patents for inventions that would not otherwise occur without the patent incentive. Professor Mark Lemley once explained that "if we do not need patents to encourage new inventions, we certainly do not want to grant them in an effort to regulate the use of those inventions in the marketplace." However, this paper is the first to suggest that that the traditionally negative consequences of patents may actually promote innovation in long term. This paper questions the conventional risk-seeking approach that favors the unbridled commercialization of all new inventions. Instead, it suggests that it may actually be desirable for patents to regulate the diffusion of new inventions into the marketplace. This paper focuses on how, in the lead-up to the global financial crisis in 2008, Congress, the courts, and the U.S. Patent and Trademark Office all supported removing any patent barriers to the widespread use and commercialization of financial innovation. The uninhibited spread of high-risk financial innovations went on to spur global economic crisis. This may have been an instance where the traditionally negative consequences of patent holdup, stifling litigation, and limited commercialization of innovation would have been keenly beneficial –– not only in the short term, but also in the long term and with effects across many industries. Strong patents may have been able to contain the use of high-risk financial innovation and, in turn, isolate the global financial crisis to the bankruptcy of just a few firms. This would have had profound effects on countless other industries that were hampered by the financial crisis. While industry-specific regulations have since been enacted to reduce the possibility of repeating past mistakes, patents in the area of financial and business innovation are still highly disfavored. And while industry-specific regulations tend to focus on past problems, patents tend to focus on future problems. This paper suggests that patents may provide a valuable mechanism for market regulation. A lack of strong patents could spur the next global market collapse.
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I. INTRODUCTION Patents are traditionally viewed as monopolistic, anti-competitive market restraints that are an acceptable tradeoff to achieve greater incentives to innovate.1 The price of that tradeoff is that, after the innovation has been achieved, commercialization of that innovation as well as follow-on innovation may be slowed.2 This balance is important because the purpose of patents is to “Promote the Progress of Science and useful Arts.”3 One area where the effect of patents has recently been of great concern is financial innovation and business methods. After State Street Bank & Trust Co. v. Signature Financial Group, Inc. 4 in 1998, the United States Patent and Trademark Office (USPTO) and the courts began a trend to remove any patent barriers to the widespread commercialization of financial innovation.5 The concern seemed to be whether or not patents in this area “would, on balance, facilitate or impede the progress of American business.”6 But in the context of high- risk financial innovation, it may have actually been desirable to impede "progress" towards global financial meltdown. By 2008, high-risk financial innovations created in the late 1990s and early 2000s had plunged economies around the world into massive recession.7 If Congress, the courts, and the USPTO had instead supported State Street and accorded strong patent rights to financial innovations, the excessively risky financial innovations that caused the global market collapse could have been isolated to a much smaller group of parties (i.e., the patent owners and licensees). In the competitive industry of financial product offerings,8 patent owners may have offered very few
1 See Diamond v. Chakrabarty, 447 U.S. 303, 319 (1980) (Brennan, J., dissenting) (explaining that patent laws are a reconciliation of dislike for monopolies with the “need to encourage progress”). 2 Id. at 317. 3 U.S. CONST. art I, § 1, cl. 8. 4 State St. Bank & Tr. Co. v. Signature Fin. Grp., Inc., 149 F.3d 1368, 1370 (D.C. Cir. 1998) (reversing the district court's holding of unpatentable subject matter regarding claims of a system for mutual fund investment accounting). 5 See, e.g., 35 U.S.C. § 273 (2012) (creating a prior use defense against business method claims). See also Am. Stock Exch., LLC v. Mopex, Inc., 250 F. Supp. 2d 323, 329–30 (S.D.N.Y. 2003) (invalidating claims for the exchange traded fund); Ex parte Bilski, No. 2002-2257 (B.P.A.I. Sept. 26, 2006) (rejecting claims for a commodities hedging strategy). 6 Bilski v. Kappos, 561 U.S. 593, 653 (2010) (Stevens, J., concurring). 7 See Sugato Bhattacharyya & Amiyatosh K. Purnanandam, Risk-Taking by Banks: What Did We Know and When Did We Know It? 8–12 (AFA 2012 Chi. Meetings Paper, 2011), available at http://ssrn.com/abstract=1619472. 8 See generally Stijn Claessens, Competition in the Financial Sector: Overview continued . . . 2016] COULD A LACK OF STRONG PATENTS 185 SPUR A GLOBAL MARKET COLLAPSE? licenses and restricted the reach of these risky innovations even further. Patent owners would have been able to raise prices to monopolistic levels and limit the supply to only a select few.9 And when the market finally collapsed, all of the typically negative monopolistic behaviors would have actually protected the broader markets because so few parties would have been participating in the collapse. This paper is the first to suggest that strong patent rights may provide a valuable regulation on the participation in the commercialization of innovation by limiting excessive risk taking to patent owners and parties sophisticated enough (and wealthy enough) to acquire a license. Wholly independent of the traditional justification for the patent system, this paper will argue that market regulation actually promotes the long-term health of competitive financial markets. In Section II, the paper will describe how market restraints serve to stabilize financial markets. Section III will then describe how the patent system shares many of the same qualities as the finance industry and how strong patent rights can serve the same market stabilization function. In Section IV, the paper will assess empirical data on patent rights as market regulators. Finally, Section V will present conclusions and broader policy implications.
II. FINANCIAL INDUSTRY BENEFITS FROM MARKET RESTRAINTS Restraints on competition are generally considered economically inefficient.10 But at the same time, market restraints are sometimes necessary to achieve a healthy, sustainable market. For example, a completely unregulated financial industry experiences destructive and abusive behavior due to information asymmetry in investment offerings between sellers and buyers.11 This led to market regulations for publicly offered financial products, mostly in the form of requiring sellers to make numerous mandatory disclosures. 12 These restraints actually stabilized a of Competition Policies (IMF Working Paper No. 45, 2009), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1366175. 9 See Jerry A. Hausman & Jeffrey K. MacKie-Mason, Price Discrimination and Patent Policy, 19 RAND J. ECON. 253, 254 n.5 (“[P]atents may establish the necessary monopoly power for price discrimination to take place . . .”). 10 See RICHARD A. POSNER, ANTITRUST LAW 2 (Univ. Chi. Press 2d ed. 2001) (“[E]conomic theory provides a solid basis for the belief that monopoly pricing, which results when firms create an artificial scarcity of their product and thereby drive price above its level under competition, is presumptively inefficient . . .”). 11 Duke K. Bristow, Benjamin D. King & Lee R. Petillon, Venture Capital Formation and Access: Lingering Impediments of the Investment Company Act of 1940, 2004 COLUM. BUS. L. REV. 77, 85 (2004). 12 Id.
186 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. competitive market for these products.13 But the regulations also made exceptions for private (non-public) offerings.14 Private offerings are often called "unregulated markets," but these markets simply regulate the buyers who can participate, rather than regulating the sellers. 15 Unregulated markets nonetheless require that only sophisticated (i.e., wealthy) buyers be allowed to take the risks associated with participating in financial offerings in the absence of mandatory disclosures by the seller.16 The theory behind this nonregulation is that sophisticated buyers are sufficiently able to protect themselves in the absence of regulation through their own research, private contracts, and greater ability to absorb loss of wealth.17 Similar access and tools are unavailable for unsophisticated buyers, and therefore participation by an unsophisticated buyer in an unregulated market is excessively risky and thus disallowed.18 For example, venture capital (“VC”) funds are high-risk private investment offerings. Most VC-backed startup companies fail, and, since 1999, VC funds have failed to generate positive returns. 19 Because of the extreme uncertainty and information asymmetry between sellers and buyers present in this system, VC fund investors rely extensively on private contracts.20 But the private nature of these offerings does not alone create an exemption from mandatory disclosures required by securities law.21 VC funds are still limited to accredited investors only.22 The Securities Act of 1933 requires an investor to have a net worth of at least $1,000,000 or an income of at least $200,000 per year.23 In the state of California, an investor must have $250,000 in tangible net worth and $5,000,000 in funds to be invested.24 These requirements recognize that these investments are too risky to allow truly unregulated participation. 25 Removal of these accredited investor requirements forfeits available exemptions from
13 Id. at 87–88. 14 See id.; Olufunmilayo B. Arewa, Financial Firewalls: The Credit Crisis and Network Contagion, 4 ENTREPRENEURIAL BUS. L. J. 304, 312–13 (2010). 15 Bristow et al., supra note 11, at 103–05. 16 Id. at 95, 103. 17 See id. at 88. 18 See id. at 119; Arewa, supra note 14, at 314. 19 Diane Mulcahy, Six Myths About Venture Capitalists, HARV. BUS. REV., May 2013, at 80, 81. 20 Ronald J. Gilson, Engineering a Venture Capital Market: Lessons from the American Experience, 55 STAN. L. REV. 1067, 1069, 1078 (2003). 21 Bristow et al., supra note 11, at 110. 22 Id. 23 Id. at 104. 24 Id. at 98. 25 Id. at 102. 2016] COULD A LACK OF STRONG PATENTS 187 SPUR A GLOBAL MARKET COLLAPSE? mandatory disclosures.26 Rather, decreased regulation on the buyers would need to be supplemented by increased regulation on the sellers (e.g., disclosures), which amounts to substituting one form of regulation for another.27 Another example of a high-risk private investment offering is the over-the-counter (“OTC”) derivative. OTC derivatives are exempt from regulation under the Commodity Futures Modernization Act of 200028 because the transactions involve sophisticated parties.29 Again, the theory is that sophisticated buyers are able to protect themselves without the need for regulation. 30 Participation by unsophisticated buyers would deny the exemption from regulation on the seller-side.31 Thus, while the "regulated" and "unregulated" markets derive their names from whether or not sellers are regulated, both markets are actually regulated. This is summarized below in Table 1.32 A true unregulated financial industry could not survive because sellers would cheat buyers.33 Table 1: Financial markets are regulated, either from the seller-side or buyer-side. Market Seller-side Buyer-side Examples "Unregulated" No mandatory Sophisticated VC, hedge disclosures only funds "Regulated" Mandatory Open Common disclosures participation stock
It is beyond the scope of this paper to explain why the free market does not fix this problem without regulation. In theory, buyers could simply stop buying from sellers who do not provide truthful and adequate disclosures. Accordingly, buyers could stop buying from sellers who do not produce adequate returns, regardless of disclosures. However, I will proceed under the assumption that Congress was correct in concluding that public markets cannot function without seller- side regulation and that private markets cannot function without buyer-
26 Id. at 122. 27 Id. at 125. 28 Commodities Futures Modernization Act, Pub. L. No. 106-554, 114 Stat. 2763 (2000). 29 Arewa, supra note 14, at 313. 30 Id. 31 Cf. id. 32 See infra Table 1. 33 See infra Table 1.
188 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. side regulation.34 The underlying theory seems to be that the more private the transaction, the less regulation is necessary, provided that the parties are sophisticated.35 Thus, I turn to how this system responds to the excessive risk-taking incentivized by the asymmetric payout structure pervasive in the American economy. America conducts transactions through “agents,” such as various corporations, banks, and money managers, to whom people give money in the form of investments, loans, or savings.36 When agents perform well, they receive a portion of the earnings.37 When agents perform poorly, they pay nothing.38 Thus, agents participate in the gains but not the losses that result from their decisions. 39 This is called an asymmetric payout structure.40 Once short-term gains are rewarded, long-term losses usually do not require paying back any of the already- rewarded short term gains.41 Furthermore, the increase in the number of investors after profitable years exceeds the decrease in the amount of investors after unprofitable years.42 In other words, most buyers do not stop investing with agents to punish their agents for losses. This perhaps explains why some studies have shown that compensation in underperforming years does not seem to decrease as much from the outperforming years as one might expect.43 This is most frequently observed in high-risk financial investments, such as venture capital or hedge funds, but also occurs for relatively “safe” investments in the common stock of publicly traded financial institutions. 44 Thus, asymmetric payout structures affect risk-taking in both the regulated and unregulated markets. They incentivize our agents to take disproportionate risks even in situations where the likelihood of success is overwhelmingly small.45 In response, some industries have developed measures to combat excessive risk-taking incentives. For instance, many hedge funds have
34 See infra Table 1. 35 See Arewa, supra note 14, at 313–14. 36 See BLACK’S LAW DICTIONARY 232 (10th ed. 2014) (“an agent who acts as an intermediary or negotiator esp. between buyers and sellers”). 37 12 AM. JUR. 2D § 278 (2009). 38 Assuming that no crime has been committed. Typically, we still pay a management or transaction fee even if our agent loses our money. 39 See Krishnan Sharma, Financial Sector Compensation and Excess Risk- taking—A Consideration of the Issues and Policy Lessons 4 (Dep’t Econ. and Soc. Affairs, Working Paper No. 115, 2012). 40 Id. at 2. 41 Id. at 3. 42 Id. at 4. 43 Id. at 6. 44 Id. at 3. 45 Id. at 2. 2016] COULD A LACK OF STRONG PATENTS 189 SPUR A GLOBAL MARKET COLLAPSE? a “hurdle” rate of return, below which no performance-related compensation will be paid to the fund manager.46 Some even have a “high water mark,” whereby funds must actually make up for past losses before profits can be accounted. 47 VC funds also have similar protections, such as paying investors back before compensating the fund managers and “claw back” provisions that retrieve compensation from profitable investments to reimburse investors for unprofitable investments. 48 However, it has been suggested that none of these provisions provides adequate protection against excessive risk-taking, given that funds can be easily shuttered and new ones created with little long-term accountability.49 Certain industries appear more affected than others by the asymmetric payout structure, but the structure is pervasive in the American economy.50 That is, it exists in every market, not just the financial market.51 Taking excessive risks can easily evolve into a herd mentality throughout any industry. 52 Fortunately, the majority of business decisions are likely to have sufficiently limited negative consequences for this not to matter most of the time. However, this fact may not provide much insulation from even a few high-risk decisions, if the bets are big enough. In the regulated market, the hope is that mandatory disclosures allow the unsophisticated buyer to avoid parties who take excessive risks.53 In the unregulated market, the hope is that excessive risk-taking is limited to a small percentage of the population (i.e., the sophisticated buyers). However, after the financial crisis of 2007-2009, this system was found to not adequately limit the effects of excessive risk-taking.54 This will be further analyzed in Section IV, but perhaps the asymmetric payout structure was simply too strong for the regulations that were in place before 2007.55
46 Id. at 5. 47 Id. 48 Gilson, supra note 20, at 1072. 49 Sharma, supra note 39, at 5. 50 Id. at 3. 51 Almost all of us are compensated by an asymmetric payout structure in our own jobs. For instance, if I do well at my job and make the company money, I may receive a year-end bonus. If I do poorly and lose the company money, I may be fired, but I will not be forced to reimburse the company or its clients for any losses that I may have caused (assuming no fraud or crime has been committed). 52 See Sharma, supra note 39, at 4. 53 See Danielle A. Higgins, Comment, Regulation S-K Item 402(S): Regulating Compensation Incentive-Based Risk through Mandatory Disclosure, 61 CASE W. RES. L. REV 1049, 1049 (2011). 54 See id. at 1050. 55 See Paul Slattery, Note, Square Pegs in a Round Hole: SEC Regulation of continued . . .
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Would a stronger patent system have provided the necessary regulation to bridge the gap? More specifically, would excessively risky financial innovations have been patented and effectively enforced through infringement litigation to stifle the widespread use of those financial innovations? Before addressing this question in Section IV, Section III explains how patents can provide such a market regulating mechanism.
III. PATENTS ARE BUYER-SIDE MARKET RESTRAINTS A patent creates exclusionary rights with respect to the subject matter claimed in the patent.56 A patentee may legally prevent others from making, using, or selling the patented invention.57 These rights are restrictions on the free market. They create static inefficiencies, dynamic inefficiencies, rent-seeking behavior, administrative costs, and distortionary overinvestment in research and development. 58 The American system generally accepts these otherwise undesirable qualities because they purportedly encourage inventions that we would not otherwise get. 59 There are many theories as to how this mechanically works. First, prospect theory supposes that a patent right gives the patentee incentive to maximize the value of the subject matter covered by the patent.60 Second, commercialization theory focuses on post-invention and argues that a patent right provides the patentee with the incentive to undertake the risky venture of commercializing a new invention.61 Third, disclosure theory asserts that a patent right is the “quid pro quo” for dissemination of information to the public.62 There are other alternative theories, but these are the main three.63 Naturally,
Online Peer-to-Peer Lending and the CFPB Alternative, 30 YALE. J. ON REG. 233, 235–36 (2013). 56 35 U.S.C. § 271(a)-(c) (2012). 57 General Information Concerning Patents, U.S. PATENT AND TRADEMARK OFFICE (Oct. 2014), http://www.uspto.gov/patents-getting-started/general- information-concerning-patents. 58 Mark A. Lemley, The Myth of the Sole Inventor, 110 MICH. L. REV. 709, 736 (2012). 59 Id. 60 Id. at 738. 61 Id. at 739. 62 See id. at 745; Eldred v. Ashcroft, 537 U.S. 186, 224 (2003) (Stevens, J., dissenting) (“Complete disclosure as a precondition to the issuance of a patent is part of the quid pro quo that justifies the limited monopoly for the inventor as consideration for full and immediate access by the public when the limited time expires.”); Festo Corp. v. Shoketsu Kinzoku Kogyo Kabushiki Co., 535 U.S. 722, 736 (2002) (“[P]atent rights are given in exchange for disclosing the invention to the public.”). 63 Lemley, supra note 58, at 711. 2016] COULD A LACK OF STRONG PATENTS 191 SPUR A GLOBAL MARKET COLLAPSE? none of these is without serious criticism. Prospect theory implies that a lack of competition better serves innovation, 64 while most other theories and evidence strongly suggest the opposite. 65 Commercialization theory fails to recognize that once an invention exists, a patent primarily stands in the way of (rather than assists) commercialization.66 Disclosure theory belies the reality that scientists and innovators generally do not learn the latest information by reading patents.67 In response to these criticisms, many have searched for alternative justifications for the patent system, such as patent racing theory, which posits that multiple parties racing to acquire a patent leads to more inventions, at a quicker pace. 68 Others have argued that the patent system needs reform to account for its perceived shortcomings, such as issuing more patent rights based on commercialization activity.69 Some have even suggested that it is best to eliminate patents altogether.70 As Professor Mark Lemley states: “If we don’t need patents to encourage new inventions, we certainly don’t want to grant them in an effort to regulate the use of those inventions in the marketplace.”71 But is that necessarily true? In this paper, I argue that it is not. Even if I assume that all innovation occurs without the promise of exclusive patent rights and that inventors disclose them to the public too, nevertheless, there still remains a reason to have patents. Section II described the characteristics of the financial markets and why the so- called “unregulated” markets are in fact necessarily regulated in order to build a sustainable, healthy marketplace. Since private investment offerings are excessively risky, their access is limited to sophisticated buyers through buyer-side regulation.72 This type of limited access
64 Id. at 738. 65 Robert P. Merges & Richard R. Nelson, On the Complex Economics of Patent Scope, 90 COLUM. L. REV. 839, 872 (1990); John F. Duffy, Rethinking the Prospect Theory of Patents, 71 U. CHI. L. REV. 439, 442–43 (2004); Mark A. Lemley, Economics of Improvement in Intellectual Property Law, 75 TEX. L. REV. 989, 1048–58 (1997). 66 Lemley, supra note 58, at 739–44. 67 Id. at 745. 68 Id. at 749–60. 69 Michael B. Abramowicz, The Problem of Patent Underdevelopment, GEO. WASH. LAW FACULTY PUBL’NS & OTHER WORKS, 1, 41–55 (2005); Ted Sichelman, Commercializing Patents, 62 STAN. L. REV. 341, 402–12 (2010). 70 MICHELE BOLDRIN & DAVID K. LEVINE, AGAINST INTELLECTUAL MONOPOLY 22–25 (2008). 71 Lemley, supra note 58, at 745. 72 These sophisticated buyers subject to regulation are known as accredited investors. See 17 C.F.R. § 230.501 (2012).
192 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. could also be a valuable function of patents if there was some reason to want to regulate the diffusion of innovation into the commercial marketplace. Such a reason could be that the commercialization of innovation is essentially an extremely risky private investment offering.73 First, the vast majority of attempts to commercialize innovation will fail because the vast majority of patentable inventions are commercially worthless.74 Studies have found that most patents are worth so little that the patent owner cannot even justify paying the maintenance fee.75 This applies broadly across all industries and patented subject matter. 76 Litigation-based metrics come to similar conclusions: fewer than 1% of patents have any value at all.77 Of course, a patent’s litigation value is not quite the same as its commercial value, but the two values are related. For example, a patent must have commercialization value in order to have litigation value. Overall, the success rate of finding value in patentable inventions is so low that some even compare patents to lottery tickets.78 This is true despite the assertion that many patents are only incremental improvements over existing knowledge.79 Thus, even an incremental improvement is statistically likely (in fact, overwhelmingly so) to be a losing commercial investment. Second, there is little disclosure to protect the “buyer” (which in this case is the party attempting to commercialize the innovation) in the form of information that may help differentiate which inventions may be riskier than others. Some argue that the disclosure requirements to receive a patent do not actually produce enough information to allow a person having ordinary skill in the art to effectively make or use the invention (despite that being the required benchmark).80 Furthermore, the patent disclosure requirements do not include how much the invention costs to develop, how much it costs to make and use, what its potential value is, how its worth should be calculated, probability of success, market analysis, or any disclosures that approximate disclosure
73 John R. Allison et al., Valuable Patents, 92 GEO. L.J. 435, 440–41 (2004). 74 Id. at 437. 75 Id. at 441. 76 Id. 77 Id. at 441–45. 78 Dennis D. Crouch, The Patent Lottery: Exploiting Behavioral Economics for the Common Good, 16 GEO. MASON L. REV. 141, 142 (2008). See also F.M. Scherer, The Innovation Lottery, in EXPANDING THE BOUNDARIES OF INTELLECTUAL PROPERTY: INNOVATION POLICY FOR THE KNOWLEDGE SOCIETY 3, 3 (Rochelle Cooper Dreyfuss et al. eds., 2001). 79 Value studies do not evaluate incremental inventions separately from truly “ground-breaking” ones. So value measures apply to all patents as a whole. 80 HARVARD LAW REVIEW ASS’N, The Disclosure Function of the Patent System (Or Lack Thereof), 118 HARV. L. REV. 2007, 2025–26 (2005). 2016] COULD A LACK OF STRONG PATENTS 193 SPUR A GLOBAL MARKET COLLAPSE? requirements of publicly offered securities.81 Third, Section II discussed how asymmetric payout structures create incentives for agents to take excessive risk.82 In this case, the excessive risk is the attempted commercialization of a patentable invention. While it may appear most salient in the financial industry, almost every industry in the United States compensates its employees on an asymmetric payout structure.83 At our own jobs, we are the very agents who are incentivized to take more risk than we otherwise would. If we perform well, we may be rewarded with additional compensation. But if we lose our company's or client's money, we will not have to pay it back. 84 Thus, across all industries in general, the market for commercializing innovation looks just like the unregulated financial markets. The lack of seller-side regulation must be compensated by buyer-side regulation, which is provided by patents. Here, patents effectively serve as the same type of sophisticated parties limitation that exists in the unregulated financial markets. That is, only a sophisticated party is likely to own a patent or otherwise be able to contact the patent owner, successfully negotiate a license, and then pay for that license.85 Therefore, with patents, only sophisticated parties may participate in the market for commercialization of innovation.86 Again, the question arises as to whether the free market should be allowed to govern success and failure in the commercialization of innovation. The regulatory function of patents could deter useful, low- risk innovation along with excessively high-risk innovation. Strong patent rights could potentially transfer benefits from society as a whole to relatively few sophisticated parties. However, this is also true of securities offerings. Mandatory disclosures are not exempted simply because a particular industry has been deemed “low-risk.”87 And there
81 Daniel R. Cahoy et. al., Fracking Patents: The Emergence of Patents as Information-Containment Tools in Shale Drilling, 19 MICH. TELECOMM. & TECH. L. REV. 279, 295, 307–10 (2013). 82 Sharma, supra note 39, at 5. 83 Id. at 2. 84 Id. We may be fired, but we do not reimburse the money that we lost (assuming no illegal activity). 85 See ROBERT A. MATTHEWS, JR., 5 ANNOTATED PATENT DIGEST § 35:31 (2015) (demonstrating that parties involved in patent negotiation are, as a general proposition, sophisticated). 86 Of course, an unsophisticated party may participate without authorization and risk being sued for patent infringement just like an unsophisticated party may participate in a private investment vehicle and risk imprisonment for violating securities laws. 87 See Karen K. Nelson & Adam C. Pritchard, Shift from Voluntary to Mandatory Disclosure of Risk Factors, HARV. L. SCH. FORUM ON CORP. continued . . .
194 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. are many fair and lucrative deals in which only wealthy investors can participate. So again, there is the assumption that Congress was correct in determining that high-risk private markets cannot function properly without buyer-side regulation. Moreover, as discussed in Section II, the prevalence of asymmetric payout structures make the prospect of functioning properly in the absence of regulation even more dubious.88 Therefore, if the commercialization of innovation is a sufficiently risky private offering (not only in the financial industry but in any industry), then it follows that the marketplace should benefit from the buyer-side regulation that patents provide. Of course, the patent system has never been justified as any kind of mechanism to mitigate excessive risk-taking. In fact, the patent reward deliberately encourages taking at least some risk in order to innovate in the first place.89 Innovation is valuable, but also risky. Given that the vast majority of patents are worthless,90 unregulated commercialization of innovation is perhaps excessively risky.91 Thus, independent of any value in incentivizing innovation in the first place, patents may actually perform a valuable gating function that limits excessively risky attempts at commercializing innovation to only sophisticated parties.92 Similar to the case with securities law described in Section II, relaxing buyer- side restrictions must be accompanied by compensating regulation somewhere else, if the health and sustainability of the marketplace is to be maintained.93 Therefore, if patent rights are weakened or narrowed in a particular high-risk market (and no compensating regulation is added somewhere else), that market may lose a valuable restriction on
GOVERNANCE AND FIN. REG. (July 17, 2014), http://corpgov.law.harvard.edu/2014/07/17/shift-from-voluntary-to-mandatory- disclosure-of-risk-factors/. 88 See supra note 81 and accompanying text. 89 Douglas Gary Lichtman, The Economics of Innovation: Protecting Unpatentable Goods, 81 MINN. L. REV. 693, 718 (1997) (“The point here is that patent law is an effective incentive system because it rewards innovators––and, hence, investors––at levels above those available in traditional markets. This is why investors choose to support the work of modern-day Edisons; this is why innovators are willing to assume the risks of innovation. Systematically under-rewarding innovators who produce unpatentable goods, however, is not a necessary part of this calculus.”). 90 See Allison et al., supra note 73, at 440–41. 91 This paper emphasizes the difference between the acceptable risk associated with innovation and the excessive risk associated with the attempted commercialization of that innovation. 92 Raising the price is the equivalent of restricting participation. As in the case with accredited investor requirements, every price increase excludes another potential buyer who cannot or will not pay the higher price. 93 See Bristow et al., supra note 11, at 122. 2016] COULD A LACK OF STRONG PATENTS 195 SPUR A GLOBAL MARKET COLLAPSE? excessive risk-taking and become ripe for destabilization.94 In the next section, I take an empirical look at finance-related patents and their role in providing a potentially valuable market regulation mechanism.
IV. AN EMPIRICAL LOOK AT PATENTS IN REGULATING THE COMMERCIALIZATION OF FINANCIAL INNOVATION In order to assess the value of patents as a market-regulating mechanism, it is necessary to understand how patents affect market behavior. Some studies argue that the mere existence of patents has little effect on what products are produced and sold in the marketplace.95 From a product availability standpoint, it would seem that patents are basically ignored.96 This could be because most patents are never read by competitors. 97 On the other hand, there is some evidence that publication citation rates drop 10-20% once information is patented.98 This indicates that patents do become known and may have some cooling effect on follow-up research.99 But still, patent language can be quite vague. Even after reading a patent, it might not be clear whether there is enough of a risk of infringement to alter one's plans for commercialization.100 Furthermore, over 99% of patent owners never sue for infringement.101 On the other hand, once a patent lawsuit is initiated, the situation is much less vague, at least in the sense that there is a real dispute that is going to cost money to resolve. A number of studies have shown that patent litigation decreases a company's stock price and, in turn, the resources available for future research and development.102 Results have reported a mean stock value loss of $122 million due to patent
94 See Abramowicz, supra note 69, at 41. 95 Mark A. Lemley, Ignoring Patents, 2008 MICH. ST. L. REV. 19, 20 (2008). 96 Id. at 21. 97 Id. at 20–22. 98 Fiona Murray & Scott Stern, Do Formal Intellectual Property Rights Hinder the Free Flow of Scientific Knowledge? An Empirical Test of the Anti-Commons Hypothesis, 63 J. ECON. BEHAV. & ORG. 648, 669–72 (2007). 99 See id. at 673. 100 James Bessen, Jennifer Ford & Michael J. Meurer, The Private and Social Costs of Patent Trolls, REG., Winter 2011-12, at 26, 28. 101 Allison et al., supra note 73, at 435. Additionally, there are a host of reasons why a party may wish to obtain patents but not assert them. These include defensive reasons, leverage in cross-licensing negotiations, perceived asset value to the public, freedom to operate, and marketing. See Stuart J.H. Graham & Ted Sichelman, Why Do Start-Ups Patent?, 23 BERKELEY TECH. L.J. 1063, 1065–69 (2008). 102 James Bessen & Michael Meurer, The Private Costs of Patent Litigation 11 (Bos. Univ. Sch. of Law, Working Paper No. 07-08, 2007); Bessen et al., supra note 100, at 31–32.
196 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. litigation, the vast majority of which does not return after the lawsuit is resolved.103 Interestingly, both the plaintiff and the defendant lose stock value; not surprisingly, the defendant tends to lose more stock value.104 Some cases show that defendants’ product innovation ceases altogether.105 Thus, in looking for empirical evidence of patents in marketplace regulation, it is important to examine not only the existence of patents but also their assertion and enforcement. If patents are to provide a meaningful market regulation mechanism, they must not only be issued, but also successfully enforced. The next section will examine whether a lack of strong patents failed to limit participation in the commercialization of high-risk financial innovation and helped spur market failure.
A. Methodology
As mentioned earlier, it is important to examine both the existence of patents and the assertion (and enforcement) of those patents. I obtained the number of patent issues, patent applications, and patent applications that issue by keyword searches on the USPTO Patent Full- Text and Image Database (PatFT) and USPTO Patent Application Full- Text and Image Database (AppFT).106 I measured assertion activity from Derwent Litigation Alerts 107 and measured the enforcement outcomes by any published final judgment.108
B. Finance Patents During the Global Financial Meltdown
Excessive risk-taking by the financial industry plunged economies across the globe into massive recession beginning in 2007. 109 This dramatically highlighted the growing intricacy and interconnectivity of marketplaces.110 The regulated financial markets had tied themselves to the unregulated financial markets because banks and pension funds
103 Bessen et al., supra note 100, at 31–32. 104 See Sanjai Bhagat, John Bizjak & Jeffrey L. Coles, The Shareholder Wealth Implications of Corporate Lawsuits, 27 FIN. MGMT. 5, 18 (1998). 105 Catherine Tucker, Patent Trolls and Technology Diffusion 25–26 (Tilburg L. & Econ. Cntr., Working Paper No. 2012-030, 2013), available at http://ssrn.com/abstract=2136955. 106 Both of these are publicly available on uspto.gov. USPTO publishes applications that were filed on or after November 29, 2000. Publication usually occurs about 18 months after filing. 107 Available on Westlaw. 108 Available on Westlaw. 109 Bhattacharyya & Purnanandam, supra note 7, at 8–12. 110 Id. at 1–2. 2016] COULD A LACK OF STRONG PATENTS 197 SPUR A GLOBAL MARKET COLLAPSE?
(for instance) were invested in highly risky private offerings, such as venture capital and hedge funds.111 At the other end of the investment lifecycle, the unregulated markets were tied to the regulated markets because those private investors relied on healthy common stock markets to exit their investments. 112 And because big businesses, small businesses, and individuals rely on banks to finance investments, homes, cars, and to store money, the result was that the entire economy took these excessive risks together. Prior to this, financial innovation was widely believed to be positive.113 Perhaps it is still generally positive, but it is clear that not every financial innovation ought to enjoy widespread commercialization. However, leading up to the global financial meltdown, the USPTO and the courts tended to remove any patent barriers to the widespread commercialization of highly risky financial innovation.114 Even after the crisis, this trend continued.115 It began with State Street in 1998, when the Federal Circuit validated a 1991 patent claiming a system for mutual fund investment accounting.116 Congress almost immediately created a statutory defense against business method patents that was interpreted as legislative disapproval of the State Street decision.117 Not long after, the courts also seemed to have a change of heart. In 2003, the court in American Stock Exchange, LLC v. Mopex, Inc.,118 went out of its way to invalidate a patent on exchange traded funds.119 By 2006, the USPTO also seemed to agree with the trend of unpatentability when it rejected a patent application on hedging commodities after review by the Board of Patent Appeals and
111 Bristow et al., supra note 11, at 113. 112 Arewa, supra note 14, at 316. 113 Josh Lerner, Trolls on State Street?: The Litigation of Financial Patents, 1976-2005 1, 3 (unpublished paper, Harv. U. & Nat’l Bureau of Econ. Res.), available at http://www.people.hbs.edu/jlerner/Trolls.pdf. 114 See, e.g., 35 U.S.C. § 273 (2012) (creating a prior use defense against business method claims). See also American Stock Exch., LLC v. Mopex, Inc., 250 F. Supp. 2d 323, 329–30 (S.D.N.Y. 2003) (invalidating claims for the exchange traded fund); Ex parte Bilski, No. 2002-2257 (B.P.A.I. Sept. 26, 2006) (rejecting claims for a commodities hedging strategy). 115 See, e.g., Bilski v. Kappos, 561 U.S. 593, 597–98, 612 (2010). 116 State St. Bank & Trust Co. v. Signature Fin. Grp., Inc., 149 F.3d 1368, 1370 (D.C. Cir. 1998) (reversing district court's holding of unpatentable subject matter). 117 See Kappos, 561 U.S. at 644 (Stevens, J., concurring) (“In 1999 . . . Congress passed . . . 35 U.S.C. § 273 . . .”). 118 250 F. Supp. 2d 323 (S.D.N.Y. 2003). 119 Id. at 329–30 (finding a prior art reference qualified as a printed publication despite not being indexed anywhere because a person skilled in the art would be able to find it among hundreds of documents in the one room where the publication physically resided).
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Interferences.120 Both the Federal Circuit and eventually the Supreme Court of the United States affirmed the denial of this patent application.121 Barely batting an eye at the global financial crisis and the potentially devastating power of “desired” financial innovations, by 2010, the Supreme Court had four Justices willing to categorically invalidate all business method patents on the fear that they "may prohibit a wide swath of legitimate competition and innovation.”122 In 2012, the Federal Circuit reconfirmed this sentiment when it invalidated both method and system patents regarding a technique for mitigating transaction settlement risk.123 In Bilski v. Kappos,124 the four concurring Supreme Court Justices explained their concerns that “even if patents on business methods were useful for encouraging innovation and disclosure, it would still be questionable whether they would, on balance, facilitate or impede the progress of American business.”125 But in the context of high-risk financial innovations, it may have actually been desirable to impede “progress” towards global financial meltdown. 126 If Congress, the courts, and the USPTO had instead supported State Street and accorded strong patent rights to financial innovations, the excessively risky financial innovations that caused the global market collapse could have been isolated to a much smaller group of parties (i.e., the patent owners and licensees). In the competitive industry of financial product offerings,127 the patent owners may have offered very few licenses and restricted the reach of these risky innovations even further. Patent owners would have been able to raise prices to monopolistic levels and limit the supply to only a select few. When the market finally collapsed, all of the typically negative monopolistic behaviors would have actually protected the broader markets because so few parties would have been participating in the collapse.
120 Ex parte Bilski, No. 2002-2257 (B.P.A.I. Sept. 26, 2006). 121 In re Bilski, 545 F.3d 943, 997–98 (Fed. Cir. 2008); Kappos, 561 U.S. at 613. 122 Id. at 653 (Stevens, J., concurring). 123 CLS Bank Int’l v. Alice Corp. Pty. Ltd., 717 F.3d 1269, 1292 (D.C. Cir. 2013). 124 561 U.S. 593 (2010). 125 Id. at 653 (Stevens, J., concurring). 126 See Bristow et al., supra note 11, at 80–82 (examining the “inherent” risks to the “pursuit of economic and technological advances”). 127 Cf. Colleen V. Chien, From Arms Race to Marketplace: The Complex Patent Ecosystem and Its Implications for the Patent System, 62 HASTINGS L.J. 297, 310 (2010) (characterizing the increase of patents as an “arms race”). 2016] COULD A LACK OF STRONG PATENTS 199 SPUR A GLOBAL MARKET COLLAPSE?
Of course, it is possible that a patent owner could serve the entire market demand for a product or otherwise license the patent to others to address any demand beyond the capacity of the patent owner to supply.128 But generally, the theory is that a monopolist does not do that.129 The whole point of a monopoly is that the monopolist can restrict supply and raise prices above the competitive level. 130 By raising prices above the competitive level, the monopolist necessarily restricts access to the patented product.131 The stronger the patent right, the more drastic the monopolist’s power.132 In sum, weak patent rights may have spurred along the commercialization of excessively risky financial innovation. A bolder version of this statement is that stronger patent rights could have helped avoid the global financial meltdown of 2007-2009. But Judge Mayer's dissent in In re Bilski points out that there are mountains of patents in this area and that the number of patents are growing exponentially.133 A more in-depth study found that patent applications on new types of securities initially increased in the early 2000s, but subsequently fell off after 2004.134 Perhaps by 2004, it was obvious to potential patentees that the USPTO and the courts had changed positions on these types of patents. But in the years leading up to the financial crisis, finance-related patents were litigated at a rate twenty-seven times that of patents as a whole.135 This was true both before and after the State Street decision.136 So if there were plenty of patents in the space, and those patents were being litigated frequently, then why was there no shut down in the commercialization of high-risk financial innovation (sometimes referred to as a patent holdup)?137 A
128 See LOUIS ALTMAN & MALLA POLLACK, 1 CALLMANN ON UNFAIR COMPETITION, TRADEMARKS & MONOPOLIES § 4:56 (4th ed. 2015). See also Chien, supra note 127, at 321–22 (discussing the advantages of cross-licensing to expand the patent holder’s market and use of the holder’s product). 129 See Ill. Tool Works, Inc. v. Indep. Ink, Inc., 547 U.S. 28, 31 (2006). 130 ALTMAN & POLLACK, supra note 128, at § 4:56. 131 Ill. Tool Works, 547 U.S. at 31. 132 See id. at 33 (finding that increasing the scope of a patent tends to strengthen the monopoly and burden the public). 133 In re Bilski, 545 F.3d 943, 1004 (D.C. Cir. 2008) (Mayer, J., dissenting) (arguing that all business methods should be categorically unpatentable subject matter). 134 Stefania Fusco, Is the Use of Patents Promoting the Creation of New Types of Securities?, 25 SANTA CLARA COMPUTER & HIGH TECH. L.J. 243, 267–68 (2009). 135 Lerner, supra note 113, at 4. 136 Interestingly, litigation in this area did not actually increase as a result of State Street. See Josh Lerner, The Litigation of Financial Innovations, 53 J.L. & ECON. 807, 808 (2010). 137 See generally Mark A. Lemley & Carl Shapiro, Patent Holdup and Royalty Stacking, 81 TEX. L. REV. 1991 (2007) (discussing patent holdups).
200 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. closer look at the data reveals that the patent system was (and likely still is) weaker here than has been suggested by other studies.
2016] COULD A LACK OF STRONG PATENTS 201 SPUR A GLOBAL MARKET COLLAPSE?
Figure 1 displays the number of patents issued by year in the business method class (“705 issues”) along with a subset of those patents that match financial keywords (“705/Terms issues”). 138 As Judge Mayer noted, the number of patents in this space seems to exponentially rise.139 Figure 1: Patents issued per year in the 705 class (business methods) and the subset of the class that match financial keywords in the patent specifications.
10000 705 Issues 9000 705/Terms Issues
8000
7000
6000
5000
4000 No. of Patents of No. 3000
2000
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0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Year
Examination of patent applications lends a more nuanced explanation. As shown in Figure 2, the number of patent applications is rising, but not exponentially.140 Moreover, the number of issued patents are rising at an even slower pace.141 Thus, the exponential rise in patents issued is likely almost entirely due to the USPTO's increased pace of approving patent applications that had previously been tied up in the patent office for years.142 In fact, the ratio of applications that
138 See infra Figure 1. USPTO class 705 is the business method class. Additionally, the class was searched for patents with any of the following keywords in the specification: financial OR trading OR securities OR debt OR mortgages OR commodities OR banking. See infra Figure 1. 139 In re Bilski, 545 F.3d 943, 1004 (D.C. Cir. 2008) (Mayer, J., dissenting). 140 See infra Figure 2. 141 See infra Figure 2. 142 There was a significant uptick in applications after State Street, but the dramatic rise in issues is an exaggeration of this behavior. But see John R. Allison & Starling D. Hunter, On the Feasibility of Improving Patent Quality One
202 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. ultimately get approved is decreasing slightly over time.143 Figure 2: Patent applications per year in the 705 class (business methods) and the subset of the class that match financial keywords in the patent specifications.
10000 705 Apps Filed 9000 705 Apps Filed that Issued 705/Terms Apps Filed 8000 705/Terms Apps Filed that Issued
7000
6000
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4000 No. of Patents of No. 3000
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0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Year
Still, there are (and were) plenty of patents to assert. Surely, thousands of patents are enough to stifle progress in an industry if those patents are successfully asserted. To assess litigation activity, I randomly selected twenty-one patents from each year between 1999- 2006144 for the subset of the 705 class that matched financial keywords and traced any litigation history for those patents.145 Additionally, I examined all of the patents from the subset that belonged to a notable bank.146 Such notable banks represent the most sophisticated parties in
continued . . . Technology at a Time: The Case of Business Methods, 21 BERKELEY TECH. L.J. 729,734–35 (2006). Allison and Hunter suggest that some applicants may have strategically avoided language that resulted in categorization in class 705 to circumvent the patent office's enhanced scrutiny of the class—or worse, the patent examiners themselves avoided the class to simplify their own work. Id. 143 Id. at 761. 144 See infra Table 2. These are the years between State Street and the start of the global financial crisis. The 21 patents selected were simply every fifth patent of the first 100 patents listed for that year in USPTO.gov database. 145 See infra Table 2. 146 "Notable" simply means a handful of household bank names that were still in existence after the financial crisis. The list of banks is provided in the table footnotes. See infra Table 2. 2016] COULD A LACK OF STRONG PATENTS 203 SPUR A GLOBAL MARKET COLLAPSE? the industry and are the most likely parties in that class to have the resources to assess the likelihood of successful assertion.147 Litigation activity is summarized in Tables 2 and 3.148 Table 2: Finance patent litigation summary table. Of the 248 total unique patents analyzed, fifteen were litigated, and two received final judgments. Finance Related # with Final Year Patents 1 # Litigated Judgment 1999 21 5 0 2000 21 2 1 - invalid 2001 21 1 0 2002 21 1 0 2003 21 2 0 1 - no 21 1 2004 infringement 2005 21 1 0 2006 21 1 0
Notable # with Banks Final Year Patents 2 # Litigated Judgment 1999 16 0 0 2000 17 0 0 2001 11 0 0
2002 7 0 0
2003 6 0 0
2004 3 0 0
2005 8 0 0
2006 16 1 0 1 Randomly selected patents by issue year from ccl/705/$ and spec/(financial OR trading OR securities OR debt OR mortgages OR commodities OR banking) 2 Patents filed by issue year from ccl/705/$ and an/((Goldman Sachs) or (Merrill Lynch) or (Morgan Stanley) or (Citibank) or (Bank of America)). Four of these patents overlap with those analyzed in the Finance Related Patents group 1.
147 See Megan M. La Belle & Heidi Mandanis Schooner, Big Banks and Business Method Patents, 16 U. PA. J. BUS. L. 431, 431, 441 (2014), available at http://scholarship.law.upenn.edu/jbl/vol16/iss2/2. 148 See infra Tables 2 and 3.
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Of the 248 unique patents that were analyzed, fifteen of them had been asserted.149 This would seem to be consistent with other studies reporting relatively high rates of patent litigation for finance-related patents.150 However, only one of the assertions came from a notable bank,151 indicating that the more sophisticated parties may have known that assertions would not be fruitful.152 Indeed, only two of the fifteen total assertions were carried to final judgment, and in neither case was the patent successfully enforced. As shown in Table 3, the vast majority of patents were never asserted.153 Additionally, the total number of lawsuit filings is skewed by the focus on a few asserted patents.154 Table 3: Finance patent assertion counts for the 248 unique patents analyzed through 1999-2006.
Total assertions # Patents 0 233 1 10 2 3 3 0 4 0 5 1 6 0 7 1
Thus, finance-related patents actually appear much weaker when it comes to enforcement than relative litigation rates alone would imply.155 They are growing at a much slower pace than some studies suggest. 156 While they may be asserted more than other types of
149 See infra Table 3. 150 Lerner, supra note 113, at 4. 151 See supra Table 2. Notable banks included in the author’s search were Goldman Sachs, Merrill Lynch, Morgan Stanley, Citibank, and Bank of America. 152 Larger companies have fewer potential defendants that are economically worthwhile to sue. There are also a number of reasons why a party may obtain a patent besides the value in asserting it, such as defensive reasons, leverage in cross- licensing negotiations, perceived asset value to the public, freedom to operate, and marketing. See Graham & Sichelman, supra note 101, at 1065–69. 153 See infra Table 3. 154 See supra Table 2; infra Table 3. 155 See supra Table 2. 156 See supra Figures 1 and 2. 2016] COULD A LACK OF STRONG PATENTS 205 SPUR A GLOBAL MARKET COLLAPSE? patents,157 they rarely go to final judgment.158 In the few instances where they were carried to final judgment, they did not prevail.159 A stronger patent system may have yielded more patent enforcement, encouraged patent litigation, and ultimately slowed the pace of the commercialization of highly risky financial innovation.160 While these effects are usually considered undesirable, they may provide an extremely valuable market regulation mechanism in high-risk areas that are controlled by asymmetric payout structures.161 They might have restrained the industry enough to have prevented the global financial collapse. But instead, patent rights had been weakened over time in this area, and there was no regulation elsewhere added to compensate for this loss of regulation.162 When the global financial collapse occurred, Congress responded by adding such compensatory financial-specific regulation.163 Unfortunately, these regulations were reactionary. Thus, while strong patents could have potentially avoided the disaster in the first place, reactive industry-specific regulation may only prevent repeating past mistakes.
V. CONCLUSION When patent rights are weakened, the overall regulation necessary to sustain a healthy market is weakened. During the lead up to the financial crisis of 2007-2009, Congress, the courts, and the USPTO had been on a trend to remove any patent barriers to the widespread commercialization of high-risk financial innovation.164 If they had instead followed State Street and accorded strong patent rights to financial innovations, the excessively risky financial innovations that
157 See Lerner, supra note 113, at 4 (noting that finance-related patents are asserted about 27 times more often than other types of patents). 158 See supra Table 2 (showing that only two of the fifteen litigated patents analyzed received a final judgment). 159 See supra Part IV.B (finding that in neither of the two patent litigations that received a final judgment were the patents successfully enforced). 160 An important note is that innovations that are kept trade secret cannot be directly regulated by the patent system. However, strong patent rights may encourage less use of trade secrets given the risk that a competitor can independently discover the same invention. With high employee turnover in the financial industry, the strength of the patent system could have significant effects in that regard. Moreover, patent claims can always be written to cover an invention broadly without disclosing the actual underlying trade secrets needed to most effectively practice the invention. 161 See generally Sharma, supra note 39. 162 See generally Patent Wars, ECONOMIST, Apr. 6, 2000, available at http://www.economist.com/node/332256. 163 See Slattery, supra note 55, at 235–36. 164 See supra note 5.
206 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. caused the global market collapse may have been isolated to a much smaller group of parties (i.e., the patent owners and licensees). Patent holdup, stifling litigation, and other typically negative consequences of patents may have actually been a good thing. Although industry- specific regulation was subsequently passed to prevent repeating mistakes of the past,165 strong patents could limit the reach of mistakes in the future that have yet to be predicted. However, the trend disfavoring finance and business method patents has actually continued. For instance, four Supreme Court Justices believe innovation is best served by the categorical elimination of all business method patents.166 This paper argues that strong patents can regulate the pace of commercialization of risky innovations, which may best serve overall innovation rates in the long term. Given that the vast majority of commercialization attempts will fail and that there is strong incentive created by the asymmetric payout structure to take excessively risky bets that any given commercialization is nevertheless worth attempting 167 , the absence of sufficient regulation in any particular industry threatens the health of the market. In this way, commercialization of innovation mimics the high-risk private financial market, which is regulated by limiting participation to sophisticated parties.168 Patents provide an analogous buyer-side restriction because patents require market participants to be sophisticated enough to either be a patentee or one who can negotiate and pay for a license.169 The financial crisis of 2007-2009 affected every industry, which in turn significantly reduced resources that would have otherwise been available to fund innovation.170 The continued weakening of patent rights for financial and business method innovations, without compensating regulation elsewhere, may spur the next global market collapse. There also may be other areas where the risks or the costs of failed innovation are sufficiently high as to justify using patents as market regulators, but more work must be done to examine whether or not such broad value exists. It may be the case that in other areas, the consequences of failure are small enough that nothing more than reactive industry-specific regulation is desirable. On the other hand, early in a technology's lifecycle might be the most critical time to use
165 See, e.g., Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111–203, 124 Stat. 1376–2223 (2010) (codified as amended at 15 U.S.C. § 780). 166 Bilski v. Kappos, 130 S.Ct. 3218, 3256–57 (Stevens, J., concurring). 167 See Sharma, supra note 39, at 6. 168 See supra Part II. 169 See supra Part III. 170 See Slattery, supra note 55, at 234–36. 2016] COULD A LACK OF STRONG PATENTS 207 SPUR A GLOBAL MARKET COLLAPSE? patents to actively regulate a market and give a fledgling industry time to sort out the good innovations from the bad ones. An industry without strong patents in the beginning may lose the ability to meaningfully restrict the market later because the foundational tools are already free to use. There are still too many factors to simply conclude that stronger patents across the board will best serve innovation and society's goals, but it may very well be the case that sometimes patent holdup can be more of a good thing than a bad thing.
WAKE FOREST JOURNAL OF BUSINESS AND INTELLECTUAL PROPERTY LAW
VOLUME 16 WINTER 2016 NUMBER 2
AN ECONOMIC ANALYSIS OF MARKET FAILURES IN COPYRIGHT LAW: IATROGENESIS AND THE FAIR USE DOCTRINE
Colin Kennedy†
I. INTRODUCTION ...... 209 II. BACKGROUND ...... 213 A. HISTORICAL BACKGROUND ...... 213 B. COPYRIGHT PROTECTION ...... 214 C. COPYRIGHT INFRINGEMENT ...... 215 D. COPYRIGHT LIMITATIONS – THE FAIR USE DOCTRINE ...... 216 III. ANALYSIS ...... 218 A. THE ECONOMICS OF COPYRIGHT LAW AND THE FAIR USE DOCTRINE ...... 218 B. MICROECONOMIC THEORY AND THE FAIR USE DOCTRINE ...... 222 1. Landes and Posner’s transaction cost approach .... 224 2. Gordon’s market failure approach ...... 226 C. MACROECONOMIC THEORY AND THE FAIR USE DOCTRINE ...... 230 1. Fair use and macroeconomic theory ...... 230 D. EX ANTE UNCERTAINTY ...... 234 IV. PROPOSED SOLUTION ...... 235 V. CONCLUSION ...... 240
† J.D. candidate, May 2016, Wake Forest University School of Law. Staff Member: 2014-16; Executive Editor: 2015-16, Wake Forest Journal of Business and Intellectual Property Law. The author would like to thank his father, Dr. Charles Kennedy, for inspiring his love of written words; Aaron Merz for sparking his interest in Economics; and Professor Simone Rose, who provided invaluable assistance in the drafting and editing of this article. 2016] AN ECONOMIC ANALYSIS OF MARKET 209 FAILURES IN COPYRIGHT LAW
“Call it what you will, incentives are what get people to work harder.”1 - Nikita Khrushchev
I. INTRODUCTION
Money makes the world go around—or so they say.2 Even Mr. Khrushchev, the famed Communist propagandist, was keen to the fact that incentives drive behavior. 3 Despite incongruous ideologies, incentives likewise play a fundamental role in America’s economy and legal system. 4 In particular, intellectual property law, and for the purposes of this article, copyright law, owes its origin to the Founders’ recognition that certain protections are necessary to stimulate the market’s production of creative works. 5 Whether or not explicitly articulated, economic considerations have existed for hundreds of years in copyright law,6 and continue to permeate modern law today.7 Article 1, section 8, clause 8 of the Constitution (the “IP
1 See Nikita Kruschev Quotes, BRAINYQUOTE, http://www.brainyquote.com/quotes/quotes/n/nikitakhru126015.html (last visited Nov. 8, 2015). 2 See Cabaret, THEBROADWAYMUSICALS.COM, http://www.thebroadwaymusicals.com/lyrics/cabaret/moneysong.htm (last visited Nov. 8, 2015). 3 See supra note 1 and accompanying text. See also Nikita Khrushchev (1894- 1971), PBS, http://www.pbs.org/redfiles/bios/all_bio_nikita_khrushchev.htm (last visited Nov. 8, 2015) (“Certainly the most colorful Soviet leader, Khrushchev is best remembered for his dramatic, oftentimes boorish gestures and ‘harebrained schemes’ designed to attain maximum propaganda effect . . . [and] his enthusiastic belief that Communism would triumph over capitalism . . . . ”). 4 See generally Ron Harris, The Encounters of Economic History and Legal History, 21 LAW & HIST. REV. 297 (2003). 5 See U.S. CONST. art. I, § 8, cl. 8. For a more detailed history of the text, purpose, and scope of the intellectual property clause, see Edward C. Walterscheid, To Promote the Progress of Science and Useful Arts: The Background and Origin of the Intellectual Property Clause of the United States Constitution, 2 INTELL. PROP. L. J. 1 (1994). 6 See U.S. CONST. art. I, § 8, cl. 8. 7 See William M. Landes & Richard A. Posner, An Economic Analysis of Copyright Law, 18 J. LEGAL STUD. 325, 325 (1989) (“Intellectual property is a natural field for economic analysis of law, and copyright is an important form of intellectual property.”). See also Simone A. Rose, The Supreme Court and Patents: Moving Towards a Postmodern Vision of “Progress”?, 23 FORDHAM INTELL. PROP. MEDIA & ENT. L.J. 1197, 1199 (2013) (“Although many Framers had concerns about the anticompetitive effect of monopolies, in the end, they were persuaded by the Madisonian view that federal intellectual property protection was needed to promote both economic and overall societal ‘progress.’”).
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Clause”) empowers Congress “to Promote the Progress of Science and useful Arts, by securing for limited Times, to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.” 8 Copyright law’s overarching purpose is thus to stimulate the production of creative works by incentivizing authors’ creative expression.9 To that end, copyright holders are granted a limited monopoly in the rights of their works and, absent certain exceptions,10 may exclusively control the reproduction, distribution, performance, and display of their works.11 Over the years, the duration of this “limited monopoly” has progressively expanded, eventually necessitating congressional reexamination of the underlying purposes of copyright law.12 First codified in the 1976 Copyright Act (“1976 Act”), the “fair use” doctrine has been Congress’ most ambitious attempt to abate the monopolistic market failures of copyright law. 13 In certain circumstances, it allows copyright infringers to assert an affirmative defense to justify what would otherwise constitute unlawful
8 U.S. CONST. art. I, § 8, cl. 8. 9 See generally Dotan Oliar, Making Sense of the Intellectual Property Clause: Promotion of Progress as a Limitation on Congress’s Intellectual Property Power, 94 GEO. L.J. 1771 (2006). 10 See 17 U.S.C. § 107 (2012). 11 See 17 U.S.C. § 106 (2012). These rights include: (1) to reproduce the copyrighted work in copies or phonorecords; (2) to prepare derivative works based upon the copyrighted work; (3) to distribute copies or phonorecords of the copyrighted work to the public by sale or other transfer of ownership, or by rental, lease, or lending; (4) in the case of literary, musical, dramatic, and choreographic works, pantomimes, and motion pictures and other audiovisual works, to perform the copyrighted work publicly; (5) in the case of literary, musical, dramatic, and choreographic works, pantomimes, and pictorial, graphic, or sculptural works, including the individual images of a motion picture or other audiovisual work, to display the copyrighted work publicly; and (6) in the case of sound recordings, to perform the copyrighted work publicly by means of a digital audio transmission. 12 The Copyright Act of 1790 allowed a maximum twenty-eight years (one fourteen-year term, with the option for one fourteen-year renewal). See Act of May 31, 1790, ch. 15, 1 Stat. 124. It has since been amended in 1802, 1831, 1870, and 1909, with each subsequent version lengthening the copyright period. See Act of Apr. 2, 1802, ch. 36, 2 Stat. 171 (repealed 1831); Act of Feb. 3, 1831, ch. 16, 4 Stat. 436 (repealed 1870); Act of July 8, 1870, ch. 230, 16 Stat. 198 (repealed 1909); H.R. REP. NO. 60-2222, at 7 (1909). The Current Copyright Act, passed in 1976, extends copyright protection for the life of the author plus seventy years. See H.R. REP. NO. 94-1476, at 66 (1976). For more on monopolies and copyright law, see infra note 97 and accompanying text. 13 See Frank P. Darr, Testing an Economic Theory of Copyright: Historical Materials and Fair Use, 32 B.C. L. REV. 1027, 1033 (1991). 2016] AN ECONOMIC ANALYSIS OF MARKET 211 FAILURES IN COPYRIGHT LAW appropriation of copyrighted material.14 As a market failure solution, economic analysis supports the contention that fair use successfully mitigates certain monopolistic inefficiencies of copyright law. 15 Unfortunately, however, inconsistent application of the doctrine has yielded significant ex ante uncertainty for litigants16 and generated a market failure of its own: namely—chilled expression. 17 Ex ante uncertainty engenders endemic risk aversion 18 and results in the underutilization of the doctrine by individuals.19 As a result, copyright law’s goal of promoting social progress20 through the dissemination of knowledge is undermined.21 For these reasons, this article likens the market failures created by the fair use doctrine to iatrogenic pathologies in medicine. Derived from the Greek word iatros (meaning “physician” or “healer”), the term “iatrogenesis” means “brought forth by the healer.”22 In the medical context, it describes a secondary problem or pathology caused by the treatment of a primary illness.23 Iatrogenesis can encompass a wide array of issues from a mundane scar, to a minor adverse drug reaction,
14 See Campbell v. Acuff-Rose Music, Inc., 510 U.S. 569, 590 (1994) (“Since fair use is an affirmative defense . . . .”); Harper & Row Publishers, Inc. v. Nation Enters., 471 U.S. 539, 561 (1985) (“The drafters resisted pressures from special interest groups to create presumptive categories of fair use, but structured the provision as an affirmative defense requiring a case-by-case analysis.”). 15 See Darr, supra note 13, at 1033–34. 16 Some courts, despite express statutory language to the contrary, have failed to find fair use in the paradigmatic examples listed in section 107. See, e.g., Am. Geophysical Union v. Texaco, Inc., 60 F.3d 913 (2d Cir. 1994) (research); L.A. News Serv. v. Tullo, 973 F.2d 791 (9th Cir. 1992) (news reporting); Salinger v. Random House, Inc., 811 F.2d 90 (2d Cir. 1987) (scholarship), cert. denied, 484 U.S. 890 (1987); Hi-Tech Video Prods. v. Capital Cities/ABC, Inc., 804 F. Supp. 950 (W.D. Mich. 1992) (news reporting), rev'd on other grounds, 58 F.3d 1093 (6th Cir. 1995). 17 See Michael Carroll, Fixing Fair Use, 85 N.C. L. REV. 1087, 1119 (2007). 18 See generally Thomas F. Cotter, Fair Use and Copyright Overenforcement, 93 IOWA L. REV. 1271 (2008). 19 See id. at 1275. 20 See U.S. CONST. art. I, § 8, cl. 8. 21 See Cotter, supra note 18, at 1273. 22 The term “iatrogenic” is one borrowed from the medical field. In medicine, an iatrogenic problem or pathology is one that is caused by the treatment of a primary disease or ailment. See MERRIAM-WEBSTER’S DICTIONARY (defining an “iatrogenic” process as one: “induced inadvertently by a physician or surgeon or by medical treatment or diagnostic procedures.”). Iatrogenesis in the medical context can be the result anything from an adverse drug reaction (e.g. a rash) to a fatal surgery as a result of a doctor’s negligence. Likewise, in the context of copyright law, fair use—a market failure solution—creates market failures of its own. 23 See id.
212 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. to fatal malpractice.24 By analogy, copyright law’s “primary illness” is market failure brought on by the increasingly monopolistic overprotection of authors’ rights. As a “treatment,” fair use successfully mitigates certain inefficiencies of copyright law. However, in the process, it unintentionally gives rise to the very problem it seeks to ameliorate—market failure. This article aims to briefly explore the economic underpinnings of copyright law’s largest exception—the fair use doctrine—and explain how courts’ inconsistent application of the doctrine contravenes its purpose as a corrective tool by propagating iatrogenic market failure. Part II provides a historical backdrop and a brief synopsis of copyright law and the fair use doctrine. 25 Part III26 provides an overview of copyright law’s relevant economic principles and delves more specifically into the various economic theories used to explain the fair use doctrine.27 The article concludes by noting the incompleteness of economic analysis as a tool for predicting fair use outcomes and proposes a three-step solution—the combined goal of which is to diminish litigants’ ex ante uncertainty and curtail the doctrine’s recent trend of chilling creative expression.28 Step one involves amending Section 107 to include a statutory safe-harbor for certain types of use. Step two requires, at the very least, clarification of the current balancing test for cases that fall outside the scope of step one. Finally, step three advocates for the implementation of a mandatory appeals circuit that would eliminate much of the current uncertainty derived from the doctrine’s competing interpretations in various circuits.
24 See SANDRA CROUCH, CAROL CHAPELHOW & MICHAEL CROUCH, MEDICINES MANAGEMENT: A NURSING PERSPECTIVE 102–03 (Routledge 2013). 25 See infra Part II. 26 Part III highlights the economic principles relevant to analysis of the fair use doctrine in relation to this article, but by no means accomplishes an all- encompassing economic analysis of copyright law. For more on copyright law in general, see Landes & Posner, supra note 7. For a more encompassing analysis of the economics of the fair use doctrine, see Wendy J. Gordon, Fair Use as Market Failure: A Structural and Economic Analysis of the Betamax Case and Its Predecessors, 82 COLUM. L. REV. 1600 (1982). 27 See infra Part III. 28 See infra Part IV. 2016] AN ECONOMIC ANALYSIS OF MARKET 213 FAILURES IN COPYRIGHT LAW
II. BACKGROUND
A. Historical Background
Copyright law finds its genesis in England’s 1710 Statute of Anne.29 In the United States, copyright protection can be traced back to the Constitution,30 and creative expression has been statutorily protected, in various forms, since 1790. 31 The Founders first articulated the underlying public benefit rationale of copyright law—“[t]o promote the Progress of Science and useful Arts.” 32 Since that time, copyright statutes have sought to further the general goal of establishing incentives for authors to produce creative works.33 Undergirding the constitutional grant of copyright protection is an economic rationale34 premised on the notion that “[p]rogress” (i.e. the free flow of information to society) is best promoted when authors have strong incentives to produce creative works. 35 The IP Clause incentivizes creativity by “securing for limited Times to Authors . . . the exclusive Right to their respective Writings.”36 Put simply, copyright law protects authors’ rights, thereby incentivizing the production of creative works, which ultimately benefits the public at large.37
29 See Act for the Encouragement of Learning (Statute of Anne), 8 ANN., C. 19 (1710) (Gr. Brit.). 30 See U.S. CONST. art. I, § 8, cl. 8. 31 See The Copyright Act of 1790, ch. 15, 1 Stat. 124. 32 U.S. CONST. art. I, § 8, cl. 8. 33 See Mazer v. Stein, 347 U.S. 201, 219 (1954) (“The economic philosophy behind the clause empowering Congress to grant patents and copyrights is the conviction that . . . [it] is the best way to advance public welfare through the talents of authors and inventors in ‘Science and useful Arts.’”). See also Gordon, supra note 26, at 1602. For a more detailed overview of the history of copyright statutes, see BENJAMIN KAPLAN, AN UNHURRIED VIEW OF COPYRIGHT 25 (The Lawbook Exchange, Ltd., 2008); 2 ALAN LATMAN, COPYRIGHT FOR THE EIGHTIES 1–10 (Michie Co. 1981). 34 See Steven B. Thau, Copyright, Privacy, and Fair Use, 24 HOFSTRA L. REV. 179, 180 (1995) (“When writing about copyright law, scholars and judges frequently focus on its ability to create economic incentives for creativity.”). 35 Id. 36 U.S. CONST. art. I, § 8, cl. 8. 37 See 17 U.S.C. § 106 (2012); Thau, supra note 34, at 197. For a more detailed discussion, see infra note 112 and accompanying text; infra Part III.
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B. Copyright Protection
Copyright law protects “original works of authorship”38 the moment they are “fixed in any tangible medium of expression.”39 The sine qua non of protectable expression is originality.40 The bar is low, requiring only independent creation 41 and a “minimal creative spark,” 42 irrespective of how crude, obvious, or humble it may be. 43 The Supreme Court has held that originality, not effort, is afforded protection.44 In Feist Publications, Inc. v. Rural Telephone Service Co.,45 the Supreme Court clarified that copyright protection would not extend to factual compilations lacking originality, irrespective of the effort expended in creation.46 Feist thus reaffirmed that facts are not copyrightable 47 and cemented creativity as originality’s bedrock prerequisite. 48 Once a work falls within the realm of protectable expression, the 1976 Act requires registration 49 with the Copyright
38 17 U.S.C. § 102(a) (2012). 39 Id. The term “author” has been defined as “he to whom anything owes its origin; originator; maker; one who completes a work of science or literature.” Burrow-Giles Lithographic Co. v. Sarony, 111 U.S. 53, 58 (1884). The term “writings” is not limited to printed material and has been broadly construed to include other intellectually creative products, such as recordings or artistic performances. See, e.g., 17 U.S.C. § 101 (2012) (“A work is ‘fixed’ in any tangible medium of expression when its embodiment . . . is sufficiently permanent or stable to permit it to be perceived, reproduced, or otherwise communicated for a period of more than transitory duration.”); Goldstein v. California, 412 U.S. 546 (1973). 40 See Feist Publ’ns v. Rural Tel. Serv. Co., 499 U.S. 340, 348 (1991) (“Originality remains the sine qua non of copyright.”). See also Eldred v. Reno, 239 F.3d 372 (D.C. Cir. 2001), cert. granted, 534 U.S. 1126 (2002); Murray Hill Publ’ns, Inc. v. ABC Commc’ns., Inc., 264 F.3d 622 (6th Cir. 2001); RT Computer Graphics, Inc. v. U.S., 44 Fed. Cl. 747 (1999); Beal v. Paramount Pictures Corp., 20 F.3d 454 (11th Cir. 1994). 41 Feist, 499 U.S. at 346 (“[O]riginality requires independent creation plus a modicum of creativity . . . .”); id. at 353 (“[T]he only defense to infringement was independent creation . . . .”). 42 Id. at 363. 43 Id. at 345 (quoting 1 M. NIMMER & D. NIMMER, COPYRIGHT § 2.01(C)(1)) (“To be sure, the requisite level of creativity is extremely low; even a slight amount will suffice. The vast majority of works make the grade quite easily, as they possess some creative spark, no matter how crude, humble or obvious it might be.”) (internal quotation marks omitted). 44 Feist, 499 U.S. at 364. 45 499 U.S. 340. 46 See id. at 347. 47 Id. See also Tracy A. Meade, Note, Ex-Post Feist: Applications of a Landmark Copyright Decision, 2. J. INTELL. PROP. L. 245 (1994). 48 Feist, 499 U.S. at 345. 49 Registration becomes exceedingly important in copyright lawsuits because an continued . . . 2016] AN ECONOMIC ANALYSIS OF MARKET 215 FAILURES IN COPYRIGHT LAW
Office in order to judicially enforce copyright protection for U.S. works.50
C. Copyright Infringement
Section 501(b) 51 of the 1976 Act entitles legal or beneficial copyright holders to sue for infringement when any one of Section 106’s statutorily granted rights is violated.52 The plaintiff in an infringement suit bears the burden of proof, and at the outset, must prove ownership of a valid copyright.53 A prima facie infringement case requires proof that the alleged infringing material is substantially similar to the copyrighted work, and was not independently created by the second author. 54 A strict liability offense, 55 which lacks an intent requirement,56 infringement may occur either directly57 or indirectly.58 Copying in fair uses cases, however, is often a forgone conclusion because defendants may only raise the affirmative defense after
infringement claim cannot go forward unless the plaintiff can establish ownership of a valid copyright. See Robert R. Jones Assocs., Inc. v. Nino Homes, 858 F.2d 274, 276–77 (6th Cir. 1988) (“In order to establish copyright infringement, the owner of a valid copyright must prove that the defendant or the person who composed the allegedly-infringing work copied the copyrighted material.”). See also Ferguson v. Nat’l Broad. Co., 584 F.2d 111, 113 (5th Cir. 1978). 50 See 17 U.S.C. § 101 (2012) (providing that the term "registration" means “registration of a claim in the original or the renewed and extended term of copyright”). To register a copyright, an author is required to register with the Copyright Office. This requires depositing an application and fee with the Copyright Office. See id. § 409. Beginning January 1, 1978, registration of a copyright grants owners protection for the life of the author plus 70 years. See id. 302(a). In the case of joint works, the copyright extends 70 years after the death of the last surviving author. See id. § 302(b). In the case of anonymous works, pseudonymous works, or works made for hire, the copyright extends for 95 years from the date of publication or 120 years from the date of creation, whichever is shorter. Id. § 302(c). 51 17 U.S.C. § 501(b) (2012). 52 See supra notes 10–12 and accompanying text. 53 See JULIE E. COHEN ET AL., COPYRIGHT IN A GLOBAL INFORMATION ECONOMY 290 (3d ed. 2010). 54 Some copyright scholars have referred to this as “copying in fact.” Id. at 291. 55 See, e.g., King Records, Inc. v. Bennett, 438 F. Supp. 2d 812, 852 (M.D. Tenn. 2006) (“Liability for copyright infringement does not turn on the infringer's mental state because a general claim for copyright infringement is fundamentally one founded on strict liability.”) (internal quotation marks and citation omitted). 56 Id. 57 See, e.g., Religious Tech. Cent. v. Netcom On-Line Commc’n Servs., Inc., 907 F. Supp. 1361, 1367 (N.D. Cal. 1995). 58 See, e.g., Cartoon Network LP v. CSC Holdings, Inc., 536 F.3d 121, 133 (2d Cir. 2008).
216 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. infringement of a valid copyright has been established or admitted.59
D. Copyright Limitations – The Fair Use Doctrine
The 1976 Act codified a series of limitations 60 to reign in the increasingly monopolistic nature of copyright law. 61 Fair use— copyright law’s largest limitation—seeks to strike a balance between an author’s right to remuneration and the public’s interest in accessing works.62 In certain circumstances,63 fair use allows individuals to use portions of a copyrighted work without the author’s approval and without compensating the copyright holder.64 In an attempt to guide courts in making fair use determinations, the 1976 Act codified the common law fair use doctrine65 in 17 U.S.C. § 107 by laying out four “guiding” factors: (1) the purpose and character of the use, including whether such use is of a commercial nature or is for non- profit educational purposes; (2) the nature of the copyrighted work; (3) the amount and substantiality of the portion used in relation to the copyrighted work as a whole; and (4) the effect of the use upon the potential market for and value of the copyrighted work.66 Section 107’s four-factor analysis is a necessarily fact-specific inquiry—one which, in large part, mirrors Justice Story’s original formulation in Folsom v. Marsh in 1841.67
59 See generally COHEN, supra note 53. 60 17 U.S.C. §§ 107-22 (2012). While a number of these limitations were present in previous versions of the Copyright Act, the 1976 Act was the first instance in which the fair use doctrine was statutorily codified, See An Act for the general revision of the Copyright Law, title 17 of the United States Code, and for other purposes, Pub. L. No. 94-553, Title 17, § 107, 90 Stat. 2541 (1976). 61 See generally Michael G. Anderson & Paul F. Brown, The Economics Behind Copyright Fair Use: A Principled and Predictable Body of Law, 24 LOY. U. CHI. L.J. 143, 163 (1993). 62 See Gordon, supra note 26, at 1602. 63 See supra note 11 and accompanying text. 64 See Landes & Posner, supra note 7, at 357. 65 See Folsom v. Marsh, 9 F. Cas. 342 (C.C.D. Mass. 1841). 66 17 U.S.C. §§ 107(1)–(4) (2012). 67 See Folsom, 9 F. Cas. at 344–45. (“[A] reviewer may fairly cite largely from the original work, if his design by really and truly to use the passages for the purposes of fair and reasonable criticism. On the other hand, it is as clear, that if he cites the most important parts of the work, with a view, not to criticize, but to supersede the use of the original work, and substitute the review for it, such a use continued . . . 2016] AN ECONOMIC ANALYSIS OF MARKET 217 FAILURES IN COPYRIGHT LAW
Much of the fair use’s uncertainty, and, consequently, its inefficiency, results from the doctrine’s lack of uniform application. Section 107’s legislative history indicates that fair use’s codification was intended to create a “more uniform and predictable body of case law.” 68 However, “[t]hose familiar with copyright law are well acquainted with the difficulties courts face in providing guidance under [Section] 107.”69 The four factors are non-exhaustive,70 and neither Congress nor the courts have provided useful guidance regarding future application of this “equitable rule of reason.”71 Congress ultimately left application of the four factors to the discretion of the courts, 72 and many, including the Supreme Court, have struggled to consistently
will be deemed in law a piracy.”). See also id. at 348. (“In short, we must often . . . look to the nature and objects of the selections made, the quantity and value of the materials used, and the degree in which the use may prejudice the sale, or diminish the profits, or supersede the objects, of the original work.”). Of note, Justice Story never used the phrase “fair use.” The term was not coined for another twenty-eight years. See Lawrence v. Dana, 15 F. Cas. 26, 44 (C.C.D. Mass. 1869). 68 See Anderson & Brown, supra note 61, at 146. 69 See Carroll, supra note 17, at 1094. 70 The 1976 Act states that: “[i]n determining whether the use . . . is a fair use the factors to be considered shall include” those factors listed in the text. 17 U.S.C. § 107 (2012). Furthermore, the term “including” is “illustrative and not limitative.” Id. § 101. See also H.R. REP. NO. 1476 (1976), reprinted in 1976 U.S.C.C.A.N. 5659, 5680 (“Beyond a very broad statutory explanation of what fair use is and some of the criteria applicable to it, the courts must be free to adapt the doctrine to particular situations on a case-by-case basis.”). 71 See H.R. REP. NO. 1476 (1976), reprinted in 1976 U.S.C.C.A.N. 5659, 5679 (“[S]ince the doctrine is an equitable rule of reason, no generally applicable definition is possible, and each case raising the question must be decided on its own facts.”). See also Harper & Row Publishers, Inc., v. Nation Enters., 471 U.S. 539, 552 (1984) (“[F]air use analysis must always be tailored to the individual case.”); HORACE G. BALL, THE LAW OF COPYRIGHT AND LITERARY PROPERTY 260 (1944) (“[P]rivilege in others than the owner of a copyright to use the copyrighted material in a reasonable manner without his consent, notwithstanding the monopoly granted to the owner.”). 72 See Harper & Row, 471 U.S. at 560 (“The factors enumerated in the section are not meant to be exclusive: ‘[S]ince the doctrine is an equitable rule of reason, no generally applicable definition is possible, and each case raising the question must be decided on its own facts.’”) (quoting H.R. REP NO. 94–1476 (1976), reprinted in 1976 U.S.C.C.A.N 5659, 5679)). See also Ty Inc. v. Publ’ns. Int’l Ltd., 292 F.3d 512, 522 (7th Cir. 2002) (“The important point is simply that, as the Supreme Court made clear . . . the four factors are a checklist of things to be considered rather than a formula for decision.”); Gordon, supra note 26, at 1602–03; William F. Patry & Richard Posner, Fair Use and Statutory Reform in the Wake of Eldred, 92 CAL. L. REV. 1639, 1645 (2004) (“All section 107 really amounts to in practical terms is confirmation that the courts are entitled to allow in the name of fair use a certain undefined amount of unauthorized copying from copyrighted works. This may seem an unsatisfactory solution to the problem of defining fair use, and indeed the uncertain contours of the defense raise serious problems . . . . ”).
218 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. apply the doctrine.73 Adding to the confusion, various circuits have placed differing weight on different factors, creating inconsistent results and exacerbating litigants’ ex ante uncertainty.74 Naturally, fair use has earned its characterization as “the most troublesome [doctrine] in the whole law of copyright.”75
III. ANALYSIS
A. The Economics of Copyright Law and the Fair Use Doctrine
Economics is a social science that seeks to explain how various factors affect the production and consumption of goods.76 An economic theory of copyright law thus seeks to function as an explanatory tool of how judges and courts interpret the 1976 Act. 77 For this reason, economic analysis of copyright law is a “positive theory attempting to describe how results are reached, rather than a normative theory suggesting the goals copyright should seek to achieve.”78 Accordingly, for the purposes of this article, an economic theory of copyright law attempts to explain how the fair use doctrine seeks to promote the efficient allocation of resources. 79 In particular, micro and macroeconomic theory work in tandem to explain how the fair use doctrine steps in to correct market failures created by copyright law’s increasingly monopolistic grants to authors.80 An economic analysis of copyright law necessarily begins with an examination of incentives. An efficient copyright system seeks to maximize social welfare by balancing the private interests of copyright holders with the public’s interest in accessing knowledge. 81 In
73 Recent Supreme Court decisions, decided by a 5-4 split, have seen various justices emphasize different factors in the majority and dissent. Compare Sony Corp. of Am. v. Universal City Studios, Inc., 464 U.S. 417 (1984) (finding defendant not liable for infringement because the public was making fair use copies of the plaintiff's television programs), with Harper & Row, 471 U.S. at 540 (finding the defendant liable for infringement even though news reporting is one of the uses given specific mention in the preamble to § 107). 74 See Anderson & Brown, supra note 61, at 146. 75 See Universal City Studios, 659 F.2d at 969 (quoting Dellar v. Samuel Goldwyn, Inc., 104 F.2d 661, 662 (2d Cir. 1939), cert. granted, 457 U.S. 1116 (1982) (No. 81-1687)). 76 See generally N. GREGORY MANKIW, PRINCIPLES OF ECONOMICS (7th ed. 2015). 77 See RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW 21 (3d ed. 1986); Landes & Posner, supra note 7, at 325. 78 Darr, supra note 13, at 1033. 79 Or in this case—creative works. See Landes & Posner, supra note 7, at 326. 80 See infra Part III.B-C. 81 See Landes & Posner, supra note 7, at 326. 2016] AN ECONOMIC ANALYSIS OF MARKET 219 FAILURES IN COPYRIGHT LAW economics jargon, copyrightable material has long been viewed as a non-excludable “public good,” meaning that it can be “enjoyed by an unlimited number of people without being ‘used up.’”82 Public goods differ from “private goods,” in that public goods are non-excludable— meaning they can be repeatedly and infinitely used without diminishing others’ ability to do the same.83 For example, Shakespeare’s Hamlet,84 a public good, can be “consumed” (i.e. read) over and over without excluding or diminishing others’ ability to likewise read and enjoy the play. However, consumption of a private good (e.g. a cheeseburger) is finite and hence excludable.85 For this reason, the economic rationale of copyright law “arises from the assumption that the variable cost of producing a book is the same for the author and any infringer.”86
82 Lydia Pallas Loren, Redefining the Market Failure Approach to Fair Use in an Era of Copyright Permission Systems, 5 J. INTELL. PROP. L. 1, 22–23 (1997) (internal quotations omitted). 83 See id. at 23. See also infra note 86 and accompanying text. 84 For the purposes of this simplistic example, I will ignore the fact that in the United States, Shakespeare’s Hamlet is in the “public domain” and hence, no longer subject to copyright protection or limitations. However, for those interested in one of Shakespeare’s enduring literary masterpieces, see WILLIAM SHAKESPEARE, HAMLET (Barbara A. Mowat & Paul Werstine eds., Simon & Schuster, Inc. 2012) (1603). 85 For more on the subject of public goods, see Paul Samuelson, The Pure Theory of Public Expenditure, 36 REV. OF ECONS. & STATS. 387–89 (1954). Of note, for the purposes of this article, I only separate “public” and “private” goods insofar as it aids the understanding of the economics of copyright law and fair use. I am not unmindful of the distinction between “pure public goods,” which are non-rival and non excludable, and “pure private goods” which are rival and excludable. Furthermore, any introduction of the concept of “mixed goods” or “common goods” is beyond the scope of this article, and would only serve to over-complicate a minor point. 86 Darr, supra note 13, at 1034. See also Landes & Posner, supra note 7, at 326– 27 (“The cost of producing a book or other copyrightable work . . . has two components. The first is the cost of creating the work . . . The second component of the cost of producing a work increases with the number of copies produced, for it is the cost of printing, binding, and distributing individual copies. The cost of expression does not enter into the making of copies because, once the work is created, the author’s efforts can be incorporated into another copy virtually without cost.”).
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If authors are unable to recover their fixed costs of production, they will not produce.87 To remedy this market failure, Section 106 of the 1976 Act grants authors limited monopolistic protection in an enumerated “bundle of rights.” 88 Subsequent amendments to the Copyright Act have lengthened the term of protection and increased this monopoly power. 89 Economic theory suggests that unfettered monopoly power distorts the price of goods by allowing an author, as the sole supplier of a good, to manipulate an otherwise competitive market by pricing his work above the marginal cost of production (the “monopoly price”).90 Two consequences naturally follow. First, the author will reap a healthy profit;91 second, consumers who value the good at or above the market price,92 but below the monopoly price,93 will not purchase it.94 The latter effect creates allocative inefficiency in the form of “deadweight loss”95 and results in a socially undesirable underproduction of goods.96
87 See Landes & Posner, supra note 7, at 327. 88 See 17 U.S.C. § 106 (2012). See also notes 9–13 and accompanying text. 89 The first Copyright Act provided a maximum twenty-eight year period (two fourteen year renewable periods). It has since been amended in 1802, 1831, 1870, and 1909. Each subsequent version increased the length of an author’s copyright period. See Act of Apr. 29, 1802, ch. 36, 2 Stat. 171 (repealed 1831); Act of Feb. 3, 1831, ch. 16, 4 Stat. 436 (repealed 1870); Act of July 8, 1870, ch. 230, 16 Stat. 178 (repealed 1909); H.R. REP. NO. 60-2222, 60th Cong., 2d Sess. 7 (1909). 90 See infra Figure 1, at P1. For more on monopolies and the economic effect of monopolistic pricing, see THOMAS KARIER, BEYOND COMPETITION: ECONOMICS OF MERGERS AND MONOPOLY POWER (1993). 91 See William W. Fisher III, Reconstructing the Fair Use Doctrine, 101 HARV. L. REV. 1659, 1700–01 (1988). 92 See infra Figure 1, at point C. 93 See infra Figure 1, at point B. 94 See Fisher, supra note 91, at 1700–02. 95 For more on deadweight loss in copyright law, see infra Figure 1. See also infra note 97 and accompanying text. For a more detailed analysis of deadweight loss in general, see generally Jerry A. Hausman, Exact Consumer’s Surplus and Deadweight Loss, 71 AM. ECON. REV. 662 (1981). 96 Δ ABC represents society’s deadweight loss. See infra Figure 1. See also RICHARD POSNER, ECONOMIC ANALYSIS OF LAW 256 (3d ed. 1986) (treating "the transfer of wealth from consumers to producers brought about by increasing the price from the competitive to the monopoly level . . . as a wash"); Richard Posner, The Social Costs of Monopoly and Regulation, 83 J. POL. ECON. 807, 807–15 (1975); F.M. SCHERER, INDUSTRIAL MARKET STRUCTURE AND ECONOMIC PERFORMANCE 450–54 (2d ed. 1980); Fisher, supra note 91, at 1701–02. 2016] AN ECONOMIC ANALYSIS OF MARKET 221 FAILURES IN COPYRIGHT LAW
FIGURE 1: MONOPOLISTIC PRICING AND DEADWEIGHT LOSS 97
Accordingly, “for the optimal number of works to be produced, an economically rational law must provide the means for new material to be produced as well as provide protection to existing materials.”98 Courts, commentators, and scholars have espoused two economic rationales explaining the fair use doctrine: 99 one rooted in microeconomic theory100 and the other in macroeconomic theory.101
97 Figure 1 shows the market inefficiencies that result from monopolistic pricing. The Y-axis (“Costs and Revenues”) represents Price (P) (i.e. the total compensation the author receives, described here as “Costs and Revenues”). The X- axis represents Output or Quantity (Q). In a competitive market, supply and demand converge at an equilibrium Price (P) and Quantity (Q). For a simplistic supply and demand model, see infra Figure 2. Figure 1 illustrates the effect of monopolistic pricing. To display the effect of pure monopolistic pricing, the above graphic is illustrative, where: (1) MC = Marginal Cost (2) MR = Marginal Revenue (3) ATC = Average Total Cost (4) AR = Average Revenue Typically, firms (or individuals) maximize profits when their marginal costs equal their marginal revenues (MC=MR). Absent a monopoly, this occurs at (P, Q) [or point B in Figure 1]. However, because monopolies distort market effects, average revenue (AR) in monopoly firms exceeds average total cost (ATC) (i.e. AR > ATC). Accordingly, Point C in Figure 1 distorts the point at which MC=MR. As a result, the supplier (or author in the case of copyright) is able to reap “supernormal” or monopoly profits. For more on monopoly profits, see KARIER, supra note 90 and accompanying text. The result of monopolistic pricing, as demonstrated above, is a reduced quantity of goods (Q1) and a higher price (P1). Additionally, society experiences deadweight loss results (shown in ∆ ABC). 98 Darr, supra note 13, at 1034. 99 Thau, supra note 34, at 193. 100 Id. See also infra Part III.B. 101 Thau, supra note 34, at 193. See also infra Part III.C.
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Microeconomic theory justifications focus on how transaction costs and externalities affect individual decision-making and create market failures. 102 Macroeconomic theorists view fair use as a utilitarian mechanism for promoting the IP Clause’s goal of maximizing social welfare through the dissemination of knowledge—often, however, at the expense of individual profit.103 Individually, both theories have their limits,104 and while neither wholly solves the issue of ex ante uncertainty, together they may offer some insight for prospective litigants and provide judges an analytical framework that may better effectuate consistent and efficient market outcomes for all parties involved.
B. Microeconomic Theory and the Fair Use Doctrine
Microeconomics studies how competing incentives affect individual decision-making in the marketplace, and examines the concomitant effect on the supply and demand of goods. 105 Microeconomic theory posits that resources will be most efficiently allocated when rational, utility-maximizing individuals are left to their own devises in the marketplace.106 In theory, absent market failure or outside intervention, individual decision-making will allow supply and demand to converge at a market equilibrium price and yield a socially optimal allocation of goods and services.107
102 See generally Gordon, supra note 26; Landes & Posner, supra note 7. 103 See generally Peter N. Leval, Toward a Fair Use Standard, 103 HARV. L. REV. 1105, 1106–07 (1990). 104 See infra Parts III-V. 105 See generally WALTER NICHOLSON, MICROECONOMIC THEORY: BASIC PRINCIPLES AND EXTENSIONS (5th ed. 1992). 106 See Aryeh S. Friedman, Law and the Innovative Process: Preliminary Reflections, 1986 COLUM. BUS. L. REV. 1, 19, n.67 (1986). 107 Figure 2 provides a simplistic graphical illustration of equilibrium pricing and output from a microeconomic standpoint. See generally NICHOLSON, supra note 105. 2016] AN ECONOMIC ANALYSIS OF MARKET 223 FAILURES IN COPYRIGHT LAW
FIGURE 2: OPTIMAL PRODUCTION OF CREATIVE WORKS 108
Market failures interfere with the optimal allocation of goods.109 In copyright law, this occurs when “a copyright owner and potential user [can] not reliably engage in a socially valuable market exchange.”110 Market failures in copyright law primarily occur in two forms. First, high transaction costs prevent otherwise desirable transactions111 from occurring when the expected cost of negotiating a license exceeds the parties’ anticipated benefit of the bargain.112 Second, when parties fail to account for the social benefit of their bargain, society bears a negative externality in the form of deadweight loss.113 In either situation, the fair
108 In Figure 2, supply (S) and demand (D) converge at an efficient market equilibrium price. Absent market failure, the supply curve intersects with the demand curve, yielding an optimal price and output of a copyrighted work (P*, Q*). At equilibrium, Q* represents the total number of works authors will produce, and P* represents the price paid by society for the work. It is important to note that P* does not represent the price received by an author for a single work, rather P* represents the price garnered from all sales (including books, movie rights, or any other licensing/royalty fees that may be applicable). Id. For more on the social benefits of requiring payment for ancillary uses, see Robin A. Moore, Fair Use and Innovation Policy, 82 N.Y.U. L. REV. 944, 952–57 (2007). 109 See NICHOLSON, supra note 105. Of note, market failures interfere with the optimal allocation of both goods and services. However, for the purposes of this article, it suffices to focus on the former. 110 Moore, supra note 108, at 946. 111 See id. See also infra Part III.B.1. 112 See Moore, supra note 108, at 946. See also infra Part III.B.1. 113 An “externality” is any cost or benefit that affects a party who did not choose continued . . .
224 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. use doctrine steps in, and, at least theoretically, corrects the market failure created by copyright law’s overprotection of authors.114 The extent to which it effectively does so will be examined below.115
1. Landes and Posner’s transaction cost approach
In 1989, Professor William Landes and Judge Richard Posner undertook the first comprehensive economic analysis of copyright law.116 They begin with the contention that “[s]triking the balance between access and incentives is the central problem in copyright law.”117 Their fair use analysis focuses primarily on the doctrine’s corrective function in situations where resources are inefficiently allocated as a result of burdensome transaction costs.118 In economics, a “transaction cost” is a cost that is incurred as a result of the time, effort, or expense required to negotiate a deal.119 Landes and Posner note that market failures breed inefficiency when the transaction costs associated with enforcement of a copyright exceed the would-be benefits of a lawsuit.120 Accordingly, they posit that lawsuits should not occur when the copyright holder’s cost of enforcement exceeds the potential benefits of a suit or settlement.121 An illustrative example of their theory follows. 122 Suppose an author (“A”) wants to quote a portion of another author’s (“B”) copyrighted work.123 If a hypothetical licensing negotiation was to
to incur that cost or benefit. See NICHOLSON, supra note 105, at 746. (“An externality occurs whenever the activities of one economic agent affect the activities of another agent in ways that are not taken into account by the operation of the market.”) (emphasis in original). See also STEFANO ZAMAGNI, MICROECONOMIC THEORY: AN INTRODUCTION 538 (Anthony Fletcher trans., Basil Blackwell 1987) (“Externalities are those (favourable or unfavourable) effects on the consumption or production of one economic agent (an individual or firm) on the production and/or consumption of another economic agent for which no price is paid or received.”). For a more detailed discussion of externalities in copyright law, and examples in the fair use context, see infra Part III.B.1; infra Figure 3. 114 See generally Gordon, supra note 26; Landes & Posner, supra note 7. 115 See infra Part III.B.1–2. 116 See Landes & Posner, supra note 7. 117 Id. at 326. 118 See id. at 327–30. 119 See BLACK’S LAW DICTIONARY (10th ed. 2014) (defining transaction cost as: “a cost connected with a process transaction, such as a broker's commission, the time and effort expended to arrange a deal, or the cost involved in litigating a dispute.”). 120 See Landes & Posner, supra note 7, at 357–58. 121 See id. 122 This example largely mirrors the one found in Landes and Posner’s work, with slight variations. See Landes & Posner, supra note 7, at 357–58. 123 See id. 2016] AN ECONOMIC ANALYSIS OF MARKET 225 FAILURES IN COPYRIGHT LAW occur, assume that “A” would be willing to pay $1,000 for use of the text, and “B” would be willing to accept.124 Up to this point, market forces and individual preferences dictate the occurrence or non- occurrence of the transaction. 125 Next, however, assume that consummation of the transaction requires “A” and “B” to retain counsel, which creates an additional $5,000 expense. Here, because the transaction costs are well in excess of the bargain’s potential benefit, each party’s expected return vanishes and an otherwise agreeable transaction fails to materialize.126 In this situation, the fair use doctrine steps in to correct the market failure by allowing “A” to use small portions of “B’s” work for academic purposes.127 Landes and Posner’s transaction-cost theory correctly identifies the fair use doctrine’s corrective function in an economic model where high transaction costs would prevent otherwise efficient licensing agreements.128 Their cost-benefit analysis, which seeks to explain the fair use doctrine solely as a redress to be narrowly applied in certain high-transaction cost situations, however, is not without its critics.129 One critic focuses on the practical limitations of Landes and Posner’s theory by arguing: The fact that fair use is successfully invoked in a large number of suits in which the transaction cost rationale simply does not apply—e.g., where the defendant can easily identify the would-be plaintiff ex ante and would be willing to negotiate a license— indicates that courts view fair use as more than merely a means of avoiding costly negotiating.130 In essence, certain commentators believe that in practice, Landes and Posner’s transaction-cost theory falls significantly short of offering a complete explanation for judicial outcomes.131
124 See id. 125 Here, the “equilibrium price” equals $1,000. See supra Figure 2; supra note 109 and accompanying text. 126 See supra Figure 2; supra note 109 and accompanying text. 127 See supra text accompanying note 115. See generally Gordon, supra note 26, at 1615 (explaining market failure as one element of a three part test for determining fair use.); Landes & Posner, supra note 7, at 357 (“A fair use privilege creates a clear benefit to A but does not harm B.”). 128 See Landes & Posner, supra note 7, at 357–58. 129 See Thau, supra note 34, at 195–97. 130 Id. at 195–96. 131 The author of this article shares this belief with these other commentators, e.g., Thau, supra note 34, at 195.
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One observer astutely notes that in the context of high transaction costs, fair use operates “primarily on the mind of the copyright infringer.”132 In the context of high transaction costs and low value licenses, the logic of this assertion is undeniable. Even in the absence of Section 107, no rational copyright holder will choose to sue when the cost of bringing suit far outweighs the potential for reward.133 This will invariably happen in situations similar to the above example. 134 In practice, “A” will go ahead and infringe, knowing that “B’s” cost- prohibitive lawsuit will likely never materialize.135 As a result, in the context of high-transaction cost scenarios, fair use may only serve a limited role—to assuage the conscience of an otherwise reticent infringer.
2. Gordon’s market failure approach
More than thirty years ago, in response to the Supreme Court’s pending decision in Sony Corp. of America v. Universal City Studios, Inc., 136 (“Sony” or the “Betamax” case) Professor Wendy Gordon provided the first comprehensive economic analysis of the fair use doctrine.137 Gordon argued that fair use is justifiable only when three conditions are met: 138 first, a market failure must prevent the prospective parties from efficiently negotiating a license;139 second, the transfer of rights from the copyright holder to the would-be user must produce a “socially desirable” result;140 and finally, the transfer must not negatively impact an author’s incentive to create new works.141
132 Id. 133 See id. (“If courts took seriously Landes and Posner's suggestion to limit fair use to cases in which the benefit of the use accruing to an alleged infringer is outweighed by the costs of enforcement borne by the copyright owner, we would hardly expect to see any cases in which the fair use defense is successfully raised. The plaintiffs in those cases would lack the economic incentive to sue, and if a suit did occur, a defendant would be wiser to settle rather than raise an expensive defense like fair use.”). 134 See supra notes 90–95 and accompanying text. 135 See id. 136 464 U.S. 417 (1984). 137 See Gordon, supra note 26, at 1602. 138 See id. at 1614 (“Fair use should be awarded to the defendant in a copyright infringement action when (1) market failure is present; (2) transfer of the use to defendant is socially desirable; and (3) an award of fair use would not cause substantial injury to the incentives of the plaintiff copyright owner.”). 139 See id. at 1614–15. 140 See id. at 1615 (“If market failure is present, the court should determine if the use is more valuable in the defendant’s hands or in the hands of the copyright owner.”). 141 See id. at 1614–22. 2016] AN ECONOMIC ANALYSIS OF MARKET 227 FAILURES IN COPYRIGHT LAW
Parts two and three of Gordon’s work142 largely reflect traditional fair use analysis. 143 Her “primary contribution to fair use scholarship”144 lies in her assertion that market failure should precede application of the fair use doctrine.145 She points to three categories in which market failures arise in copyright law: transaction costs, externalities, and antidissemination incentives.146 Her transaction costs analysis, in substantive part, mirrors that of Landes and Posner. 147 Gordon’s externality analysis, in the microeconomic context,148 focuses on situations in which externalities are not factored into individual decision-making 149 and examines the concomitant macroeconomic consequences.150 In copyright law, externalities exist when licensing negotiations fail to account for the social benefit of a transaction. 151 The following simplistic example is illustrative.152 Assume a similar situation to the one above: an author or academic scholar wishes to quote a portion of a copyrighted work in an upcoming book.153 The scholar values use of
142 See supra note 101 and accompanying text. 143 See, e.g., Campbell v. Acuff-Rose Music, Inc., 510 U.S. 569 (1994); Time Inc. v. Bernard Geis Assocs. 293 F. Supp. 130, 143 (S.D.N.Y. 1968). See also Thau, supra note 34, at 197–99 (expounding upon the public benefits explanation of the fair use doctrine). 144 Thau, supra note 34, at 194. 145 See Gordon, supra note 26, at 1614–15 (“Because courts in the copyright area ordinarily assume that reliance on the market will serve social purposes, an economic judgment that transfer of a use to defendant will bring a net social benefit should not alone be sufficient to negate the tort of infringement.”); id. at 1615 (“An economic justification for depriving a copyright owner of his market entitlement exists only when the possibility of consensual bargain has broken down in some way. Only where the desired transfer of resource use is unlikely to take place spontaneously, or where special circumstances such as market flaws impair the market's ordinary ability to serve as a measure of how resources should be allocated, is there an economic need for allowing nonconsensual transfer.”). 146 See Gordon, supra note 26, at 1627–35. 147 In regards to transaction costs, Gordon succinctly notes: “[when] transaction costs exceed anticipated benefits . . . no transactions will occur.” See Gordon, supra note 26, at 1628. For Landes and Posner’s transaction-cost analysis, see supra Part III.B.1. 148 For more on externalities, see supra note 92; supra Part III.B.2. 149 See supra Part III.B.1. 150 See Gordon, supra note 26, at 1630–32. 151 See id. 152 This example similarly tracks the examples given by Landes & Posner. See Landes & Posner, supra note 7, at 346 (using a similar example of an author who wishes to quote another author’s work to illustrate the need for fair use to rectify externality-related market failures). See also Moore, supra note 108, at 952 (similarly borrowing Landes and Posner’s transaction costs example). 153 For simplicity’s sake, this example ignores the potential conflict between de minimus use and fair use.
228 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. the work at $1,000. However, the copyright holder is unwilling to negotiate any price below $5,000. At this point, there is no market failure. The parties will simply refuse to come to a bargain because the author’s expected benefit of use (i.e. the price he is willing to pay, here $1,000) is less than the cost demanded by the copyright holder ($5,000). Given the same facts, next assume that the author’s publication of the book, with the included copyrighted excerpt, would benefit society by creating a “positive externality” in the amount of $10,000.154 Here, externalities create allocative inefficiency and society experiences a deadweight loss when the transaction fails to materialize. 155 Even though society would benefit $6,000 if the transaction occurred ([$10,000 + $1,000] - $5,000 = $6,000),156 it will not come to fruition, despite now being efficient, because the externality will not be factored into the parties’ calculus.157 The fair use doctrine, which allows authors “A” and “B” to eschew negotiations in this context, steps in to correct the market failure.158
154 See infra Figure 4. See also Cotter, supra note 18 (describing a “positive externality” as one in which “the net social value of the use exceeds the value to the copyright owner of preventing the use”). 155 See Hausman, supra note 95, at 662–76. 156 This figure is calculated by subtracting the net cost of completing the transaction (the $5,000 not paid to the copyright holder) from the net benefit accrued as a result of the transaction ($1,000 [benefit to the author] + $10,000 [benefit to society at large]). 157 See Gordon, supra note 26, at 1630 (“The costs and benefits of the parties contracting for the uses often differ from the social costs and benefits at stake, so that transactions leading to an increase in social benefit may not occur.”). 158 See Moore, supra note 108, at 952. 2016] AN ECONOMIC ANALYSIS OF MARKET 229 FAILURES IN COPYRIGHT LAW
FIGURE 3: FAIR USE: ENABLING POSITIVE EXTERNALITIES 159
Ostensibly, a socially desirable bargain has been struck. As output increases from Q to Q1, society reaps the benefit of the positive externality, albeit at the expense of the copyright holder. 160 The individual preferences of microeconomic theory thus yield to a utilitarian public benefit model.161
159At the outset, it is important to note that Figure 3 illustrates the effect of a positive externality. The preceding academia example dealt with a scenario where a positive externality was not realized. See supra notes 158–65 and accompanying text. On the contrary, Figure 3 is illustrative of a situation where the full social benefit of a positive externality is reached. To begin, like Figure 1, the Y-axis represents Price (i.e. the cost of a copyrighted work), and the X-axis represents Quantity (or units of goods supplied). The following terms are defined: (1) MSB = Marginal Social Benefit [which is societal demand + MPB]; (2) MPB = Marginal Private Benefit [individual demand]; and (3) MSC = Marginal Social Cost [supply]. Absent the fair use doctrine, parties would negotiate when MPB = MSC, or, put differently, when private individual demand equals supply. This yields a price and output at (P, Q) [point C on the graph]. However, when the Marginal Social Benefit (MSB) (i.e. society’s gain as a result of access to the free flow of information + MPB) is taken into account, the demand curve for creative works shifts right, changing the market equilibrium price. The new market equilibrium (P1, Q1) reflects how the fair use doctrine allows society to gain a “a positive externality.” As a result, price and output both increase, and society benefits from a “positive externality” (shown in Δ ABC). In the process, the “free flow of information” to society (i.e. output) increases, albeit sometimes at the expense of the individual. 160 See Gordon, supra note 26, at 1631. 161 See U.S. CONST. art. I, § 8, cl. 8. See also supra Part III.B. See also infra Part.III.C.
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C. Macroeconomic Theory and the Fair Use Doctrine
While microeconomics is the study individual decision-making, macroeconomics examines the economy as a whole.162 In its most basic form, macroeconomic theory seeks to optimize output and maximize social welfare.163 With respect to copyright law, macroeconomic theory justifies monopolistic protection of an author’s work only insofar as the public-at-large benefits.164 Professor Leval explains: [C]opyright law embodies a recognition that creative intellectual activity is vital to the well-being of society. It is a pragmatic measure by which society confers monopoly-exploitation benefits for a limited duration on authors and artists . . . in order to obtain for itself the intellectual and practical enrichment that results from creative endeavors.165
1. Fair use and macroeconomic theory
Fundamental to the utilitarian theory of copyright law is a belief that incentivizing authors’ creative expression avoids the inevitable underproduction of works that would result from a no-recourse system.166 As a result, copyright law recognizes that granting authors remunerative rewards is necessary to stimulate expression. 167 However, too much of a good thing168 can be just that—too much. The trite idiom thus has an apropos place in the context of fair use. Left unchecked, monopolistic grants to authors have the potential to be counter-productive by creating economic inefficiencies of their own— namely, overprotection. 169 To avoid overprotection, an iatrogenic inefficiency in its own right, lawmakers have limited the term of
162 See generally RICHARD T., MACROECONOMICS: THEORIES AND POLICIES (9th ed. 2009). 163 See U.S. CONST. art. I, § 8, cl. 8. See also Alfred C. Yen, Restoring the Natural Law: Copyright as Labor and Possession, 51 OHIO ST. L.J. 517, 541–42 (1990). Of note, this article ignores the difference between Pareto efficiency and wealth maximization as macroeconomic theories justifying copyright law. For simplicity’s sake, we note that society is better off in a “macro” sense when the Article 1, Section 8, Clause 8’s goal of promoting progress is furthered. 164 See Thau, supra note 34, at 194. 165 See Leval, supra note 103, at 1109. 166 See Fisher, supra note 91, at 1700. 167 See Darr, supra note 13, at 1034 (“Copyright, by prohibiting unauthorized copying, solves the problem of marginal cost copies destroying the incentive to write.”). 168 E.g., the overprotection of authors’ rights. 169 See Fisher, supra note 91, at 1700. 2016] AN ECONOMIC ANALYSIS OF MARKET 231 FAILURES IN COPYRIGHT LAW copyright protection, narrowed the realm of protectable material to the actual expression of ideas,170 and allowed a number of exceptions that permit lawful copying in certain circumstances.171 Copyright law implicitly recognizes the principle of nihil sub sole novum: “there is nothing new under the sun.”172 Creative expression necessarily draws from, and builds upon, the work of previous authors.173 Affording too much protection to one author may stifle subsequent works by future authors. 174 Accordingly, copyright law must strike a balance that provides a means for encouraging the production of new material as well as protecting existing material.175 Fair use seeks to maximize social welfare by “encouraging the dissemination of copyrighted works.”176 A utilitarian public-benefit explanation of fair use permits infringement only when society’s benefit exceeds the harm borne by individual copyright holders. 177 Conceptually, this cost-benefit analysis may be simple. However, as technology progresses, the array of copyrightable material expands, and the cost-benefit analysis becomes increasingly complex. Specifically, it is difficult to reconcile Section 107’s current four-factor balancing test with a purely utilitarian explanation of fair use.178 The doctrine’s paradigmatic examples (i.e., scholarship, news reporting, criticism, and parody)179 are not difficult to justify from a public benefit standpoint.180 Allowing access to academic scholarship undoubtedly benefits society’s wealth of knowledge while costing individual authors little.181 Here, the public benefit model fits. Unfortunately, fair use cannot
170 For a more detailed explanation of the idea/expression dichotomy, see Landes & Posner, supra note 7, at 347–53. 171 See 17 U.S.C §§ 107–122 (2012). See also Fischer, supra note 91, at 1703 (“The task of a lawmaker who wishes to maximize efficiency, therefore, is to determine, with respect to each type of intellectual product, the combination of entitlements that would result in economic gains that exceed by the maximum amount the attendant efficiency losses.”). For a more detailed economic analysis of intellectual property lawmaking, see Louis Kaplow, The Patent-Antitrust Intersection: A Reappraisal, 97 HARV. L. REV. 1813, 1827–28 (1984). 172 Ecclesiastes 1:9 (King James). 173 See Landes & Posner, supra note 7, at 332. 174 See Darr, supra note 13, at 1034 (“All works contain elements that are copied from some other text. If protection is too extensive, authors will have to engage in expensive searches, risk liability, or pay royalties to write.”). 175 See id. 176 Thau, supra note 34, at 197. 177 Id. 178 Id. at 198. 179 See 17 U.S.C. § 107 (2012). 180 See id. See also supra notes 167–75 and accompanying text. 181 See 17 U.S.C. § 107 (2012).
232 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. readily be explained solely by reference to Section 107’s four factors.182 Only one of Section 107’s four factors directs courts towards a utilitarian conception of fair use.183 The first,184 third,185 and fourth186 factors overwhelmingly favor the interests of private litigants over society at large. Section 107’s first factor—“the purpose and character of the use”187—may purport to function as a utilitarian justification for fair use; however, courts’ frequent emphasis on the “commercial nature” of the alleged infringement often analyzes not whether the public was harmed, but whether the defendant individually profited from the infringement.188 Similarly, the third factor “focuses on the interests of the private litigants”189 by comparing the amount of work taken by the defendant in relation to the copyrighted work as a whole.190 The fourth factor,191 which is often given the most weight by courts,192 again focuses on the interests of the private litigants by looking at the potential impact on the market for the copyright holder’s work.193 Only Section 107’s second factor, which examines the “the nature of
182 See id. 183 See Thau, supra note 34, at 197. 184 17 U.S.C. § 107(1) (2012). 185 Id. § 107(3). 186 Id. § 107(4). 187 Id. § 107(2). 188 See, e.g., Marobie-FL, Inc. v. Nat’l Ass’n of Fire Equip. Distribs., 983 F. Supp. 1167, 1175 (N.D. Ill. 1997) (“The crux of the profit/nonprofit distinction is not whether the sole motive of the use is monetary gain but whether the user stands to profit from exploitation of the copyrighted material without paying the customary price”) (citing Harper & Row Publishers, Inc. v. Nation Enters., 471 U.S. 539, 562 (1985). Cf. Thau, supra note 34, at 197 n.103 (“Courts’ emphasis on the commercial nature of the work in their analyses of the first factor is likely to diminish following Campbell, in which the Court emphasized that the commercial nature of a work is only one factor to be weighed in the balance. Campbell’s ability to refocus courts on more public benefit-oriented aspects of the fair use inquiry is not certain; however, because it can be read as emphasizing the public benefits of parody and criticism, and thus limited accordingly.”) (internal citations omitted). 189 See Thau, supra note 34, at 198. 190 17 U.S.C. § 107(3) (2012). 191 Id. § 107(4). 192 See Stewart v. Abend, 495 U.S. 207, 236–38 (1990); Harper & Row, Publishers v. Nation Enters., 471 U.S. 539, 566 (1985); Nat’l Rifle Ass’n of America v. Handgun Control Fed’n of Ohio, 15 F.3d 559 (6th Cir. 1994); Twin Peaks Prods., Inc. v. Publ’ns. Int’l, Ltd., 996 F.2d 1366, 1377 (2d Cir. 1993). But cf. Campbell v. Acuff-Rose Music, Inc., 510 U.S. 569, 578 (1994) (indicating that the factors are to be given approximately equal weight). However, the fourth factor has become a mainstay of lower courts’ fair use analyses. See, e.g., Twin Peaks Prods., Inc. v. Publ’ns. Int’l, 996 F.2d 1366, 1377 (2d Cir. 1993); Lewis Galoob Toys, Inc. v. Nintendo of Am., Inc., 964 F.2d 965, 971 (9th Cir. 1992). 193 See Thau, supra note 34, at 197–99. 2016] AN ECONOMIC ANALYSIS OF MARKET 233 FAILURES IN COPYRIGHT LAW the work,” 194 accords with a macroeconomic model that seeks to maximize social welfare. Rooted in the Constitution’s objective of promoting progress195 through the accumulation of knowledge, courts have been less likely to afford copyright protection to factual works than fictional works.196 In contrast, courts have frequently justified findings of fair use “in cases involving so-called ‘productive’ or ‘transformative’ uses, in which the defendant’s work incorporates the plaintiff’s in a way that creates a new and different work.”197 Commentators have pointed out,198 however, that the idea/expression dichotomy already functions to protect only the expression of ideas, not the ideas themselves.199 Accordingly, in light of the idea/expression dichotomy and courts’ frequent focus on a work’s “transformative” nature, justifying fair use as a means of stimulating the dissemination of factual works to society has appropriately been criticized.200
194 17 U.S.C. § 107(2) (2012). 195 See U.S. CONST. art. I, § 8, cl. 8. 196 See id. See also Sony Corp. of Am. v. Universal City Studios, 464 U.S. 417, 496–97 (1984) (Blackmun, J., dissenting) (“[I]nformational works, such as news reports, that readily lend themselves to productive use by others, are less protected than creative works of entertainment.”); PAUL GOLDSTEIN & P. BERNT HUGENHOLTZ, INTERNATIONAL COPYRIGHT: PRINCIPLES, LAW AND PRACTICE 305 (3d ed. 2013); Thau, supra note 34, at 197 (“Since society benefits from the free flow of information, and because fair use encourages the dissemination of copyrighted works, fair use adds to the aggregate public good if the value to the public of a use outweighs the individual harm it creates.”). 197 See Campbell, 510 U.S. at 589 (noting that so-called “transformative” uses of a work are less likely to economically harm the original author than exact copying); Sony, 464 U.S. at 478–79; Maxtone-Graham v. Burtchaell, 803 F.2d 1253, 1259 (2d Cir. 1986); Thau, supra note 34, at 197. Judge Leval’s fair use analysis centers around whether or not a work is “transformative,” which he asserts diminishes the fourth factor. See Leval, supra note 103, at 1111. See also Cariou v. Prince, 714 F. 3d 694, 710 (2d Cir. 2013). Cf. Sony, 464 U.S. at 455–56 n.40 (“The distinction between ‘productive’ and ‘unproductive’ uses may be helpful in calibrating the [fair use] balance, but it cannot be wholly determinative.”); Id. (“The statutory language does not identify any dichotomy between productive and nonproductive time- shifting, but does require consideration of the economic consequences of copying.”). 198 See Thau, supra note 34, at 198 (noting that facts are “already recognized in copyright law through the idea/expression distinction”). 199 See Amaury Cruz, What’s the Big Idea Behind the Idea-Expression Dichotomy?-Modern Ramifications of the Tree of Porphyry in Copyright Law, 18 FLA. ST. U. L. REV. 221, 221 (“AN AXIOM of copyright law is that only the expression of ideas, not the ideas themselves, are copyrightable.”). See also Thau, supra note 34, at 198–99. 200 See Thau, supra note 34, at 198–99.
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D. Ex Ante Uncertainty
Copyright scholars and treatise authors are in agreement that fair use creates significant ex ante uncertainty.201 By permitting an affirmative defense to copyright infringement, the fair use doctrine seeks to curtail the market failures created by copyright law’s overbroad protection of authors’ rights.202 However, courts have failed to consistently apply the four factors in factually similar cases, and various circuits have made little progress in reaching a consensus as to how the doctrine should be applied.203 Moreover, the Supreme Court has offered little prospective guidance,204 and in the absence of judicial predictability, litigants’ ex ante uncertainty abounds.205 Significant litigation costs and statutory
201 See 2 PAUL GOLDSTEIN, GOLDSTEIN ON COPYRIGHT § 12.2.2, at 12:34 (3d ed. 2005); 4 MELVILLE B. NIMMER & DAVID NIMMER, NIMMER ON COPYRIGHT § 13.05(A)(1)(b) (citing Castle Rock Entm’t, Inc. v. Carol Publ’g Group, Inc., 150 F.3d 132, 141 (2d Cir. 1998)); WILLIAM F. PATRY, THE FAIR USE PRIVILEGE IN COPYRIGHT LAW (2d ed. 1995). See also David Nimmer, “Fairest of Them All” and Other Fairy Tales of Fair Use, 66 LAW & CONTEMP. PROBS. 263, 280 (2003) (“[H]ad Congress legislated a dartboard rather than the particular four fair use factors . . . it appears that the upshot would be the same.”). 202 See generally Carroll, supra note 17. 203 Compare Fisher v. Dees, 794 F.2d 432, 438 (9th Cir. 1986) (finding fair use in a parody case because works were “directed at different markets”), with MCA, Inc. v. Wilson, 677 F.2d 180, 185 (2d Cir. 1981) (failing to find fair use in a similar parody case because the court viewed the author and the parodist as “competitors”). 204 See Harper & Row Publishers, Inc., v. Nation Enters., 471 U.S. 539, 552 (1985) (“[F]air use analysis must always be tailored to the individual case.”); H.R. REP. NO. 94-1476, at 16 (1976), reprinted in 1976 U.S.C.C.A.N. 5659, 5679 (“[S]ince the doctrine is an equitable rule of reason, no generally applicable definition is possible, and each case raising the question must be decided on its own facts.”); HORACE G. BALL, THE LAW OF COPYRIGHT AND LITERARY PROPERTY 260 (1944) (“[P]rivilege in others than the owner of a copyright to use the copyrighted material in a reasonable manner without his consent, notwithstanding the monopoly granted to the owner.”); Carroll, supra note 17, at 1094 (“A fair user’s uncertainty about the scope of her rights stems not only from the fair use doctrine's case specificity but also from its codification in a nonexclusive four-factor test set forth in § 107 of the Copyright Act.”). 205 See Anderson & Brown, supra note 61, at 173–74; Carroll, supra note 17, at 1095 (claiming that the doctrine is a cause of “significant ex ante uncertainty”); Joseph P. Liu, Two-Factor Fair Use?, 31 COLUM. J. L. & ARTS 571, 574, 577–80, n.51 (2008) (describing fair use as “notoriously difficult to predict”). See also 2 PAUL GOLDSTEIN, GOLDSTEIN ON COPYRIGHT § 12.1 (3d ed. 2005) (“No copyright doctrine is less determinate than fair use.”); Darren Hudson Hick, Mystery and Misdirection: Some Problems of Fair Use and Users’ Rights, 56 J. COPYRIGHT SOC’Y U.S.A. 485, 497 (2009) (“[T]he fair use doctrine provides us with very little direction in making legal or ethical decisions.”); Nimmer, supra note 201, at 263. But see Pamela Samuelson, Unbundling Fair Uses, 77 FORDHAM L. REV. 2537, 2541 continued . . . 2016] AN ECONOMIC ANALYSIS OF MARKET 235 FAILURES IN COPYRIGHT LAW damages further compound the problem. As a result of this uncertainty, potential fair users are deterred from engaging in desired uses, and society fails to capture the full benefit of the doctrine.206
IV. PROPOSED SOLUTION
Michael Carroll describes four potential options for eliminating the economic inefficiencies brought about by the fair use doctrine: (1) reduce the costs of obtaining a fair use determination ex ante under the current legal standard; (2) reduce the ex post penalties for misjudging fair use in good faith; (3) sharpen the fuzzy edges of the doctrine by establishing clearly delineated safe harbors or by making the entire doctrine more rule-like; or (4) implement a combination of these measures.207 This article opts for a fifth option—to repeal and replace Section 107. For nearly forty years, the 1976 Act has generated uncertainty. During that time, scholars have attempted to delineate the doctrine’s unclear boundaries through qualitative 208 and quantitative 209 economic analysis. Numerous frameworks have been proposed to analyze and predict fair use outcomes,210 yet courts’ indeterminate application of the
(2009) (“[F]air use law is both more coherent and more predictable than many commentators have perceived once one recognizes that fair use cases tend to fall into common patterns.”). 206 See Carroll, supra note 17, at 1096. 207 Id. at 1123. 208 See, e.g., Carroll, supra note 17; Fischer, supra note 91; Landes & Posner, supra note 7; Moore, supra note 108. 209 See, e.g., Barton Beebe, An Empirical Study of U.S. Copyright Fair Use Opinions, 1978-2005, 156 U. PA. L. REV. 549 (2008); Matthew Sag, Predicting Fair Use, 73 OHIO ST. L.J. 47 (2012); Samuelson, supra note 205. 210 E.g. COLLEGE ART ASSOCIATION, CODE OF BEST PRACTICES IN FAIR USE FOR THE VISUAL ARTS (Feb. 2015), available at http://www.collegeart.org/pdf/fair- use/best-practices-fair-use-visual-arts.pdf. The College Art Association (“CAA”) promotes and advocates for visual arts and visual artists. See id. Their February 2015 Report surveyed 12,000 CAA members and personally interviewed 100 members to “identify points of consensus concerning best practices in use of [fair use] materials.” See id. at 3. The CAA seeks to set forth an approach to fair use that adapts to both “familiar and emergent” fair issues. Id. at 6. The CAA lays out “principles” to help make fair use determinations in five situations: (1) analytic writing; (2) teaching about art; (3) making art; (4) museum use; and (5) online access to related collections in memory institutions. See id. at 9–12. The principles are extensive, but ultimately only provides guidance for visual arts community in the “most common [fair use] situations.” Id. at 8.
236 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. doctrine persists.211 In drafting a new fair use statute, Congress would be wise to draw upon the aforementioned economic principles as well as the experience of other nations. This article proffers a three-step approach. First, a statutory safe harbor should be included for certain types of use. Analogous to the United States’ fair use doctrine, many continental European countries212 employ a doctrine of “free utilization” or “free use,” which specifically exempts certain uses from infringement, including private, non- commercial use; parody; news reporting; and educational/research uses.213 Wisely, these countries curtail ex ante uncertainty by rarely departing from the statutorily enumerated exemptions, and only do so when confronted with emerging technologies not envisioned by their respective legislatures.214 To avoid chilled expression resulting from fair use’s current uncertainty, the United States should likewise enumerate specific statutory exemptions to serve as safe harbors. Exempting the aforementioned uses would not contravene the IP Clause’s goal of promoting progress. On the contrary, from a macroeconomic and microeconomic perspective, the utilitarian benefit of allowing fair use in each case far outweighs the costs to individual authors.215 Additionally, this approach would have the benefit of, at least in part, converging the United States’ fair use doctrine with more commonly accepted international practices.216
211 See Leval, supra note 103, at 1106–07 (“Earlier decisions provide little basis for predicting later ones. Reversals and divided courts are commonplace. The opinions reflect widely differing notions of the meaning of fair use. Decisions are not governed by consistent principles, but seem rather to result from intuitive reactions to individual fact patterns.”). 212 E.g., France, Belgium, Italy, Spain, Switzerland, and Sweden. See COHEN, supra note 53, at 531. 213 See id. See also Holger Postel, The Fair Use Doctrine in the U.S. American Copyright Act and Similar Regulations in the German Law, 5 CHI.-KENT. J. INTELL. PROP. 142 (2006). 214 See COHEN, supra note 53, at 531. 215 This is especially true in the case of private, non-commercial use, and educational/research uses, both of which have significant social value and little detrimental effect on the individual market for an authors’ works. News reporting, while hardly a “non-commercial” use, can be justified due to its monumental social importance. Finally, exempting parody follows as a matter of common-sense conformity with existing copyright law, because, in reality, authors rarely “authorize” parodists. 216 See COHEN, supra note 53, at 530–34. 2016] AN ECONOMIC ANALYSIS OF MARKET 237 FAILURES IN COPYRIGHT LAW
Second, any determination of fair use that falls outside the enumerated exceptions should rework Section 107’s current balancing test to provide more certainty, including categorically abolishing Section 107’s first factor.217 The first factor’s ambiguity has served little purpose other than to muddle the doctrine’s intended effect218 by creating a “value-laden hierarchy” 219 of judicially determined meritorious uses.220 Additionally, factors two, three, and four221 should be merged into a single balancing test, which accounts for the competing economic considerations discussed in this article.222 Judicial outcomes in fair uses cases have all too often focused on either: (1) the IP Clause’s macroeconomic concerns (i.e. the promotion of progress);223 or (2) the impact on the individual market.224 The resulting ex ante uncertainty and attendant chilled expression have been detrimental to an efficient copyright system. Accordingly, Congress should draft a balancing test that accounts for both macro and microeconomic concerns, with an eye towards the IP Clause’s goal of promoting the former.225 Finally, this article suggests taking the lead of patent law by establishing a mandatory federal circuit of appeals with exclusive jurisdiction over copyright cases.226 Fair use’s uncertainty, in large part, stems from inconsistent application of the doctrine by different
217 See 17 U.S.C. § 107(1) (2012) (“the purpose and character of the use, including whether such use is of a commercial nature or is for nonprofit educational purposes . . . . ”). 218 See Thau, supra note 34, at 198. 219 Darr, supra note 13, at 1048. 220 The words “purpose” and “nature” may potentially be broadly construed to cover a vast array of uses. See 17 U.S.C. § 107(1) (2012). Furthermore, 107(1)’s second clause uses the disjunctive “or,” which draws a distinction between “commercial” and “non-profit educational purposes,” but fails to account for non- education non-profit uses. Id. 221 See id. § 107(2)–(4). 222 See supra Part III. 223 U.S. CONST. art. I, § 8, cl. 8. 224 See supra Part III.B. 225 The Intellectual Property Clause’s goal is to promote the progress of science and the arts by protecting authors’ writings. See U.S. CONST. art. I, § 1, cl. 8. The end goal is the free flow of information to society, not the unfettered protection of authors’ rights. Article 13 of the TRIPS Agreement is instructive: “Members shall confine limitations or exceptions to exclusive rights to special cases which do not conflict with a normal exploitation of the work and do not unreasonably prejudice the legitimate interests of the right holder.” See Agreement on Trade-Related Aspects of Intellectual Property Rights, 33 I.L.M. 81 (Dec. 15, 1993), available at https://www.wto.org/english/docs_e/legal_e/27-trips.pdf. 226 See generally Wendy Levenson Dean, Let’s Make a Deal: Negotiating Resolution of Intellectual Property Disputes Through Mandatory Mediation at the Federal Circuit, 6 J. MARSHALL L. REV. INTELL. PROP. L. 365 (2007).
238 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. circuits.227 Creating a mandatory circuit of appeals would, hopefully, diminish the number of fair use lawsuits by curtailing litigants’ ability to forum shop. This suggestion is not unmindful of the fact that certain commentators doubt the effectiveness of this solution in patent law.228 However, the distinctions between patent and copyright are numerous,229 not the least of which is copyright law’s limited protection of authors, as opposed to the absolute grants given to patent holders.230 In sum, the three-step approach proffered in this article seeks to curtail chilled expression and promote an efficient copyright system by limiting litigants’ uncertainty. Replacing Section 107 with a more definitive fair use statute that includes categorical exemptions and a refined balancing test should provide ex ante clarity. Additionally, creating a mandatory appeals circuit should provide further clarity by eliminating divergent fair use standards. Together—as demonstrated in Figure 4231—these proposals should diminish authors’ risk aversion, thereby promoting the production of creative works and increasing society’s access to information. Ultimately, the IP Clause’s goal of promoting progress in a modernist society will be furthered.
227 See Anderson & Brown, supra note 61, at 146. 228 Compare Hon. Diane P. Wood, Is It Time to Abolish the Federal Circuit’s Exclusive Jurisdiction in Patent Cases?, 13 CHI.-KENT J. INTELL. PROP. (2013), with Paul R. Gugliuzza, Saving the Federal Circuit, 13 CHI.-KENT INTELL. PROP. 350 (2014). 229 For more on this point, see Robert E. Thomas, Vanquishing Copyright Pirates and Patent Trolls: The Divergent Evolution of Copyright and Patent Laws, 43 AM. BUS. L.J. 689 (2006). 230 For a more thorough discussion of the economic shortcomings of the existing patent law system, see Simone Rose, Further Reflections Distinguishing the Fountainhead of Knowledge: A Call to Transition to the “Innovative Policy” Narrative in Patent Law, 66 SMU L. REV. 609 passim (2013). 231 See infra Figure 4; Rose, supra note 230 and accompanying text. 2016] AN ECONOMIC ANALYSIS OF MARKET 239 FAILURES IN COPYRIGHT LAW
FIGURE 4: EFFECT OF PROPOSED SOLUTION: SUPPLY, PRICE, AND OUTPUT 232
232 The ultimate goal of the IP Clause is to “promote . . . [p]rogress” through the dissemination of knowledge. See U.S. CONST. art. I, § 8, cl. 8. Not unmindful of the substantial capital investments (a.k.a., “fixed costs” in economic terms) this proposed solution would foist upon policymakers, it is the opinion of this author that the long-run benefits of reforming the fair use doctrine will outweigh the substantial short-run costs. The above solutions seek to do exactly this, and in the process create an economically efficient solution. Figure 4 shows three separate supply curves— each of which is applicable to Part IV’s proposed solution. In theory, as ex ante uncertainty dissipates, the supply curve for creative expression shifts right (Supply 1 Supply 2 Supply 3). As a result, the point of equilibrium shifts from A B C, and in the process, price decreases (from P* to P1 to P2) and output increases (from Q* to Q1 to Q2). Finally, it is important to note that this analysis will vary based on the elasticity of demand (ED) (a measure used in economics to show responsiveness of the quantity demanded [QD] of a particular good or service—here a creative work—in relation to price) will have invariably impact on the graphical representations shown in Figures 1, 2, and 3. For example, a JD Salinger novel, which has a relatively inelastic demand (i.e. a steep demand curve)—meaning that due to the unavailability of substitutes—price increase has little effect on the quantity demanded of the book. See, e.g., Salinger v. Random House, Inc., 811 F.2d 90, 100 (2d Cir. 1987). Conversely, “creative works” which are “elastic” in nature, have flat demand curves (e.g. for a straight to DVD movie) diminish a copyright holder’s quasi-monopolistic profit manipulation.
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V. CONCLUSION
Economic analysis has long been the popular vehicle by which the fair use doctrine has been explained and applied. Both micro and macroeconomic explanations are useful tools for delineating various aspects of a doctrine that has been historically mired in conflicting justifications, accused of preferential post-hoc rationalizations, and, to a large extent, been undermined by its inability to uniformly predict judicial outcomes. Unfortunately, fair use’s economic explanations, both individually and together, fail to provide sufficient ex ante certainty for potential users of copyrighted work. This problem has been exacerbated recently as “[w]ide distribution of digital technologies has greatly increased copyright law's domain while also giving rise to a significantly larger pool of potential fair users attracted to the remarkable reproductive and adaptive power of these new technologies.”233 This article has endeavored to explain the competing economic explanations of the fair use doctrine and elucidate its major flaw—its iatrogenic nature. In many cases, fair use serves its intended purpose by limiting market failures created by copyright law’s monopolistic grants. However, in other cases, it creates uncertainties and market failures of its own—thereby causing the very problem it seeks to correct. Thau234 may liken this iatrogenesis to a surgeon who severs an artery during a routine surgery, while Landes and Posner 235 would likely see it as an unsightly scar, and hence a regrettable necessity of curing a much larger problem. Whichever theory more accurately mirrors reality, history indicates that judicial clarification of the uncertainty is not likely. The task is thus one for Congress. There may be no simple solution, but one thing is abundantly clear: in the absence of this article’s proposed reform, or at least some measure akin to it, ex ante uncertainty will continue to create market failure, and ultimately, the Founders’ goal of promoting progress will continue to be undermined.
233 See Carroll, supra note 17, at 1093. 234 See Thau, supra note 34, at 197–98. 235 See Landes & Posner, supra note 7, at 333, 357–63. WAKE FOREST JOURNAL OF BUSINESS AND INTELLECTUAL PROPERTY LAW
VOLUME 16 WINTER 2016 NUMBER 2
THE NEED FOR COMPULSORY LICENSING OF ANTIRETROVIRAL DRUGS: THE INDIAN PERSPECTIVE
Ambika Sahai & Kruthika N. S.†
I. INTRODUCTION ...... 242 II. THE PERVASIVENESS OF THE DISEASE IN INDIA ...... 243 III. THE CHANGES IN INTERNATIONAL TRADE LAW: INFLUENCING THE PATH OF ART ...... 247 IV. COMPULSORY LICENSING UNDER THE TRIPS REGIME ...... 249 V. COMPULSORY LICENSING: HOW VIABLE A SOLUTION?...... 250 A. FOREIGN RELATIONS AFFECTING FOREIGN DIRECT INVESTMENT ...... 251 B. FEAR TO FILE APPLICATIONS FOR COMPULSORY LICENSES ...... 254 C. COMPETITION AND INNOVATION ...... 255 D. PARALLEL INCREASE IN THE NUMBER OF PATENTS FILED ...... 256 E. BRAIN DRAIN ...... 257 F. LOOMING PROBLEMS DUE TO A WEAKENED GENERIC MARKET ...... 258 G. PROCEDURAL INFIRMITIES SURROUNDING COMPULSORY LICENSES IN INDIA ...... 259 VI. CONCLUSION ...... 260
† B.A. LL.B. (Hons.) candidates, the W.B. National University of Juridical Sciences, Kolkata. We are grateful to Mr. Saurabh Bhattacharjee, Assistant Professor, WBNUJS, for his invaluable comments on the preliminary draft of the paper. Any errors that remain are solely ours. 242 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L.
I. INTRODUCTION Human immunodeficiency virus infection and acquired immune deficiency syndrome (“HIV/AIDS”) has been one of the most fatal diseases since the early 1980’s, and the medical field has struggled to find a cure, which even now remains in the shadows.1 With years of intensive research that has demanded capital and time, a breakthrough in treatment has been antiretroviral treatment (“ART”). 2 However, since this treatment is relatively new, most of the antiretroviral drugs (“ARV drugs”) continue to remain proprietary, i.e., under patent, with the rights vesting in rich multinational companies based in developed nations, such as the United States, Switzerland, etc.3 In the course of this paper, we will analyze the current situation in India regarding ART and how it has been affected by the changes in patent law on the global stage. Through this analysis, we shall attempt to show that the pervasiveness of the disease at this point in time, coupled with the rigid laws that have recently cropped up, is a recipe for disaster for HIV/AIDS patients in India. The first part of the paper deals with the pervasiveness of the disease in India. AIDS is a disease that has most affected the poor and marginalized groups in society.4 As a result of their abject poverty, it has become extremely difficult for this section of people to gain access to medicine for a life threatening disease such as AIDS.5 We shall attempt to show the incredibly deplorable condition of a large chunk of society, which has been affirmed by not only studies in India, but also those of international organizations. The next part will deal with a brief introduction to ART and elucidate the importance of the various stages of ART. In this part we seek to show the incredibly delicate nature of how the disease must be dealt with, and how a slight deviation from the
1 Treatment of HIV Infection, NAT’L INST. OF ALLERGY AND INFECTIOUS DISEASES, https://www.niaid.nih.gov/topics/hivaids/understanding/treatment/ (last visited Jan. 17, 2016). 2 Id. 3 See generally Ellen ‘t Hoen et al., Driving a Decade of Change: HIV/AIDS, Patents, and Access to Medicines for All, J. INT’L AIDS SOC’Y 1, 3 (2011), available at http://www.biomedcentral.com/1758-2652/content/14/1/15. 4 BASANTA K. PRADHAN, SHALABH K. SINGH & RAMAMANI SUNDAR, NAT’L COUNCIL OF APPLIED ECON. RESEARCH, SOCIO-ECONOMIC IMPACT OF HIV AND AIDS IN INDIA 5 (2006), available at http://www.undp.org/content/dam/india/docs/socio_eco_impact_hiv_aids_%20india. pdf (last visited Jan. 15, 2016). 5 See EJ Lane, Price Controls Fail to Improve Poor People’s Access to Medicines in India, IMS Report Says, FIERCEPHARMAASIA (July 15, 2015), http://www.fiercepharmaasia.com/story/price-controls-fail-access-poor-medicines- india-ims-report-says/2015-07-15. 2016] COMPULSORY LICENSING OF 243 ANTIRETROVIRAL DRUGS patient’s schedule can result in fatality. It will also attempt to trace the timeline of invention and production of the ARV drugs which are of two types: the older first line of treatment and the newer second line.6 This part of the paper will then make way for the third part, which will trace the developments in international trade law, with the center of discussion being the Agreement on Trade-Related Aspects of Intellectual Property Rights (“TRIPS”) regime. At this juncture, we seek to highlight the juxtaposition of the timelines of breakthroughs in ARV drug invention and the development of law under TRIPS. This will show that the current point in time has the worst of combination of scenarios, with the most rigid patent laws being in line with the need for second line of ARV drugs being at its zenith. After introducing TRIPS, we shall specifically discuss compulsory licensing under TRIPS, and then finally, in the last part of the paper, we shall discuss the viability of compulsory licensing as a solution to the crisis that poor patients currently face. This part will debate in detail the pros and cons of compulsory licensing from both points of view: that of the developed nations and that of the developing countries. While we do not seek to leave the discussion open ended, we will also try to mention without bias the practical problems surrounding compulsory licensing, even though we advocate for the same.
II. THE PERVASIVENESS OF THE DISEASE IN INDIA The first few cases of HIV/AIDS in India were reported in 1986 among sex workers in Chennai.7 As more cases were detected, the National AIDS Control Organization (“NACO”) was established in 1992. Subsequently, the National AIDS Control Programme was commenced by the government.8 The program has been successful in reducing the number of new HIV cases during the last decade, and the number of deaths (172,041 in 2010 as opposed to 196,466 in 2005).9
6 WORLD HEALTH ORG., PRIORITIZING SECOND-LINE ANTIRETROVIRAL DRUGS FOR ADULTS AND ADOLESCENTS: A PUBLIC HEALTH APPROACH 13 (2007), available at http://www.who.int/hiv/pub/meetingreports/Second_Line_Antiretroviral.pdf. 7 NAT’L AIDS CONTROL ORG., 2012-2013 DEP’T OF AIDS CONTROL ANN. REP. 1 (2003), available at http://www.naco.gov.in/upload/Publication/Annual%20Report/Annual%20report%2 02012-13_English.pdf (last visited Jan. 17, 2016) [hereinafter NACO REPORT]. 8 Id. 9 BB Rewari, HIV/AIDS in India: Journey So Far and the Road Ahead, in 23 MEDICINE UPDATE 57, 58 (2013), available at http://www.apiindia.org/medicine_update_2013/chap14.pdf.
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However, even though India has come a long way from being termed as the “AIDS capital of the world,”10 the number of cases of HIV/AIDS in India still remains at a staggering 20.89 lakh,11 amounting to the third largest population of AIDS patients in the world.12 To add to this, HIV treatment coverage remains at a dismal 36 percent, ensuring that 64 percent of the HIV-infected persons in this country do not have access to ART.13 Thus, in a country where 51 percent of AIDS related deaths occur, the acute social and economic impact of the disease14 makes it imperative to increase access to treatment. HIV/AIDS is not a disease which spreads sporadically. It is transmitted as a result of specific harmful behavioral patterns and deplorable socio-economic conditions. 15 As a result, the rampant poverty in India and its strong linkage with HIV/AIDS has worsened the scourge of the disease in the country.16 Studies have noted that there exist strong bi-directional linkages between HIV/AIDS and poverty.17 For instance, the World Bank’s 1997 report titled Confronting AIDS noted that “widespread poverty and unequal distribution of income that typify underdevelopment appear to stimulate the spread of HIV.”18 Thus, as HIV/AIDS is an outcome of poverty, taking grip where livelihoods are unsustainable, it becomes a cause of poverty as well.19 This mutual reinforcement between HIV/AIDS and poverty further complicates the battle against the disease.20
10 See Pallava Bagla, India’s New HIV/AIDS Numbers, 42 ECON. POL. WKLY. 3080 (2007). 11 NACO REPORT, supra note 7, at 1. 12 Id. 13 Id. at 48. 14 See generally K. Anand, L.M. Nath & C.S. Pandav, Impact of HIV/AIDS on the National Economy of India, 47 HEALTH POL’Y 195, 195 (1999) (noting an estimated productivity loss of 1,014 billion Indian rupees in the year of 1991 in the country because of HIV/AIDS). 15 WORLD BANK, CONFRONTING AIDS: PUBLIC PRIORITIES IN A GLOBAL EPIDEMIC 1, 65, 127 (Oct. 1997), available at http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/1997/ 10/01/000009265_3980219162747/Rendered/PDF/multi0page.pdf. [hereinafter Confronting AIDS]. 16 Id. at 13. 17 See generally INT’L LABOUR OFFICE PROGRAMME ON HIV/AIDS AND THE WORLD OF WORK, HIV/AIDS AND POVERTY: THE CRITICAL CONNECTION (2005), available at http://www.ilo.org/wcmsp5/groups/public/@ed_protect/@protrav/@ilo_aids/docu ments/publication/wcms_120468.pdf [hereinafter ILO REPORT]. 18 See Confronting AIDS, supra note 15, at 27. 19 ILO REPORT, supra note 17. 20 Justin O. Parkhurst, Understanding the Correlations Between Wealth, continued . . . 2016] COMPULSORY LICENSING OF 245 ANTIRETROVIRAL DRUGS
This interplay of poverty can be seen in the nature of the sections of society that the disease affects the most. High HIV Risk Groups include female sex workers (4.95%), men who have sex with men (7.3%), injecting drug users (7.14%), and the bridge population, composed of truckers (1.62%) and migrants (2.35%).21 A closer examination of the such high risk groups reveals the existence of a vicious circle between HIV/AIDS, poverty and high-risk behavior at the individual level. Poverty decreases choices and makes individuals vulnerable. 22 For instance, poverty compels unemployed persons to search for seasonal and temporary work and, thereby, become a part of unskilled migratory labor pools.23 Similarly, poverty pushes young girls and women to take up prostitution for survival.24 In such scenarios, individuals are reduced to leading a day-to-day existence wherein basic survival needs, a “fatalistic” and indifferent attitude to “high-risk sexual and other behaviors” take center stage.25 Migrant workers, for example, face conditions such as life in squalor, isolation from their families, long working hours, etc., which together, encourage casual sexual relationships. 26 Thus, poverty becomes a key factor in fostering HIV/AIDS among poorer sections of the population.
Poverty, and Human Immunodeficiency Virus Infection in African Countries, 88 BULL. WORLD HEALTH ORG. 519, 519–524 (2010), available at http://www.who.int/bulletin/volumes/88/7/09-070185/en/#. 21 NACO REPORT, supra note 7, at 12–13. 22 ILO REPORT, supra note 17. 23 Id. 24 Id. 25 Id. 26 Thomas A. Arcury & Sara A. Quandt, Living and Working Safely: Challenges for Migrant and Seasonal Farmworkers, 72 N.C. MED. J. 466, 468 (2011).
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Abject poverty and its relation with the disease forces a large portion of the population to be solely dependent on the NACO provided free ART drugs. Close to 750,000 patients in India rely on this free distribution of drugs, 27 thereby putting enormous pressure on the government to ensure access to treatment. The magnitude of government responsibility can be seen from the instance in 2012 wherein only 50 percent of those eligible for the free government- sponsored treatment had access to it. 28 Moreover, this problem of access to medicine in India and poverty can be further gauged from the fact that the first line of HIV/AIDS drugs, which are cheaper than the second line drugs, cost about 3,000 Indian rupees ($50) for one month’s supply in the retail market, in a country where one in three live on under $1.25 a day in 2009-2010.29 Due to medical advancements in the field, for those with access to medicine and disposable incomes, AIDS is a disease which can be kept under check through strict medication. 30 On the other end of the spectrum, inaccessibility to HIV/AIDS treatment can easily prove to be fatal.31 The biggest fear in the realm of access to treatment now, is that international developments and stricter patent laws would severely impede access to medicine, and the country would come back to the situation of 1998 where only 5 percent of those requiring ART could afford it.32 Thus, it is imperative for the government to ensure a regular and affordable supply of ART in the country. One such tool we propose is the issuance of Compulsory Licenses for ART drugs, which we shall deal with later on in the paper. ART is the treatment most widely used to tackle the HIV virus and AIDS in patients.33 It is a rigorous treatment
27 Poor Patients in India Facing HIV/AIDS Drug Shortages, THE FIN. EXPRESS (Sep. 5, 2014, 11:57 IST), http://www.financialexpress.com/news/poor-patients-in- india-facing-hivaids-drug-shortages/1285871/1. 28 Aditya Kalra, Exclusive – India Set to Run Out of Critical Free Drug for HIV/AIDS Programme, REUTERS (Oct. 1, 2014, 2:04 IST), http://in.reuters.com/article/aids-india-idINKCN0HQ3DU20141001. See also WORLD HEALTH ORG., Global Update on HIV Treatment 2013: Results, Impact and Opportunities,16 (2013), available at http://apps.who.int/iris/bitstream/10665/85326/1/9789241505734_eng.pdf. 29 Aditya Kalra & Zeba Siddiqui, Poor Patients in India Facing HIV/AIDS Drug Shortages, REUTERS, (Sep. 4, 2014, 9:04 PM), http://in.reuters.com/article/india- pharmaceuticals-aids-idINKBN0GZ0L120140904. 30 See UNAIDS, GLOBAL REPORT: UNAIDS REPORT ON THE GLOBAL AIDS EPIDEMIC 50 (2012), available at http://www.unaids.org/sites/default/files/media_ass et/20121120_UNAIDS_Global_Report_2012_with_annexes_en_1.pdf. 31 Id. 32 See generally NACO REPORT, supra note 7. 33 Overview of HIV Treatment, AIDS.GOV, https://www.aids.gov/hiv-aids- basics/just-diagnosed-with-hiv-aids/treatment-options/overview-of-hiv-treatments/ (last visited Jan. 21, 2015). 2016] COMPULSORY LICENSING OF 247 ANTIRETROVIRAL DRUGS with the use of set dosages of specific drugs that need to be taken at set intervals of time, lest the virus becomes immune to the treatment.34 On detection, the patient is first subject to the first line of treatment, where drugs administered are the ones which have been around for many decades.35 These form the earliest manufactured drugs and India has managed to produce many generic versions.36 However, due to the ineffective administration of these drugs, most patients in India have become immune to this line of treatment.37 If, and when this treatment fails, such as most cases in India today,38 then the patient will have to be subject to the newer, second line of treatment, where the dosage changes and the drugs administered are more sophisticated. 39 These drugs have mainly been manufactured post-2005, and are still undergoing research and development to make them better and more effective.40 The next part of the paper will show how these drugs have been made subject to extremely rigid patent laws as compared to their first line counterparts.
III. THE CHANGES IN INTERNATIONAL TRADE LAW: INFLUENCING THE PATH OF ART Before 2005, the Indian generic industry flourished and became a significant provider of essential medicines.41 This was the time during which the first line of ARV drugs had been made available in the market, and Indian manufacturers produced many generic versions of these.42 However, changes in world trade law the past few decades have restricted the growth of generic industries, thereby threatening access to essential medicines in the country.43 The establishment of the World Trade Organization (“WTO”) in 1994 and its TRIPS required all
34 DIPIKA JAIN & RACHEL STEPHENS, THE STRUGGLE FOR ACCESS TO TREATMENT FOR HIV/AIDS IN INDIA 8, 10 (2008). See also M. Halliburton, Drug Resistance, Patent Resistance: Indian Pharmaceuticals and the Impact of a New Patent Regime, 4 GLOBAL PUB. HEALTH 515 (2009). 35 JAIN & STEPHENS, supra note 34, at 10. 36 Id. at 11. See also Brenda Waning, Ellen Diedrichsen & Suerie Moon, A Lifeline to Treatment: The Role of Indian Generic Manufacturers in Supplying Antiretroviral Medicines to Developing Countries, 13 J. INT’L AIDS SOC’Y 1, 3 (2010), available at http://www.jiasociety.org/content/13/1/35. 37 JAIN & STEPHENS, supra note 34 at 21–22. 38 Id. at 52–53. 39 Id. at viii. 40 Id. at 112. 41 Id. at 110–11. 42 Id. at 115. 43 Dipika Jain & Jonathan J. Darrow, An Exploration of Compulsory Licensing as an Effective Policy Tool for Antiretroviral Drugs in India, 23 HEALTH MATRIX 424, 427–28 (2013).
248 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. member nations to implement or strengthen their patent laws to include pharmaceutical products within the ambit of patent protection.44 The TRIPS Agreement reinforced the emerging trend of bringing pharmaceuticals within the fold of patent coverage.45 Moreover, TRIPS took patenting to the next step by mandating process patenting of products.46 Thus, as it was relatively easy to “invent around” a patent under a product patent, the same was no longer possible.47 This greatly enhanced the grip of big pharmaceutical companies to completely exclude affordable generic production of medicines. 48 Such an exclusionary function of patents remains one of the key reasons behind limited availability and affordability of HIV/AIDS medication.49 Being a developing country, India was allowed a window of ten years to implement the new mandate under TRIPS.50 Eventually, in consonance with its international obligations, India enacted the Indian Patents (Amendment) Act (“IPA Act”) in 2005.51 For the first time since the colonial-era’s drug patent laws of 1970, pharmaceuticals were put under patent protection.52 Drugs already on market as of January 1, 2005, were immune from the rigors of the new law.53 However, the biggest setback was received by the newer second-line and contingency third-line ARV drugs.54 Developed post-2005, most of the newer and more expensive second-line and third-line ARV drugs are governed by the new IPA Act.55 The new law precludes generic production of these medicines
44 Agreement on Trade-Related Aspects of Intellectual Property Rights art. 70, Apr. 15, 1994, Marrakesh Agreement Establishing the World Trade Organization, Annex 1C, 1869 U.N.T.S. 299, 33 I.L.M. 1197 (1994) [hereinafter TRIPS Agreement]. 45 Jain & Darrow, supra note 43, at 427–28. 46 Id. 47 Id. at 429. 48 Id. 49 See Waning et al., supra note 36, at 2. 50 See Laura Chung, Use of Paragraph 6 System for Access to Medicine, 36 N.C. J. INT’L L. & COM. REG. 137, 146 (2010). 51 See Shamnad Basheer, India’s Tryst with TRIPS: The Patents (Amendment) Act, 2005, 1 INDIAN J. L. & TECH. 15, 16–17 (2005). 52 Philippe Cullet, The Patents Amendment Act and Access to Medicine, THE HINDU, May 27, 2002, available at http://www.thehindu.com/thehindu/biz/2002/05/27/stories/2002052700040200.htm. 53 See The Patents (Amendment) Act, 2005, No. 15, Acts of Parliament, 2005 (India). 54 See generally Jain & Darrow, supra note 43. 55 Janice M. Mueller, The Tiger Awakens: The Tumultuous Transformation of India’s Patent System and the Rise of Indian Pharmaceutical Innovation, 68 U. PITT. L. REV. 575, 531 (2007). 2016] COMPULSORY LICENSING OF 249 ANTIRETROVIRAL DRUGS until the patent protection expires. 56 Thus, as touted by scholars, “access to newest treatments” has only worsened as they are now “subject to patent protection and priced accordingly.”57 Therefore, we argue that in light of the second and third line of ARV drugs being so essential to the treatment of AIDS, and their inaccessibility post 2005, there is a pressing need for other methods of ensuring access to the poor.58 The method we advocate in the later part of the paper is compulsory licensing, which is also mandated in the IPA Act. 59 This ensures availability of the drugs at reasonable prices, as well as their adequate supply.60 However, in that part, we shall also delve into the discussion of the pros and cons surrounding compulsory licensing and suggest a framework to strengthen this mechanism.
IV. COMPULSORY LICENSING UNDER THE TRIPS REGIME “Compulsory licenses have application in developed economies as well when used to curb the dominant market power created by a patent.” 61 Under the terms of TRIPS as modified by the Doha Implementation Decision in 2003, governments may issue compulsory licenses to permit government or third-party manufacture of a patented invention without the patent holder’s permission, subject to certain conditions being met. 62 The history behind compulsory licensing becoming an important part of the TRIPS Regime is briefly elucidated below. Concerns regarding public health of developing nations culminated in the institution of the Doha Declaration.63 The Declaration came as a response to the developed nations making access to medicine extremely difficult for the poor due to rigid patent laws. 64 For instance, as HIV/AIDS remains closely linked with poverty, the problem posed by implementation of TRIPS and stricter patents further added to the
56 Jain & Darrow, supra note 43, at 430. 57 Id. at 430–31. 58 Id. at 428–31. 59 Id. at 431. 60 Id. at 431–32. 61 John M. Wechkin, Drug Price Regulation and Compulsory Licensing for Pharmaceutical Patents: The New Zealand Connection, 5 PAC. RIM L. & POL’Y J. 237, 240 (1995). 62 Roger Kampf & Hannu Wager, The Role of the TRIPS Agreement in the Global Health Policy, 5 STAN. J.L. SCI. & POL’Y 17, 22 (2011). 63 World Trade Organization, Ministerial Declaration of 20 November 2001, WT/MN(01)/DEC/2 (2001). 64 Kampf & Wager, supra note 62, at 24–25.
250 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. scourge of the disease in India.65 Under the framework of the Doha Declaration, India and other developing countries were successful in negotiating for flexibilities beyond those contained within TRIPS.66 The most notable amongst them was the compulsory licensing provisions under Article 31 of TRIPS.67 The primary purpose behind Article 31 is protection of the public from patent holders who refuse to sell their products for reasonable prices.68 Under this framework, governments can issue compulsory licenses to permit a third-party manufacturer to produce a patented invention, without the patent holder’s permission.69 If it is found that the patent holder was not successful in providing its product at affordable prices to the public, generic manufacture may be allowed.70 Moreover, TRIPS allows member nations to issue compulsory licenses, even when no national emergency exists. 71 Therefore, by way of compulsory licensing, governments can effectively manage and control the cost of essential medication by placing reasonable limits on patent rights.
V. COMPULSORY LICENSING: HOW VIABLE A SOLUTION? Intellectual property rights have had optimists and pessimists alike. While the debates largely depend on one’s individual opinion, with regard to pharmaceutical patents, the opinions stem from moral, economic, and of late, even nationalistic grounds. 72 While a drug manufacturer from a developed nation might cry foul when his patented drugs are made almost freely available in developing countries, the latter may regard the non-access of such medicine despite leaps in science to the poor to be regrettable. This debate has begun ever since the conception of TRIPS itself. It has been argued by scholars in favor of patents that TRIPS policies that affirmatively helped developing nations, would eventually result in increased prices as a consequence of decreased competition, fewer medicines available to the poor, and negative overall public
65 Mueller, supra note 55, at 503, 529. 66 Kampf & Wagner, supra note 62, at 25–26. 67 TRIPS Agreement art. 31. 68 Stephen Barnes, Note, Pharmaceutical Patents and TRIPS: A Comparison of India and South Africa, 91 KY. L.J. 911, 922 (2003). 69 TRIPS Agreement art. 31(b). 70 Id. 71 Id. 72 See, e.g., Siripen Supakankunti et al., Impact of the World Trade Organization TRIPS Agreement on the Pharmaceutical Industry in Thailand, 79 BULL. WORLD HEALTH ORG. 381, 469 (2001), available at http://www.who.int/bulletin/archives/79(5)461.pdf. 2016] COMPULSORY LICENSING OF 251 ANTIRETROVIRAL DRUGS health effects as final consequence.73 TRIPS was also speculated to result in less foreign direct investment, and research and production of medicines in developing countries, or in other words, a higher concentration of advanced technologies to developed countries.74 This, according to those scholars, results in a skewed perspective on which areas of research need attention and funding as well as a lower degree of technology transfers. 75 However, despite these apprehensions, TRIPS has managed to work well for both sides–– offering a time gap for developing and underdeveloped nations to comply, while aiding the developed nations by simply introducing the concept of pharmaceutical patents on a global scale.76 However, at this juncture, the scope of this paper demands that we analyze specifically compulsory licensing under TRIPS. Like TRIPS itself, compulsory licensing is a controversial topic for economists, policy makers and lawyers alike. The interplay between trade, policy and the law make it an extremely delicate subject, bringing to the forefront the tussle between the developed and developing nations like never before. In this section, we shall attempt to look at both sides of the argument, and try to ascertain the path that India must take, especially with regard to ARV drugs. In pursuance, we shall first look at the pros and cons of compulsory licensing in general, and then apply it to the situation at hand. These have been discussed and deliberated below.
A. FOREIGN RELATIONS AFFECTING FOREIGN DIRECT INVESTMENT
A policy measure as bold as compulsory licensing not only has economic ramifications, but also affects relations with countries producing patented drugs.77 The overt act of issuing a compulsory license is not required. Sometimes, the mere apprehension of issuance of one is enough to strain relations.78 The most direct consequence of strain in relations is the dwindling of foreign direct investment. For instance, developed nations, such as the United States of America openly voiced their disappointment with the decision in Natco Pharma Ltd. v. Bayer Co., 79 and insinuated at a possible drop in new
73 Id. at 461–62. 74 Id. at 462. 75 See id. at 463. 76 Id. at 466. 77 Muhammad Z. Abbas, Pros and Cons of Compulsory Licensing: An Analysis of Arguments, 3 INT’L J. OF SOC. SCI. & HUMAN. 254, 256 (2013). 78 Id. at 255. 79 Bayer Corp. v. Natco Pharm. Ltd., No. 45 (2013) (Intellectual Prop. Appellate continued . . .
252 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. investments.80 Developing nations such as India, and its local industries have a lot to gain from foreign investment and cannot afford such trade frictions.81 The reluctance to invest is closely linked with the pricing of pharmaceuticals.82 Development of a drug comes with high costs.83 These expenses are incurred not only for the development and testing of the drug, but also due to costs associated with drugs that eventually prove unmarketable. 84 A study has estimated that the price of a compound reaching the market must cover the price of approximately 3999 compounds that do not. 85 So it is argued that a patent holder is at great disadvantage as a compulsory license cuts short the time he has to charge a price, which adequately covers the research and development investment. A generic manufacturer on the other hand, is able to charge a lower price as it already had access to the patented technology without having to incur substantial expenses.86 Thus, the price quoted by the generic manufacturer need not reflect the research and development costs. Additionally, as the risk associated with the investment is lower, these manufacturers expect a lower return. 87 This implies a lower profit margin, which in turn enables the manufacturer to charge lower prices in the market place.88 Moreover, this unwillingness to enter the markets of countries with lenient patent regimes dissuades the manufacturer from developing drugs tailored for the country’s specific pharmaceutical requirements. 89 Thus, with regard to foreign investment, issuance of compulsory licenses is looked at with
Bd., India Mar. 4, 2013); Rachna Bakhru, India Grants First Compulsory License Under Patents Act, ROUSE MAGAZINE (June 2012), available at http://www.rouse.com/media/126620/india_grants_first_compulsory_licence.pdf. 80 Amiti Sen, US Protests Patent Issuance to Natco to Sell Copied Versions of Nexaver, THE ECONOMIC TIMES (Mar. 26, 2012, 5:07 PM), http://articles.economictimes.indiatimes.com/2012-03-27/news/31245102_1_compul sory-licence-patent-owner-indian-patent-office. 81 See Benefits of Foreign Direct Investment, ECONOMY WATCH (June 29, 2010), http://www.economywatch.com/foreign-direct-investment/benefits.html. 82 See generally Matthew Herper, The Cost of Creating a New Drug Now $5 Billion, Pushing Big Pharma to Change, FORBES (Aug. 11, 2013, 11:10 AM), http://www.forbes.com/sites/matthewherper/2013/08/11/how-the-staggering-cost-of- inventing-new-drugs-is-shaping-the-future-of- medicine/#2715e4857a0bd3225276bfcb. 83 Wechkin, supra note 61, at 241–42 (1995). 84 Id. 85 Id. at 242 n. 28. 86 Id. at 242. 87 Id. 88 Id. 89 Id. 2016] COMPULSORY LICENSING OF 253 ANTIRETROVIRAL DRUGS considerable cynicism by the critics.90 On the question of recouping research and development costs, it has been argued by proponents of compulsory licensing that it would be futile to impose this cost on unequals equally. 91 They believe that differential pricing strategies should be pursued aggressively, in order to ensure access for those who cannot afford to pay adequate remuneration.92 Given the situation in India, it would be absurd to expect a sex worker to pay lakhs of rupees on HIV/AIDS medication in the name of equality just because people on the other side of the globe can afford to pay that amount. When India issued its first compulsory license in 2012,93 the biggest fear was that it would erode the image of India as an “investing hub,” thus adversely affecting foreign direct investment.94 In consequence, two of the strongest pieces of criticism levelled against the use of compulsory licenses by the developed world are that they dissuade investment and stymie innovation. 95 From the developing nations’ perspective, even on economic analysis, several studies have shown that the impact of strong intellectual property rights has had an immensely positive effect on foreign direct investment.96 This argument is, in fact, the larger picture, which means that the threat to foreign direct investment being labelled a negative effect is the result of a combination of other factors, which developed nations find detrimental to trade. This will be dealt with in more detail below.
90 Id. at 243. 91 See F.M Scherer & Jayasheer Watal, Post-Trips Options for Access to Patented Medicines in Developing Nations, 5 J. INT’L ECON. L. 913, 914 (2002). 92 Id. at 933. 93 See Order, Bayer Corp. v. Natco Pharm. Ltd., No. 45 (2013), at *1 (Intellectual Prop. Appellate Bd., India Mar. 4, 2013). 94 Robert Bird & Daniel R. Cahoy, The Impact of Compulsory Licensing on Foreign Direct Investment: A Collective Bargaining Approach, 45 AM. BUS. L.J. 2, 2–3. 95 See Order, Bayer Corp. at *1. 96 See, e.g., Garrett Halydier, A Hybrid Legal and Economic Development Model that Balances Intellectual Property Protection and Economic Growth: A Case Study of India, Brazil, Indonesia, and Vietnam, 14 ASIAN-PAC. L. & POL’Y J. 86 (2012).
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B. Fear to File Applications for Compulsory Licenses
One need not wander far from the topic of foreign direct investment to find another cause of concern. Some scholars, most being from developed nations, argue that compulsory licenses have shown not to be as efficient as intended in solving for unreasonable prices. 97 To substantiate this argument, they state that they do not even attempt to file for compulsory licenses.98 However, there is a need to evaluate the basis on which such statements are made. For instance, there are authors that used a report conducted by the United Nations in 2001 that showed that developing countries refrain from or hesitate to file for compulsory licenses out of fear of the repercussions from developed countries.99 This reason in itself is considered by such authors to be an argument not in favor of compulsory licensing.100 However, we argue that the mere fear of repercussions of a scheme does not make the scheme faulty in itself. To illustrate the above circular problem, in the United States, the Section 301 Watch List in the Trade Act of 1974 allows the nation to take up measures against any country supposedly denies American companies or persons adequate and effective protection of their IP rights. 101 This clearly shows the developed nations’ capability of managing world trade and influencing laws through the application of economic and political will. Moreover, in this regard, scholars have stated that global institutions need to undertake regular checks and balances to the TRIPS framework, and also see to it that the United States does not exert its power to alter WTO rules in bilateral arrangements. 102 This view shows that the problem lies in the developed nations’ disregard and aggression. The view is even more persuasive in showing that it is not compulsory licensing that is faulty, but the treatment towards it.
97 See Jodie Liu, Compulsory Licensing and Anti-Evergreening: Interpreting the Trips Flexibilities in Sections 84 and 3(d) of the Indian Patents Act, 56 HARV. INT’L L.J. 207, 207 (2015). 98 Felicia Ardenmark Strand, TRIPS and Medicines – Prices, Availability and Health: The Effect on India, Thailand, South Africa and Brazil (May 2014) (unpublished Master thesis) (on file with Lund University School of Economics and Management). 99 Id. at 8. 100 Id. 101 Access to Medicines in the Developing World, 160 PARLIAMENTARY OFFICE OF SCI. AND TECH. POSTNOTES 1, 2 (2001). 102 Frederick M. Abbott, The WTO Medicines Decision: World Pharmaceutical Trade and the Protection of Public Health, 99 AM. J. INT’L L. 317, 354–58. 2016] COMPULSORY LICENSING OF 255 ANTIRETROVIRAL DRUGS
C. Competition and Innovation
The key driving force behind any investment is the “expected value.”103 In the pharmaceuticals market, the potential return is seen commensurate with the risk.104 To avoid undesirable situations like a sell-off, a pharmaceutical company lowering their return to investors must also lower its risks.105 Given the inherent nature of research and development activities, reducing the risk is an arduous task for a pharmaceutical company. It could potentially reduce the risk at two fronts: by either venturing into less risky research and development in a field it already has the expertise for, or by focusing research on products unlikely to be subjected to a compulsory license in the future.106 Thus, instead of choosing to research on a breakthrough, the company would be more likely to invest its time and money in an already-existing competitive marketplace.107 Moreover, it is argued an unlikely breakthrough would not be brought to market due to concerns regarding incurring expenses on testing and making the drug marketable.108 Thus, it is vehemently argued by the opposing side of compulsory licenses that the imposition of a compulsory licensing regime instils an unwillingness to innovate.109 Therefore, this argument by the proponents of a strong patent regime stands on two pillars: that drug manufacturers prefer to work in competitive marketplaces, and that compulsory licensing stifles innovation.110 In response to the competition argument, many economists advocating for compulsory licensing have argued that excessive patent protection itself is adversative to a free market, and that adequate competition and optimum pricing are realized only without the presence of a patent. 111 Hence, compulsory licenses, which dismember the strength of the patent system, actually contribute to effective competition in the free market.112 With regard to the argument regarding stifling of innovation, it has
103 CHARLES J. GOETZ, CASES AND MATERIALS ON LAW AND ECONOMICS 77 (1984) (“An expected value is the weighted average of all possible payoffs.”). 104 Alan M. Fisch, Compulsory Licensing of Pharmaceutical Patents: An Unreasonable Solution to an Unfortunate Problem, 34 JURIMETRICS J. 295, 311 (1994). 105 Id. 106 Id. 107 Id. 108 Id. 109 See id. 110 Id. 111 Gianna Julian-Amold, International Compulsory Licensing: The Rationales and the Reality, 33 J. L. & TECH. 349, 349 (1994). 112 Id.
256 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. been fervently argued by proponents of compulsory licensing that the pretext of research and development used by most drug manufacturers to support the patent regime is not really for innovation per se. 113 Instead, economists have considered the efforts of these drug manufacturers to have been making only incremental changes in drug effectiveness, rather than large breakthroughs that might justify large capital expenditures.114 In fact, the presence of patent protection may provide an incentive to develop drugs that simply escape patent infringement, rather than drugs which are truly innovative.115 This is called “evergreening” and has been heavily criticized for stifling competition.116 Interestingly, India has taken a strong stand against evergreening as seen in recent case law.117
D. Parallel Increase in the Number of Patents Filed
Additionally, scholars opposing compulsory licensing believe that a negative effect of issuing multiple such licenses could also emerge from a parallel increase in the number of patents filed.118 A condition often put on compulsory licenses is that the generic version of the drug must have a different packaging.119 Post Natco v. Bayer, it was feared that the decision may trigger issuance of numerous compulsory licenses.120 In such a case, pharmaceutical drug companies may resort to filing patents in “thickets” in anticipation of compulsory licenses121. Patent thickets refer to patents filed with overlapping claims.122 Patents are
113 Wechkin, supra note 61, at 237, 241. 114 Id.; Telephone Interview with Dr. Reinhard Pauls, Manager of Research and Analysis at Pharmaceutical Management Agency Ltd. (Pharmac) (Nov. 28, 1994). 115 Wechkin, supra note 61, at 241. 116 Evergreening of Patents – An Emerging Issue, PHARMAINFO.NET, http://www.pharmainfo.net/manandkumar/evergreening-patents-emerging-issue (last visited Jan. 19, 2016). 117 See Novartis AG v. Union of India, (2007) 4 MLJ 1153 (India). 118 Mansi Sood, Natco Pharma Ltd. v. Bayer Corporation and the Compulsory Licensing Regime in India, 6 NUJS L. Rev. 99, 112 (2013). 119 See Compulsory License Application, Natco Pharm. Ltd. v. Bayer Corp., C.L.A. No. 1 (2011) at *56–57 (Controller of Patents, India 2011), available at http://www.ipindia.nic.in/ipoNew/compulsory_License_12032012.pdf. 120 See Sushmi Dey, Compulsory Licensing Could Be Big Business for Drug Makers, BUS. STANDARD (Apr. 4, 2013), http://www.business-standard.com/article/companie s/compulsory-licensing-could-be-big-business-for-drug-makers-113040300610_1.ht ml. 121 Carl Shapiro, Navigating the Patent Thicket: Cross Licenses, Patent Pools, and Standard Setting, 1 INNOVATION POL’Y & ECON. 119, 143 (2000). 122 Id. at 120. 2016] COMPULSORY LICENSING OF 257 ANTIRETROVIRAL DRUGS filed in clusters, or thickets so as to ensure that entering the field without infringing some patent would become a mammoth task.123 Even though the likelihood of patent thickets remains remote in the country,124 a situation like this would result in the market becoming overcrowded with “patents for new dosages and new usages rather than new drugs.” 125 In such a scenario, other companies would be discouraged to file for compulsory licenses and the market would continue to be saturated with generic versions of the same drug.126 This would inevitably affect competition and prices would remain high.127 Thus, it would eventually defeat the purpose of a compulsory license to make drugs affordable. The solution to this apparent problem lies in the problem itself. Not only are patent thickets highly unlikely, but the increase in generic versions of the same drug will actually also contribute to access to medicine in the country. 128 While we agree that there will be a reduction in the number of applications for compulsory licenses, this will not be a problem considering there will be generic versions of the drug available. Moreover, the increase in number of the generic versions will increase competition, and hence reduce prices in the free market.129
E. Brain Drain
Moreover, it is also argued that as issuance of compulsory licenses weakens the patent regime, making the country less competitive and leading to an obvious “brain drain.”130 It becomes difficult for such countries to retain their human capital comprising of talented scientists and researchers from seeking more research and development- conducive environments elsewhere.131 This is a flimsy argument against compulsory licenses for two reasons: first, there is no direct relationship between compulsory licenses and brain drain in a country; second, even countries issuing
123 Id. at 121. 124 See, e.g., Novartis AG v. Union of India, (2013) 6 S.C.C. 1 (India). 125 Katherine W. Sands, Prescription Drugs: India Values Their Compulsory Licensing Provision – Should the United States Follow in India’s Footsteps?, 29 HOUS. J. INT’L L. 191, 217 (2006). 126 Id. 127 Id. 128 See id. at 218. 129 Id. at 229. 130 Muhammad Zaheer Abbas, Pros and Cons of Compulsory Licensing: An Analysis of Arguments, 3 INT’L J. SOC. SCI. & HUMAN. 254, 255 (2013). 131 Id.
258 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. compulsory licenses will need people working on other drugs. 132 Interestingly, a report which stated that there was a severe crisis in developing countries with regard to brain drain, also added as one of its directives the need to increase in these countries, compulsory licensing. 133 Moreover, the second argument that demolishes this stand taken by anti-compulsory licensing advocates is the fact that there are thousands of drugs being produced every year, and not all of them are lifesaving.134 Hence, not all of them can be subject to compulsory licenses.135 In fact, we do not propose a system where all drugs are to be compulsorily licensed, as this would be unfeasible for the patent holder and also unnecessary for certain drugs that are not necessarily “lifesaving.” Hence, the pharmaceutical industry in developing nations will not exactly run out of work and job opportunities.136
F. Looming Problems due to a Weakened Generic Market
Throughout this section, we have attempted to argue that despite certain views that regard compulsory licenses disapprovingly, there are equally well backed views to support compulsory licensing. However, while we strongly advocate the opinion that compulsory licensing has its pros, we do not make a blanket statement of its viability. This is mainly because studies have also shown that compulsory licensing reduce prices dramatically, but only if generic competition is introduced.137 In the previous section, we have argued that generic medicine increases competition and reduces price, thus increasing access to healthcare. However, with the recent changes in patent law, this may be a tough task. It is also necessary to study this along with how compulsory licenses actually work. “The issuance of a compulsory license by a government does not necessarily result in immediate supply by a third-party company.”138 “The looming threat that a third party may begin to supply soon can reduce price, but the price reduction is not as steep if
132 Id. 133 See generally U.N. DEV. PROGRAMME, HUMAN DEVELOPMENT REPORT 2001: MAKING NEW TECHNOLOGIES WORK FOR HUMAN DEVELOPMENT (2001). 134 Id. at iii. 135 Id. at 106–108. 136 Abbas, supra note 130, at 255. 137 See EMMANUEL HASSAN ET AL., INTELLECTUAL PROPERTY AND DEVELOPING COUNTRIES: A REVIEW OF THE LITERATURE 28 (2010), available at http://www.rand.org/content/dam/rand/pubs/technical_reports/2010/RAND_TR804. pdf. 138 Id. at 36. 2016] COMPULSORY LICENSING OF 259 ANTIRETROVIRAL DRUGS generic competition is introduced to the market immediately after the license is issued.” 139 Hence, this is a drawback when it comes to compulsory licensing at this time in India. While product patents have been introduced, the generic industry that had earlier boomed due to the presence of process patents is now extremely weak.140 This makes it an insurmountable task to introduce generic versions of the compulsorily licensed drug.141 The only glimmer of hope lies in the fact that the patented drug will be sold at an extremely low price when the applicant for the license acquires it.
G. Procedural Infirmities Surrounding Compulsory Licenses in India
As though the substantive law surrounding compulsory licenses was not enough of an issue, India also has procedural laxities contributing to lapses in the proposal. Section 84 of the Indian Patents (Amendment) Act 2005 lays down the provision for the issuance of a compulsory license in the country.142 The Act lays down grounds for issuance of the same: (a) if the public deems the patented invention to be unsatisfactory, (b) if the public cannot access the patented inventions at a reasonable price, and (c) if the patented invention is being worked outside the territory of India.143 However, the compulsory license provision of the IPA Act of 2005 is riddled with various infirmities, diluting the effectiveness of the same. One such is that of inherent administrative cumbersomeness. Under Section 84(6) of the Act, the Controller is responsible for evaluating applications under Section 84 on the basis of numerous factors. 144 Additionally, as per Section 90, the Controller is empowered to also set the terms and conditions of a compulsory license. 145 Notably such provisions only delay the administrative sanction of a license. Moreover, an applicant is required to state the nature of his interest in the issuance of a license, and the patentee can oppose the same.146 Such a provision leaves open the possibility of indefinite prolonging of opposition proceedings, thereby defeating the purpose of a compulsory
139 Id. 140 See Jain & Darrow, supra note 43, at 441. 141 See id. at 440–41. 142 The Patents (Amendment) Act, 2005, No. 15, Acts of Parliament, 2005 (India). 143 The Patents Act, 1970, No. 39, Acts of Parliament, 1970 (India). 144 Jain & Darrow, supra note 43, at 439. 145 The Patents Act, 1970, No. 39, Acts of Parliament, 1970 (India), § 90. 146 Id. at § 84(3).
260 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. licenses.147 Such delays played out in the case of Imperial Chemical Industries Ltd. v Controller General of Patents, Designs and Trade Marks, wherein the case was closed because the patent expired.148 Additionally, one of the biggest infirmities of the Act lies in the three-year lock-in period imposed by it.149 As a result, an applicant can file for a compulsory license only three years after the grant of the patent.150 As HIV/AIDS patients are rapidly developing resistance to first-generation drugs, the need for still-patented second and third-line drugs is on the rise.151 In light of such urgency, the three-year lock-in period is a cause for concern as it could further hamper access. Thus, in order to fully realize the potential of a compulsory license in ensuring regular access to essential ART drugs, the legislature must amend the Act. Plugging in these infirmities by way of installing a specific protocol and time period, and doing away with the delay-causing provisions would enable better access.152
VI. CONCLUSION Throughout the course of this paper, we have tied our focus on two main issues. The first issue is the juxtaposition of the timeline tracing ARV drug manufacture and the changes in patent law. On analyzing, we have found that reading these timelines together, coupled with the discussion on the pervasiveness of the disease in India at this point in time, there is a glaring need for an easier way to access lifesaving drugs. The need of the hour is recourse to second line of treatment. With these drugs coming up only post-2005, which corresponds to the time from which TRIPS’ patent laws became exceedingly rigid, it has been a travesty on the Indian poor. Hence, the current point in time has the worst combination of scenarios, with the most rigid patent laws making a metaphorical head-on collision with the need for second-line of ARV drugs being at its peak. The second issue that we have focused on in our paper is the solution to the problem posed by the first issue. Better access to life-saving second-line ARV drugs is the need of the hour, and for this, we have proposed compulsory licensing as a solution. We have discussed the viability of such a solution by deliberating and discussing the pros and cons of compulsory licensing from the points of view of
147 See generally Harshita Mathur, Compulsory Licensing under Section 92A: Issues and Concerns, 13 J. INTELL. PROP. RTS. 464, 466 (2008). 148 Imperial Chem. Indus. Ltd. v. Controller Gen. of Patents, Designs and Trade Marks, (1978) Cal. 77 (Calcutta High Court, India 1978). 149 The Patents (Amendment) Act, 2005, No. 15, Acts of Parliament, 2005 (India) § 84(1). 150 Id. 151 Jain & Darrow, supra note 43, at 439. 152 Id. at 439–40. 2016] COMPULSORY LICENSING OF 261 ANTIRETROVIRAL DRUGS both developed countries and developing nations. While the developed nations are most perturbed by factors such as innovation, competition, and brain drain, there is enough evidence to show that none of the above will be adversely affected by compulsory licensing. However, it would be utopian to state that compulsory licensing does not come with its share of problems. Procedural infirmities, and the apprehension of high costs due to no competition from generic versions of the drug may plague the system. However, despite its inadequacies, compulsory licensing of ARV drugs is the need of the hour if both focal issues of the paper are weighed together. Compulsory licensing is a speedy solution to the drug drought brought about by the new regime. With the patients racing against time due to the peculiarity of ART and the pervasiveness of the disease, a speedy solution is all that is required.
WAKE FOREST JOURNAL OF BUSINESS AND INTELLECTUAL PROPERTY LAW
VOLUME 16 WINTER 2016 NUMBER 2
USEDSOFT AND ITS AFTERMATH: THE RESALE OF DIGITAL CONTENT IN THE EUROPEAN UNION
Sven Schonhofen†
I. INTRODUCTION ...... 264 II. THE DOCTRINE OF EXHAUSTION IN EUROPEAN COPYRIGHT LAW ...... 265 III. RATIONALES FOR AND AGAINST A SECOND-HAND MARKET FOR DIGITAL CONTENT ...... 268 IV. THE RESALE OF SOFTWARE ...... 269 A. THE SITUATION IN EUROPE PRIOR TO ORACLE V. USEDSOFT ...... 269 B. THE CJEU JUDGMENT ORACLE V. USEDSOFT ...... 270 1. Facts ...... 270 2. Opinion of the Advocate General Bot ...... 272 3. Judgment of the CJEU ...... 272 C. IMPLICATIONS OF THE CJEU JUDGMENT ORACLE V. USEDSOFT ...... 276 1. Doctrine of Exhaustion as a general principle of the online sale of software ...... 277 2. Free Movement of Goods ...... 278 3. Relativity of Copyright ...... 279 4. Economic Reasoning of the CJEU ...... 280
† Ph.D. candidate, Siegen University; Fellow, Fordham IP Institute; Research Assistant, Olswang Germany LLP, Munich; L.L.M., Intellectual Property and Information Technology Law, Fordham University School of Law, 2015; Higher Regional Court Hamm, Second State Examination in Law, 2013; Bayreuth University, First State Examination in Law, 2011. I am grateful to Professor Hugh C. Hansen for his guidance and suggestions throughout the research and writing process as well as being a great mentor. I would like to thank Fellows Nick Bartelt and Greg Mantych for advising me on this Note and all the staff at the Fordham IP Institute for being great friends and colleagues. Thank you to all the staff members of the Wake Forest Journal of Business and Intellectual Property Law for preparing this Note for publication. Finally, a tremendous, special thank you to my family and friends for their constant support and encouragement. 2016] USEDSOFT AND ITS AFTERMATH 263
5. Ban on dividing greater number of licenses ...... 280 6. Subsequent acquirers are “lawful acquirers” ...... 281 D. PRACTICAL CONSEQUENCES OF THE CJEU JUDGMENT ORACLE V. USEDSOFT ...... 281 1. From the Copyright Holder’s Point of View ...... 281 2. From an Acquirer’s Point of View ...... 284 E. SUMMARY ...... 285 V. THE DISCUSSION AFTER ORACLE V. USEDSOFT: CAN THE CJEU JUDGMENT BE APPLIED TO DIGITAL GOODS OTHER THAN SOFTWARE? ...... 285 A. USEDSOFT DECISION WAS BASED ON SOFTWARE DIRECTIVE ...... 286 B. PARALLEL EXHAUSTION DOCTRINES IN SOFTWARE AND INFOSOC DIRECTIVES ARE SIMILAR...... 287 C. UNIFORM INTERPRETATION OF THE DIRECTIVES REQUIRED ...... 287 D. NEW EU LEGISLATION WITHOUT LIMITATION TO MATERIAL COPIES ...... 287 E. BINDING EFFECT OF THE RECITALS TO THE INFOSOC DIRECTIVE ...... 288 F. WCT IS NO LEGAL REASON AGAINST THE EXTENSION OF THE EXHAUSTION DOCTRINE ...... 290 G. SIMILAR SITUATIONS WITH RESPECT TO ONLINE AND OFFLINE DISTRIBUTION ...... 290 H. CONCLUSION ...... 292 VI. THE RESALE OF DIGITAL GOODS OTHER THAN SOFTWARE ...... 293 A. THE JUDGMENT OF THE COURT OF APPEALS IN HAMM, GERMANY (AZ. U 60/13) ...... 293 1. Facts ...... 293 2. The Judgment of the Court of Appeals in Hamm, Germany ...... 294 B. ANALYSIS OF THE JUDGMENT OF THE COURT OF APPEALS IN HAMM, GERMANY ...... 295 VII. A QUICK GLANCE ACROSS THE ATLANTIC: CAPITAL RECORDS, LLC V. REDIGI INC...... 296 VIII. CONCLUSION ...... 297
264 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L.
I. INTRODUCTION The biggest challenge for the European Union copyright law today is applying traditional copyright doctrines to the digital world. The prime example is the issue whether the acquirer of copyrighted digital content can resell the protected work without the authorization of the copyright holder. Courts, scholars and practitioners have discussed this problem for a decade now. Due to the ubiquity of high-speed internet connections and the ease of carrying out transactions online, more and more copyright holders have come to rely on digital distribution channels for delivering copies of purchased works to their customers.1 Many of them use clauses in their terms and conditions that suppress the second-hand market for these works.2 Competition issues between “new” and “used” digital content arise because the functionalities of copies of “used” digital goods are usually the same as they were when the good was originally distributed in the sense that no degradation can be expected to have occurred over time.3 Copies of used digital content can therefore retain their value and compete on price in secondary markets with digital goods distributed for the first time by owners.4 The question of whether such a secondary market can be suppressed by the right holder will be answered by the doctrine of exhaustion. Three different scenarios need to be looked at in order to understand the issue of whether the doctrine of exhaustion can be applied in the digital world. First, a consumer walks into a bookstore and buys the physical copy of a book. Second, the same consumer buys the same work as an e-book and downloads the book from the website of an online store. Third, the consumer buys software from the same online store and downloads the software from the website, without receiving the software on a CD or DVD. In the first scenario, the application of the principle of exhaustion of the copyright holder’s distribution right is straightforward: It is recognized that the copyright holder, by introducing a copy of the book
1 Yin Harn Lee, UsedSoft GmbH v. Oracle International Corp (Case C- 128/11)—Sales of “Used” Software and the Principle of Exhaustion, INT’L REVIEW OF INTELLECTUAL PROP. AND COMPETITION LAW 846, 847 (2012); Michael Neuber, Online-Erschöpfung doch nur für Software? [Online Exhaustion Only for Software?], WETTBEWERB IN RECHT UND PRAXIS (WRP) 1274 (2014). 2 Neuber, supra note 1, at 1274. 3 Ronny Hauck, Gebrauchthandel mit digitalen Gütern [Trade of Used Digital Goods], NEUE JURISTISCHE WOCHENSCHRIFT (NJW) 3616, 3617 (2014); Louis Longdin, Inexhaustible Distribution Rights for Copyright Owners and the Foreclosure of Secondary Markets for Used Software, IIC 541, 542 (2013); Neuber, supra note 1, at 1274. 4 Longdin, supra note 3, at 542. 2016] USEDSOFT AND ITS AFTERMATH 265
for sale into a particular market, has exhausted his right to control the further distribution of that copy within the relevant market.5 In the second and third fact pattern, the applicability of the principle of exhaustion is much less clear cut, as is the corresponding right of the first acquirer to resell his copy of the e-book or software.6 This Note will analyze the possibility of a second-hand market for used digital content and the applicability of the doctrine of exhaustion in the digital realm. The thesis of this Note is that the doctrine of exhaustion should be applied to software as well as other digital content in order to open the door for a secondary market for used digital content. This Note commences with a brief overview of the doctrine of exhaustion in European copyright law and the rationales for and against a second-hand market for digital content. Then the Note turns to the resale of software and focuses on the CJEU’s UsedSoft decision. Next, it discusses whether the CJEU’s UsedSoft decision can be applied to digital content other than software. Finally, the Note will take a quick glance at United States case law.
II. THE DOCTRINE OF EXHAUSTION IN EUROPEAN COPYRIGHT LAW The doctrine of exhaustion is a legal concept in the European Union copyright law that limits certain rights of a copyright holder.7 This is necessary since two property rights are at play: the “ownership of a copyright” and the “ownership of a material object.” 8 Under the doctrine of exhaustion, the “owners’ rights to control the distribution of tangible items embodying their intellectual property is exhausted once a sale has been made to an original purchaser.”9 Exhaustion aims “to strike a balance between the necessary protection of intellectual property rights, which notionally confer on their holders a monopoly on exploitation, and the requirements of the
5 Jochen Marly, Der Handel mit so genannter “Gebrauchtsoftware” [The Trade of So Called “Used Software”], EUROPÄISCHE ZEITSCHRIFT FÜR WIRTSCHAFTSRECHT (EUZW) 654, 655 (2012); Til Kreutzer, Was das EuGH- Urteil zu Gebrauchtsoftware bedeutet [What Does the CJEU Judgment about Used Software Mean?] GOLEM (Apr. 7, 2012), available at http://www.golem.de/news/analyse-was-das-eugh-urteil-zu-gebrauchtsoftware- bedeutet-1207-92960.html. 6 Hauck, supra note 3, at 3617; Kreutzer, supra note 5; Lee, supra note 1, at 847. 7 Emma Gallacher & Sean Jauss, The Principle of Exhaustion, MEWBURN ELLIS LLP (Jan. 31, 2014), available at http://www.lexology.com/library/detail.aspx?g=29f0d605-aae8-4163-966b- 3d2acb0ba3a3. 8 Longdin, supra note 3, at 543. 9 Id.
266 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. free movement of goods.”10 That principle, which limits the exclusive right of the intellectual property right holder to be the first to put into circulation the product covered by the right in question, is the expression of the legal notion that that right does not make it possible to prevent the distribution of an authentic product once it has been placed on the market.11 The rule is justified, economically, by the consideration that the holder of parallel rights must not profit unduly from the exploitation of his right, which would be the case if he could benefit from the economic advantage conferred on him by that right every time an EU internal frontier is crossed.12 “The copyright holder receives a reward for his or her labor at the point of first sale”13; any further downstream control of distribution would arguably be exerting an ownership right over the material object itself and not simply ownership of the copyright.14 The exhaustion principle was adopted by the European Union legislature into a number of directives, in particular the Information Society Directive15 (hereinafter: InfoSoc Directive) and the Software Directive.16 The InfoSoc Directive is designed to implement the obligations of the European Community under the World Copyright Treaty 17 (hereinafter: WCT) and came into effect on June 22, 2001. 18 The Directive makes a clear distinction between online dissemination on the one hand (communication to the public right in Article 3 of the InfoSoc
10 See Opinion of Advocate General Bot in CJEU, Case C-128/11, UsedSoft GmbH v. Oracle Int’l Corp., delivered on Apr. 24, 2012, at § 43. 11 Id; Neuber, supra note 1, at 1274; Martin Senftleben, Die Fortschreibung des urheberrechtlichen Erschöpfungsgrundsatzes im digitalen Umfeld – Die UsedSoft- Entscheidung des EuGH [The Continuation of the Copyright Doctrine of Exhaustion in the Digital World – The CJEU UsedSoft Decision], NJW 2913, 2924 (2012). 12 See Opinion of Advocate General Bot in CJEU, Case C-128/11, UsedSoft GmbH v. Oracle Int’l Corp., delivered on Apr. 24, 2012, at § 45. 13 Gallacher & Jauss, supra note 7. 14 Id. 15 Directive 2001/29, of the European Parliament and of the Council of 22 May 2001 on the Harmonisation of Certain Aspects of Copyright and Related Rights in the Information Society, (O.J. 2001 L 167 p.12) [hereinafter InfoSoc Directive]. 16 Article 4 of Directive 2009/24/EC, of the European Parliament and the Council of 23 April 2009 on the Legal Protection of Computer Programs (O.J. 2009 L 111, p.18) [hereinafter Software Directive]. 17 World Intellectual Property Organization, World Copyright Treaty, Dec. 20, 1996, 36 ILM 65. 18 InfoSoc Directive, supra note 15, at art. 14. 2016] USEDSOFT AND ITS AFTERMATH 267
Directive) and distribution of the material object on the other hand (distribution right in Article 4 of the InfoSoc Directive).19 Article 3(3) of the InfoSoc Directive says that the communication to the public right is not exhausted. 20 Article 4(2) states that the distribution right is exhausted if there is a first sale or other transfer of ownership in the Community in respect to the original or copies of the work. 21 Additionally, Recital 28 to the InfoSoc Directive refers expressly to the “exclusive right to control distribution of the work incorporated in a tangible article.”22 According to Recital 29 to the InfoSoc Directive, The question of exhaustion does not arise in the case of services and on-line services in particular. . . . Unlike CD-ROM or CD-I, where the intellectual property is incorporated in a material medium, namely an item of goods, every on-line service is in fact an act which should be subject to authorization where the copyright or related right so provides.23 The Software Directive deals with the legal protection of computer programs.24 Directive 91/25025 first came into force on May 14, 1991, and was replaced by Directive 2009/2426 on April 23, 2009, following various minor amendments over the years. The Software Directive ensures that computer programs are protected by copyright as literary works and establishes several rights for computer programs, including distribution and reproduction rights. 27 “It does not make any clear distinctions between online and offline delivery.” 28 “This may be because online delivery was not a common occurrence in 1991.”29 Article 4(2) of the Software Directive establishes a broader exhaustion rule: “The first sale in the Community of a copy of a program by the right holder or with his consent shall exhaust the distribution right within the Community of that copy.”30 Article 5(1) of the Software Directive includes the exemption that the reproduction of a computer
19 Id. at arts. 3–4, p. 16. 20 Id. at art. 3, p. 16. 21 Id. at art. 4, p. 16. 22 Id. at 12 (emphasis added). 23 Id. 24 Directive 91/250/EEC, (OJ 1991 L 122, p.42). 25 Id. 26 Software Directive, supra note 16, at art. 11. 27 Id. at art. 1. 28 Ellen Franziska Schulze, Resale of Digital Content Such as Music, Films or eBooks Under European Law, 36 EUR. INTELL. PROP. REV. 9, 10 (2014). 29 Id. 30 Software Directive, supra note 16, at art. 4.
268 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. program “shall not require authorization by the right holder where they are necessary for the use of the computer program by the lawful acquirer in accordance with its intended purpose.”31
III. RATIONALES FOR AND AGAINST A SECOND-HAND MARKET FOR DIGITAL CONTENT The traditional doctrine of exhaustion was first established when no one could even think of distributing a copyrighted work solely in an intangible form. However, this is the reality in today’s world. Many protected works—whether it is music, films, books or software—are purchased solely in an intangible form. Therefore, the issue arises whether the traditional doctrine of exhaustion can be applied in the digital world in order to open a second-hand market for digital content. There are various policy arguments that can be made for and against a second-hand market for digital content. On the one hand, the copyright holder wants to prevent a second- hand market for digital content due to four reasons. First, the copyright holder has the exclusive right of distribution.32 If there is no second- hand market for his products, there is no competition for him, and his sales will increase.33 Second, a ban on the transfer of the work allows optimal price strategies, such as reduced pricing for students or educational institutions.34 Third, there “might be lower prices for all consumers by spreading costs among a large number of purchasers.”35 Fourth, allowing copyright holders to bring infringement actions against unauthorized resellers might reduce incidences of product piracy.36 On the other hand, the acquirer of a copyrighted work will argue for a broad interpretation of the doctrine of exhaustion in order to open the door to a second-hand market for digital content. There are three major arguments for a second-hand market in the digital realm. First, the acquirer should be able to fully dispose of his property.37 “Restrictions of the resale of copies of a digital work might not vindicate the law’s general aversion to restraints on alienation of personal property.” 38
31 Id. at art. 5, p. 18. 32 Senftleben, supra note 11, at 2924. 33 Marly, supra note 5, at 655. 34 Id; Peter Ganea, Ökonomische Aspekte der urheberrechtlichen Erschöpfung [Economic Aspects of the Doctrine of Exhaustion in Copyright Law], GEWERBERLICHER RECHTSSCHUTZ UND URHEBERRECHT INTERNATIONALER TEIL (GRUR Int.) 102, 103 (2005). 35 Cf. Vernor v. Autodesk, Inc., 621 F.3d 1102, 1114–15 (9th Cir. 2010). 36 Id. at 1115. 37 ULRICH LOEWENHEIM, HANDBUCH DES URHEBERRECHTS [HANDBOOK ON COPYRIGHT LAW], § 20 no. 33 (2010). 38 Vernor, 621 F.3d at 1115. 2016] USEDSOFT AND ITS AFTERMATH 269
Second, the application of the doctrine of exhaustion would create clear legal relationships for the transfer of the property of a good.39 Third, a second-hand market for digital content “contributes to the public good by (1) giving consumers additional opportunities to purchase and sell copyrighted works, often at below-retail prices, (2) allowing consumers to obtain copies of works after a copyright holder has ceased distribution, and (3) allowing the proliferation of businesses.”40 These arguments show that the interests of the copyright holders and acquirers of protected content collide even more in the digital world than in the analogue world and a balancing act between these interests is required.
IV. THE RESALE OF SOFTWARE
A. The Situation in Europe prior to Oracle v. UsedSoft
In its UsedSoft decision, the CJEU had to consider whether the first acquirer of software could resell it.41 Prior to the decision, there was a discussion whether the right of distribution was exhausted if no tangible copy of the software was distributed, but the customer instead received access to download the software.42 On the one hand it has been argued that the doctrine of exhaustion does not apply in this case since the wording of Article 4(2) of the Software Directive requires a tangible copy of the work.43 Additionally, an analogous application of Article 4(2) of the Software Directive was rejected because it is an exemption that should be applied restrictively.44 On the other hand, it has been argued that the sale of a computer program on a CD-ROM or DVD and the sale of a program by downloading from the internet are similar—from an economic and from a legal point of view.45
39 LOEWENHEIM, supra note 37, at § 20 no. 33. 40 Vernor, 621 F.3d at 1115. 41 CJEU, Case C-128/11, UsedSoft GmbH v. Oracle Int’l Corp., Judgment of the Court (Grand Chamber) of July 3, 2012, 2012 E.C.R. 407, at § 47. 42 Id. 43 Thomas Hoeren & Matthias Försterling, Onlinevertrieb “gebrauchter” Software – Hintergründe und Konsequenzen der EuGH-Entscheidung “UsedSoft” [The Online Sale of “Used” Software – Background and Consequences of the CJEU “UsedSoft” Decision], MULTIMEDIA UND RECHT (MMR) 642 (2012). 44 Landgericht [Regional Court] Munich I, Germany, Mar. 15, 2007, 7 O 7061/06, MMR 328, 330 (2007). 45 Hoeren & Försterling, supra note 43, at 642; Malte Grützmacher, “Gebrauchtsoftware” und Erschöpfungslehre: Zu den Rahmenbedingungen eines Second-Hand-Marktes für Software [“Used Software” and the Doctrine of continued . . .
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To limit the application of the principle of exhaustion of the distribution right solely to copies of computer programs that are sold in a material medium would allow the copyright holder to control the resale of copies downloaded from the internet and to demand further remuneration on the occasion of each new sale, even though the first sale of the copy had already enabled the right holder to obtain an appropriate remuneration.46
B. The CJEU Judgment Oracle v. UsedSoft
1. Facts Oracle develops and markets computer software. Oracle distributes the software at issue in eighty-five percent of the cases by downloading from the internet. The customer downloads a copy of the software directly to his computer from Oracle’s website. The software is what is known as “client-server-software.” The user right for such a program, which is granted by a license agreement, includes the right to store a copy of the program permanently on a server and to allow a certain number of users to access it by downloading it to the main memory of their work-station computers.47 Oracle offers group licenses for the software for a maximum of twenty-five users each.48 For example, a customer requiring licenses for twenty-seven users would have to buy two licenses, which would cover up to fifty users.49 Oracle’s license agreements for the software contain the following term: “With the payment for services you receive, exclusively for your internal business purposes, for an unlimited period a non-exclusive non-transferable user right free of charge for everything that Oracle develops and makes available to you on the basis of this agreement.”50 Based on a maintenance agreement, “updated versions of the software (‘updates’) and programs for correcting faults (‘patches’) can be downloaded from Oracle’s website.”51
Exhaustion: The Requirements of a Second-Hand Market for Software], ZEITSCHRIFT FÜR URHEBER-UND MEIDEINRECHT (ZUM) (2006), 302 (305). 46 Grützmacher, supra note 45, at 305. 47 UsedSoft GmbH, 2012 E.C.R. 407, at § 20–21. 48 Id. at § 22. 49 Id. 50 Id. at § 23 (emphasis added). 51 Id. at § 21. 2016] USEDSOFT AND ITS AFTERMATH 271
UsedSoft markets used software licenses, including user licenses for the Oracle computer program at issue. For that purpose, UsedSoft acquires from customers of Oracle such user licenses, or parts of them, where the original licenses relate to a greater number of users than required by the first acquirer. In October 2005, UsedSoft promoted an “Oracle Special Offer.”52 Oracle objected to the practice of UsedSoft and brought proceedings for copyright infringement in the Regional Court Munich I.53 That court allowed Oracle’s application.54 UsedSoft’s appeal against the decision was dismissed.55 UsedSoft thereupon appealed on a point of law to the German Federal Court of Justice, which referred the following questions to the CJEU on February 3, 2011:56
1. Is the person who can rely on exhaustion of the right to distribute a copy of a computer program a “lawful acquirer” within the meaning of Article 5(1) of the Software Directive? 2. If the reply to the first question is in the affirmative: Is the right to distribute a copy of a computer exhausted in accordance with the first half-sentence of Article 4(2) of the Software Directive when the acquirer has made the copy with the right holder’s consent by downloading the program from the internet onto a data carrier?
3. If the reply to the second question is also in the affirmative: can a person who has acquired a “used” software license for generating a program copy as “lawful acquirer” under Article 5(1) and the first half-sentence of Article 4(2) of Software Directive also rely on exhaustion of the right to distribute the copy of the computer program made by the first acquirer with the right holder’s consent by downloading the program from the internet onto a
52 Id. at §§ 24-25. 53 Id. at § 27. 54 Landgericht [Regional Court] Munich, Germany, Mar. 15, 2007, 7 O 7061/06, MMR 328, 330 (2007). 55 Oberlandesgericht [Court of Appeals] Munich, Germany, July 3, 2008, 6 U 2759/07, MMR 601 (2008). 56 Bundesgerichtshof [Federal Court of Justice], Germany, Feb. 2, 2011, I ZR 129/08, MMR 305 (2011).
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data carrier if the first acquirer has erased his program copy or no longer uses it?57 The case was allocated to the Grand Chamber of the CJEU (“indicating that the case was regarded as particularly complex or important” 58 ) and was heard on March 6, 2012. The European Commission, Spain, France, Italy and Ireland supported Oracle’s position.59
2. Opinion of the Advocate General Bot
On April 24, 2012, Advocate General Yves Bot delivered his Opinion which stated that the copyright in a copy of a computer program is exhausted where the right holder allowed the copy to be downloaded from the internet to a data carrier and granted, for consideration of a lump-sum payment, the right to use that copy for an unlimited period of time.60 Nonetheless, AG Bot continued his analysis to conclude that the sale of the copy of the program only exhausted the distribution right and did not exhaust the reproduction right. 61 Moreover, he found that the concept of the “lawful acquirer” who had the right to reproduce under Article 5(1) of the Software Directive was restricted to someone who had acquired a copy of the program under a contract with the copyright holder.62 Therefore, he concluded that a subsequent acquirer could only use a program already incorporated into a data carrier by the original acquirer and could not make a fresh copy, regardless whether the original purchaser erased his copy or no longer used it.63
3. Judgment of the CJEU
The Grand Chamber’s judgment was handed down on July 3, 2012.64 Although it considered the questions in the same order as the Advocate General, and generally agreed with his conclusions on the second question, it took a different view on the first and third
57 UsedSoft GmbH, 2012 E.C.R. 407, at § 34. 58 Christopher Stothers, When Is Copyright Exhausted by a Software License?: UsedSoft v. Oracle, 34(11) EUR. INTEL. PROP. REV. 787, 788 (2012). 59 UsedSoft GmbH, 2012 E.C.R. 407. 60 Opinion of Advocate General Bot in CJEU, Case C-128/11, UsedSoft GmbH v. Oracle Int’l Corp., delivered on Apr. 24, 2012, at § 84. 61 Id. at § 97. 62 Id. at § 98. 63 Id. at § 100. 64 UsedSoft GmbH, 2012 E.C.R. 407. 2016] USEDSOFT AND ITS AFTERMATH 273
questions.65
a. Exhaustion and the Right of Distribution
The CJEU held that the right of distribution of a copy of a computer program is exhausted if the copyright holder who has authorized the downloading of that copy from the internet onto a data carrier has also conferred, in return for payment of a fee intended to enable him to obtain a remuneration corresponding to the economic value of the copy of the work of which he is the proprietor, a right to use that copy for an unlimited period.66 Accordingly, the following three factors must be fulfilled for an exhaustion of the right of distribution:67 First, there must be a “sale” in accordance with Article 4(2) of the Software Directive.68 According to the CJEU, a sale is “an agreement by which a person, in return for payment, transfers to another person his rights of ownership in an item of tangible or intangible property belonging to him.”69 The CJEU chose to broadly interpret the term “sale” to encompass all forms of product marketing.70 A more narrow interpretation would undermine the effectiveness of Article 4(2) of the Software Directive because suppliers would merely have to call a contract a “license” rather than a “sale” in order to circumvent the rule of exhaustion and divest it of all scope.71 Under the second factor in the exhaustion analysis, the copyright holder must receive the payment of a fee in order to be able to “obtain an appropriate remuneration.”72 Here, the court refers to the principle of participation. 73 According to the principle of participation, the copyright holder should have a reasonable share in the exploitation of his or her work.74 Due to the effect of the doctrine of exhaustion, the copyright holder must calculate the fee in a way so that he already receives a reasonable remuneration by the first sale of the copy.75 “A
65 Id. at § 89. 66 Id. at § 72. 67 Id. at §§ 35 et seq. 68 Id. at § 38. 69 Id. at § 42. 70 Id. at § 49. 71 Id. 72 Id. at § 63. 73 See id. 74 Bundesgerichtshof [Federal Court of Justice] Oct. 28, 2010, I ZR 18/09, ZUM 141, at § 19 (2012); THOMAS DREIER & GERNOT SCHULZE, URHEBERRECHTSGESETZ [COPYRIGHT ACT], § 11 no. 8 (2013). 75 Thomas Hartmann, Weiterverkauf und “Verleih” Online Vertriebener Inhalte [Resale and “Rental” of Digital Content], GRUR INT. 980, 981 (2012).
274 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. restriction of the resale of copies of computer programs downloaded from the internet” by allowing the copyright holder to demand further remuneration on the occasion of each new sale “would go beyond what is necessary to safeguard the specific subject-matter of the intellectual property concerned.”76 Third, the principle of exhaustion requires the transfer of ownership of the copy of the computer program. 77 The CJEU held that the ownership of the copy is transferred because the copyright holder grants a right to use the copy for an unlimited period.78 The scope of the license, in particular whether it is an exclusive or non-exclusive license, is irrelevant.79
b. Exhaustion and the Right of Reproduction
According to the UsedSoft system, the first acquirer does not forward the original copy to the second acquirer. 80 Instead he downloads a copy of the program directly from Oracle’s website.81 This download, however, does not concern the right of distribution, but rather the right of reproduction.82 The doctrine of exhaustion does not apply with regard to the right of reproduction.83 Due to this reason, Advocate General Bot rejected UsedSoft’s system.84 The CJEU found the solution to this issue in Article 5(1) of the Software Directive.85 “Since the copyright holder cannot object to the resale of a copy of a computer program for which that right holder’s distribution right is exhausted under Article 4(2) of the Software Directive”, the court concludes that “a second acquirer of that copy and any subsequent acquirer are ‘lawful acquirers’ of it within the meaning of Article 5(1) of the Software Directive.”86 The court does not accept the argument put forward by Oracle that the concept of “lawful acquirer” in Article 5(1) of the Software Directive relates only to an acquirer who is authorized, under a license agreement concluded
76 See UsedSoft GmbH, 2012 E.C.R. 407, at § 63. 77 Hartmann, supra note 75, at 981. 78 See UsedSoft GmbH, 2012 E.C.R. 407, at § 45. 79 Hartmann, supra note 75, at 981. 80 See UsedSoft GmbH, 2012 E.C.R. 407, at § 21. 81 Id. 82 Id. 83 Senftleben, supra note 11, at 2925. 84 See Opinion of Advocate General Bot in CJEU, Case C-128/11, UsedSoft GmbH v. Oracle Int’l Corp., delivered on Apr. 24, 2012, at § 84. 85 UsedSoft GmbH, 2012 E.C.R. 407, at § 75 et seq. 86 Id. at § 80. 2016] USEDSOFT AND ITS AFTERMATH 275
directly with the copyright holder, to use the computer program.87 “That argument would have the effect of allowing the copyright holder to prevent the effective use of any used copy in respect of which his distribution right has been exhausted . . . by relying on his exclusive right of reproduction,” and would thus render the exhaustion of the distribution right ineffective.88 “Consequently, in the event of a resale of the copy of the computer program by the first acquirer, the new acquirer will be able . . . to download . . . the copy sold to him by the first acquirer . . .” onto his computer.89 “Such a download must be regarded as a reproduction of a computer program that is necessary to enable the new acquirer to use the program in accordance with its intended purpose.”90 The terms in the license agreement, in particular the non-transferability of the user right, do not change this result.91
c. Exemptions
i. Ban on dividing a greater number of licenses Volume or package licenses allow a certain number of users to use the software by buying multiple licenses.92 The CJEU held that the acquirer is “not authorized by the effect of exhaustion of the distribution right under Article 4(2) of the Software Directive to divide the license and resell only the user right for the software concerned corresponding to a number of users determined by him.”93 This is the case since the original acquirer of the software must, “in order to avoid infringing the right holder’s exclusive right of reproduction under Article 4(1) (a) of the Software Directive, make the copy downloaded onto his computer unusable at the time of its resale.”94 By dividing the licenses, however, the first acquirer does not make his copy unusable, but rather still uses it himself.95
87 Id. at § 82. 88 Id. at § 83. 89 Id. at § 81. 90 Id. 91 Id. at § 84. 92 Hartmann, supra note 75, at 981. 93 UsedSoft GmbH, 2012 E.C.R. 407, at § 69. 94 Id. at § 78. 95 Hartmann, supra note 75, at 981.
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ii. Technical Protective Measures
The court also addresses the issue of product piracy.96 A copyright holder is faced with the same problem––whether he distributes the software in a “digital” or “classic” way––that it is “only with great difficulty that he can make sure that the original acquirer has not made copies of the program, which he will continue to use after reselling the software.”97 To solve the problem, the CJEU held that it is permissible for the distributor to make use of technical protective measures (such as product keys).98
C. Implications of the CJEU Judgment Oracle v. UsedSoft
The CJEU UsedSoft judgment has been recognized as a “landmark decision” by many commentators.99 The court’s judgment opens up the second-hand market for software delivered through digital distribution channels, while simultaneously imposing several restrictions on such distribution. Most notably, the court requires resellers to render their copies of the software unusable to ensure that the rights of software copyright holders do not become further exposed to violation.100 The decision is outcome-oriented and driven by policy.101 It should be noted that the two parties of the case were in a “good guy/good guy situation.” The software developers—on the one side—used substantial effort, risk, and entrepreneurship to create a value. In line with John Locke’s labor theory of property 102 this value creates property that needs to be protected by intellectual property rights. The software developer, seeking protection of his copyright and remuneration for the value he created, is a “good guy.” On the other side, there are limitations of the copyright. They are driven in the present case by the property rights of the acquirer of the copyrighted good and by the fundamental freedom of the free movement of goods. 103 Since the copyright owner had the chance to get remuneration for his work by the
96 Id. 97 See UsedSoft GmbH, 2012 E.C.R. 407, at § 79. 98 Id. 99 Kreutzer, supra note 5; Lee, supra note 1, at 847. 100 See UsedSoft GmbH, 2012 E.C.R. 407, at § 78. 101 Thomas Dreier, Online and Its Effect on the “Goods” Versus “Services” Distinction, IIC 137, 138 (2013), available at http://paperity.org/p/33121649/online- and-its-effect-on-the-goods-versus-services-distinction. 102 See generally John F. Henry, John Locke, Property Rights, and Economic Theory, 33 J. ECON. ISSUES 609 (Sep., 1999) (discussing and analyzing John Locke’s neoclassical theory on the formation of property rights). 103 See Dreier, supra note 101, at 137–38. 2016] USEDSOFT AND ITS AFTERMATH 277
first sale, the acquirer should be able to freely dispose of his property. The defendant of the case (UsedSoft) simply offers a platform for the acquirers of copyrighted works to do so.104 Hence, the defendant was also a “good guy.” The judgment of the CJEU is a case of “facts plus policy = results = doctrine.” It follows from the language used by the CJEU that the court wanted to enable the acquirer of a copy of the software to transfer the use rights in that particular copy to subsequent acquirers without further control by the initial right holder. 105 “However, this result could only be achieved on the basis of exhaustion, i.e. only on the basis of freedom of movement of goods.”106 Therefore, the CJEU had to qualify the facts of the case as a “sale” . . . and broadly interpret the exception in Article 5(1) of the Software Directive.107 For software developers, the judgment will “clearly be disappointing and it has surprised some in the light of the more positive opinion of Advocate General Bot.”108 However, given the limited scope of the judgment itself, “it is not as disastrous as might first be thought.”109 In summary, the approach taken by the CJEU strikes an appropriate balance between the interest of software copyright holders in extracting maximum financial profit by controlling the distribution of their products and the public interest in ensuring the free circulation of software products that have already been placed on the markets.110 In doing so, it recognizes the need for copyright law to keep pace with technological development, particularly in the relation to new distribution models.111 Hereafter, the Note will analyze some of the policy and doctrinal aspects of the judgment in more detail.
1. Doctrine of Exhaustion as a general principle of the online sale of software
The CJEU applied the doctrine of exhaustion in the digital world of online sales of software and therefore overruled earlier opposing views of scholars and the German courts.112 The court transferred a general
104 Id. at 138. 105 Id. 106 Id. 107 Id. 108 Stothers, supra note 58, at 790. 109 Id. See also Truiken Heydn, EuGH: Handel mit gebrauchter Software [CJEU: Resale of Used Software], MMR 586, 591 (2012). 110 Lee, supra note 1, at 852 111 Id. 112 See supra Part III.A.
278 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. principle of the copyright law and embedded it as a basic concept of the distribution of computer software.113 It could not be more clear-cut with the rule it established in the judgment. The acquirer can resell software that has been sold with the consent of the copyright holder—without any further authorization of the right holder—without infringing the distribution right.114 There is no differentiation between the online and offline sale of software.115 “Any notion that the exhaustion doctrine is itself facing exhaustion in Europe has now definitely been laid to rest” as far as licensed software is concerned.116 Hence, the CJEU ends a long legal debate and creates legal certainty in the market of the distribution of software.117 Following the Football Association Premier League decision,118 this is the second major judgment of the CJEU in just nine months that considers how the European single market should treat the distribution of copyrighted works in non-material form.”119 It seems likely that both decisions “will become fundamental decisions on the interaction between intellectual property rights and the European single market in the online world, in the same way that Consten and Grundig120 and Deutsche Grammophon 121 set the current framework in relation to physical goods in the 1960s and 1970s.”122
2. Free Movement of Goods
The CJEU acts as a “guardian of a fundamental freedom in the EU,” in particular the free movement of goods, which is not a surprise.123 The CJEU connects the doctrine of exhaustion with the requirement of the free movement of goods in the internal market. 124 According to
113 Hoeren & Försterling, supra note 43, at 644. 114 UsedSoft GmbH, 2012 E.C.R. 407, at § 89. 115 Hoeren & Försterling, supra note 43, at 644. 116 Longdin, supra note 3, at 548. 117 Id. 118 CJEU, Joined Cases C-403/08 & C-429/08, Football Ass’n Premier League Ltd. v. QC Leisure, Judgement of the Court (Grand Chamber) of Oct. 4, 2011, 2011 E.C.R. I-9162. 119 Stothers, supra note 58, at 790. 120 CJEU, Joined Cases 56/64 & 58/64, Ètablissements Consten, S.A.R.L. v. Comm’n, Judgment of the Court (Grand Chamber) of July 13, 2966, 1966 E.C.R. 301. 121 CJEU, Case 78/70, Deutsche Grammophon Gesellschaft mbH v. Metro-SB- Grossmärkte GmbH & Co. KG, Judgment of the Court (Grand Chamber) of June 8, 1971, 1971 E.C.R. 489. 122 Stothers, supra note 58, at 790. 123 Senftleben, supra note 11, at 2926. 124 Id. 2016] USEDSOFT AND ITS AFTERMATH 279
Advocate General Bot, “the aim of the principle of exhaustion . . . is to strike a balance between the necessary protection of intellectual property rights, which notionally confer on their holders a monopoly on exploitation, and the requirements of the free movement of goods.”125 The CJEU states that the objective of the doctrine of exhaustion is, “in order to avoid partitioning of markets, to limit restrictions of the distribution of those works to what is necessary to safeguard the specific subject-matter of the intellectual property concerned.” 126 It follows from the aforementioned that the CJEU does not see the unplanned gap in the Software Directive as the exception.127 Instead, the rejection of digital exhaustion in the InfoSoc Directive is the real exception from the requirement of the free movement of goods.128 The CJEU underlines the importance of this fundamental freedom by a broad interpretation of the term “sale” and the exception in Article 5(1) of the Software Directive.129 These broad interpretations ensure that the effectiveness of the doctrine of exhaustion is not undermined.130
3. Relativity of Copyright
The most important lesson learned from the CJEU UsedSoft judgment is not the specific requirements for the resale of used software licenses. It is, rather, the fact that the CJEU retains the option to find boundaries for a copyright protection that the court finds too broad.131 The court held that the first sale of the copy had already enabled the right holder to obtain an appropriate remuneration. 132 Therefore, a restriction of the resale of copies of computer programs downloaded from the internet “would go beyond what is necessary to safeguard the specific subject-matter of the intellectual property concerned”.133 This is more than a statement about the remuneration of the copyright holder in the specific fact pattern.134 The CJEU does not even specifically refer
125 Opinion of Advocate General Bot in CJEU, Case C-128/11, UsedSoft GmbH v. Oracle Int’l Corp., delivered on Apr. 24, 2012, 2012 E.C.R. 407, § 43. 126 Case C-128/11, UsedSoft GmbH v. Oracle Int’l Corp., Judgment of the Court (Grand Chamber) of July3, 2012, E.C.R. 407, at § 62. See also Joined Cases C- 403/08 & C-429/08, Football Ass’n Premier League Ltd. v. QC Leisure, Judgement of the Court (Grand Chamber) of Oct. 4, 2011, 2011 E.C.R. I-9162, at § 106. 127 Senftleben, supra note 11, at 2926. 128 Id. 129 Id. 130 UsedSoft GmbH, 2012 E.C.R. 407, at §§ 49, 83. 131 Senftleben, supra note 11, at 2926–27. 132 UsedSoft GmbH, 2012 E.C.R. 407, at § 63. 133 Id. 134 Senftleben, supra note 11, at 2926.
280 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. to the protection of “copyright.”135 Rather, the court makes a statement about the boundaries of the protection of “the subject-matter of the intellectual property concerned” which results from the basic freedom of the free movement of goods in the European Union.136 The court has argued similarly in October 2011 in its Football Association Premiere League judgment.137
4. Economic Reasoning of the CJEU
The CJEU was led by economic considerations.138 The court found that sales of computer programs on a CD-ROM or DVD and Internet sales of the same work were so similar in economic terms139 that it took a wide view of what is meant by a sale and refused to limit the application of the principle of exhaustion to copies of a computer program sold on a material medium.140 These economic considerations are in line with the importance of the free movement of goods that the court stretched throughout the entire reasoning of its judgment.141
5. Ban on dividing greater number of licenses
Nevertheless, the UsedSoft judgment is not as disastrous for software developers as they might have first thought for two reasons.142 First, the ban on dividing a great number of licenses by reselling only “unused” licenses limits the practical applicability and usefulness of a second-hand store for used software.143 Therefore, only companies that completely stop using the software—e.g. because they started using an alternative software or because they are insolvent—can be suppliers of the used software platform.144 Additionally, the reseller has to find subsequent acquirers that want to use the same volume of licenses,
135 See generally UsedSoft GmbH, 2012 E.C.R. 407. 136 Senftleben, supra note 11, at 2926. 137 Joined Cases C-403/08 & C-429/08, Football Ass’n Premier League Ltd. v. QC Leisure, Judgment of the Court (Grand Chamber) of Oct. 4, 2011, 2011 E.C.R. I- 9162, at §§ 105–108. 138 Longdin, supra note 3, at 567. 139 UsedSoft GmbH, 2012 E.C.R. 407, at § 61. 140 Hauke Hansen & Oliver Wolff-Rojczyk, Erschöpfung des Verbreitungsrechts bei “gebrauchten” Softwarelizenzen [Exhaustion of the Distribution Right for “Used” Software Licenses], GEWRBLICHER RECHTSCHUTZ UND URHEBERRECHT (GRUR) 904, 909 (2012); Longdin, supra note 3, at 567. 141 See generally UsedSoft GmbH, 2012 E.C.R. 407. 142 See generally id. 143 See Heydn, supra note 109, at 591. 144 See id. 2016] USEDSOFT AND ITS AFTERMATH 281
which can be quite difficult.145 The CJEU was right by establishing this ban. If license packages could lawfully be divided and resold, that would have the potential to undermine the multi-user license model, which would increase the complexity of licensing and require more careful pricing of additional licenses.146 Second, most developers will be able to change their distribution model from that used by Oracle in 2005 in order to circumvent the direct impact of the judgment.147
6. Subsequent acquirers are “lawful acquirers”
The CJEU UsedSoft judgment creates legal certainty for the second acquirers of software, too. 148 The doctrine of exhaustion cannot be applied with respect to the right of reproduction. 149 However, subsequent acquirers of used software are regarded as “lawful acquirers” of a copy of the computer software within the meaning of Article 5(1) of the Software Directive.150 This holding is consequent since the possibility of reselling the software as a result of the exhaustion of the distribution right would render the right ineffective otherwise.151 Accordingly, the subsequent acquirer can download onto his computer the copy of software sold to him by the first acquirer.152
D. Practical Consequences of the CJEU Judgment Oracle v. UsedSoft
This Part will describe the consequences of the UsedSoft judgment for the contractual practice. First, the consequences will be examined from the copyright holder’s point of view. Next, the Note will move to the acquirer’s point of view.
1. From the Copyright Holder’s Point of View
a. Contractual Exemption of the Exhaustion of the Distribution Right
145 See id. 146 Stothers, supra note 58, at 790. 147 See Part III.D.1. 148 Hoeren & Försterling, supra note 43, at 644. 149 Id. 150 See Case C-128/11, UsedSoft GmbH v. Oracle Int’l Corp., Judgment of the Court (Grand Chamber) of July 3, 2012, 2012 E.C.R. 407, at § 80. 151 Id at § 83. 152 Hoeren & Försterling, supra note 43, at 645.
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A “this is a license, not a sale” clause or a non-transferability clause cannot lead to the non-applicability of the exhaustion issue.153 The CJEU stressed the importance of the free movement of goods in its judgment. Accordingly, the court clearly rejects any loopholes.154 Additionally, the title of the contract is irrelevant.155 The right holder cannot simply call the contract a “license” rather than a “sale” in order to prevent the doctrine of exhaustion from applying.156 Exhaustion is a matter of copyright, not a matter of contract law.157 The relevant factor is whether the right holder grants a right to use a copy of the software, for an unlimited time, in return for payment of a fee.158 The CJEU therefore interprets the term “sale” in the broadest possible way and—rightly so—stops the possibility to circumvent the rule of exhaustion.159 “Consequently, the acquirer of a software copy benefits from the exhaustion of the distribution right despite a possible clause in the initial license agreement prohibiting any further transfer.”160
b. License only for a limited time period
The distribution right is not exhausted in the case of a license for a limited time period. 161 Software producers might attempt to put themselves beyond the reach of the UsedSoft judgment “by shifting to a true subscription-based model, where customers are granted access to a copy of the software in question, for a limited period of time in each instance, upon the payment of an annual or other periodic fee.” 162 Granting a right to use a copy for a limited time can be regarded as a rental of the program, rather than a sale.163 This result can be reached
153 See Hartmann, supra note 75, at 985; Ralf Weisser & Claus Färber, Weiterverkauf gebrauchter Software—UsedSoft-Rechtsprechung und ihre Folgen [Resale of Used Software—The UsedSoft Judgment and its Consequences], MMR 364, 366 (2014); Christian Frank & Dietrich Kamlah, Oracle vs. Usedsoft— Practical Consequences of the CJEU Decision C-128/11 of July 3, 2012, available at http://deutschland.taylorwessing.com/de/news-insights/details/oracle-vs-usedsoft- 2012-08-07.html (last visited Jan. 30, 2016). 154 Senftleben, supra note 11, at 2927. 155 Id. 156 Case C-128/11, UsedSoft GmbH v. Oracle Int’l Corp., Judgment of the Court (Grand Chamber) of 3 July 2012, 2012 E.C.R. 407, at § 49. 157 Frank & Kamlah, supra note 153. 158 Id. 159 Hoeren & Försterling, supra note 43, at 645. 160 Frank & Kamlah, supra note 153. 161 Hauck, supra note 3, at 3618; Heydn, supra note 109, at 591; Weisser & Färber, supra note 153, at 367. 162 See Lee, supra note 1, at 852; Stothers, supra note 58, at 791; Hartmann, supra note 75, at 985. 163 Frank & Kamlah, supra note 153; Hartmann, supra note 75, at 985. 2016] USEDSOFT AND ITS AFTERMATH 283
by the use of the licensing and delivery model “SaaS” (Software as a Service)164 or by Cloud Computing.165 An advantage of these licensing models is the high flexibility.166 Due to the current trend of Streaming and Cloud Computing, it also seems likely that the sale of software— whether by using a CD-ROM, DVD or download—will soon be a relic of the distant past and the question of the exhaustion of the distribution right would become obsolete.167
c. Technical protective measures
Ascertaining whether the copy of the first acquirer has been made unusable and whether he does not continue to use the software after reselling it may prove difficult.168 Additionally, in the case of a careless seller of used software there is a risk of reselling more licenses than originally acquired.169 Therefore, the right holder needs to control or monitor the resale of the copies of its software.170 For this purpose the right holder has the means of contractual notification obligations and DRM (Digital Rights Management) systems.171 First, there is the possibility of a contractual notification obligation.172 However, such an obligation would conflict with the policy reasons of the doctrine of exhaustion.173 The acquirer of the right to use the software should be able to freely dispose of his property after the distribution right is exhausted. 174 Therefore, such contractual obligations are unacceptable violations of the property right of the acquirer.175 Additionally the document management might get out of hand.176
164 SaaS is a software licensing and delivery model in which software is licensed on a subscription basis and is centrally hosted. It is sometimes referred to as “on- demand-software.” 165 Cloud Computing involves deploying groups of remote servers and software networks that allow centralized data storage and online access to computer services or resources. 166 Hartmann, supra note 75, at 985. 167 Senftleben, supra note 11, at 2927; Kreutzer, supra note 5. 168 Case C-128/11, UsedSoft GmbH v. Oracle Int’l Corp., Judgment of the Court (Grand Chamber) of July 3, 2012, 2012 E.C.R. 407, at § 79; Hartmann, supra note 75, at 985. 169 See Hartmann, supra note 75, at 985. 170 Id. 171 Id. 172 Id. 173 Id. 174 Id. 175 Id. 176 Id.
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Second, to prevent misuse and software piracy, right holders should consider the use of DRM systems.177 These might prove a lot more effective than contractual obligations.178
d. Control of the resale of software
Another possibility is continuing to use the old system of selling the software and then controlling the resale of it.179 First, controlling the resale of the software can be achieved by using technical protective measures to prevent the dual use of the software by the first and subsequent acquirers.180 Second, the right holder could provide its own platform to resell the software. The right holder could benefit from such a platform by receiving a sales commission.181
2. From an Acquirer’s Point of View
From a private acquirer’s point of view the sale of software for a limited time period might be sufficient and attractive in price. 182 A company that acquires software will take a closer look at the practical consequences. First, in case the company wants to purchase a certain software strategically and use it company-wide, it has an interest in an independent license position, including the possibility of reselling the software when it does not want to further use it.183 Therefore, the company should enter into a contract that fulfills the requirements for online exhaustion, in particular, a sale for an unlimited period of time.184 In this context it should be noted, that in general, in a B2B constellation the acquirer has more room to negotiate than in a B2C constellation.185 Second, the ban on dividing a great number of licenses will be important for business acquirers of software.186 The more fragmented the license packages are, the more flexibly they can be resold. 187 However, smaller license packages are more likely to be higher- priced.188
177 Frank & Kamlah, supra note 153, at 9; Hauck, supra note 3, at 3619. 178 Hartmann, supra note 75, at 985. 179 Weisser & Färber, supra note 153, at 367. 180 See Part IV.B.3.c.ii. 181 Weisser & Färber, supra note 153, at 367. 182 Hartmann, supra note 75, at 986. 183 Id. 184 Id. 185 Id. 186 Id. 187 Id. 188 Id. 2016] USEDSOFT AND ITS AFTERMATH 285
E. Summary
The CJEU opened—in a policy-driven judgment—a secondary market for used software. 189 The court ruled that the doctrine of exhaustion applies equally whether software is first sold in tangible form, such as on a CD-ROM or DVD, or intangible form, e.g. via download, provided that, in the online context, the first acquirer buys his copy on a “download-to-own” basis in a way that is analogous to purchasing software on a CD-ROM in a shop.190 Moreover, the second acquirer can download a new copy of the software from the copyright holder’s website in order to use the software, which will not infringe the copyright. 191 The CJEU acts in this decision as a guardian of the fundamental freedom of the free movement of goods and strikes an appropriate balance between the copyright holder’s and acquirer’s interests. The decision is not as disastrous for the copyright holder as it might seem at first glance because the court bans the possibility of dividing greater numbers of licenses. However, the decision might still lead to practical consequences, including the increased use of DRM systems and different license and delivery models, e.g. SaaS and Cloud Computing. In summary, the application of the doctrine of exhaustion to software downloads is now clear. What is less clear is whether the doctrine would apply to digital content other than software. This problem arises since the UsedSoft judgment concerns the doctrine of exhaustion in the Software Directive while the InfoSoc Directive is applicable to other digital content.
V. THE DISCUSSION AFTER ORACLE V. USEDSOFT: CAN THE CJEU JUDGMENT BE APPLIED TO DIGITAL GOODS OTHER THAN SOFTWARE? The greatest question of the European copyright community in the aftermath of the UsedSoft judgment is whether the reasoning of the CJEU can be applied to sales of other types of copyrighted works that are delivered to purchasers in the digital format, such as e-books.192
189 See id. at 984. 190 Id; UsedSoft GmbH, 2012 E.C.R. 407, at § 61 191 Hartmann, supra note 75, at 981. 192 In favor of exhaustion with respect to other digital works: Hartmann, supra note 75, at 984; Hoeren & Försterling, supra note 43, at 647; DREIER & SCHULZE, supra note 74, at § 69 c no. 20; Marly, supra note 5, at 657. Against exhaustion with respect to other digital works: Marcus von Welser, Weiterverkauf von Gebrauchter Software ist Zulässig [Resale of Used Software is Permissible], GEWERBLICHER RECHTSCHUTZ UND URHEBERRECHT, PRAXIS IM IMMATERIALGÜTER-UND continued . . .
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The Intellectual Property Blog “IPKat” put this question to its readers in the form of a poll.193 The results of the poll revealed that fifty- seven percent of the respondents think that exhaustion of the distribution right as per Article 4(2) of the InfoSoc Directive encompasses both tangible and intangible copies. 194 Twenty-seven percent of the respondents believe that the UsedSoft judgment will not be extended to digital copies of works other than software.195 Finally, fifteen percent of the voters feel that the answer will really depend on whether the CJEU approves of the IP owner’s conduct.196 In this Part, the Note will present and critically analyze the arguments pertaining to the extension of the doctrine of exhaustion, and the application of the UsedSoft decision to other digital content.
A. UsedSoft Decision was Based on Software Directive
At first sight, an application of the CJEU UsedSoft judgment to other constellations does not seem obvious. The judgment concerned the interpretation of the Software Directive.197 Consequently the reasoning of the CJEU related to the specific provisions of the Software Directive.198 The court highlighted the special legal framework for the copyright protection of software in relation to the general copyright law. 199 The provisions of the Software Directive “constitute a lex specialis” in relation to the provisions of the InfoSoc Directive. 200 Therefore, the CJEU judgment has a direct binding effect only for
WETTBEWERBSRECHT (GRUR––Prax) 326 (2012); Malte Stieper, Anmerkung zu EuGH, Urteil vom 3. Juli 2012 – C-128/11 – UsedSoft [Comment on CJEU, Judgment of July 3, 2012 – C-128/11 – UsedSoft], ZUM 668, 670 (2012); Stefan Krüger et al., Keine “Used Games” aus dem Netz—Anwendbarkeit der “UsedSoft” Entscheidung auf Videospiele [No “Used Games” From the Internet—Application of the “UsedSoft” Decision to Videogames], MMR 760, 765 (2013). 193 Eleonora Rosati, UsedSoft Katpoll: Exhaustion Will Apply to Any Work (and the UK Might Achieve This Via Private Copying?), THE IPKAT (July 7, 2013), available at http://ipkitten.blogspot.com/2013/07/usedsoft-katpoll-exhaustion-will- apply.html. 194 Id. 195 Id. 196 Id. 197 Hartmann, supra note 75, at 981. 198 Reto Hilty et al., Software Agreements: Stocktaking and Outlook—Lessons from the UsedSoft v. Oracle Case from a Comparative Law Perspective, 44 INT’L REV. INTELL. PROP. & COMPETITION L., 263, 284 (2013); Hoeren & Försterling, supra note 43, at 647; Hartmann, supra note 75, at 981. 199 Hartmann, supra note 75, at 981. 200 Case C-128/11, UsedSoft GmbH v. Oracle Int’l Corp., Judgment of the Court (Grand Chamber) of July 3, 2012, 2012 E.C.R. 407, at § 51. 2016] USEDSOFT AND ITS AFTERMATH 287
software.201
B. Parallel Exhaustion Doctrines in Software and InfoSoc Directives are similar
The provisions in the InfoSoc and the Software Directive dealing with the exhaustion of the distribution right are similar in principal: Article 4(2) of the InfoSoc Directive refers to the first sale of the “original” or “copies” of the work.202 Article 4(2) of the Software Directive requires the first sale of a “copy.”203 Due to the wording of the Directives it could be argued that there is a unified legal situation.204
C. Uniform Interpretation of the Directives Required
It would be inconsistent if the doctrine of exhaustion would apply in the digital context with respect to software, but not with respect to other digital goods, such as e-books or digital music, since there is no reason for the unequal treatment of the different types of digital content.205 In particular, the economic arguments of the CJEU206 apply to computer programs as well as other digital content.207
D. New EU legislation without limitation to material copies
The InfoSoc Directive came into force in 2001.208 Recital 28 to the InfoSoc Directive refers expressly to the “exclusive right to control distribution of the work incorporated in a tangible article.” 209 According to Recital 29 of the Directive, “the question of exhaustion does not arise in the case of services and on-line services in particular.” 210 In 2009, when the current version of the Software Directive came into force, the European legislature did not add such a limitation of the doctrine of exhaustion—neither in the Articles of the Directive nor in its Recitals. 211 Therefore the European Union legislature expressed a different intention in the specific context of the
201 Hartmann, supra note 75, at 981; Hauck, supra note 3, at 3618; Marly, supra note 5, at 657; von Welser, supra note 192, at 326. 202 InfoSoc Directive, supra note 15, at art. 4. 203 Software Directive, supra note 16, at art. 4. 204 Neuber, supra note 1, at 1275; Hartmann, supra note 75, at 982. 205 Hartmann, supra note 75, at 982; Kreutzer, supra note 5. 206 UsedSoft GmbH, 2012 E.C.R. 407, at § 61. 207 Hartmann, supra note 75, at 982. 208 InfoSoc Directive, supra note 15. 209 Id. at recital 28. 210 Id. at recital 29. 211 See Software Directive, supra note 16.
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Directive. 212 It should be noted that it was not very common to download copyrighted works at the end of the 1990s when the InfoSoc Directive was proposed. This fact changed quite significantly by 2009. Accordingly, the timeline of the two Directives supports the argument that it is the intention of the European Union legislature not to differentiate between the online and offline sale of copyrighted works.213
E. Binding effect of the Recitals to the InfoSoc Directive
A transfer of the UsedSoft judgment to other digital content could fail due to Recitals 28 and 29 of the InfoSoc Directive.214 Concepts used by the body of European Directives must have the same meaning due to the requirement of unity of the European Union legal order and its coherence, unless the European Union legislature has, in a specific legislative context, expressed a different intention.215 In principal, the doctrine of exhaustion should have the same meaning in all European Directives. 216 This would not be the case if the European Union legislature expressed a different intention. 217 Some scholars have argued that—with respect to Recitals 28 and 29 of the InfoSoc Directive—the legislature expressed such a different intention.218 Nevertheless, the Recitals 28 and 29 are not taking today’s reality into consideration and are therefore outdated.219 The InfoSoc Directive entered into force fourteen years ago.220 Hence, it is impossible for the Directive to take every issue of the digital realm in the year 2015 into consideration.221 This is a problem that copyright law continuously has to face. The law has to be applied to a fact pattern that is not specifically
212 Hartmann, supra note 75, at 982. 213 Id. 214 Id. 215 CJEU, Joined Cases C-403/08 & C-429/08, Football Ass’n Premier League Ltd. v. QC Leisure, Judgment of the Court (Grand Chamber) of Oct. 4, 2011, 2011 E.C.R. I-9162, at § 188; Hansen & Wolff-Rojczyk, supra note 140, at 909. 216 Hansen & Wolff-Rojczyk, supra note 140, at 909. 217 CJEU, Joined Cases C-403/08 & C-429/08, Football Ass’n Premier League Ltd. v. QC Leisure, Judgment of the Court (Grand Chamber) of Oct. 4, 2011, 2011 E.C.R. I-9162, at § 188. 218 Hauck, supra note 3, at 3618; Krüger et al., supra note 192, at 762; Stieper, supra note 192, at 670. 219 Thomas Hoeren & Sebastian Jakopp, Der Erschöpfungsgrundsatz im digitalen Umfeld [The Doctrine of Exhaustion in the Digital World], MMR 646, 649 (2014). 220 InfoSoc Directive, supra note 15. 221 Hoeren & Jakopp, supra note 219, at 649; Neuber, supra note 1, at 1275. 2016] USEDSOFT AND ITS AFTERMATH 289
legislated in the statute.222 Thus, traditional and established doctrines should be applied.223 Eventually, this is also the intention of Recital 5 to the InfoSoc Directive: Technological development has multiplied and diversified the vectors for creation, production and exploitation. While no new concepts for the protection of intellectual property are needed, the current law on copyright and related rights should be adapted and supplemented to respond adequately to economic realities such as new forms of exploitation.224 It is remarkable that the Directive states that no new concepts for the protection of intellectual property are needed.225 Furthermore, Recitals of Directives describe the intentions of the legislature for the main provisions of the Directives.226 However, they do not have a binding character and use non-mandatory language.227 If a main provision of a Directive conflicts with a Recital, the Recital does not need to be taken into account.228 Therefore, the CJEU could hold that the doctrine of exhaustion in Article 4(2) of the InfoSoc Directive is applicable to digital works and Recitals 28 and 29 are repressed.229
222 Hoeren & Jakopp, supra note 219, at 649. 223 Id. 224 InfoSoc Directive, supra note 15. 225 Id. 226 Hartmann, supra note 75, at 982. 227 Joint Practical Guide of the European Parliament, the Council and the Commission for Persons Involved in the Drafting of Legislation within the Community Institutions, at § 10.1 (Mar. 16, 2000), available at http://legislationline.org/download/action/download/id/2245/file/EU_Practical_Guid e_Persons_involved_Drafting_legislation_200.pdf. 228 Hartmann, supra note 75, at 982. 229 Id.
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F. WCT is no legal reason against the extension of the Exhaustion Doctrine
Some commentators have argued that the WCT is a legal reason against the extension of the exhaustion principle to intangible objects other than software.230 The “[a]greed statements concerning Article 6 and 7” of the WCT state that the expressions “copies” and “original and copies” being subject to the right of distribution refer exclusively to fixed copies that can be put into circulation as tangible objects. 231 Accordingly, only the sale of tangible goods can lead to the exhaustion of the distribution right according to Article 6(2) of the WCT.232 Since the InfoSoc Directive serves to implement the obligations under the WCT (Recital 15 of the InfoSoc Directive), it has been argued that it must differentiate between the distribution of a good in the tangible and intangible form.233 However, it should be noted that the WCT was signed on December 20, 1996.234 It was passed at a time when the legislature could not have foreseen the online services we have today.235
G. Similar situations with respect to online and offline distribution
Finally, the CJEU has introduced a new rule that goes beyond the wording of the relevant provisions of the Software Directive, as these provisions do not sufficiently cover the current state of the art in data transmission and internet technologies. 236 The involved parties’ interests need to be taken into consideration in the context of the economic circumstances in the individual case. 237 Such economic considerations as well as other policy arguments that the CJEU made in the UsedSoft judgment are also relevant for works other than software.238 The principle of equal treatment requires that there be no differentiation between software and other digital content (e.g. e-books
230 See Hansen & Wolff-Rojczyk, supra note 140, at 909; Heydn, supra note 109, at 591; Krüger et al., supra note 192, at 764; Stieper, supra note 192, at 668. 231 World Intellectual Property Organization, World Copyright Treaty, Dec. 20, 1996, 36 ILM 65 232 See Heydn, supra note 109, at 591. 233 See id. 234 World Intellectual Property Organization, World Copyright Treaty, Dec. 20, 1996, 36 ILM 65 235 See Schulze, supra note 28, at 13. 236 Hilty et al., supra note 198, at 284. 237 Id. 238 Id. 2016] USEDSOFT AND ITS AFTERMATH 291
or music files).239 The court held that, from an economic point of view, the sale of a computer program on CD-ROM or DVD and the sale of a program by downloading from the internet are similar.240 Additionally the online transmission method is the functional equivalent of the supply of a material medium.241 “To limit the application of the principle of the exhaustion of the distribution right solely to copies of computer programs that are sold on a material medium would allow the copyright holder to control the resale of copies downloaded from the internet and to demand further remuneration on the occasion of each new sale, even though the first sale of the copy had already enabled the right holder to obtain an appropriate remuneration.”242 “Such a restriction of the resale of copies of computer programs downloaded from the internet would go beyond what is necessary to safeguard the specific subject-matter of the intellectual property concerned.” 243 Furthermore, the objective of the principle of exhaustion is to “avoid partitioning of markets.”244 All these policy arguments that the CJEU stated in its UsedSoft judgment also apply to the situation of the sale of digital content other than software.245 Additionally, there are no different interests at stake in the scenarios of online and offline distribution of copyrighted works; in other words buying a print book or a CD is essentially the same as acquiring perpetual access to an e-book, film, music, game file and should therefore be treated alike.246 Nonetheless, it has been questioned whether there are major
239 Zhaoli Wang, Pei Zhang, & Hanwei Wang, Following the “UsedSoft” Judgment: Should the “Principle of Equal Treatment” Also Be Applied to Online Markets Other Than Computer Programs?, BLOG INTELL. PROP. & KNOWLEDGE MGMT (May 23, 2014), available at https://law.maastrichtuniversity.nl/ipkm/following-the-usedsoftjudgment-should-the- principle-of-equal-treatment-also-be-applied-to-online-markets-other-than- computer-programs/. 240 Case C-128/11, UsedSoft GmbH v. Oracle Int’l Corp., Judgment of the Court (Grand Chamber) of July 3, 2012, 2012 E.C.R. 407, at § 61. 241 Id. 242 Id. at § 63. 243 Id. 244 Id. at § 62. 245 Hartmann, supra note 75, at 984. 246 Id; DREIER & SCHULZE, supra note 74, at § 69 c no. 24; Hoeren & Försterling, supra note 43, at 647; Marly, supra note 5, at 657; Schulze, supra note 28, at 13.
292 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. differences between selling a work in tangible form and in intangible form with respect to the risk of product piracy.247 Some commentators demanded a more in-depth analysis of the special technical and economic features of the different ways of distribution by the CJEU.248 Others have argued that resales have an immediate and potentially detrimental effect on sales of “originals” because there is no difference in digital quality and the consumer reseller is free to price the content far below the price of the “original,” so that this competition could seriously undermine the sales of originals.249 However, I do not think that the risk of product piracy is higher in the online scenario compared to the offline situation. Stickers noting that the owner has a license to use the program might mark original CDs or DVDs.250 But in the situation of a download of digital content, DRMs or digital watermarks might be used.251 Therefore, there are similar possibilities of protection against product piracy. Additionally, the question whether a second-hand market for digital content is necessary is not a question that needs a solution by lawyers, but by economists.252 Furthermore, this is not a question that should be answered by courts. It is, rather, so fundamental that the European legislature should find a solution for it and clarify it in new legislation.
H. Conclusion
In conclusion, the arguments in favor of allowing an extension of the exhaustion principle to intangible objects outweigh the arguments against it. Two different Directives apply for software and other digital content: the Software Directive and the InfoSoc Directive.253 Since the Software Directive constitutes a lex specialis in relation to the provisions of the InfoSoc Directive, the UsedSoft judgment has a direct binding effect only for Software.254 However, it should be noted that the current version of the Software Directive came into force eight years after the InfoSoc Directive. In the Software Directive, the European legislature did not add a limitation of the doctrine of exhaustion to tangible goods.255 Additionally, it was a lot more common to download
247 Stieper, supra note 192, at 669. 248 Id. 249 Schulze, supra note 28, at 13. 250 Marly, supra note 5, at 657. 251 Id. 252 Hauck, supra note 3, at 3618. 253 Hartmann, supra note 75, at 982. 254 Id. at 981; Hauck, supra note 3, at 3618; Marly, supra note 5, at 657; von Welser, supra note 192, at 326. 255 Kreutzer, supra note 5. 2016] USEDSOFT AND ITS AFTERMATH 293
copyrighted goods when the current version of the Software Directive entered into force compared to the time when the InfoSoc Directive was proposed. This argument does not change because of Recitals 28 and 29 to the InfoSoc Directive. Since Recitals 28 and 29 are outdated, an application of the doctrine of exhaustion to other digital content cannot be denied. Most importantly the doctrine of equal treatment requires that there be no differentiation between software and other digital content. In both cases, the first sale of the protected work enabled the copyright holder to obtain an appropriate remuneration. It follows from the aforementioned that the doctrine of exhaustion applies to digital content other than software, too. The European legislator should add a clarification in this respect to both Directives.
VI. THE RESALE OF DIGITAL GOODS OTHER THAN SOFTWARE
A. The Judgment of the Court of Appeals in Hamm, Germany (Az. U 60/13)
1. Facts
The Court of Appeals in Hamm, Germany is the first higher court that dealt with the resale of digital goods other than software after the CJEU UsedSoft decision. 256 The German Federation of Consumer Organizations sued a web platform that sold e-books and audiobooks on CDs/DVDs and by download.257 The defendant used the following terms and conditions: Within the scope of this offer the customer acquired the non-exclusive and non-transferrable right to use the file on offer merely for private use according to the copyright code and in the way they are offered in each case. It is not allowed to . . . copy them for third parties . . . [or] to resell them.258 The plaintiff claimed that the platform’s terms and conditions violated the German law on terms and conditions since the user had the right to resell the e-book/audiobook under copyright law.259
256 Alberto Bellan, Breaking—Copyright Exhaustion Does Not Apply to Digital Goods Other Than Software, Hamm Court of Appeal Says, THE IPKAT, (June 13, 2014), available at http://www.ipkitten.blogspot.com/2014/06/breaking-copyright- exhaustion-does-not.html. 257 Oberlandesgericht [Court of Appeals] Hamm, Germany, 15 May, 2014, 22 U 60/13, GRUR 853 (2014). 258 Id. at 854. 259 Id.
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The Regional Court in Bielefeld, Germany, ruled in favor of the defendant and took the view that the UsedSoft decision only concerned computer programs and the Software Directive, while the InfoSoc Directive—which is the one applicable to e-books and audio books— clearly and consciously excludes exhaustion for all other digital contents.260 The German Federation of Consumer Organizations appealed the judgment.261
2. The Judgment of the Court of Appeals in Hamm, Germany
The Court of Appeals in Hamm, Germany, upheld the Regional Court decision on May 15, 2014.262 The court denied the applicability of the principles expressed in the UsedSoft judgment (whether direct or by analogy), confirming that the Software Directive is lex specialis and therefore not applicable to subject-matter other than software.263 The court held that the sale of audio files over the internet in a way that allows customers to have the opportunity to download and save corresponding files locally on their own data carriers is not covered by the right of distribution (§ 17 of the German Copyright Act, which implements Article 4 of the InfoSoc Directive). 264 It should be considered as an act of making available to the public, which is not subject to exhaustion (§ 19a of the German Copyright Act, which implements Article 3 of the InfoSoc Directive). 265 Accordingly, the exhaustion of the distribution right within the meaning of § 17(2) of the German Coypright Act (which implements Article 4(2) of the InfoSoc Directive) is not caused if customers are given the opportunity to download and save corresponding files locally on their own data carriers and do so.266 Section 17(2) of the German Copyright Act cannot be applied by analogy.267 In light of that, providers of digital audio files can validly include clauses in terms and conditions that prohibit customers from reselling
260 Landgericht [Regional Court] Bielefeld, Germany, 5 March, 2013, 4 O 191/11, ZUM 2013, 688. 261 Oberlandesgericht [Court of Appeals] Hamm, Germany, 15 May, 2014, 22 U 60/13, GRUR 853, 855 (2014). 262 Id. 263 Id. at 855. 264 Id. 265 Id. 266 Id. 267 Id. at 858. 2016] USEDSOFT AND ITS AFTERMATH 295
audiobooks.268
B. Analysis of the Judgment of the Court of Appeals in Hamm, Germany
While the CJEU opened the door for a second-hand market for software, the Court of Appeals in Hamm, Germany closed this door again for digital content other than software. 269 Nevertheless, this decision will mean some relief for digital content providers.270 The judgment creates an economically paradox result. Let us return to the three scenarios established in the introduction of this Note.271 A consumer walks into a bookstore and buys the physical copy of a book. According to current case law, this would be a case of exhaustion of the distribution right (Article 4(2) of the InfoSoc Directive) 272 and the consumer can resell the book. The same consumer buys the same work as an e-book and downloads the e-book from the website of an online store. The doctrine of exhaustion does not apply according to the Court of Appeals in Hamm, Germany, and the consumer cannot resell the e- book.273 The consumer buys software from the same online store and downloads the software from the website. Here, the doctrine of exhaustion applies (Article 4(2) of the Software Directive),274 and the consumer can resell the software he purchased in the online store. The decisions of the CJEU and the Court of Appeals in Hamm show that there currently is a situation in Europe in which the ability of a digital good to be resold depends on what kind of good it is.275 Software can be resold; e-books and digital music cannot be resold. Hence, the current state of the doctrine of exhaustion in the digital world is not satisfactory. The denial of transferring the UsedSoft judgment to other digital content results in an unequal treatment of e-books and software.276 Rather than establishing a clear, unified doctrine for the
268 Id. at 861. 269 Id. 270 See generally Ganea, supra note 34, at 104 (explaining the negative effects on digital content providers when digital content can be resold). 271 See supra Part I. 272 InfoSoc Directive, supra note 15, at art. 4; Hoeren & Jakopp, supra note 219, at 647. 273 Hoeren & Jakopp, supra note 219, at 647. 274 Software Directive, supra note 16, at art. 4. See also Case C-128/11, UsedSoft GmbH v. Oracle Int’l Corp., Judgment of the Court (Grand Chamber) of July 3, 2012, 2012 E.C.R. 407. 275 Hauck, supra note 3, at 3616. 276 Ronny Hauck, Keine Anwendung des Erschöpfungsgrundsatzes beim Download von Hörbuchern [No Application of the Exhaustion Doctrine for the Download of E-books], GRUR-Prax 309, 309 (2014).
296 WAKE FOREST J. [VOL. 16 BUS. & INTELL. PROP. L. resale of digital content, the Court of Appeals in Hamm, Germany, further underlines the special status of software in European copyright law.277 In addition, the rule that was established by the Court of Appeals in Hamm, Germany, creates a serious barrier to the single market, in particular to the digital single market.278 Unfortunately, appeal to the German Federal Court of Justice was not granted.279 This court—and the CJEU—could have finally ended this decade-long legal debate. The unequal treatment of software and other digital content should be solved de lege ferenda by establishing an extensive doctrine of online exhaustion. This doctrine should not differentiate between the distribution of a copyrighted work in a tangible or intangible form.280 This would require giving up the distinction between the tangible distribution and intangible making available to the public of digital works and taking a step back from the current understanding of the traditional doctrine of exhaustion.281 Furthermore, instead of having a differentiation based on the type of digital content (software or e-books), it could also be based on whether there is a B2C or B2B situation.282 This could open the door for policy reasons of the European Consumer Protection Law.283
VII. A QUICK GLANCE ACROSS THE ATLANTIC: CAPITAL RECORDS, LLC V. REDIGI INC. In 2013, the first U.S. case dealing with the resale of digital content was decided.284 In Capitol Records, LLC v. ReDigi Inc.,285 ReDigi was a service that allowed the resale of digital music tracks originally purchased from the iTunes Store.286 ReDigi made some limited efforts to make sold songs unusable, but those efforts did not lead to automatic deletions and could not ensure the song was deleted from all places where the user may have stored it.287 The case raises the novel question whether a digital music file, lawfully made and purchased, is eligible for resale under the first-sale
277 Hauck, supra note 3, at 3618. 278 Hoeren & Jakopp, supra note 219, at 647. 279 See Oberlandesgericht [Court of Appeals] Hamm, Germany, 15 May, 2014, 22 U 60/13, GRUR 853 (2014). 280 Hauck, supra note 276, at 309. 281 Id. 282 Hauck, supra note 3, at 3618. 283 Id. 284 See Capitol Records, LLC v. ReDigi Inc., 934 F. Supp. 2d 640 (S.D.N.Y. 2013). 285 Id. 286 Id. at 645. 287 Id. 2016] USEDSOFT AND ITS AFTERMATH 297
doctrine.288 In its current form under 17 U.S.C. § 109(a), the first-sale doctrine allows the owner of a particular copy of a copyrighted work “lawfully made under this title,” or an individual authorized by such owner, to sell or dispose of his copy without the copyright owner’s authorization.289 On March 30, 2013, the United States District Court for the Southern District of New York ruled in favor of Capitol Records.290 It held that an unauthorized transfer of a digital music file over the internet, even if only one file exists before and after the transfer, was an act of reproduction, and therefore required the right holder’s permission.291 The fact that a file had moved from one material object (the user’s computer) to another material object (ReDigi’s server) was sufficient for there to be an act of reproduction, even if there was only one file before and after the transfer.292 The court held that the first-sale defense did not apply to ReDigi because first-sale only affects the copyright holder’s distribution right, not reproduction right.293
VIII. CONCLUSION This Note demonstrated that the doctrine of exhaustion should apply to software as well as other digital content in order to open the door for a secondary market for used digital content. While the CJEU already opened the door for a second-hand market for software, the Court of Appeals in Hamm, Germany, recently closed the door for a second-hand market for other digital content. However, this Note posits that the arguments in favor of applying the doctrine of exhaustion to digital content other than software outweigh the arguments against it. The European legislature should add a clarification in this respect to the Software and InfoSoc Directive.
288 Id. at 648. 289 Id. 290 Id. at 640. 291 Id. at 650. 292 Id. 293 Id. at 655.