Digital Resale & Copyrights: Why the Second Circuit Won’t Buy It

In 2011, ReDigi Inc. introduced technology that effectively attempted to establish a secondary market for “used” digital music files, where owners who had legally downloaded music files from iTunes could sell the music that they no longer wanted.  In a nutshell, the system allowed the owner of a digital file to transfer the music to ReDigi’s cloud storage locker, from which ReDigi could then sell it to a willing buyer for a lower price than the cost of an “original” purchase from the iTunes Store.  When a sale was made, Redigi would retain 60% of the sales price, while the seller and artist got 20% each. Although the process of transferring a file from an owner’s personal computer to ReDigi required that it be reproduced on ReDigi’s server, the system removed the file from the owner’s personal computer as the file was moved.  In this way, the process was analogized to the transporter on Star Trek since with both, a physical item starts at point A and incrementally ends up at point B.

Capitol Records, the copyright owner of many music files sold over the ReDigi system, sued ReDigi for copyright infringement, alleging that the company reproduced and distributed its copyrighted works without permission. (Capitol Records, LLC. v. ReDigi Inc.)  Regarding reproduction, ReDigi argued that one does not make a copy of a digital file by reproducing it when the original file is destroyed in the process.  Judge Richard Sullivan, though, determined that by the plain language of the Act, a reproduction necessarily occurs when a copyrighted work is fixed in a new material object.  According to the judge, what happens to the original work while or after the copy is made is irrelevant. It is the creation of the new file on a different physical storage drive that determines the outcome.

As for distribution, ReDigi sought relief from the application of the first sale doctrine in copyright, which is embodied in section 109 as follows:

Notwithstanding the provisions of section 106(3), the owner of a particular copy or phonorecord lawfully made under this title, or any person authorized by such owner, is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy or phonorecord.

This, of course, is the provision that allows owners of CDs and LPs to sell their music at traditional used record stores without incurring liability for distributing the copyrighted performances that are attached to the physical media. ReDigi argued that what it was doing was really no different; it was simply providing a means for owners of digital music files to dispose of their copies.  Just as with a transaction for a used CD, the buyer of a digital file would take possession of the file after the transfer while the original owner would no longer have it. Judge Sullivan, however, would have nothing of this argument. Again, he looked to the plain language of the statute, which he believed clearly ties the first sale entitlement to the original physical media by limiting its application exclusively to a “particular” copy.

ReDigi also argued that its system should be legitimized as a fair use, even if it results in unauthorized reproductions and distributions. The judge quickly disposed of this argument, finding that none of the four fair use factors favored ReDigi’s position.  Most importantly, he determined that the system was commercial, but not transformative, and that it would have a significant effect on the market value of the copyrighted works.  In the end, Judge Sullivan ruled that ReDigi was liable for direct, contributory and vicarious infringement, and granted summary judgment for Capitol Records on these claims.

Subsequently, the litigation continued regarding other matters and with the determination of damages.  ReDigi ultimately stipulated that it would pay Capitol Records $3.5 million in damages, but the liability was contingent on the result of its appeal to the Second Circuit.  In August 2016, ReDigi declared bankruptcy, but proceedings before the Second Circuit continued, and in August 2017, the court held oral arguments.  ReDigi came armed at its appeal with several amici curiae, including a large set of copyright law scholars and the Library Copyright Alliance.  Capitol Records had supporters as well, such as the Association of American Publishers.  Most copyright experts believe that this will be the most important copyright decision of the year, and potentially a landmark in the field.  Thus all eyes await the decision of the Second Circuit in this case.

Although ReDigi is backed by some powerful voices, I believe that the Second Circuit will not rule in its favor for fear of the Pandora’s box it might otherwise open.  The amicus brief of the law scholars rests substantially on the philosophical notion that the first sale doctrine derives from the right — or entitlement — that owners of objects have to dispose of their property. The million-dollar question is whether the owner’s property pertains only to the physical items that incidentally include the copyrighted works, or whether the ownership interest can ever actually extend to the copyrighted aspects as well.  So, everyone probably agrees that copyright owners who put their works on, let’s say CDs, should not be able to leverage their exclusive distribution interests to control the typical property rights that the CD owners have to dispose of their physical discs. Thus, in this context, there is a clear line of separation between the music on a CD, which the copyright holder owns, and the CD itself, which belongs to the owner of the physical disc. The language of the Copyright Act makes it very clear that the owner of the CD can sell the CD, but can’t transfer the copyrighted performance to another CD or other physical medium, for that would require a reproduction in a material object. Also, Judge Sullivan was correct that the Act does not anywhere indicate that liability may be contingent on what happens to the original, such as whether it is retained or destroyed.

One might wonder why a copyright owner should care if a buyer transfers the contents of a CD to a new physical disc while destroying the original, since that person paid for the original CD and nothing substantively has changed.  The first problem comes down to enforcement.  For instance how can the copyright owner be sure that the original was really destroyed in the process?  Even with ReDigi’s system, it might have been possible to save duplicates on unattached hard drives prior to transferring the files from the computer.

The other issue regards the opportunities that copyright owners have to use physical media to engage in price discrimination.  For instance, as an author, I might be willing to sell an essay on extremely flimsy paper for a small fee, knowing that the ink will destroy the paper in such a short period of time that the work cannot possibly be resold.  I also might sell works on higher quality paper and charge a higher fee, not simply because of paper costs, but also knowing that these versions might enter the secondary market.  If purchasers of the flimsy paper versions could readily transfer my works to new paper, whether similarly flimsy or not, my distribution strategy may be foiled.  The end result is that I might not again be willing to sell such inexpensive versions of my work. Thus, the physical characteristics of the selected media – in terms of longevity, portability and other dimensions – may be crucial to copyright owners.  For this reason, owners of copyrighted works theoretically should be able to exercise control over the physical media upon which their expressions are attached.

But wait a minute!  In their brief, the copyright scholars note that owners of digital music download that music to hard drives on their computers.  If the first sale doctrine is strictly tied to the original physical media, then those who own digital files can only lawfully dispose of their works if they sell them along with the computer, or at least its hard drive, since that is the physical medium upon which the copyright owner chose to place the work.  This, they say, violates the spirit of the first sale doctrine, since the owner of the digital file then has no practical way to legally transfer the music that he previously acquired.  To solve the problem, they allege that a copyright owner’s reproduction rights should not preclude copying that is necessary to preserve the purchaser’s first sale privileges.

Although this might ultimately make good policy, there are several problems with this approach.  First, the scholars are asking the courts to essentially force a square peg though a pretty clear round hole in order to achieve hypothetical, albeit perhaps appropriate, objectives.  My guess is that under these circumstances, the court would prefer it if Congress would take the step of clarifying the limits of the reproduction right.  Second, the concept basically provides that a purchaser of a digital work effectively owns the words or notes in a fashion divorced from any physical object.  In this regard, the scholars rely on a previous district court case (C.M. Paula Co. v. Logan), which addressed a company that removed copyrighted images from the surface of greeting cards and then applied them to ceramic plaques.  The court held there was no duplication in this instance, and so no reproduction had occurred.  Thus, in a sense, the court allowed the company to take the copyrighted works from the original media and place them on other physical objects, just as ReDigi wants to do. Of course, this is just a single lower court decision, and one might question its soundness.  Also, the case is distinguishable since the company transferred the actual ink from the original media to the plaques, thus preserving some notion of physicality.  Without requiring that physical connection, who knows where the pendulum might stop.  For instance, could I argue that I should be entitled to transfer a copyrighted sculpture overseas through use of a 3D printer as long as I destroy the original, on the theory that it is the most efficient way to transport the object? After all, it is my sculpture and the artist has already been paid, so why does he or she care how I get it there, and practically speaking, it is far too heavy to ship. Or what if someone sets up a music file sharing system based on lawful digital transfers? Would this resurrect sites such as the original Napster or Grokster, but this time with a solid legal foundation? My guess is that faced with so many “what-ifs”, the court will not be willing to venture down this road.

Those supporting ReDigi also argue that Judge Sullivan did not appraise fair use correctly, but again, I believe that the Second Circuit will affirm his decision.  Judge Sullivan evaluated the “purpose of the use” factor by considering whether the work has been transformed such that it adds something new with a further purpose or character. This is a very prevalent test that is founded on the Supreme Court’s Acuff-Rose opinion, and it is very often used to legitimize new technologies, such as certain search engines. However, it seems pretty clear that ReDigi does not create anything transformative in the sense that courts have previously intended. However, transformation is not necessarily required for technologies to have a positive fair use purpose.  For instance, courts have determined that it may be a fair use to make a reproduction when the copying is necessary to achieve a lawful objective.  One example is converting object code into source code so that programmers can access the unprotected system “ideas” that they need for interoperability. (Sega Enterprises, Ltd. v. Accolade, Inc.)   So, perhaps one could argue that duplicating the digital file is necessary to achieve the lawful ends permitted under the first sale doctrine.  The problem, of course, is that the statutory language does not expressly legalize the distribution of content on new media, and so the analysis is tenuous at best.

The Library Copyright Alliance may give the court further reason to pause, as it suggests that a fair use ruling in favor of ReDigi will give libraries increased legal certainty to roll out innovative digital services that provide increased access to library resources. On the one hand, this demonstrates the potential public benefits that might be achieved with digital transfers, but it also again illustrates the potentially dangerous slippery slope that a decision for ReDigi may establish.  Again, I believe that the court will not want to venture down that road, but instead will put the ball in the hands of Congress, on the theory that it is best equipped to balance the significant competing economic and social concerns and resolve the controversy in the most suitable fashion for all involved. Of course, many interested parties are eagerly watching how the Second Circuit will ultimately address the situation.  Fortunately, we should not have to wait too much longer.