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SHOW ME THE MONEY!: THIRD-PARTY COPYRIGHT INFRINGEMENT LIABILITY REACHES INVESTORS & LENDERS† Thomas B. Foley* Half a dozen years after Napster‟s free peer-to-peer file-sharing platform service went offline, new lessons for legal academics, professionals, and the public are emerging. The Napster story is not only a warning to online audiovisual content providers and facilitators. The latest chapters were written for investors and lenders. New plaintiffs are taking up the pen of the plaintiffs in the Napster litigation and adding to the landscape of third-party liability for copyright infringement. To date, there has been no comprehensive response. There is indeed tremendous legal uncertainty in this area. This paper seeks to fill much of that gap, looking at recent and current litigation and the theories of vicarious and contributory liability for copyright infringement. The paper then explicates how liability could extend to investors and lenders, and poses strategies for such parties to follow in order to reduce exposure to liability. This paper suggests that these liability theories are indeed viable, and venture capitalists, private equity firms, banks, and other investors and lenders should proceed with caution. The loss to a defendant could be staggering—multiples of the actual financial backing to the direct infringer. The paper divides financiers along the scale from pure lending to pure investing, examining hybrid financing along the way.

† An earlier version of this paper was awarded 2nd place in the 2008 New York Intellectual Property Law Association‟s Hon. William C. Connor Writing Competition. * J.D., Emory University School of Law, 2008; B.S. Econ., Business & Public Policy, The Wharton School, University of Pennsylvania, 2004. The author thanks Prof. Kristen Jakobsen Osenga and the participants of her Fall 2007 seminar at Emory. The views expressed herein do not necessarily reflect the views of any of the author‟s current or past employers.

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INTRODUCTION ............................................................................................ 92 I. THIRD-PARTY LIABILITY LEADING UP TO ITS INCLUSION IN COPYRIGHT INFRINGEMENT LAW .................................................... 93 A. Third-Party Liability in Tort ..................................................... 93 B. Third-Party Liability in Copyright ............................................ 95 II. DEFINING THIRD-PARTY LIABILITY IN COPYRIGHT INFRINGEMENT LAW ........................................................................ 98 A. Contributory Liability ............................................................. 100 1. The Inducement Theory .................................................... 100 i. Requirement of Knowledge......................................... 100 ii. Requirement of Material Contribution ........................ 101 2. The Product Distribution Theory ...................................... 102 B. Vicarious Liability .................................................................. 103 1. The Requirement of Financial Benefit .............................. 104 2. The Requirement of Control ............................................. 105 III. RECENT & CURRENT LITIGATION INVOLVING INVESTORS & LENDERS......................................................................................... 107 A. The Napster Litigation I: Bertelsmann.................................... 107 B. The Napster Litigation II: Hummer Winblad ......................... 110 C. The KaZaA Litigation ............................................................. 111 D. The Deutsche Bank Litigation ................................................ 112 IV. INVESTORS‟ & LENDERS‟ POTENTIAL LIABILITY: GOING THROUGH THE FACTORS ................................................................ 113 A. Investors‟ & Lenders‟ Contributory Liability ......................... 114 1. Investors‟ & Lenders‟ Knowledge .................................... 114 2. Investors‟ & Lenders‟ Material Contribution.................... 115 B. Investors‟ & Lenders‟ Vicarious Liability .............................. 116 1. Investors‟ & Lenders‟ Financial Benefit ........................... 116 i. Investors‟ Financial Benefit ........................................ 116 ii. Lenders‟ Financial Benefit .......................................... 117 a. Plain Vanilla Lenders‟ Financial Benefit .............. 118 b. “Belgian Chocolate” Lenders‟ Financial Benefit .. 119 c. Convertible Debt-Holding Lenders‟ Financial Benefit ................................................................... 120 d. Warrant-Holding Lenders‟ Financial Benefit ....... 120 e. The Financial Benefit of “Draw” .......................... 121 2. Investors‟ & Lenders‟ Control .......................................... 122 C. Individuals‟ Possible Liability in Investing & Lending .......... 123 1. Piercing the Corporate Veil ............................................... 123 2. Piercing the Limited Liability Company Veil ................... 124 3. Personal Liability .............................................................. 125

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HOW TO AVOID & MITIGATE LIABILITY ........................................ 125 A. Remember There Are Multiple Bases for Liability ................ 125 B. Communicate Cautiously ........................................................ 126 C. Take Action in Response to Notices of Copyright Infringement............................................................................ 126 D. Due Diligence ......................................................................... 126 E. Indemnification ....................................................................... 127 F. Obtain a License ..................................................................... 127 G. Insurance ................................................................................. 128 H. Target‟s Representation & Warranty of No Knowledge and No Infringement ...................................................................... 129 VI. OFFSHORE ACTIVITIES MAY LEAD TO LIABILITY IN U.S. & ABROAD ......................................................................................... 129 CONCLUSION ............................................................................................. 130

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INTRODUCTION Half a dozen years after Napster‟s free peer-to-peer file-sharing platform service went offline, new lessons for legal academics, professionals, and the public are emerging. The Napster story is not only a warning to online audiovisual content providers and facilitators. The latest chapters were written for investors and lenders. New plaintiffs are taking up the pen of the plaintiffs in the Napster litigation and adding to the landscape of third-party liability for copyright infringement. Some academics have asked if third-party liability ought to extend to parties such as investors.1 Others have questioned the benefits of stretching copyright law to reach investors, wondering if it might have a “chilling effect” on investments.2 To date, there has been no comprehensive response.3 There is indeed “tremendous legal uncertainty” in this area.4 This paper seeks to fill much of that gap, looking at recent and current litigation and the theories of vicarious and contributory liability for copyright infringement. It then explicates how the current law could extend to investors and lenders, and poses strategies for such parties to follow in order to reduce exposure to liability. This paper suggests that these liability theories are indeed viable, and venture capitalists, private equity firms, banks, and other investors and lenders should proceed with caution. The paper divides financiers along the scale from pure lending to pure investing, examining hybrid financing along the way. This paper is divided into six parts. Part I traces the history of thirdparty liability (vicarious and contributory liability) in tort and then in copyright. Part II defines third-party liability in copyright law. It first elucidates the two bases of contributory infringing: the inducement theory and the product distribution theory. It examines the inducement theory‟s knowledge and material contribution elements. Then, it reviews vicarious liability and its elements of financial benefit and control. Part III updates the reader on recent and current litigation in the field, including cases involving (1) the Bertelsmann company and (2) the venture capital firm Hummer Winblad for their role in Napster, (3) KaZaA‟s investors and lenders, and (4) Deutsche Bank for its lending activities. Part IV sets out to 1. CRAIG JOYCE, MARSHALL LEAFFER, PETER JASZI & TYLER OCHOA, COPYRIGHT LAW 810 (6th ed. 2003). 2. Amy Harmon, Universal Sues Bertelsmann Over Ties to Napster, N.Y. TIMES, May 13, 2003, at C4. 3. Mark Bartholomew & John Tehranian, The Secret Life of Legal Doctrine: The Divergent Evolution of Secondary Liability in Trademark and Copyright Law, 21 BERKELEY TECH. L.J. 1363, 1418 (2006). 4. Id. at 1364.

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analyze just how investors and lenders may be liable as third parties. Part V provides suggestions for reducing exposure to liability. Finally, Part VI briefly cautions financiers about activities outside the U.S. that could lead to liability.

I.

THIRD-PARTY LIABILITY LEADING UP TO ITS INCLUSION IN COPYRIGHT INFRINGEMENT LAW

A concise history of third-party liability in copyright infringement will shed light on the form this paper asserts is the next wave in the field—the liability of investors and lenders for the copyright infringement of those they fund. This section of the paper first defines just what is meant by “third-party liability.” Then, it explores the history of third-party liability in tort and then, more narrowly, in copyright infringement.

A. Third-Party Liability in Tort Third-party liability encompasses two different concepts: contributory liability and vicarious liability.5 These terms come from the law of torts.6 Contributory liability arises from the notion that a person “acting in concert” with a tortfeasor should be liable.7 A person “acts in concert” to commit a tort with a direct tortfeasor when he aids or encourages the direct tortfeasor in the tort‟s commission.8 The law imposes on such a contributor as much liability as on the individual who actually committed the physical acts of the tort, regardless of whether the direct tortfeasor would have acted in the same manner anyway.9 Vicarious liability is a strict liability rule under which a person is held liable for the tort of a second person simply because there is a relationship between the two people and the second person was acting within the scope of that relationship when he committed the tort.10 The history of each concept, respectively, is briefly described below. The history of contributory liability and “acting in concert” in tort law

5. MARSHALL LEAFER, ET AL., UNDERSTANDING COPYRIGHT LAW 425 (4th ed. 2005). 6. Id. 7. JOHN L. DIAMOND, LAWRENCE C. LEVINE & M. STUART MADDEN, UNDERSTANDING TORTS 230 (2d ed. 2000). 8. Id. See also RESTATEMENT (SECOND) OF TORTS § 876 (1976). 9. DIAMOND, supra note 7. 10. EDWARD J. KIONKA, TORTS IN A NUTSHELL 229 (2d ed. 1992).

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is a long one.11 It can trace its roots back to courts, as early as the 16th Century, holding abettors in crimes guilty as principals.12 The idea of holding liable persons acting in concert with a direct actor was soon thereafter brought into the tort realm.13 English courts then made those who encourage another to commit a tort liable.14 U.S. courts after the Revolution adopted the English approach.15 Contributory liability even became codified in some states.16 Vicarious liability also shares a long history.17 The roots of the modern American doctrine of vicarious liability trace themselves back to both Roman and German law.18 Oliver Wendell Holmes, as a professor, looked to the Roman law of pater potestas (paternal 11. See infra notes 12-14 and accompanying text. 12. See, e.g., Matters of the Crown Happening at Salop, 75 Eng. Rep. 153 (K.B. 1907) (holding abettors guilty as principals in a murder case). 13. See, e.g., Smithson v. Garth, 83 Eng. Rep. 711 (K.B. 1691) (holding tortfeasors acting in concert jointly and severally liable). 14. Rafael v. Verelst, 96 Eng. Rep. 621, 623 (K.B. 1776) (holding a defendant liable for his “awe and influence” over another which caused the second person to commit a trespass against a third party). This case is from the Hilary Term of 1776. Id. at 616. Thus, it pre-dates the July 4, 1776 Declaration of Independence and is a part of U.S. common law. Under English law, the legal year is divided into four terms: Michaelmas from October to December, Hilary from January to April, Easter from April to May and Trinity term from June to July (approximately). The Hilary Term is so named because the feast day of St. Hilary of Poitiers, January 14, falls during this term. 15. See, e.g., State v. Lymburn, 3 S.C.L. (1 Brev.) 397 (1804) (The Constitutional Court of Appeals of South Carolina holding that “wherever a man commands another to commit a trespass, who afterwards commits it in pursuance of such command, he seems, by necessary consequence, to be as guilty of it, as if he had done it himself.”) (quoting WILLIAM HAWKINS, A TREATISE OF THE PLEAS OF THE CROWN: OR A SYSTEM OF THE PRINCIPAL MATTERS RELATING TO THAT SUBJECT, DIGESTED UNDER PROPER HEADS 311 (London, Nutt & Gosling 1721)); Sikes v. Johnson, 16 Mass. 389, 389 (1820) (holding that “all persons aiding and abetting, or counseling and procuring a trespass to be done, are principals, whether present or not”); Bird v. Lynn, 49 Ky. (10 B. Mon.) 422, 423 (1850) (noting that a defendant could be liable if her words actually directed another person to whip or beat a third party); Brown v. Perkins, 83 Mass. (1 Allen) 89, 98 (1861) (describing any person who encourages or excites a trespass “by words, gestures, looks, or signs, or who in any way or by any means countenances or approves the same, is . . . an aider and abettor, and as liable as a principal”); Frantz v. Lenhart, 56 Pa. 365, 367 (1867) (holding that those who encourage a battery assume upon themselves the consequences of the acts done); Hilmes v. Stroebel, 17 N.W. 539, 539 (1883) (holding in a trespass case that any “encouragement or aid” given to the principal actor or any concert of action will amount to liability); Wright v. Stewart, 130 F. 905, 914 (D. Mo. 1904), aff’d, 147 F. 321 (8th Cir.), cert. denied, 203 U.S. 590 (1906) (holding that a party who encourages or promotes, knowingly, the commission of a trespass or a fraud, is equally liable with the active participants). 16. See, e.g., Irwin v. Scribner, 15 La. Ann. 583, 584 (1860) (describing a piece of 1844 legislation mandating that under the Louisiana state code, “those who commit torts, or assist or encourage others in so doing, are bound in solido to make reparation to the person injured.”). 17. Fleming James, Jr., Vicarious Liability, 28 TUL. L. REV. 161, 164 (1954). 18. Id.

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power), under which the male head of the household (the pater familias) was liable for the acts of members of the family and of slaves.19 John Henry Wigmore, on the other hand, saw Germanic origins to the concept, as a lord under German law was responsible to third persons for those attached to his house.20 These respondeat superior21 (“let the master answer”) notions were passed down and made their way into English common law22 as early as the 11th Century23 and were later adopted by U.S. courts, as early as Marshall‟s Court.24

B. Third-Party Liability in Copyright Given the acceptance of third-party liability in American tort jurisprudence, it was not surprising that third-party liability was later stretched to copyright infringement. Tort law concepts are, after all, the 19. Professor Holmes, later Justice Holmes, made these remarks in two lectures delivered at Harvard Law School in 1882, and the lectures were later published. Oliver Wendell Holmes, Jr., Agency, 4 HARV. L. REV. 345, 350 (1891); Oliver Wendell Holmes, Jr., Agency, II, 5 HARV. L. REV. 1 (1891); Oliver Wendell Holmes, Jr., The History of Agency, in SELECT ESSAYS IN ANGLO AMERICAN LEGAL HISTORY 368, 373 (1909). 20. John H. Wigmore, Responsibility for Tortious Acts: Its History, 7 HARV. L. REV. 315, 330 (1894) (quoting Heinrich Brunner, Deutsche Rechtsgeschichte ii. § 93 (Leipzig, Duncker & Humblot, 1892)). 21. For an in-depth historical review of the development of the doctrine of respondeat superior, see Stover Bedding Co. v. Indus. Comm‟n, 107 P.2d 1027, 1033-38, 437-44 (1940) (Wolfe, J., dissenting). 22. See, e.g., Morse v. Slue, 86 Eng. Rep. 159, 160 (K.B. 1675) (referring to respondeat superior), available at Gale Group‟s Eighteenth Century Collections Online, Doc. Nos. CW3323652308, CW3323652309, CW3323652356, & CW3323652357. Sir John Holt argued the case for the plaintiff. Morse, 86 Eng. Rep. at 159. Holt later served from 1689 until his death in 1710 as Lord Chief Justice of England and Wales, the second-highest judge in England and Wales. CECILIA LUCY BRIGHTWELL, MEMORIALS OF THE EARLY LIVES & DOINGS OF GREAT LAWYERS 94-95 (Lawbook Exchange 2002) (1866). After the April 3, 2006 effective date of the Constitutional Reform Act 2005, this title connotes the head of the judiciary (previously one of the roles of the Lord Chancellor). Judiciary of England and Wales, http://www.judiciary. gov.uk/about_judiciary/roles_types_jurisdiction/lord_chief_justice/index.htm (last visited Oct. 17, 2008). 23. Holmes, supra note 19, at 355 (referring to a similar concept at the time of the Norman Conquest). 24. See, e.g., Clark v. Corp. of Wash., 25 U.S. 40, 63 (1827) (finding a city corporation to be a principal and holding it liable for the acts and contracts of an individual the Court found to be its agent). See also Samuel Livermore, A TREATISE ON THE LAW OF PRINCIPAL AND AGENT; AND OF SALES BY AUCTION 207 (1818); William Paley, A TREATISE ON THE LAW OF PRINCIPAL AND AGENT, CHIEFLY WITH REFERENCE TO MERCANTILE TRANSACTIONS 126-1310 (John Horatio Lloyd ed., John S. Little 2d. American ed. 1840); Joseph Story, COMMENTARIES ON THE LAW OF AGENCY AS A BRANCH OF COMMERCIAL AND MARITIME JURISPRUDENCE, WITH OCCASIONAL ILLUSTRATIONS FROM THE CIVIL AND FOREIGN LAW § 308 (Nicholas St. John Green ed., Boston, Little, Brown 8th ed. 1874).

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“genesis” of copyright infringement doctrine,25 and copyright infringement may indeed be classified as a tort.26 Common law concepts of tort liability are thus “relevant” in determining the scope of remedies for copyright infringement.27 The verb “stretched” is appropriate to describe the use of third-party liability in copyright in the United States, as it is an invention of courts.28 In contrast to the Patent Act, which forbids “actively induc[ing] infringement of a patent”29 and imposes liability on certain individuals labeled “contributory” infringers,30 the Copyright Acts of 1790,31 1909,32 and 197633 did not explicitly recognize third-party liability for infringement. U.S. copyright infringement doctrine, in contrast to copyright law‟s statutory provisions for protect-ability34 and remedies,35 has always been highly court-driven.36 From a “bare legislative backdrop,” courts designed copyright infringement standards through “incremental” jurisprudence.37 The Copyright Act of 1790 did not provide a formal definition of infringement, instead opting for the basic provision that “any person or persons who shall print or publish any manuscript, without the consent and approbation of the 25. Screen Gems-Columbia Music, Inc. v. Mark-Fi Records, Inc., 256 F. Supp. 399, 403 (S.D.N.Y. 1966). 26. See Ted Browne Music Co. v. Fowler, 290 F. 751, 754 (2d Cir. 1923). 27. Screen Gems, 256 F. Supp. at 403. 28. Peter S. Menell, Indirect Copyright Liability: A Re-examination of Sony’s Staple Article of Commerce Doctrine 5, BERKELEY CTR. FOR L. & TECH., Mar. 10, 2005, available at http://repositories.cdlib.org/bclt/lts/6. 29. 35 U.S.C. § 271(b) (2000). 30. 35 U.S.C. § 271(c) (2000). 31. Copyright Act of 1790, ch. 15, 1 Stat. 124 (1790) (superseded by Copyright Act of 1909), available at http://www.copyright.gov/history/1790act.pdf. 32. Copyright Act of 1909, ch. 320, 35 Stat. 1075 (1909) (superseded by Copyright Act of 1976), available at http://www.copyright.gov/history/1909act.pdf. 33. Copyright Act of 1976, 17 U.S.C. §§ 101-810 (1976). Note, the House Report on the bill claims that the language of the exclusive right to “authorize” others to perform the specified five rights was meant “to avoid any questions as to the liability of contributory infringers.” H.R. R EP. NO. 1476, at 61 (1975) as reprinted in 1976 U.S.C.C.A.N. 5674; see S. REP. NO. 473, at 57 (1975). Also, another Title 17 section, 17 U.S.C. § 905(3), grants to the owner of a mask work the exclusive right to induce or knowingly cause another person to exercise the reproduction, distribution or importation rights of § 905(1)-(2). 17 U.S.C. § 905 (2000). Thus, there is a statutory provision for contributory liability in mask work infringement. This provision, however, does not cover general copyright infringement. See NIMMER ON COPYRIGHT § 12.04(A) (2007). 34. Sony Corp. of Am. v. Universal City Studios, Inc., 464 U.S. 417, 431 (1984) (“The protection given to copyrights is wholly statutory”) (citing Wheaton v. Peters, 33 U.S. 591, 661-62 (1834)). 35. Id. at 431 (“The remedies for infringement „are only those prescribed by Congress.‟”) (quoting Thompson v. Hubbard, 131 U.S. 123, 151 (1889)). 36. Menell, supra note 28. 37. Id.

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author or proprietor thereof . . . shall be liable to suffer and pay to the said author or proprietor all damages occasioned by such injury.” 38 Congress similarly left little explanation in the Copyright Act of 1909, declaring that any person who “shall infringe the copyright in any work protected under the copyright laws of the United States . . . shall be liable” for a range of remedies.39 The legislature was not much more detailed with its basic infringement standard in the Copyright Act of 1976: Anyone who violates any of the exclusive rights of the copyright owner as provided by sections 106 through 118 or who imports copies or phonorecords into the United States in violation of section 602, is an 40 infringer of the copyright or right of the author, as the case may be.

From these statutory provisions, courts have added their take on infringement.41 The courts‟ interpretations have included third-party liability for infringement. Approximately two decades before the 1909 Act, an owner of copyrights in graphical works sued individuals who had bought the works and tried to have them reproduced by a photogravure company.42 The defendants sought to defeat liability on the ground that they did not do the copying themselves.43 Referring to tort principles, a district court extended liability to those who authorize copyright violations, calling the defendants joint tortfeasors for their acts of purchasing the pictures, furnishing them to the photogravure company, ordering copies, and giving general directions.44 A few years later, just before the turn of the century, vicarious liability made its way into court decisions on copyright.45 A map‟s copyright owner sued a newspaper for publishing the map in a particular edition of the newspaper.46 The newspaper publisher replied that 38. Copyright Act of 1790, ch. 15, 1 Stat. 124 (1790) (superseded by Copyright Act of 1909), available at http://www.copyright.gov/history/1790act.pdf, cited in Menell, supra note 28, at 5. 39. Copyright Act of 1909, ch. 320, 35 Stat. 1075 § 25 (1909), recodified § 101 (1912) (superseded by Copyright Act of 1976), available at http://www.copyright.gov/history/1909 act.pdf, cited in Menell, supra note 28, at 5. 40. 17 U.S.C. § 501 (1976) (as initially enacted), cited in Menell, supra note 28, at 6. 41. For example, the substantial similarity requirement and tests, the de minimus limiting doctrine test, and the fair use exception all have judicial origins. Menell, supra note 28, at 5. 42. Fishel v. Luekel, 53 F. 499, 500 (S.D.N.Y. 1892), referenced in Peter S. Menell & David Nimmer, Unwinding Sony, BERKELEY CTR. FOR L. & TECH., Oct. 23, 2006, available at http://repositories.cdlib.org/bclt/lts/27. 43. Fishel, 53 F. at 500. 44. Id. 45. McDonald v. Hearst, 95 F. 656, 657 (N.D. 1899), referenced in Menell & Nimmer, supra note 42. See also W. Publ‟g Co. v. Lawyers‟ Co-operative Publ‟g Co., 79 F 756, 772-73 (2d Cir. 1897); Trow v. Boyd 97 F. 586 (C.C.D.N.Y. 1899); Leon v. Pac. Tel. & Tel. Co., 91 F.2d 484, 487 (9th Cir. 1937), cited in Menell & Nimmer, supra note 42. 46. McDonald, 95 F. at 656.

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the infringing material was inserted without his knowledge or consent.47 The district court held for the plaintiff, extending respondeat superior to copyright law.48 Shortly before the passing of the 1909 Act, the Supreme Court recognized contributory liability in copyright infringement.49 Over the next sixty years, courts revisited the area so much that by the time of the passing of the 1976 Act, third-party liability in the copyright arena was a “well-established principle,” according to the House Report on the bill.50 The House Report also expressed the understanding that both contributory51 and vicarious52 liability would continue under the 1976 Act.

II. DEFINING THIRD-PARTY LIABILITY IN COPYRIGHT INFRINGEMENT LAW To call third-party liability in copyright “well-established” is a spot-on comment, as investors and lenders will join a long list of third-party defendants in copyright infringement cases.53 In the defendant catalog of the first sixty years of third-party liability in copyright infringement suits, we find movie producers,54 concert producers,55 and landlords of varying properties and owners of certain business establishments, including dance halls,56 night clubs,57 stores with concessions,58 cafés,59 hotels,60 movie theaters,61 racetracks,62 and athletic and social clubs.63 Even advertising 47. Id. at 657. 48. Id. 49. Scribner v. Straus, 210 U.S. 352, 355 (1908). The next Supreme Court case on contributory liability was just three years later. Kalem Co. v. Harper Bros., 222 U.S. 55, 63 (1911). 50. H.R. Rep. No. 94-1476, at 159 (1976). 51. Id. at 61. 52. Id. at 61, 159-60. 53. See infra notes 54-76 and accompanying text. 54. Kalem Co. v. Harper Bros., 222 U.S. 55, 60 (1911). 55. Gershwin Publ‟g Corp. v. Columbia Artists Mgmt., Inc., 443 F.2d 1159, 1160 (2d Cir. 1971). 56. Dreamland Ball Room, Inc. v. Shapiro, Bernstein & Co., 36 F.2d 354, 355 (7th Cir. 1929); Buck v. Russo, 25 F. Supp. 317, 319 (D. Mass. 1938); Buck v. Crescent Gardens Operating Co., 28 F. Supp. 576, 577 (D. Mass. 1939). 57. Buck v. Pettijohn, 34 F. Supp. 968, 968 (E.D. Tenn. 1940); Lerner v. Schectman, 228 F. Supp. 354, 355 (D. Minn. 1964). 58. Shapiro, Bernstein & Co. v. H.L. Green Co., 316 F.2d 304, 306 (2d Cir. 1963). 59. Harm‟s, Inc. v. Theodosiades, 246 F. Supp. 799, 800 (E.D. Pa. 1965). 60. Remick Music Corp. v. Interstate Hotel Co., 58 F. Supp. 523, 527 (D. Neb. 1944), aff’d 157 F.2d 744, 749 (8th Cir. 1946), cert. denied, 329 U.S. 809, 809 (1947). 61. M. Witmark & Sons v. Pastime Amusement Co., 298 F. 470, 472 (E.D.S.C. 1924); Harms v. Cohen, 279 F. 276, 277 (E.D. Pa. 1922); M. Witmark & Sons v. Calloway, 22 F.2d 412,

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agencies and packaging and shipping companies have been held liable.64 In the last three decades, plaintiffs, while continuing to go after landlord/operator types such as owners of flea markets,65 restaurants,66 and bars,67 have adjusted to the progress of technology and gone after manufacturers of copying equipment68 and are combing the internet world for possible defendants.69 Operators of plain vanilla websites,70 search engines,71 electronic bulletin boards,72 and peer-to-peer file networks,73 as well as internet service providers74 have all been the subject of suits based on third-party liability. This “veritable secondary liability revolution”75 arises from the reality that “adequate protection of a monopoly may require the courts to look beyond actual duplication of a device or publication to the products or activities that make such duplication possible.”76 A more in414 (E.D. Tenn. 1927). 62. Famous Music Corp. v. Bay State Harness Horse Racing & Breeding Ass‟n, 554 F.2d 1213, 1214 (1st Cir. 1977). 63. M. Witmark & Sons v. Tremont Soc. & Athletic Club, 188 F. Supp. 787, 788 (D. Mass. 1960). 64. Screen Gems-Columbia Music, Inc. v. Mark-Fi Records, Inc., 256 F. Supp. 399, 401-02 (S.D.N.Y. 1966), later opinion, 327 F. Supp. 788, 788-89 (S.D.N.Y. 1971). 65. Fonovisa, Inc. v. Cherry Auction, Inc., 76 F.3d 259, 260 (9th Cir. 1996); UMG Recordings, Inc. v. Sinnott, 300 F. Supp. 2d 993, 994 (E.D. Cal. 2004); Arista Records, Inc. v. Flea World, Inc., No. 03-2670 (JBS), 2006 U.S. Dist. LEXIS 14988, at *2-3 (D.N.J. Mar. 31, 2006). 66. Chess Music, Inc. v. Sipe, 442 F. Supp. 1184, 1184-85 (D. Minn. 1977); KECA Music, Inc. v. Dingus McGee‟s Co., 432 F. Supp. 72, 74 (W.D. Mo. 1977); Leigh v. Sakkaris, No. C-811273 RPA, 1982 U.S. Dist. LEXIS 12118 at *1 (N.D. Cal. 1982); Warner Bros., Inc. v. Lobster Pot, Inc., 582 F. Supp. 478 (N.D. Ohio 1984). 67. Wow & Flutter Music v. Len‟s Tom Jones Tavern, 606 F. Supp. 554, 555 (W.D.N.Y. 1985). 68. Sony, 464 U.S. at 419. 69. Intellectual Reserve, Inc. v. Utah Lighthouse Ministry, Inc., 75 F. Supp. 2d 1290, 1292 (D. Utah 1999); Perfect 10, Inc. v. Talisman Commc‟ns, Inc., No. CV99-10450 (RAP) (MCx), 2000 U.S. Dist. LEXIS 4564, at *3-4 (C.D. Cal. 2000). 70. See supra note 69. 71. Perfect 10, Inc. v. Amazon.com, Inc., 487 F.3d 701, 710 (9th Cir. 2007). 72. Sega Enters. v. MAPHIA, 948 F. Supp. 923, 926 (N.D. Cal. 1996); Sega Enters. v. Sabella, No. C93-04260 CW, 1996 U.S. Dist. LEXIS 20470, at *4 (N.D. Cal. Dec. 18, 1996); Playboy Enters. v. Russ Hardenburgh, 982 F. Supp. 503, 505 (N.D. Ohio 1997). 73. A&M Records v. Napster, Inc., 239 F.3d 1004, 1011 (N.D. Cal. 2001); Grokster, 545 U.S. 913. 74. Religious Tech. Ctr. v. Netcom On-Line Commc‟ns Servs., Inc., 907 F. Supp. 1361, 1365 (N.D. Cal. 1995); Arista Records, Inc. v. MP3Board, Inc., No. 00 Civ. 4660 (SHS), 2002 U.S. Dist. LEXIS 16165, at *2 (2002); Ellison v. Robertson, 357 F.3d 1072, 1074 (9th Cir. 2004). 75. Mark Bartholomew & John Tehranian, The Secret Life of Legal Doctrine: The Divergent Evolution of Secondary Liability in Trademark and Copyright Law, 21 BERKELEY TECH. L.J. 1363, 1364 (2006). 76. Sony, 464 U.S. at 442.

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depth explanation of what acts will give rise to contributory and vicarious liability, respectively, specifically in copyright infringement, now follows.

A. Contributory Liability Contributory liability started out being premised upon intentional inducement or encouragement in direct infringement, and, subsequently, distribution of products without a noteworthy non-infringing use was brought under the contributory liability umbrella.77 Each theory of liability is explained below.

1.

The Inducement Theory

The inducement premise of contributory liability requires (1) actual or constructive knowledge of the infringement78 and (2) a material contribution to the infringement.79 Each prong is now explained.

i.

Requirement of Knowledge

The secondary infringer must “know or have reason to know” of the direct infringement80 so that the contribution is intentional.81 Proof of knowledge can come in numerous forms.82 A supported allegation of copyright ownership from the owner to the infringer would be sufficient to prove knowledge.83 Internal documents admitting infringement would be a smoking gun in discovery.84 Industry experience could also indicate constructive knowledge.85 Under common law principles, intent can also be imputed.86 An actor is said to intend to cause the “natural and probable 77. Metro-Goldwyn-Mayer Studios Inc. v. Grokster, Ltd., 545 U.S. 913, 930, 932 (2005). 78. Gershwin Publ‟g Corp. v. Columbia Artists Mgmt., 443 F.2d 1159, 1162 (2d. Cir. 1971) (“[O]ne who, with knowledge of the infringing activity, induces, causes or materially contributes to the infringing conduct of another may be held liable as a „contributory infringer.‟”). 79. Perfect 10, 487 F.3d at 728 (“[A]n actor‟s contribution to infringement must be material to warrant the imposition of contributory liability.”). 80. A&M Records v. Napster Inc., 239 F.3d 1011, 1020 (N.D. Cal. 2001). 81. Grokster, 545 U.S. at 930. 82. Religious Tech. Ctr. v. Netcom On-Line Commc‟ns Servs. Inc., 907 F. Supp. 1361, 1374 (9th Cir. 2004); see A&M Records, 239 F.3d at 1020 n.5. 83. Religious Tech., 907 F. Supp. at 1374. 84. See A&M Records, 239 F.3d at 1020 n.5. 85. Id. 86. Perfect 10, 508 F.3d at 1171.

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consequences” of his conduct under tort law.87 Following a finding of knowledge, courts looks to see if the actor has indeed made a material contribution to the infringement.88

ii. Requirement of Material Contribution As for material contribution, what one looks for is in effect an “aider and abettor.”89 This is somewhat of an “I know it when I see it”90 standard. Such ambiguity led the four-justice dissent in Sony Corp. of America v. Universal City Studios, Inc.,91 a case over the Betamax video cassette recorder which made individual copies of complete television shows, to call the doctrine of contributory copyright infringement “not well defined.” 92 Providing the real or virtual site or facility upon which infringement takes place has been held sufficient.93 Support services such supplying utilities, parking, advertising, plumbing, and customers might also be sufficient.94 Additionally, taking part in promotion of the infringing product or service could be enough,95 but promoting a non-infringing product in a forum in which another party promotes an infringing product would likely not be sufficient.96 Claims that a third party established merchant accounts to 87. See BURR W. JONES, “Presumption that Men Know the Consequence of their Acts,” LAW EVIDENCE IN CIVIL CASES § 27(23) (2d ed., Bancroft-Whitney, 1912) at 27; see also DeVoto v. Pac. Fid. Life Ins. Co., 618 F.2d 1340, 1347 (9th Cir. 1980). 88. Perfect 10, 487 F.3d at 728. 89. In re Aimster Copyright Litig., 334 F.3d 643, 645-46 (7th Cir. 2003). 90. Jacobellis v. Ohio, 378 U.S. 184, 197 (1964) (Stewart, J., concurring) (famous quote from an obscenity case). 91. 464 U.S. 417, 457 (1984). 92. Sony, 464 U.S. at 487 (Blackmun, J., dissenting). 93. A&M Records, 239 F.3d at 1022; see also Fonovisa, 76 F.3d at 264 (holding swap meet owner defendant provided material contribution by providing space for infringement along with further services, including, among others, the provision of utilities, parking, advertising, plumbing, and customers). 94. See Fonovisa, 76 F.3d at 264. Note, in Fonovisa, the defendant swap meet owner also provided the space for infringement. Id. See also Adobe Sys. v. Canus Prods., 173 F. Supp. 2d 1044, 1055-56 (C.D. Cal. 2001) (holding providing or arranging for the provision of parking, advertising, and customers sufficient). 95. Faulkner v. Nat‟l Geographic Soc‟y, 211 F. Supp. 2d 450, 473-74 (S.D.N.Y. 2002) (in partial denial of motion for partial summary judgment, held that promoting an infringing product or service via advertisement or another method may be sufficient to satisfy the material contribution requirement); Arista Records, Inc. v. Flea World, Inc., No. 03-2670 (JBS), 2006 U.S. Dist. LEXIS 14988, at *52 (D.N.J. 2006) (holding plaintiffs materially contributed by, among other things, promoting the site of infringement and working to attract customers to it). 96. Livnat v. Lavi, No. 96 Civ. 4967 (RWS), 1998 U.S. Dist. LEXIS 917 at *12 (S.D.N.Y. Jun. 29, 1998) (granting of summary judgment for certain defendants, holding that mere advertisement in a magazine “which carries an article containing infringing photographs does not OF

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process credit card payments, deposited customer checks made out to the direct infringer, managed the direct infringer‟s accounts payable, and remitted monies to the direct infringer have been held to raise triable issues of material facts as to contributory infringement.97 Providing physical means for copying would also be sufficient,98 though this might better fall into the next category.

2.

The Product Distribution Theory

The other form of contributory liability involves the provision of “materials or equipment necessary for the infringement to occur.”99 As the Court in Sony put it: “the contributory infringement doctrine is grounded on the recognition that adequate protection of a monopoly may require the courts to look beyond actual duplication of a device or publication to the products or activities that make such duplication possible.”100 Cases under the product distribution theory of contributory liability were first concerned with physical audio101 and video102 copying equipment. They may be said to be descendants of an early postbellum case in which a district court held constitute a material contribution to that infringement.”). 97. U2 Home Entm‟t., Inc. v. Gatechina.com, Inc., No. C05-260 JF (PVT), 2007 U.S. Dist. LEXIS 27430 at *16-17 (N.D. Cal. Mar. 27, 2007) (holding that third party‟s establishing merchant accounts to process credit card payments, depositing customer checks made out to direct infringer, managing direct infringer‟s accounts payable, and remitting monies to direct infringer raises triable issues of material fact as to whether the third party is liable for contributory infringement). 98. A&M Records, Inc. v. Abdallah, 948 F. Supp. 1449 (C.D. Cal. 1996) (company owner sold empty cassette cartridges, spools of blank recording tape, audio duplicating equipment, and “time-loaded” audio tapes to individuals who used to them to illegally counterfeit copyrighted works, and the court found that provision of time-loaded cassettes was a material contribution to his customers‟ counterfeiting activities, not relying on the Sony product distribution prong). 99. PAUL GOLDSTEIN, GOLDSTEIN ON COPYRIGHT (3d ed. 2008). 100. Sony, 464 U.S. at 442 (emphasis added). 101. RCA Records v. All-Fast Sys., Inc., 594 F. Supp. 335 (S.D.N.Y. 1984) (granting preliminary injunction against store that operated a sound recording cassette-copying machine which records cassettes onto specially designed blank cassettes, which defendant sold to customers who wished to use the machine, under direct and contributory liability theories, and referencing and rejecting the Sony exception in this case); see Elektra Records Co. v. Gem Elec. Distribs., Inc., 360 F. Supp. 821 (E.D.N.Y. 1973) (granting preliminary injunction against stores selling electronic equipment and supplies including both blank and pre-recorded tapes and cartridges and having tape-making systems on the premises, though not explicitly referencing infringement as contributory). 102. Sony, 464 U.S. at 442 (carving out exception to liability where such copying equipment is “widely used for legitimate, unobjectionable purposes,” “capable of substantial non-infringing uses,” or “capable of commercially significant non-infringing uses,” without explaining any differences in the terminology and explicitly declining to “give precise content to the question of how much use is commercially significant”).

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that an individual who had made an electrotype copy of a newspaper and sold the plate to another newspaper was a party acting in concert and a joint tortfeasor.103 Cases under this basis of liability later moved into the computer world, including challenges to search engines104 and software.105 There is an exception to product distribution cases.106 In the important Supreme Court case of Sony Corp. of America v. Universal City Studios, Inc., the Court carved out an exception to liability where such copying equipment is “widely used for legitimate, unobjectionable purposes,” “capable of substantial non-infringing uses,” and “capable of commercially significant non-infringing uses.”107 The Court did not explain any differences in those phrases and explicitly declined to “give precise content to the question of how much use is commercially significant.”108 One can see why such an exception is important when you consider the utility of typewriters, word processors, copy machines, and cameras.

B. Vicarious Liability A copyright infringement plaintiff can additionally or alternatively recover from a third party under the theory of vicarious liability.109 Following on the heels of turn-of-the-century printing cases in which employers were held for the copyright infringements of employees,110 going after owners and operators of premises upon which infringement was taking place became all the rage.111 It is now clear that a plaintiff can sue for 103. See Harper v. Shoppell, 28 F. 613, 615 (C.C.S.D.N.Y. 1886). 104. Perfect 10, 508 F.3d at 1170 (analyzing Google‟s search engine). 105. In re Aimster Copyright Litig., 252 F. Supp. 2d 634, 652 (N.D. Ill. 2002) (granting preliminary injunction where defendant provided software and the support services necessary for individual Aimster users to connect with each other to share files, thereby giving users a “road map” to infringement). 106. Sony, 464 U.S. at 442. 107. Id. 108. Id. 109. Metro-Goldwyn Mayer Studios Inc. v. Grokster, Ltd., 545 U.S. 913, 930 (2005). 110. McDonald v. Hearst, 95 F. 656 (D.C.Cal. 1899), referenced in Menell & Nimmer, supra note 42. See also W. Publ‟g Co. v. Lawyers‟ Co-operative Publ‟g Co., 79 F. 756, 773 (2d Cir. 1897); Trow Directory, Printing & Bookbinding Co. v. Boyd 97 F. 586, 587 (S.D.N.Y. 1899); Leon v. Pacific Tel. & Tel. Co., 9 Cir., 91 F.2d 484, 487 (9th Cir. 1937), cited in Menell & Nimmer supra note 42. 111. Dreamland Ball Room, Inc. v. Shapiro, Bernstein & Co., 36 F.2d 354, 355 (7th Cir. 1929) (dance hall); Buck v. Russo, 25 F. Supp. at 318-19 (dance hall); Buck v. Crescent Gardens Operating Co., 28 F. Supp. at 577 (dance hall); Buck v. Pettijohn, 34 F. Supp. at 968 (night club); Lerner v. Schectman, 228 F. Supp. 354 (D. Minn. 1964) (night club); Shapiro, Bernstein & Co. v. Veltin, 47 F.Supp. 648, 649 (W.D. La. 1942); Bourne v. Fouche, 238 F.Supp. 745, 745 (E.D.S.C. 1965) (amusement club); Shapiro, Bernstein & Co. v. H.L. Green Co., 316 F.2d 304, 305-06 (2d

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vicarious infringement when the other party (1) profits from the direct infringement and (2) refuses to exercise a right to stop or limit it.112 These elements are independent requirements, and each must be present to render a defendant vicariously liable.113 Lack of knowledge of the infringement is irrelevant.114 Each prong is discussed below.

1.

The Requirement of Financial Benefit

A financial benefit accruing to the alleged vicarious infringer is the first requirement.115 Vicarious liability cases are indeed “permeated with the profit motive.”116 A lack of such a motive will require dismissal of the case.117 Financial benefit can come in numerous forms.118 Getting a “cut” from the business would certainly count.119 Note, however, that a monetary sum fixed up-front going to the alleged vicarious infringer without other Cir. 1963) (stores with concessions); Harm‟s, Inc. v. Theodosiades, 246 F. Supp. 799, 800 (E.D. Pa. 1965) (café); Remick Music Corp. v. Interstate Hotel Co., 58 F. Supp. 523, 526 (D. Neb. 1944), aff’d 157 F.2d 744 (8th Cir. 1946), cert. denied, 329 U.S. 809 (1947) (hotel); M. Witmark & Sons v. Pastime Amusement Co., 298 F. 470, 471-72 (E.D.S.C. 1924) (movie theater); Harms v. Cohen, 279 F. 276, 277 (E.D. Pa. 1922) (movie theater); M. Witmark & Sons v. Calloway, 22 F.2d 412, 413 (E.D. Tenn. 1927) (movie theater); Famous Music Corp. v. Bay State Harness Horse Racing & Breeding Ass‟n, 554 F.2d 1213, 1214 (1st Cir. 1977) (racetrack); M. Witmark & Sons v. Tremont Soc. & Athletic Club, 188 F. Supp. 787 (D. Mass. 1960) (athletic and social clubs); Fonovisa, 76 F.3d 259 (flea market); UMG Recordings, Inc. v. Sinnott, 300 F. Supp. 2d 993 (E.D. Cal. 2004) (flea market); Arista Records, Inc. v. Flea World, Inc., No. 03-2670, 2006 U.S. Dist. LEXIS 14988 at *3 (D.N.J. March 31, 2006) (flea market); Chess Music, Inc. v. Sipe, 442 F. Supp. 1184 (D. Minn. 1977) (restaurant); KECA Music, Inc. v. Dingus McGee‟s Co., 432 F. Supp. 72 (W.D. Mo. 1977) (restaurant); Leigh v. Sakkaris, No. C-81-1273 RPA., 1982 U.S. Dist. LEXIS 12118 at *1 (N.D. Cal. Jan. 17, 1982) (restaurant); Warner Bros., Inc. v. Lobster Pot, Inc., 582 F. Supp. 478, 480 (N.D. Ohio 1984) (restaurant); Wow & Flutter Music v. Len‟s Tom Jones Tavern, 606 F. Supp. 554 (W.D.N.Y. 1985) (bar). 112. Shapiro, 316 F.2d at 307; Perfect 10, Inc. v. Cybernet Ventures, Inc., 213 F. Supp. 2d 1146, 1171 (C.D. Cal. 2002). 113. See Shapiro, 316 F.2d at 307. 114. Id. 115. See id. 116. Roy Exp. Co. Establishment v. Tr. of Columbia Univ., 344 F. Supp. 1350, 1353 (S.D.N.Y. 1972). 117. Id. at 1353. 118. See Shapiro, 316 F.3d at 308; see also A&M Records, 239 F.3d at 1023; Fonvosia, Inc. v. Napster, Inc., No. 01-02669 MHP, 2002 U.S. Dist. LEXIS 4270, at *26 (N.D. Cal. 2002). 119. Shapiro, 316 F.2d at 308 (“By reserving for itself a proportionate share of the gross receipts from [direct infringer‟s] sales of phonograph records, [defendant] had a most definite financial interest”); Playboy Enters. v. Webbworld Inc., 991 F. Supp. 543, 554 (N.D. Tx. 1997) (finding that where defendant received 25% of the net income of the business he derived “significant” financial benefit, but holding for defendant on grounds of lack of control); U2 Home Entm‟t, Inc. v. Gatechina.com, Inc., No. 3-98-CV-3222-H, 2007 U.S. Dist. LEXIS 27430 at *17 (N.D. Cal. Mar. 27, 2007) (“clearly benefited financially . . . as it received a percentage of sales”).

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benefit (and without supervision) might not be enough.120 The availability of infringing material, acting as a “draw” for customers, though, would be sufficient.121 Receiving money from advertising and a larger user base, as well as increased prospects for investment may also be sufficient.122 In addition to a financial benefit, courts look for control by the defendant over the direct infringer.123

2.

The Requirement of Control

The refusal to exercise a right to stop or limit the direct infringement is the second component of vicarious liability.124 In the House Report on the Copyright Act of 1976, the Judiciary Committee, discussing the public performance right, explained that, under the common law, defendants are found to have “control” over a performance if they “either actively operate or supervise the operation of the place wherein the performances occur, or control the content of the infringing program.”125 Courts have not defined the precise terms of the control test, but it appears that numerous courts implicitly have adopted terms similar to those described in the legislative record, so that vicarious infringers “must either actively operate or supervise the operation[s] of the [direct infringer], or control the content of the infring[ement].”126 Thus, being involved in every aspect of the planning and production of the actions that are the infringement would be an easy case.127 Similarly, it has been held that having rights of refusal or requiring approval in the infringers‟ decision-making processes would also indicate a right to control and lead to an inference that the third party controlled the content of the direct infringer‟s activities.128 Conversely, where the 120. See Deutsch v. Arnold, 98 F.2d 686, 688 (2d Cir. 1938) (non-supervising landlord not liable where received only fixed rental). 121. See A&M Records v. Napster, Inc., 239 F.3d 1004, 1023 (N.D. Cal. 2001); Fonovisa, 76 F.3d at 263-64; Perfect 10, Inc. v. Cybernet Ventures, Inc., 213 F. Supp. 2d 1146, 1171 (C.D. Cal. 2002). 122. See Fonovisa, Inc. v. Napster, Inc., No. 01-02669 MHP, 2002 U.S. Dist. LEXIS 4270 at *26 (N.D. Cal. 2002) (holding that plaintiff‟s allegations that defendant received money from advertising and a larger user base, as well as increased their prospects for investment was sufficient to state a claim for the financial benefit prong vicarious liability). 123. Perfect 10, 213 F. Supp. 2d at 1171. 124. See id. 125. H.R. REP. NO. 94-1476, at 159 (1976). 126. Polygram Int‟l Publ‟g v. Nevada/TIG, Inc., 855 F. Supp. 1314, 1326 (D. Mass. 1994). 127. See, e.g., F.E.L. Publ‟ns, Ltd. v. Nat‟l Conference of Catholic Bishops, 466 F. Supp. 1034, 1042 (N.D. Ill. 1978) (discussing Gershwin). 128. Davis v. E. I. Du Pont De Nemours & Co., 240 F. Supp. 612, 631-32 (S.D.N.Y. 1965) (holding it seems logical to infer that defendant had the ultimate power to determine content

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defendant has no access to supervise and is not connected to any decisionmaking, she may possibly be absolved.129 What constitutes control may in fact be broader. The Supreme Court‟s discussion on the control requirement reveals that the control requirement might be met in a broader scenario.130 In Metro-Goldwyn-MayerStudios Inc. v. Grokster,131 a suit over the peer-topeer file-sharing companies Grokster and Streamcast (the operator of the popular file-sharing program Morpheus), the Court described the requirement as encompassing the “right and ability to supervise the direct infringer.”132 Thus, the Court suggested control need not be active. If the third party has the right and ability, but passively sits by not exercising control and influence, it will not necessarily escape liability.133 A related question, important to this paper‟s topic, is whether a party that is not directly controlling the infringement but controls the direct infringer in a broader sense is liable. There is an open question of whether ownership alone is sufficient.134 For example, in Banff Ltd. v. Limited, Inc.,135 a district court dismissed vicarious liability claims on summary judgment because the plaintiff had alleged nothing more than the parent company‟s ownership of its subsidiary.136 The court held that “[s]imply be[ing] the parent” is not enough, and it called for “some continuing connection between the [parent and subsidiary] in regard to the infringing activity.”137 The question of whether the control needs to be in relation to the infringement, however, has not been resolved. As the Supreme Court defined it in Grokster, the “vicarious liability theory . . . allows imposition of liability when the defendant profits directly from the infringement and has a right and ability to supervise the direct infringer, even if the defendant initially lacks where defendant had to approve several steps in the production of the television program and had to give consent before work commenced). 129. See id at 630-31. 130. See Metro-Goldwyn-Mayer Studios Inc. v. Grokster, Ltd., 545 U.S. 913, 930 (2005). 131. 545 U.S. 913 (2005). 132. Id. at 930 n.9 (emphasis added). 133. See Roy Exp., 344 F. Supp. at 1353 (holding defendant not liable because of lack of profit motive, but finding “We do not think . . . that the University‟s policy of not interfering with its student organizations is synonymous with its not having the right or ability to have supervised the present infringing activities.”). 134. Banff Ltd. v. Ltd., Inc., 869 F. Supp. 1103, 1107-08 (S.D.N.Y. 1994). 135. 869 F. Supp. 1103 (S.D.N.Y. 1994). 136. Id. at 1110. 137. Id. See also Goes Lithography Co. v. Banta Corp., 26 F. Supp. 2d 1042, 1045 (N.D. Ill. 1998); Bennett v. Am. Online, Inc., No. 06-13221, 2007 U.S. Dist. LEXIS 54816 at *15 (E.D. Mich. July 27, 2007).

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knowledge of the infringement.”138 The Court confined the phrase “directly from the infringement” to the financial benefit prong,139 so general supervision of the direct infringer might be sufficient. If there is significant ownership, it seems to be a good rule that the owner should police to ensure the entity is refraining from infringement and that the owner will be liable where it does not police.140 A review of recent and current litigation will provide a backdrop for this paper‟s analysis in Part IV of third-party liability for investors and lenders. It will also drive home the importance of the suggestions set forth in Part V for reducing exposure to liability.

III. RECENT & CURRENT LITIGATION INVOLVING INVESTORS & LENDERS Recent and current litigation highlights the challenge investors and lenders will face in the future.141 None of the litigation has gone to a full trial and verdict yet, so this paper is particularly timely. As practitioner Bruce D. Sunstein, a founder of Bromberg & Sunstein, was quoted, “This is out right at the edge of where the law is.”142 This section of the paper details the recent plight of defendants in this burgeoning area. The details, including specific monetary figures, are included to highlight for the reader the magnitude of the litigation. The sheer size of the sums is important, but equally so is that they are multiples of what the allegedly liable third parties gave to the alleged direct infringers. Note the international aspects of this litigation area. In our ever-shrinking world, the investors, lenders, and direct infringers will often be from abroad.143

A. The Napster Litigation I: Bertelsmann The music industry hated Napster with a vengeance when it arrived on the scene in late 1999 because it allowed free-for-all downloading of copyrighted works.144 The five largest record companies quickly sued their 138. Metro-Goldwyn-Mayer, 545 U.S. at 930 n.9. 139. See id. 140. A&M Records, 239 F.3d at 1023. 141. Joseph Menn & Jon Healey, Napster Court Case Pits Label vs. Label; Bertelsmann Plans Twofold Defense, L.A. TIMES, June 23, 2003, at C5. 142. Id. 143. Alec Foege, Bertelsmann’s Quest to Harness the Napster Genie, N.Y. TIMES, May 26, 2002, § 3, at 4. 144. Lisa Guernsey, MP3-Trading Service Can Clog Networks on College Campuses, N.Y.

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“No. 1 enemy”145 within weeks for copyright infringement.146 Within a year, Napster agreed to adjust its path, become a pay-for-use service, and distribute part of the fee as royalties.147 German media giant Bertelsmann reversed its position, agreeing to drop its suit and partner with Napster, lending an at-first-undisclosed sum to the company to develop the technology to permit copyright owners to get compensated for the tracks shared over Napster.148 While some hailed the deal as worthy of “praise,”149 Napster users fretted the end of the free service150 and internally there was discord at Bertelsmann.151 The deal would later go sour. The amount lent to Napster was revealed to be $85 million,152 but it was not enough. Bertelsmann entered negotiations to buy Napster, but the talks collapsed.153 Napster‟s chief executive, founder, and other executives left the company.154 Days later, the executives returned when Bertelsmann agreed not to acquire Napster in a merger but rather to purchase its assets for $8 million.155 Bertelsmann executives were pleased with the agreement,156 but their pleasure would later turn to dismay when the torpedo launched toward Napster by the other record companies and other copyright owners found a new target— Bertelsmann.157 Bertelsmann would face an onslaught of litigation and its Napster investment would prove to be an expensive “thorn in its side.”158 In TIMES, Jan. 20, 2000, at G3. 145. Foege, supra note 143. 146. Matt Ritchel & David D. Kirkpatrick, In a Shift, Internet Service Will Pay for Music Rights, N.Y. TIMES, Nov. 1, 2000, at A1. 147. Id. 148. Amy Harmon, Napster Users Mourn End of Free Music, N.Y. TIMES, Nov. 1, 2000, at C1. 149. Editorial, The Napster Deal, N.Y. TIMES, Nov. 2, 2000, at A30. 150. Harmon, supra note 148. 151. David D. Kirkpatrick, Top Two Executives of Bertelsmann Music Will Resign, N.Y. TIMES, Nov. 6, 2000, at C1. 152. Matt Ritchel, If Bertelsmann Wed Napster, It Could Sue Itself, and More, N.Y. TIMES, Apr. 22, 2002, at C1. 153. Matt Ritchel, Turmoil at Napster Moves the Service Closer to the Day The Music Dies, N.Y. TIMES, May 15, 2002, at C1. 154. Id. 155. John Schwartz, Bertelsmann, in a Reversal, Agrees to Acquire Napster, N.Y. TIMES, May 18, 2002, at C2. 156. Id. 157. Vidya Ram, Bertelsmann’s Napster Ghost Begins To Fade, FORBES, Sept. 4, 2007, http://www.forbes.com/markets/2007/09/04/bertelsmann-napster-publishing-markets-equity-cx_vr _0904markets07.html (last visited Oct. 17, 2008). 158. Id.

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February 2003, songwriters and composers sued Bertelsmann, claiming that the company perpetuated Napster with its investment.159 Within four months, Universal Music Group, the world‟s largest record company, sued, claiming that Bertelsmann purposely attempted to continue the infringing free service so that there could be a smooth, uninterrupted transition to the subscription service.160 A few weeks later, EMI filed suit against Bertelsmann for copyright infringement on third-party liability grounds.161 The lawsuits claimed Bertelsmann had de facto control of Napster.162 Bertelsmann contended it was not liable because it did not have an equity stake in the company, seats on its board, or otherwise control the company.163 The companies were vying for upwards of $150,000 for each pirated song, a $17 billion liability for Bertelsmann.164 Settlements followed. The settlements started small,165 but would later rock Bertelsmann.166 In January 2005, Bertelsmann agreed to pay approximately $50,000 to Bridgeport Music, a small record label.167 In September 2006, Bertelsmann decided to sell its music publishing business to Vivendi, owner of Universal Music Group.168 The Bertelsmann-Vivendi deal included a resolution to the lawsuit for $61.2 million.169 In March 2007, Bertelsmann settled with EMI.170 The next month, Bertelsmann settled with Warner Music Group, agreeing to pay $110 million without admitting liability.171 The dollars added up. The loss to Bertelsmann was close to five times its investment in 159. Reuters, Technology Briefing Internet: Bertelsmann Sued Over Napster, N.Y. TIMES, Feb. 21, 2003, at C5. 160. Amy Harmon, Universal Sues Bertelsmann Over Ties to Napster, N.Y. TIMES, May 13, 2003, at C4. 161. Lynette Holloway, Technology Briefing Internet: EMI Sues Bertelsmann On Napster Investment, N.Y. TIMES, June 5, 2003, at C6. 162. Jeff Leeds, Bertelsmann Settles With Small Music Company in Suit Over Napster, N.Y. TIMES, Jan. 20, 2005, at C10. 163. Id. 164. Doreen Carvajal, Rivals May Challenge a Proposed Vivendi-Bertelsmann Deal, N.Y. TIMES, Sept. 7, 2006, at C14. 165. See Leeds, supra note 162. 166. See 2 Music Concerns Resolve Dispute, N.Y. TIMES, Apr. 25, 2007, at C2; see also Bertelsmann Swings to 1st-Half Loss, WALL ST. J., Sept. 5, 2007, at B2. 167. Leeds, supra note 162. 168. Carvajal, supra note 164. 169. Joon Knapen, Bertelsmann Loss Blamed on Charge From Napster Tiff, WALL ST. J., May 16, 2007, at C6. 170. Jeff Leeds, Bertelsmann Reaches Deal With EMI Over Napster, N.Y. TIMES, Mar. 27, 2007, at C4. 171. 2 Music Concerns Resolve Dispute, supra note 166.

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Napster.172 In November 2007, Bertelsmann reported that its net profit for 2007‟s first three quarters fell sharply to $14.8 million from $392 million a year earlier.173 Bertelsmann blamed the settlements of copyright claims that arose from its backing of Napster as a prime reason for their financial woes.174 The results included settlements totaling $410 million related to Napster litigation175 and provisions made for possible future settlements.176

B. The Napster Litigation II: Hummer Winblad Bertelsmann was not the only target in the Napster debacle. Music companies also went after Napster‟s chief venture capital backer, Hummer Winblad, on third-party liability grounds.177 Hummer Winblad invested $13 million in Napster, seven-and-a-half times what Napster had previously raised in capital.178 In return, the firm received a 20% stake in Napster.179 A Hummer Winblad partner was named Napster‟s interim chief executive.180 A year later, he returned full-time to the venture capital firm, but remained on Napster‟s board.181 In fact, Hummer Winblad was said to control the board.182 The Hummer Winblad board members later blocked a purchase offer by Bertelsmann for $16.5 million.183 Less than a year after Napster‟s cessation of operations in July 2001, Napster filed for bankruptcy.184 The legal proceedings continued, however, with various plaintiffs taking aim at the still-solvent entities that invested in Napster before it ceased operations, including Hummer Winblad.185 In April 2003, for example, Universal Music Group and EMI set their sights 172. See id.; see also Bertelsmann Swings to 1st-Half Loss, WALL ST. J., Sept. 5, 2007, at B2. 173. Assoc. Press, Bertelsmann AG: Copyright Settlements Lead to a Drop in Profit, WALL ST. J., Nov. 15, 2007, at B2. 174. Id. 175. Bertelsmann Swings to 1st-Half Loss, WALL ST. J., Sept. 5, 2007, at B2. 176. Knapen, supra note 169. 177. Ann Grimes, Venture Firm Is Sued on Napster Role, WALL ST. J., Apr. 23, 2003, at C5. 178. Lee Gomes, Napster Says Sharing Music Files Is Legal, WALL ST. J., June 14, 2000, at B10. Elsewhere, the figure was stated as $13 million. See, e.g., Matt Ritchel, Napster Has a New Interim Chief and Gets a $15 Million Investment, N.Y. TIMES, May 23, 2000, at C27. 179. Gomes, supra note 178. 180. Ritchel, supra note 178. 181. Matt Ritchel & David D. Kirkpatrick, Napster Will Name New Chief Executive, N.Y. TIMES, July 24, 2001, at C7. 182. Ritchel, supra note 152. 183. Schwartz, supra note 155. 184. In re Napster, Inc., Case No. 02-11573 (PJW) (Bankr. D. Del. filed June 3, 2002). 185. In re Napster, Inc. Copyright Litig., No. C MDL-00-1369 MHP, 2006 U.S. Dist. LEXIS 30338, at *8 (N.D. Cal. May 17, 2006).

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on Hummer Winblad.186 The plaintiffs alleged that Hummer Winblad, along with Bertelsmann, “exercised essentially full operational control over Napster during periods in which Napster remained a conduit for infringing activity.”187 The music companies settled their dispute with Hummer Winblad in December 2006.188 The settlement became effective in March 2007 (upon the district court entering a final, non-appealable order that vacated an earlier order compelling production of privileged documents from the plaintiffs).189

C. The KaZaA Litigation Entertainment companies got “hip” to this new wrinkle in infringement litigation. AOL Time Warner, Sony and other entertainment companies sued KaZaA, a closely held company based on Vanuatu in the South Pacific operating another online file-sharing system190 which has “shaken the music industry to its roots.”191 Vanuatu promised never to disclose the identity of investors and corporate officers.192 In May 2003, however, a Central District of California magistrate judge ordered the company, Sharman Networks Ltd., to disclose its investors, as well as lenders that had declined investment offers.193 The only two Sharman Networks investors whose names were known were Janus Friis and Niklas Zennstrom who developed the Fasttrack network and the Kazaa software that uses Fasttrack enabling users to swap music, movies, software and other copyrighted files.194 The two had assisted in funding Sharman, then sold the Kazaa software and the www.kazaa.com web site to Sharman in exchange for royalties from 186. Grimes, supra note 177. 187. UMG Recordings, Inc. v. Bertelsmann AG, No. C 04-1351 MHP, 2004 U.S. Dist. LEXIS 13143, at *17 (N.D. Cal. July 14, 2004). 188. Leeds, supra note 162. 189. In re Napster, Inc. Copyright Litig., No. C-MDL-00-1369 (MHP), 2007 U.S. Dist. LEXIS 19956, at *6-7 (N.D. Cal. Mar. 20, 2007). 190. Judge says Kazaa must reveal investors, officers, HOUSTON CHRON., May 16, 2003, http://www.chron.com/CDA/archives/archive.mpl?id=2003_3654772 (last visited Oct. 17, 2008). 191. Duff McDonald, The Kazaa Boys Are at It Again, TIME, Dec. 8, 2003, http://www.time.com/time/magazine/article/0,9171,1006421,00.html (last visited Oct. 17, 2008). 192. Doug Bedell, Unlike Napster, Kazaa Can Run and It Can Hide, BOSTON GLOBE, Apr. 13, 2003, at D6. 193. Bloomberg News, KaZaA Operator Told To Disclose Investors, N.Y. TIMES, May 16, 2003, at C6. 194. Kazaa Owner Sharman Networks Dealt Another Legal Blow, 349 THE ONLINE REPORTER: THE DIGITAL MEDIA NEWSWEEKLY 12, May 24, 2003, http://www.onlinereporter.com/TORbackissues/TOR349.htm (last visited Oct. 17, 2008).

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Sharman‟s revenues.195 To grasp the international scope of KaZaA, note that it is estimated that over 200 million people in 150 countries used Sharman‟s Kazaa website frequently, several times more than Napster ever had.196 The disclosure ruling was important because it opened up the possibility that copyright owners would go after the investors and lenders on third-party liability grounds.197

D. The Deutsche Bank Litigation The string of litigation continued, and a plaintiff explicitly went after lenders. In March 2007, software developer Wayne Berry sued Deutsche Bank Trust Company Americas and JPMorgan Chase Bank for vicarious and/or contributory copyright infringement of his copyright in Freight Control System 1993 or “FCS 1993,” a software program he developed.198 The plaintiff alleged that FCS 1993 was unlawfully used by the defendants‟ borrower, Fleming Companies, Inc.199 The plaintiff had filed a direct infringement suit against the borrower in 2001,200 and the defendant lenders are alleged to be the lead agents of 195. Id. 196. Id. 197. In subsequent litigation in Australia, the lead barrister for record and movie company copyright owners, stated in his opening statement that the CEO of Sharman (at least in title if not by power) contended in answers to discovery requests ordered by the court that there were in fact no investors and that prior statements to the press about individual investors were made to make the company appear to be substantial. Susan Butler, Music Industry, Sharman Face off in Australia, CNet, Dec. 9, 2004, http://www.cnet.com.au/mp3players/musicsoftware/0,239029154, 240002881,00.htm (last visited Oct. 17, 2008). The Australian court held in favor of the copyright holders. Wayne Arnold, Australian Court Rules Kazaa Has Violated Copyrights, N.Y. TIMES, Sept. 6, 2005, at C3. The record and movie industries settled their suits with Sharman in July 2006 for $115 million. Eric Pfanner, Record & Movie Industries Reach a Settlement with Kazaa, N.Y. TIMES, July 28, 2006, at C3. 198. Scott D. Baker & Emily B. Kirsch, Does Lender Liability Exist for Copyright Infringement, REED SMITH COM. RESTRUCTURING & BANKR. ALERT, June 2007, available at http://www.reedsmith.com/_db/_documents/crab0706.pdf (last visited Oct. 17, 2008). See Berry v. Deutsche Bank Trust Co. Americas (Berry III), Case No. CV07-00172 SOM/LEK (D. Haw. filed Mar. 29, 2007). This case was transferred to the Southern District of New York in August 2007. Case No. CV07-07634-HB (assigned to Baer, J.), first amended complaint filed Aug. 28, 2007. The case was reassigned numerous times, most recently to Judge William H. Pauley III in November 2007. Notice of Assignment, case doc. no. 19, Case No. CV07-07634-WHP, Nov. 7, 2007. 199. Baker & Kirsch, supra note 198. 200. Berry v. Fleming Cos. (Berry I), Case No. CV01-00446 SPK/LEK (D. Haw. 2001). A second case followed in July 2003 against more companies and individuals. Berry v. Hawaiian Express Serv., Inc. (Berry II), Case No. CV03-00385 SOM/LEK (D. Haw. 2003). Berry II was appealed to the 9th Circuit, with an oral argument held on June 16, 2008.

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certain syndicated credit facilities that Fleming executed in 2002.201 The plaintiff claims he notified the lenders in writing of his claim that the borrower was infringing, and the lenders allegedly denied the infringement.202 In March 2003, however, a jury found that the plaintiff did own a valid copyright in the software and that the borrower had engaged in willful infringement of that copyright.203 Following the jury verdict, the borrower filed a voluntary petition for bankruptcy—it owed the lenders approximately $604 million, and the lenders ceased funding under the existing credit facilities.204 To avoid dissolution, the borrower reached out to the defendant lenders (and apparently some but not all of the participating pre-petition lenders) who lent an additional $50 million of working capital.205 The plaintiff in his most recent case claimed two theories for recovery: (1) the lenders were notified pre-petition of possible infringement, but exercised control over the debtor to continue infringing operations; and (2) the post-petition $50 million lending which allegedly continued the infringing operations.206 The case was dismissed on summary judgment in favor of Deutsche Bank Trust Company on September 30, 2008.207 Given that these cases are beginning to come to court, it seems about time an academic analysis be done to identify the unique and yet unresolved issues in this type of case and to suggest answers to resolve them. The next section of this paper attempts this feat.

IV. INVESTORS‟ & LENDERS‟ POTENTIAL LIABILITY: GOING THROUGH THE FACTORS In this section of the paper, the elements of contributory and vicarious liability are brought to life in the context of investors and lenders, in three parts. First, the author will explain when liability might arise. Possible scenarios under which investments and lending might lead to contributory and vicarious liability claims are discussed, each in turn. Then, the author points out an additional word of caution for individuals involved in these transactions.

201. 202. 203. 204. 205. 206. 207.

Id. Id. Id. Id. Id. Id. Berry III, Order on Motion for Summary Judgment, Sept. 30, 2008 (Case Doc. No. 104).

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A. Investors’ & Lenders’ Contributory Liability As discussed in Part II above, contributory liability arises under two theories: inducement and product distribution. Looking at the possibility of liability arising from “the products or activities that make . . . duplication possible,”208 it seems clear that giving another money via investment or lending will not fall under the product category, but it will raise an inducement question. As detailed above, contributory liability will arise when there is (1) actual or constructive knowledge of the infringement 209 and (2) a material contribution to the infringement.210

1.

Investors‟ & Lenders‟ Knowledge

In the context of going after investors and lenders, one can imagine a few scenarios under which a plaintiff could plead that the defendant had knowledge. If the copyright holder gave notice to the investor or lender about the infringement with support for the allegation, this would be proof of knowledge from at least that time forward.211 Potential investors and lenders must also be careful about what they say in writing about their funding target‟s practices.212 One more log on the fire that sent the Napster settlements so high was a document authored by Napster co-founder Sean Parker that discussed the need to remain ignorant of the real names and IP addresses of the system‟s users “since they are exchanging pirated music” and admitted “we are not just making pirated music available but also pushing demand.”213 In addition to that, the court in the Napster litigation found constructive knowledge because Napster executives had recording industry experience.214 The sophistication of an investor and lender in regards to the relevant technology and/or intellectual property laws may therefore also be raised as a sign of knowledge.215 If the alleged direct infringer‟s activities have been widely questioned in the media for possible 208. Sony Corp. of Am. v. Universal City Studios, Inc., 464 U.S. 417, 442 (1984). 209. Gershwin Publ‟g Corp. v. Columbia Artists Mgmt., Inc., 443 F.2d 1159, 1162 (2d Cir. 1971) (“[O]ne who, with knowledge of the infringing activity, induces, causes or materially contributes to the infringing conduct of another, may be held liable as a „contributory‟ infringer.”). 210. Perfect 10, 487 F.3d at 728 (“[A]n actor‟s contribution to infringement must be material to warrant the imposition of contributory liability.”). 211. Religious Tech. Ctr. v. Netcom On-Line Comm. Serv., Inc., 907 F. Supp. 1361, 1374 (N.D. Cal. 1995). 212. See, e.g., A&M Records, 114 F. Supp. 2d at 918. 213. Id. (emphases omitted). 214. Id. at 919. 215. See id.

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infringement, even without official notice from the copyright owner, the investor or lender might be said to have constructive knowledge. Under the common law “natural and probable consequences” of conduct principle which imputes intent,216 a court may find constructive knowledge when the company being funded is marketing technology that is quite obviously infringing. Once a court finds an investor or lender had the requisite knowledge, it will look to start its material contribution analysis.

2.

Investors‟ & Lenders‟ Material Contribution

As material contribution has been found in numerous cases beyond situations in which the alleged third-party infringer provided the site or facilities for the infringement,217 the question of whether funding alone is sufficient is legitimate. In a recent case, it was held to be a triable issue of material fact for trial whether a third party‟s assistance to an alleged direct infringer in the handling of the alleged direct infringer‟s own money was a material contribution.218 It is thus not hard to believe that a court will hold the same way when money is given to the alleged direct infringer, as was true in the Napster and Deutsche Bank cases detailed in Part III of this paper, which were not resolved on summary judgment. Given the cases 216. JONES, supra note 87; DeVoto v. Pac. Fid. Life Ins. Co., 618 F.2d 1340, 1347 (9th Cir. 1980). 217. See Fonovisa, 76 F.3d at 264 (support services of utilities, parking, advertising, plumbing, and customers). Note, in Fonovisa, the defendant swap meet owner also provided the space for infringement. Id.; see also Adobe Sys., Inc. v. Canus Prods., Inc., 173 F. Supp. 2d 1044, 1056 (C.D. Cal. 2001) (holding providing or arranging for the provision of parking, advertising, and customers sufficient); Faulkner, 211 F. Supp. 2d at 473-74 (in partial denial of motion for partial summary judgment, held that promoting an infringing product or service via advertisement or another method may be sufficient to satisfy the material contribution requirement); Arista Records, 2006 U.S. Dist. LEXIS 14988, at *52 (holding plaintiffs materially contributed by, among other things, promoting the site of infringement and working to attract customers to it); U2 Home Entm‟t., Inc. v. Gatechina.com, Inc., No. C 05-260 JF (PVT), 2007 U.S. Dist. LEXIS 27430, at *16-17 (N.D. Cal. Mar. 27, 2007) (not for citation) (holding that third party‟s establishing merchant accounts to process credit card payments, depositing customer checks made out to direct infringer, managing direct infringer‟s accounts payable, and remitting monies to direct infringer raises triable issues of material fact as to whether the third party is liable for contributory infringement). Cf. Perfect 10, Inc. v. Visa Int‟l Serv. Ass‟n, No. C 04-00371 JW, 2004 U.S. Dist. LEXIS 27477, at *10 (N.D. Cal. Dec. 3, 2004) (not for citation) (“liability for contributory copyright infringement scarcely attaches beyond the actual provision of physical sites and physical facilities for infringing activities.”). 218. U2 Home Entm’t., 2007 U.S. Dist. LEXIS 27430, at *16-17 (holding that third party‟s establishing merchant accounts to process credit card payments, depositing customer checks made out to direct infringer, managing direct infringer‟s accounts payable, and remitting monies to direct infringer raises triable issues of material fact as to whether the third party is liable for contributory infringement).

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that found material contribution when there was a provision of the site or facilities and supports services such as utilities, parking, advertising, and/or plumbing, it seems to be a good policy to hold an investor or lender just as liable. An investor or lender is just one step removed from actually making such provisions. It is her money that allows the alleged direct infringer to purchase, rent, or maintain such site or facilities and supports services. Even if such money is not used for those purposes and is used for something else, the alleged direct infringer, after the funding, can reallocate its own money to those ends. Thus, it can be said that funding has “freed up” the alleged direct infringer‟s resources so that it can self-finance the greasing of the infringing wheel. While it might seem more removed and thus unfair, remember that the third party had the knowledge, actual or constructive, of infringement and proceeded anyway.

B. Investors’ & Lenders’ Vicarious Liability As discussed in Part II above, vicarious liability attaches when a thirdparty profits from the direct infringement yet refuses to exercise a right to stop or limit it.219 Each independent requirement in the context of investors and lenders is discussed below.

1.

Investors‟ & Lenders‟ Financial Benefit

Finding a financial benefit for investors will likely not be difficult, but the story is more complicated for lenders, especially given the variety of lenders. Each is discussed below in turn, followed by a discussion of the additional possible financial benefit of “draw.”

i.

Investors’ Financial Benefit

In return for their capital, investors usually get a share of the business, in stock form or as a contractually defined percent of what the business brings in. This will likely be considered a financial benefit. In Shapiro, Bernstein & Co. v. H. L. Green Co.,220 the Second Circuit found a “most definite” financial interest when a landlord reserved for itself a proportionate share of the gross receipts from the alleged direct infringer‟s

219. See supra note 111. 220. 316 F.2d 304 (2d Cir. 1963).

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sales.221 Similarly, in Playboy Enterprises, Inc. v. Webbworld Inc.,222 a district court found that where a defendant received a percentage of the net income of the business he derived “significant” financial benefit.223 Just last year, another district court, in U2 Home Entertainment, Inc. v. Gatechina.com, Inc.,224 found that a defendant “clearly” benefited financially when it received a percentage of sales.225 Investors should be treated similarly as the value of equity will track sales, barring other factors.226 If the problem is that infringing products are being sold, then investors‟ equity meets the definition of financial benefit, as it captures profit from the infringement. ii. Lenders’ Financial Benefit A creditor‟s liability, on the other hand, may be a different story. A lender extends credit to a debtor by giving permission to borrow money if the debtor promises to pay it back at a later date on a contractual understanding that the borrower grants the lender the right to claim any of the debtor‟s contractually-defined assets upon failure to pay back the loan.227 Recently, a district court addressed the question of a loan in response to a motion for summary judgment regarding third-party copyright liability.228 In Humphreys & Partners Architects, L.P. v. George F. Tibsherany, Inc.,229 the court noted that no federal court has dealt with the 221. Id. at 308. 222. 991 F. Supp. 543 (N.D. Tex. 1997). 223. Id. at 554 (nevertheless holding for defendant on grounds of lack of control). 224. No. C 05-260 JF (PVT), 2007 U.S. Dist. LEXIS 27430 (N.D. Cal. Mar. 27, 2007). 225. Id. at *16-17. 226. See, e.g., Bloomberg News, Share Prices Up for the Week on Profit and Sales Growth, N.Y. TIMES, Oct. 21, 2000, at C3 (“Stocks rose yesterday, finishing their first winning week in seven, as computer-related and telecommunications companies reported faster-than-expected profit or sales growth”); Assoc. Press, Shares Edge Up as Investors Anticipate Earnings Reports: Worries over Jobs and Oil Put Aside, N.Y. TIMES, Oct. 12, 2004, at C10 (“Barring anything to the extreme in earnings season, we‟re just in a market now that will move sideways and in concert with economics, whether jobs data or retail sales data.”) (quoting David D. Legeay, investment strategist for McDonald Financial Group); Polya Lesova, U.S. Stocks End Marginally Higher, Led by Nasdaq: Worries over Weak Retail Sales and Downbeat Housing Data Cap Gains, MARKETWATCH, Dec. 26, 2007, http://www.marketwatch.com/news/story/us-stocks-drop-mixedretail/story.aspx?guid=0DB59E55-0804-4379-B4CF-57551C5472BF&dist=SecEditorsPicks (last visited Oct. 17, 2008) (weak sales led to drop in stocks). 227. Investopedia, Creditor, http://www.investopedia.com/terms/c/creditor.asp (last visited Oct. 17, 2008). 228. Humphreys & Partners Architects, L.P. v. George F. Tibsherany, Inc., No. CIV 03-0169PHX-SMM, 2006 U.S. Dist. LEXIS 46454 (D. Ariz. July 7, 2006). 229. Id.

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issue of whether a creditor, lender, mortgagee, debtee, or other individual who is owed money by an entity is considered to derive a direct financial benefit in the vicarious infringement context.230 Reviewing the first impression facts, the court thought it was “axiomatic” that a creditor has a direct financial benefit in infringement, as repayment of the monies lent depends on the financial success of the direct infringer.231 This quick conclusion may have been arrived at too hastily. The lender arena needs to be subdivided into the range of lenders in today‟s marketplace to explain why this is so.

a.

Plain Vanilla Lenders‟ Financial Benefit

A garden-variety lender should not be held to derive a financial benefit as it would normally not make money in relation to the infringement. A loan deals with the repayment of money. If the creditor only gets back what it lent, this alone does not sound like a financial benefit, as it is not any better off than it was before extending the credit. Of course, most creditors are not charities and credit is given in return for fees and interest, always above inflation. Nevertheless, the ordinary creditor will fight to get that debt paid back one way or another, whether the other party infringes once or a million times and without relation to the financial success of the alleged direct infringer. In fact, if the debtor is unable to make its required payments on time, the creditor will likely apply a fee. In this regard, at least some financial decline of the direct infringer benefits the creditor, at least in theory (collection may get harder), which is inconsistent with a financial benefit that is supposed to be proportional to infringement. Creditors are also the first on line in a bankruptcy proceeding and will go after the assets of the debtor if it cannot get cash (though it is true they may get much less than what was owed them). If a lender‟s fees and interest are in a standard range, they might be viewed as analogous to the landlord that gets a monetary sum fixed up-front without other benefit, which has been found to be not sufficient.232 In Deutsch v. Arnold,233 the Second Circuit held that a landlord who received a fixed sum rental ($200 in 1938 dollars, approximately $3,000 in 2008 dollars234), but was entitled to receive and in fact received nothing in 230. Id. at *15 n.3. 231. Id. 232. See Deutsch v. Arnold, 98 F.2d 686 (2d Cir. 1938) (non-supervising landlord not liable where received only fixed rental). 233. Id. 234. As calculated by the U.S. Department of Labor Bureau of Labor Statistics‟ online

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relation to the acts of infringement was not enough to make her a vicarious infringer.235 The Humphreys court236 is right in the sense that the ease at which the principal, interest, and fees are actually collected might depend on the financial success of the direct infringer. Nevertheless, like the rental in Deutsch,237 the normal fees and interest owed to a lender in an ordinary transaction will not depend on the amount of infringement. The Deutsch landlord‟s collection of rents was also dependent on the financial success of the direct infringer, but liability was not found.238 Given the diversity of lenders, this discussion is not complete. Hybrid and complex financing will lead to myriad permutations on the spectrum of lending. This paper therefore cannot cover all of them. Nevertheless, three important types are described below to start the discussion and act as guideposts.

b.

“Belgian Chocolate” Lenders‟ Financial Benefit

The plain vanilla lender who charges within what might be considered a standard range for interest rates and fees might be different from what might be termed a “Belgian chocolate” lender. Such a lender is one who charges a premium rate of interest and/or fees beyond the standard range. In such a case, the lender‟s unusually high interest rate or fees might directly arise from the fact of higher risk associated with on-going or potential infringement. This would raise the red flag of financial benefit, as the rate and/or fees are tied to infringement. Though the above average interest rate might not change with the level of infringement, it arises because of it, and is therefore problematic. A critic might say this reads some knowledge into vicarious liability. While, as noted above, knowledge of infringement is not a requirement of vicarious liability,239 it can be considered in the analysis. The Supreme Court in 2005reiterated in MetroGoldwyn-Mayer Studios, Inc. v. Grokster, Ltd.240 an idea it had previously explained two decades earlier in Sony241: “the lines between direct infringement, contributory infringement and vicarious liability are not

Consumer Price Index Inflation Calculator, http://data.bls.gov/cgi-bin/cpicalc.pl (last visited Oct. 17, 2008). 235. Deutsch, 98 F.2d at 688. 236. Humphreys, 2006 U.S. Dist. LEXIS 46454, at *15 n.3. 237. Deutsch, 98 F.2d at 688. 238. Id. 239. See supra note 122. 240. 545 U.S. at 931 n.9. See also id. at 942 (Ginsberg, J., Rehnquist, C.J., & Kennedy, J., concurring) (“the two categories overlap”). 241. Sony, 464 U.S. at 435 n.17.

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clearly drawn.”242 Although this very likely would not happen in the sophisticated commercial banking world, if a “Belgian chocolate” lender somehow did not know the risk for which it was getting the high rate, the lender should still be liable because it gained financially (though without knowledge) from the infringement. Placing responsibility for the loss on such a lender has the benefit of creating a greater incentive for the lender to police its lending operations carefully to avoid unnecessary losses to others.

c.

Convertible Debt-Holding Lenders‟ Financial Benefit

In between equity financing and debt financing there lives the hybrid known as convertible debt,243 which requires some discussion. Convertible debt is so-called because it is a loan that can be turned into equity (stock ownership).244 Usually, the conversion takes place upon the occurrence of a triggering event or events, such as a revenue threshold, a financing threshold, or another business target.245 If so contractually defined, the conversion could also occur at the election of the lender or the discretion of the company.246 Until the time the debt is converted into equity, there seems to be no reason the financial benefit test should be different from the above analysis on plain vanilla and “Belgian chocolate” lenders. If, however, the conversion can occur at the discretion of the lender, then the financing is closer to the case of a warrant-holding lender, as detailed below, which raises the question of whether it should be considered a financial benefit.

d.

Warrant-Holding Lenders‟ Financial Benefit

A warrant-holding lender is the case most like an equity holder. A warrant is a derivative security that gives the holder the right to buy equity from the issuer at a certain price within a specific time frame. 247 Warrants

242. Id. 243. Asheesh Advani, Raising Money Using Convertible Debt, ENTREPRENEUR.COM, May 15, 2006, http://www.entrepreneur.com/money/financing/startupfinancingcolumnistasheeshadvani/art icle159520.html (last visited Oct. 17, 2008). See also Jill Andresky Fraser, Anatomy of a Financing: The Benefits of Convertible Debt, INC. MAGAZINE, Feb. 1995, http://www.inc.com/ magazine/19950201/2159.html (last visited Oct. 17, 2008). 244. Advani, supra note 243. 245. Id. 246. Id. 247. Investopedia, Warrant, http://www.investopedia.com/terms/w/warrant.asp (last visited Oct. 17, 2008).

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are somewhat like call options, but issued and guaranteed by the company and measured in years, unlike options which are exchange instruments measured in months.248 As a warrant‟s exercise will occur at the lender‟s discretion within the parameters of the warrant agreement, the terms of the debt issue and its attractiveness will be affected by the expectations for the equity‟s performance. To this degree, the lender benefits from infringement if infringement boosts the value of the equity (at least in the short term before litigation). Warrant-holding lenders thus ought to be held to the same standard as an equity holder.

e.

The Financial Benefit of “Draw”

Plaintiffs have also been held to receive a financial benefit from the “draw” infringement creates toward their business, and investors and lenders should take note. In Fonovisa, Inc. v. Cherry Auction, Inc.,249 the Ninth Circuit held that the plaintiffs stated a claim for vicarious copyright infringement against the defendant swap meet owners where they had control at the site and where the sale of pirated recordings at the swap meet was a “draw” for customers.250 The rule comes implicitly from the early “dance hall cases” in which infringements of popular songs by bands drew customers to the dancing establishment.251 In addition to the use in swap and flea market cases,252 courts have recognized the draw financial benefit in the online context253 and with regards to physical products.254 The use of 248. Id. 249. 76 F.3d 259 (9th Cir. 1996). 250. Id. at 263-64 (explicitly referring to the “dance hall cases”). 251. See Dreamland Ball Room, Inc., 36 F.2d at 355; Buck v. Russo, 25 F. Supp. at 320 (“[Defendant] readily agreed that he aimed to please the patrons in his choice of selections.”); Buck v. Crescent Gardens Operating Co., 28 F. Supp. at 578. 252. Fonovisa, 76 F.3d at 259; UMG Recordings, Inc. v. Sinnott, 300 F. Supp. 2d 993, 100203 (E.D. Cal. 2004); Arista Records, Inc. v. Flea World, Inc., No. 03-2670 (JBS), 2006 U.S. Dist. LEXIS 14988, at *40, *42 (D.N.J. Mar. 31, 2006). 253. Marvel Enters., Inc. v. NCSoft Corp., No. CV 04-9253-RGK (PLAx), 2005 U.S. Dist. LEXIS 8448, at *10 (C.D. Cal. Mar. 9, 2005) (“Defendants financially benefit from the primary infringement „where the availability of infringing material acts as a draw for customers.‟”); IO Group, Inc. v. Veoh Networks, Inc., No. C06-03926, 2007 U.S. Dist. LEXIS 31639, at *8 (N.D. Cal. Apr. 13, 2007) (granting motion requesting discovery of website traffic information); A&M Records, 239 F.3d at 1023 (holding Napster increased its user base by providing its customers with access to pirated copies of protected works and finding that Napster‟s future revenue was directly dependent upon increases in user base). 254. Encore Entm‟t, L.L.C. v. KIDdesigns, Inc., No. 3:03 1129, 2005 U.S. Dist. LEXIS 44386, at *59 (M.D. Tenn. Sept. 14, 2005) (“Under these facts, there is at least a genuine issue of fact as to whether the inclusion of the infringing cassettes and CDs enhanced the attractiveness of the disputed [sing-along] products and served as a „draw‟ to purchasing customers.”).

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draw as a sufficient financial benefit seems fair, considering that there is a relationship between the activities of the counterfeiter and the overall success of the third party‟s business. The “draw” might be stretched to investors and lenders where it can be proved that their action of financing the direct infringer created a “draw” for other targets to come to the investor or creditor, bringing money to the third party via the other customers. Plaintiffs might try to establish such a draw by submitting an expert opinion and report that there was such a draw. In UMG Recordings, Inc. v. Sinnott,255 a recent district court case, the court concluded that such a report could meet the reliability requirements of Daubert v. Merrell Dow Pharmaceuticals, Inc.256 and be helpful to a jury, and therefore be admissible under Federal Rule of Evidence 702.257 The UMG court held that it is not even necessarily required that the expert quantify the draw.258 2.

Investors‟ & Lenders‟ Control

Simply investing or lending alone might not give rise to liability, but to the extent that the investor or lender can exert some degree of control over the alleged infringer‟s activities, she may be in trouble. A court will make a factual inquiry into the point at which an investor and lender would assume sufficient control of the investment or debtor as to be liable.259 Obviously, there are legal and factual differences between an investor and a lender, so the results may be different.260 Investors could run the gamut from someone who owns a single share of a company with millions of shares outstanding to a large or majority shareholder, and while the first would likely not meet the element, the latter likely would. Venture capitalists will have to be particularly careful as they generally are very involved in the strategic decision and operations of their investment.261 Creditors generally function at arm‟s length from the day-to-day operations of the debtors,262 but this might not always be the case. One can envision a scenario under which convertible debt-holding or warrant-holding lenders might exert de facto control because at a time in the possible near future they can have an equity interest, even a majority one, and their conversion or exercising can dilute outstanding shares. 255. 256. 257. 258. 259. 260. 261. 262.

300 F. Supp. 2d 993 (E.D. Cal. 2004). 509 U.S. 579, 593-94 (1993). Sinnott, 300 F. Supp. 2d at 1003 n.9. Id. Baker & Kirsch, supra note 198. Id. Id. Id.

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C. Individuals’ Possible Liability in Investing & Lending Individuals should note that in addition to entity liability, shareholders and employees as investors and lenders may also be liable. This may come about via “piercing of the corporate veil” or personal liability for torts. Each is discussed below.

1.

Piercing the Corporate Veil

One aspect of the Napster litigation that is “particularly interesting,” as pointed out by some practitioners, was that the district court did not discuss corporate law consideration as to whether owners of Napster (private and subsequently traded on Nasdaq since May 2001), Bertelsmann, or Hummer Winblad (a limited partnership whose general partner is an limited liability company)263 were entitled to limited liability for the actions of the Napster corporation, or whether there was a piercing of the corporate veil.264 The question of piercing the corporate veil will require a case-by-case factual analysis.265 It is a basic notion of corporate law that a shareholder is protected from personal responsibility.266 Every state generally follows this rule.267 There are, however, exceptions arising from contracts and case law.268 Piercing may occur when an individual owns substantially all the stock combined with other factors supporting disregard for the corporate fiction.269 Such factors include the gross undercapitalization of the corporation at incorporation or thereafter and failure to observe corporate formalities, non-payment of dividends, the insolvency of the debtor corporation at the time, siphoning of funds of the corporation by the dominant stockholder, non-functioning of other officers or directors, absence of corporate records, and the fact that the corporation is merely a façade for the operations of the dominant stockholder or 263. Hummer Winblad Venture Partners Legal Notice, http://www.humwin.com/legal.cfm (last visited Oct. 17, 2008). 264. Investors Face Potential Liability for Napster’s Copyright Infringement, ROPES & GRAY CLIENT ALERT, Aug. 2, 2004, available at http://www.ropesgray.com/files/Publication/a88a9987f486-4883-9e3a-e72c0dbc9096/Presentation/PublicationAttachment/f704911d-6b0b-49cd-99500ef6e302db81/IP_InvestorsFacePotentialLiability_August2_2004.pdf (last visited Oct. 17, 2008). 265. DeWitt Truck Brokers, Inc. v. W. Ray Flemming Fruit Co., 540 F.2d 681, 684 (4th Cir. 1976). 266. See REVISED MODEL BUS. CORP. ACT § 6.22(b) (1985); DEL. CODE ANN. tit. 8, § 162 (2001). 267. DAVID G. EPSTEIN, RICHARD D. FREER, MICHAEL J. ROBERTS & GEORGE B. SHEPHERD, BUSINESS STRUCTURES 169 (Thomson/West 2007). 268. Id. 269. DeWitt Truck Brokers, 540 F.2d at 689.

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The conclusion to disregard the corporate entity must involve a number of such factors and present an element of injustice or fundamental unfairness.271

2.

Piercing the Limited Liability Company Veil

Even if the third party is a limited liability company (LLC), it is possible that there may be piercing. Whether courts will pierce an LLC is an “open question” in the majority of states.272 It may be statutorily permitted.273 One district court has ruled on the matter, holding that Louisiana would treat an LLC in the same manner as a corporation.274 Numerous commentators agree that an LLC could be treated like a corporation for piercing purposes to the extent that the LLC is analogous to a corporation.275 Therefore, LLC owners should proceed with caution. 270. Id. at 686-87 (citing House of Koscot Dev. Corp. v. Am. Line Cosmetics, Inc., 468 F.2d 64, 66 (5th Cir. 1972) (“ignored normal corporate formalities”); Lakota Girl Scout Council, Inc. v. Havey Fund-Raising Mgmt., Inc., 519 F.2d 634, 638 (8th Cir. 1975) (“corporate formalities [were] not followed”); Dudley v. Smith, 504 F.2d 979, 982 (5th Cir. 1974) (“Corporate formalities were seldom adhered to”); TSS Sportswear, Ltd. v. Swank Shop (Guam), Inc., 380 F.2d 512, 516 (9th Cir. 1967) (“never bothered to go through the regular corporate processes”); Schoenberg v. Benner, 59 Cal. Rptr. 359, 368 (Ct. App. 1967) (non-payment of dividends); TSS Sportswear, 380 F.2d at 516 (insolvency of the debtor corporation at the time); Chatterley v. Omnico, Inc., 485 P.2d 667, 668 (Utah 1971) (siphoning of funds of the corporation by the dominant stockholder); Fin. Counselors, Inc. v. Sec. & Exch. Comm‟n, 339 F.2d 196, 197 (2d Cir. 1964) (non-functioning of other officers or directors)). 271. Dewitt Truck Brokers, 540 F.2d at 687. 272. EPSTEIN ET AL., supra note 267, at 816-17. 273. Robert R. Keatinge, Larry E. Ribstein, Susan Pace Hamill, Michael L. Gravelle & Sharon Connaughton, The Limited Liability Company: A Study of the Emerging Entity, 47 BUS. LAW. 375, 445 (1992) (“Colorado has statutorily applied the piercing of the veil doctrine to LLCs.”). 274. Hollowell v. Orleans Reg‟l Hosp. L.L.C., No. Civ.A. 95-4029, 1998 WL 283298, at *9 (E.D. La. May 29, 1998), aff’d, 217 F.3d 379, 385 n.7 (5th Cir. 2000). 275. See, e.g., Eric Fox, Piercing the Veil of Limited Liability Companies, 62 GEO. WASH. L. REV. 1143, 1167-68 (1994) (noting that most commentators assume that doctrine of piercing the corporate veil applies to LLCs); Keatinge et al., supra note 273, at 445 (“[C]orporate precedents may be appropriately analogous for LLC veil piercing purposes.”); Joseph P. Fonfara & Corey R. McCool, Comment, The Wyoming Limited Liability Company: A Viable Alternative to the S Corporation and the Limited Partnership?, 23 LAND & WATER L. REV. 523, 525 n.12 (1988) (“Thoughtful speculation . . . suggests . . . the „LLC veil‟ is likely to be treated much like the „corporate veil‟ is treated.”); Susan Kalinka, The Louisiana Limited Liability Company Law After “Check-the-Box,” 57 LA. L. REV. 715, 734 (1997) (“[I]t is possible for a court to pierce the veil of an LLC and impose liability for the LLC‟s obligations upon its members.”); Wayne M. Gazur & Neil M. Goff, Assessing the Limited Liability Company, 41 CASE W. RES. L. REV. 387, 403 (1991) (“[T]he most consistent position is that . . . claimants may pierce the LLC‟s veil.”); Curtis J. Braukmann, Comment, Limited Liability Companies, 39 U. KAN. L. REV. 967, 992 (1991) (“Commentators have suggested that courts are likely to treat the LLC much like the corporation

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Personal Liability

Shareholders and employees should keep in mind that they might be personally liable without any piercing of the corporate or LLC veil. Courts have held that vicarious liability provides an alternative source of recovery without shielding an employee from his own personal liability nor supplanting his liability with that of his employer.276 Courts may hold individuals personally liable for their own torts, even when they are acting within the scope of their employment.277 V. HOW TO AVOID & MITIGATE LIABILITY To avoid each theory of third-party liability, one need simply avoid meeting one of the prongs of the respective theories of liability (preferably both prongs, to be safe). What this ends up entailing is refraining from investing in or lending to possible infringers. A. Remember There Are Multiple Bases for Liability One must remember that the two theories of third-party liability are twin snares, and contributory liability itself has two separate bases for liability. One might not meet one of theories of liability, but be liable under another. For instance, one might not know of infringement and thus not be held liable under contributory liability, but still meet the elements of vicarious liability. Additionally, one can meet one basis of contributory liability without necessarily meeting the other. Grokster can be read to interpret Sony as prohibiting the placing into the stream of commerce products that are “„good for nothing else‟ but infringement.”278 This bar is very low. The overwhelming majority of products will be able to vault this “squat hurdle.”279 The Grokster Court nonetheless looked beyond the Sony product distribution theory of contributory liability to the older inducement theory and found liability.280 with regard to piercing.”). 276. See Shannon v. Milwaukee, 289 N.W.2d 564, 568 (1980). 277. Mark R. Hinkston, Piercing the Corporate Veil, 79 WIS. LAW. 12, 48 (2006), available at http://www.wisbar.org/AM/Template.cfm?Section=Wisconsin_Lawyer&template=/CM/Conten tDisplay.cfm&contentid=59707 (last visited Oct. 17, 2008). 278. Metro-Goldwyn-Mayer Studios, Inc. v. Grokster, Ltd., 545 U.S. 912, 932 (2005) (quoting Canada v. Mich. Malleable Iron Co., 124 F. 486, 489 (6th Cir. 1903)). 279. 3 MELVILLE B. NIMMER & DAVID NIMMER, NIMMER ON COPYRIGHT § 12.04[A][5][b] (Matthew Bender & Co. 2007) (1963). 280. Grokster, 545 U.S. at 934-37.

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B. Communicate Cautiously As providing funds to an infringer may invite claims of contributory liability, careful attorneys will counsel clients to avoid knowingly funding infringement. As knowledge must be proved, counsel should advise clients to be wary in their communications with others.281 Messages by the direct infringer encouraging customers to infringe, including in advertisements and solicitations, will be a very bad move, and may come to haunt an investor or lender who with some due diligence could have discovered such communication. Similarly, there should be no internal talk in e-mails, paper memoranda, meeting minutes, voicemails, and recorded or digitized phone calls or other communication about profiting from infringement. Employees should be trained well to avoid this, as communication is becoming rapidly quicker and terse, and comments can later be misread out of context by a judge or jury. Equally important, in the context of this paper on investors and lenders, careful attention should be paid to what is being said in the financing prospectuses and other investment and lending documentation.

C. Take Action in Response to Notices of Copyright Infringement When notified that their conduct constitutes copyright infringement, defendants who continue to infringe without any consideration as to the legitimacy of the notice have little room to claim they acted in good faith.282 Contacted parties ought to stop the actions by which the alleged copyright owner claims he infringes and seek counsel immediately to investigate the claim. Investors and lenders ought to contractually ensure that any notice sent to the target of their investment or lending is immediately forwarded to them.

D. Due Diligence Investors and lenders should consider retaining an outside independent well-recognized due diligence firm without any conflicts of interest to perform intellectual property and litigation due diligence on the targets of funding. This seems especially important given the above expressed

281. NIMMER & NIMMER, supra note 279. 282. Broad. Music, Inc. v. Mirage Images, Inc., No. 1:04-CV-387, 2005 U.S. Dist. LEXIS 42880, at *26 (E.D. Tenn. Nov. 2, 2005).

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common law principle that intent can be imputed,283 as an actor is said to intend to cause the natural and probable consequences of his conduct under tort law.284 While the natural and probable consequences of investing and lending blindly generally may not include infringement, it may be held that along with financing in particular sectors, such as the technology industry, comes the significant potential and maybe “natural” risk of intellectual property infringement, including copyright infringement.

E. Indemnification Investors and lenders should contract with the financing target to obtain the other‟s agreement to indemnify it and hold it harmless for any losses suffered as a result of copyright infringement.285 As the Second Circuit pointed out in Shapiro, Bernstein & Co. v. H.L. Green Co.,286 vicarious liability is not “unduly harsh or unfair” as a third party could have obtained an indemnity agreement.287 Like the entities doing the financing seeking indemnification, involved individual actors might seek their own contractual indemnification from the financing entity or its partners, where applicable.

F. Obtain a License Some financing defendants might opt to obtain a license for the copyright themselves. A license will virtually assure freedom from liability for copyright infringement. Some third-party defendants will be as well placed as the direct infringer to obtain such a license.288 An investor, for instance, may come to have so much control over the target that it effectively manages it. If an investor or lender does not want the license to be in their name, they might also consider funding the target‟s own attainment of a license.

283. Perfect 10, 508 F.3d at1170-71. 284. JONES, supra note 87; DeVoto v. Pac. Fid. Life Ins. Co., 618 F.2d 1340, 1347 (9th Cir. 1980). 285. GOLDSTEIN, supra note 99, at § 8.2 n.14. 286. 316 F.2d 304 (7th Cir. 1929). 287. Id. at 308 (quoting Letter from Melville B. Nimmer to the Copyright Office, in Study No. 25 Prepared for the Subcomm. on Patents, Trademarks, and Copyrights of the S. Comm. on the Judiciary, 86th Cong., 2nd Sess. 169). 288. GOLDSTEIN, supra note 99, at § 8.2 n.14.

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G. Insurance Investors and lenders should also consider obtaining insurance covering the possibility of copyright infringement before conducting financing transactions. As it did for indemnity, the Second Circuit, in Shapiro, Bernstein, pointed out the fairness in imposing vicarious liability where one could obtain insurance to cover liability costs.289 Other courts have agreed. In Columbus Farmers Market, LLC v. Farm Family Casualty Insurance Co.,290 for example, a district court recently granted a motion for partial summary judgment in favor of an insured involved in separate copyright litigation based on third-party liability on the issue of whether the insurer had a duty to defend.291 The court found that the insurer did have a duty to defend under a commercial lines insurance policy with comprehensive general liability coverage where such policy covered “advertising injury” defined in part as “injury arising out of . . . [i]nfringement of copyright.”292 Investors and lenders should be careful in the insurance policy drafting process to make sure the coverage is wide. In the New York Court of Appeals case of A. Meyers & Sons Corp. v. Zurich American Insurance,293 the court found the policy‟s “advertising injury” definition narrower than in Columbus Farmers294 and held that in order to be covered the claimed injury must arise out of an “offense occurring in the course of the insured‟s „advertising activities.‟”295 The court held so because the policy defined the term “advertising agency” as, among other things, “infringement of copyright . . . [arising] out of an offense . . . occurring in the course of named insured‟s advertising activities.”296 The more in-depth definition limited the coverage for copyright infringement to a specific class of infringement cases related to advertising.297 Investors and lenders are thus urged to know the details when purchasing an insurance policy.

289. Shapiro, Bernstein, 316 F.2d at 308 (quoting Letter from Melville B. Nimmer to the Copyright Office, in Study No. 25 Prepared for the Subcomm. on Patents, Trademarks, and Copyrights of the S. Comm. on the Judiciary, 86th Cong., 2nd Sess. 169). 290. No. 05-2087, 2006 U.S. Dist. LEXIS 92448 (D.N.J. Dec. 21, 2006). 291. Id. at *6, *51. 292. Id. at *6-8, *51. 293. 545 N.E.2d 1206 (N.Y. 1989). 294. 2006 U.S. Dist. LEXIS 92448, at *26. 295. Meyers, 545 N.E.2d at 1208. 296. Id. 297. Id.

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H. Target’s Representation & Warranty of No Knowledge and No Infringement Investors and lenders should obtain a contractual representation and warranty from the financing target that it is has done a thorough search to determine that it is not currently infringing any intellectual property. This may help to show a lack of knowledge for contributory liability purposes. Any such guarantee by the financing target should also be coupled with the financier‟s own due diligence. Financiers rely on others‟ due diligence at their own detriment. Third parties should also agree in the financing contract that the target will not infringe any copyrights. Note, though, that a defendant may be held vicariously liable even though its agreement with the target expressly requires the target not to infringe any copyright. Such an agreement does not negate its control and potential financial benefit. While contributory liability requires knowledge, an express agreement with a known infringer will not protect the financier because of the “natural and probable consequences” imputed knowledge rule.298

VI. OFFSHORE ACTIVITIES MAY LEAD TO LIABILITY IN U.S. & ABROAD Investors and lenders might not escape the clutches of third-party liability by performing their activities abroad. First, investors and lenders may be liable in the U.S. for funding activities that cause infringement in the U.S. Second, financiers may find courts in other countries will warm to third-party liability. Investors and lenders should be aware that they may be liable in the U.S. for extraterritorial funding activities that cause copyright infringement in the U.S. In Blue Ribbon Pet Products, Inc. v. Rolf C. Hagen (USA) Corp.,299 a district court, in a case involving a Canadian producer, noted that while U.S. copyright laws generally do not have extraterritorial application, a defendant can be liable for its acts committed outside the U.S. under contributory liability‟s inducement or product distribution bases when direct infringement occurs in the U.S.300 298. JONES, supra note 87; DeVoto v. Pac. Fid. Life Ins. Co., 618 F.2d 1340, 1347 (9th Cir. 1980). 299. 66 F. Supp. 2d 454 (E.D.N.Y. 1999). 300. Id. at 462-63 (citing G.B. Mktg. U.S.A., Inc. v. Gerolsteiner Brunnen GmbH & Co., 782 F. Supp. 763, 772-73 (W.D.N.Y. 1991) (“[H]olding that „Congress‟s use of the phrase “to authorize” in 17 U.S.C. § 106 was intended to establish the liability of a “contributory infringer,” which is a person “who, with knowledge of the infringing activity, induces, causes, or materially

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Financing parties should also be aware that other countries impose third-party liability301 and future plaintiffs might try to expand other nations‟ jurisprudence to cover investors and lenders. Investors and lenders should seek local counsel regarding these matters.

CONCLUSION This paper has traced third-party liability (vicarious and contributory) in the field of copyright infringement from its roots to its future use against financial backers of companies. In response to recent cases, this paper has laid out how investors and lenders may be liable as third parties and how they might avoid such liability. As this paper has demonstrated, this is an exciting new area of law for which an astute understanding will become increasingly necessary for practitioners and clients, while raising novel issues for academia and the judiciary to consider.

contributes to the infringing conduct of another,”‟ and that „when a foreign corporation is alleged to have purposefully injected itself into the American market by shipping infringing goods here— regardless of whether it does so directly or through an importer—the defendant should not be allowed to use the principle of non-extraterritoriality to shield itself from the reach of American courts and American copyright law.‟”)). 301. PAUL GOLDSTEIN, INTERNATIONAL COPYRIGHT: PRINCIPLES, LAW & PRACTICE 270-74 (2001).

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