On May 5th, the U.S. Court of Appeals for the Ninth Circuit, en banc, issued a long-awaited decision in a suit brought by a group of artists against several major auction houses, [Estate of Graham v. Sotheby’s Inc.; Sam Francis Foundation v. Christie’s, Inc., 860 F.Supp.2d 1117 (C.D. Cal. 2012)] upholding, but narrowing, the District Court’s 2012 decision, which struck down the California Resale Royalty Act (CRRA) for impermissibly regulating out-of-state conduct.  Since it was enacted in 1976, the CRRA has been the only artist’s resale royalty statute in the U.S., and remains so, applying now exclusively to sales occurring within California.  The economic impact of this California-only five percent resale royalty will likely be felt immediately, as California-based sellers weigh the convenience of a local sale against out-of-state sales.

Severability

While the District Court struck down the whole of the CRRA, finding that the out-of-state sales regulation could not be severed from the remainder of the CRRA, the Ninth Circuit struck down only the clause that imposed the resale royalty on out-of-state sales. On the question of whether the clause regulating out-of-state sales could be severed, allowing the rest of the CRRA to stand, the District Court had found that the legislative history of the CRRA showed that the legislature had considered and abandoned a version of the bill that would have only regulated sales within California.  The court noted that “the legislature endorsed the CRRA’s extraterritorial reach, despite the fact that California’s Legislative Counsel [Stanford law professor John Merryman] advised both Assemblyman Sieroty and then-Governor Brown, in opinion letters, that the bill ‘would constitute an undue burden on interstate commerce in contravention of the Federal Constitution in its application to sales which occur outside the State of California.’” [Estate of Graham v. Sotheby’s Inc.; Sam Francis Foundation v. Christie’s, Inc., 860 F.Supp.2d 1117, 1126 (C.D. Cal. 2012)]

On the question of whether that portion of the CRRA that applied the resale royalty to out-of-state sales, the Ninth Circuit was unanimous in holding that it did, in fact, facially violate the dormant Commerce Clause and was therefore unconstitutional. [Sam Francis Foundation v. Christie’s; Estate of Graham v. Sotheby’s, Case Nos. 12-56067, 12-56058, 12-56077, 2015 WL 2059003, *2 (May 5, 2015)] The Ninth Circuit was also unanimous in holding that the offending provision could indeed be severed from the rest of the CRRA, but the Ninth Circuit was divided on the extent of the portion to be severed.  The CRRA provided that the five percent resale royalty would apply if “the seller resides in California or the sale takes place in California.”  Cal. Civ. Code § 986(a). The majority severed “the seller resides in California,” leaving the in-state sales provision (“the sale takes place in California”) in effect.

In so holding, the majority reasoned that “we think that the legislature actually foresaw the partial invalidation of the statute. . . . Despite [the warnings noted above by legislative counsel that the out-of-state regulation would violate the Commerce Clause], the enacted version of the law included regulation of both in-state sales and out-of-state sales in easily separable clauses.  Perhaps most tellingly, the enacted version also added the severability clause, which expressly states the legislature’s intent that ‘the provisions of this section are severable’ if ‘any provision of this section or the application thereof to any person or circumstance is held invalid for any reason.’” [Id. at *5]

However, Judge Reinhardt, in a long and harsh partial concurrence and partial dissent, disagreed with the majority’s decision to strike all out-of-state sales.  Judge Reinhardt agreed that “the majority is compelled to conclude that, under the Supreme Court’s dormant Commerce Clause jurisprudence, the out-of-state regulation of out-of-state entities is unconstitutional and that, as a result, the auction-house defendants cannot be subjected to the obligations required of them in connection with sales that take place outside of California.” [Id.]  In Judge Reinhardt’s view, the CRRA only violated the Commerce Clause in out-of-state sales when it imposed duties to collect the resale royalty on non-California-based agents of California sellers.  If the duty to collect and pay the royalty were imposed instead on the California-based seller (and not on non-California-based auction houses), he reasons, the CRRA’s regulation of out-of-state sales could survive constitutional challenge.  By striking down the CRRA as it relates to all out-of-state sales, the majority, he states, “has simply decided an unnecessary constitutional question without any need or cause to do so.” [Id. at *7]

The Issues on Return or Remand

The most interesting issues relating to the CRRA, and the issues with the most far-reaching ramifications for state and federal resale royalty statutes, have yet to be addressed.  Because the District Court struck down the whole of the CRRA, it never reached the auction houses’ remaining arguments against the CRRA – namely, that it (i) effects an unconstitutional taking of private property, and (ii) is preempted by the federal Copyright Act of 1976. The Ninth Circuit noted that “[w]e return this case to the three-judge panel for its consideration of the remaining issues. We leave to the panel’s discretion the decision whether to address those issues on the merits or to remand them for the district court’s determination in the first instance.”[ Id. at *5]  Decisions on either or both of these remaining issues could yet invalidate the CRRA’s in-state royalty regulation, and these issues are directly relevant to the proposed federal resale royalty, the American Royalties Too (ART) Act. I have previously discussed the re-introduced ART Act here.

Fifth Amendment: Resale Royalty as a Taking of Private Property

The Fifth Amendment to the U.S. Constitution states that “private property [shall not] be taken for public use, without just compensation.” [U.S. Const. amendment V]  Opponents of resale royalty statutes argue that such statutes violate the Fifth Amendment’s prohibition against uncompensated takings by compelling the transfer of  the royalty amount from one private individual (the seller) to another private individual (the artist) without a public purpose or compensation to the seller. [Defendants’ Joint Motion to Dismiss the Complaints, 2012 WL 1580650, *15 (C.D. Cal. Jan. 12, 2012).

The U.S. Supreme Court’s takings jurisprudence recognizes two categories of governmental takings – physical takings (also known as per se takings), in which the government acquires private property typically as a result of condemnation proceedings or physical appropriations, and regulatory takings, in which governmental regulation interferes with private property owners’ reasonable investment backed expectations.  Regulatory takings require a highly fact-based analysis.  Resale royalty statutes are at their most vulnerable to takings challenges with respect to their retroactive application to already-created and already-purchased artworks – i.e., the application of the resale royalty to artworks already owned prior to the date the statute goes into effect.  The reason for this is that a collector who acquired an artwork before the resale royalty went into effect made that purchase with an understanding that the collector was acquiring clear title to the artwork, free of the encumbrance of the resale royalty.  When the resale royalty is applied to any resale of that already-owned artwork, the collector’s ability to realize on his or her investment is impaired, at least with respect to what the collector’s expectation was at the time the artwork was originally purchased.

In its 2013 report to the Senate and House Committees on the Judiciary, Resale Royalties: An Updated Analysis, which updated its earlier 1992 report, the U.S. Copyright Office acknowledged that resale royalty statutes may be vulnerable to Fifth Amendment takings challenges.  The report notes that:

the Office believes that the outcome of a takings challenge on this basis cannot be predicted with certainty – particularly given the fact-bound nature of the analysis. . . .  [I]n the interests of avoiding constitutional doubt and of minimizing the federal government’s exposure to unnecessary litigation, we recommend that Congress strongly consider making any resale royalty legislation prospective in application. . . . A prospective resale royalty law could take a number of forms.  The 1992 Report recommended that such a law be ‘effective only as to the resale of eligible works created on or after the date the law becomes effective.’  This approach would provide the greatest degree of notice to artists and prospective purchasers.  Another model would be to apply the royalty to preexisting works but to provide an exemption for the first sale of such works following the law’s effective date. [Id. at 63]

With respect to the CRRA, the auction houses challenged the statute as effecting an uncompensated, non-public taking of private property.  If the Ninth Circuit three-judge panel or the District Court were to find that the CRRA effects a per se taking, the statute could be stricken in its entirety; whereas, if the court were to analyze the statute as a regulatory taking (which is more likely where, as here, the taking at issue is economic, not physical, in nature) and find there to be a taking, the court would be more likely to strike down the statute only as it applies to artworks either created or purchased prior to 1976, the date the CRRA was enacted.  In either case, the court’s analysis will be closely watched not only for its impact on the CRRA and the California secondary market, but even more as a harbinger of possible challenges to the Art Act, should it be enacted.

First Sale Doctrine: Resale Royalty as Preempted by the Federal Copyright Act

The second remaining issue raised by the auction houses is whether the CRRA (and, by extension, any resale royalty statute) runs afoul of the federal Copyright Act’s first sale doctrine.  While the auction houses raised both the takings challenge and the first sale doctrine preemption argument in their motion to dismiss, they chiefly focused on the first sale doctrine argument in their appellate briefing.

While section 106(3) of the Copyright Act reserves to the copyright holder the right to “distribute copies. . . of the copyrighted work to the public by sale or other transfer of ownership, or by rental, lease, or lending,” [17 U.S.C. § 106(3)]  that right is limited by section 109(a), which provides that “the owner of a particular copy . . .  is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy.” [17 U.S.C. § 109(a)]  This right of the owner of a copy of a work is known as the “first sale doctrine,” and it cuts off the copyright holder’s right to control the further distribution of a copy of a work after the first sale to a purchaser.  In the context of art, where a work may exist in a single copy or a limited number of copies, once the artist has sold a work/copy, the artist no longer controls any future sales of that work/copy.  The first sale doctrine has been qualified in certain circumstances.  Under the Visual Artists Rights Act (VARA), [17 U.S.C. § 106A] for example, restricts an owner’s right to modify an artwork in a manner that is prejudicial to the artist’s reputation.

The auction houses argued that:

the CRRA dictates the terms of downstream transactions and gives the artist a financial interest in each sale, putting the CRRA in conflict with the Copyright Act. . . . By obligating resellers of fine art to locate and compensate the original copyright owner, the CRRA restrains the very downstream transactions that the Copyright Act intends to be unrestricted.  Indeed, the CRRA explicitly applies only to such downstream sales.  See Cal. Civ. Code 986(b)(1) (requirements do not apply ‘[t]o the initial sale of a work of fine art’).  And not only does the Act apply beyond the first sale, it controls all future sales until 20 years after the artist’s death.  See id. 986(a)(7).  The CRRA thus violates the first-sale doctrine, disrupting the Copyright Act’s delicate equilibrium. [Defendants’ Joint Motion to Dismiss the Complaints, 2012 WL 1580650, *59-64 (C.D. Cal. Jan. 12, 2012)]

The U.S. Copyright Office, in both its 1992 and 2013 reports, acknowledged that resale royalty statutes violate the Copyright Act’s first sale doctrine. [1] Leading copyright treatises have also noted that the first sale doctrine presents a strong challenge to resale royalty statutes.[2] As the Copyright Office has noted, there is no constitutional bar to Congress modifying the first sale doctrine to provide for a resale royalty right. [3] While this is instructive in reviewing the text and policy discussions surrounding the federal ART Act, it does little to support a conclusion that the CRRA can survive the challenge that it is preempted by the Copyright Act’s first sale doctrine.

In the interim, those interested in the secondary art market will be watching and waiting to see what the Ninth Circuit three-judge panel or the District Court will make of these arguments, and what it will mean for the CRRA.