THE PRINCIPLE OF EXHAUSTION
The principle of exhaustion is an established international legal doctrine. It provides that a copyright owner’s right to control copies of their work “exhausts” on its first sale by the copyright owner or with their consent. The principle prevents the copyright owner’s right to control copies of their work from extending beyond the point at which they receive reasonable remuneration for the copy. Further, it allows the purchaser to have control over their copy, including the right to resell it free from interference by the copyright owner. In the UK we have codified this principle in national legislation. Sections 16(1)(b), 18(1) and 18(2) of the Copyright Designs and Patents Act 1988 (the CDPA) establish the copyright holder’s exclusive right to issue (i.e. distribute) copies of their work to the public and provide that infringement shall occur where a third party encroaches on this right. Section 18(3)(a) sets out the principle of exhaustion by stating that the subsequent distribution of copies of a work (such as selling on a purchased copy second-hand) will not infringe the rightholder’s distribution right.
The European Union (the EU) has further developed the principle of exhaustion, but primarily from the perspective of enshrining the free movement of goods throughout the EU and standardising the approach across EU Member States. This was achieved through EU Directive 2001/29/EC on the harmonisation of certain aspects of copyright and related rights in the information society (the InfoSoc Directive). It was also achieved by Directive 2009/24/EC on the legal protection of computer programs (the Software Directive), which applied the principles of the InfoSoc Directive to computer programs, including games and software.
Article 4 of the Infosoc Directive establishes the copyright holder’s distribution right and also the conditions of the right’s exhaustion on first sale or other transfer of ownership of the copies or of the original. Similar provisions are made specifically in relation to computer programs under Article 2 and 4 of the Software Directive. However, there are differences between the two Directives, which were particularly relevant in the consideration of the UsedSoft decision. Most notably, the absence in the Software Directive of recitals 28 and 29 of the Infosoc Directive. Recital 28 states that protection relates to works incorporated in a tangible article (e.g. a CD-ROM) and that first sale exhausts the right to control resale of that object in the EU. Recital 29 specifically states that exhaustion does not arise in relation to services and on-line services. For a summary please refer to Table 1.
CASE ANALYSIS (USEDSOFT V ORACLE)
Oracle International Corp. (Oracle) is a software company. It offered perpetual group licences of its Client-Server-Software (a databank software) based on 25 users in exchange for a one-off payment. The licensee would receive the right to use the software, download a copy from Oracle’s website, store it on a server and allow the number of users permitted by the licence to access it by downloading it to their computer hard-drives. The perpetual licence also included a maintenance agreement, which enabled the licensees to download software updates and patches from Oracle’s website for the lifetime of the licence (i.e. forever).
Undertakings with fewer than 25 users often “hived off” what they considered to be excess user licences and sold them on to second- hand or used software companies such as the defendant in this case, UsedSoft GmbH (UsedSoft). UsedSoft would then resell these excess user licenses to their customers on the basis that the licence was still valid and the maintenance agreement element still effective. The purchaser of the second-hand licence could then download the software (and the on-going updates and patches) from Oracle’s website for the number of user licences they had bought.
In the German Regional Court (Munich) Oracle claimed that UsedSoft and its customers were infringing its exclusive rights under the German national law which had implemented the Software Directive. In particular, Oracle challenged UsedSoft on the grounds that by “permanently or temporarily reproducing Oracle’s computer program” and by “distributing the original program or copies thereof to the public without Oracle’s authorisation” UsedSoft and its customers were infringing Oracle’s exclusive rights of reproduction under Article 4(1)(a) and distribution under Article 4(1)(c). Further, Oracle argues that neither of the restricted acts had been excepted from infringement by either Article 5(1) (reproduction is necessary) or Article 4(2) (exhaustion).The court agreed with Oracle and granted them an injunction against UsedSoft’s continued activity. UsedSoft appealed to the German Federal Court (the Bundesgerichtshof). They decided to refer three questions on the application and interpretation of the Software Directive to the CJEU (refer to Table 2).
THE CJEU’S DECISION
The CJEU first established that the EU wide definition of a sale should be “an agreement by which a person, in return for payment, transfers to another person his rights of ownership on an item or tangible or intangible property belonging to him”. Despite Oracle’s use of the word “licence” and their insistence that it was a true software licence, the CJEU decided that concluding the grant of a perpetual licence with a maintenance agreement and downloading a copy of the software formed an indivisible whole transaction which amounted to a sale capable of exhausting Oracle’s right of distribution in the copies of the software.
Having determined that Oracle was selling its software, rather than granting licences, the next issue considered by the CJEU was whether UsedSoft and their customers, having both relied on the exhaustion of distribution right in the copies of the software that they purchased from customers of Oracle, could be “lawful acquirers” under Article 5(1) thus allowing them to permanently or temporarily reproduce the program without authorisation from Oracle. The CJEU concluded that, as the right of distribution had been exhausted, it was impossible for the rightholder to object to any subsequent transfers of the software. Therefore, any second-hand acquirer must also be a lawful acquirer with the right to reproduce the program for the purposes of its intended use.
However, the CJEU also concluded that where the computer program is sold as a bundle account purchase (as in this case) the “excess” accounts were not divisible from the bundle. In other words, the fact that the transaction amounts to a sale applies to the group as a whole, but not to the individual accounts, which cannot be sold on individually. So although the principle behind the resale element of UsedSoft’s business model was legitimate on the basis that the principle of exhaustion applied, the sale applied solely to the bundle and it did not enable the original bundle accounts to be divided and sold separately.
TABLE 1: RELEVANT ARTICLES OF THE SOFTWARE DIRECTIVE
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TABLE 2: QUESTIONS REFERRED TO THE CJEU
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Finally, the CJEU made a number of strong statements about the principles of equivalence between online and offline property. In particular, (1) that it made no difference in “this situation” whether the copy of the computer program was made available to the customer by the rightholder by means of a download or a physical CD or DVD and (2) that the online transmission method was the “functional equivalent” of the supply of a material medium. To reinforce this attitude towards online-offline equivalence, the CJEU advised that, in practice, to avoid infringing the Article 4(1)(a) reproduction right by relying on the exhaustion principle, the original acquirer would have to make their own copy unusable on resale, just as it would be if the program was sold on in a tangible medium.
The case has ramifications for the software community. Already some software providers are, or are being advised to, switch to fixed term licences - the intention being that granting licences for a set duration might enable companies to avoid “selling” copies of their software for the purposes of exhaustion. There has also been speculation about how this decision could impact other digital media content such as eBooks and digital music, which are governed by the InfoSoc Directive rather than the Software Directive on which the UsedSoft decision centred. The provisions of recitals 28 and 29 to the InfoSoc Directive suggest that the principle of exhaustion should only apply to tangible media. As a result one could conclude that although the decision is relevant to the computer programs and video games covered by the Software Directive, the CJEU’s judgment should not be extended to include other forms of digital media. However, if we consider the CJEU’s commitment to the principles of online-offline equivalence throughout its judgment, its frank statement that the two directives must in principle have the same meaning and, finally, its establishment of an EU wide definition of “sale” to be applied to tangible and intangible property, it is reasonable to opine that, if given the opportunity, the CJEU will also interpret the InfoSoc Directive exhaustion provisions as applying to tangible and intangible property.
On this basis, therefore, the fact that the vast majority of other digital media is licensed in the same or similar manner to software (i.e. via perpetual licences with terms and conditions applied to use rather than outright sales) it is reasonable to infer that these licences will also amount to “sales” for the purposes of exhaustion.
THE TECHNOLOGICAL ISSUES SURROUNDING EXHAUSTION FOR INTANGIBLE DIGITAL MEDIA
The practical technical issue facing software producers as a result of the UsedSoft decision (and potentially other forms of intangible media) is how to practically ensure that the original acquirer’s copy becomes unusable on resale.
The CJEU has encouraged the use of Technical Protection Measures (TPMs). An earlier German decision (Bundesgerichtshof I ZR 178/08 - Half-Life 2; OLG Hamburg) determined that the use of TPMs would not prevent the exhaustion of rights in a copy. However, in this case the restrictive TPMs applied to the video game meant that only one user per copy could ever register an account. Thus a second-hand acquirer, though in possession of the tangible media (i.e. a CD-ROM) imprinted with the software, was unable to access the game, they were “locked- out”. In light of the UsedSoft decision one can reasonably anticipate that such restrictive TPMs, while still lawful, may be held by the CJEU to frustrate the principle of exhaustion. In fact, the use of TPMs to prevent the use of the software by a purchaser after the original acquirer sold it on, recently received a negative opinion on from Advocate General Sharpston in CJEU Case-355/12 Nintendo Co. Ltd, Nintendo of America Inc. and Nintendo of Europe GmbH v PC Box Srl and 9Net Srl (Nintento v PC Box) referred to the CJEU by the Tribunale di Milano in Italy.
In this case Nintendo challenged PC Box (and 9Net Srl, the internet provider which hosts PC Box’s website) on the basis that its sale of mod chips and game copiers, which enable video games other than those manufactured by Nintendo to be played on Nintendo consoles, infringed Nintendo’s right under Article 6 of the InfoSoc Directive. Article 6 allows the copyright holder to put in place effective technological measures to prevent unauthorised acts in respect of its copyright works. AG Sharpston, however, concluded that, although the technological measures put in place by Nintendo did indeed achieve this, they also prevented authorised acts. She determined that there is unlikely to be any justification for protection of TPMs which prevent or limit acts outside of the rightholder’s authorisation. If this opinion is followed by the CJEU it should establish the boundaries for TPMs used in software as was advised in UsedSoft, and possibly for all digital media.
ECONOMIC IMPLICATIONS OF A SECOND-HAND DIGITAL MARKETPLACE
Beyond the legal ramifications resulting from the development of the principle of exhaustion to cover intangible goods, the creation of a second-hand digital media marketplace may also present significant economic issues. In the existing second-hand book market, for example, it is easy to identify the drop in value of a second hand copy - e.g. by the fact that the book looks “worn”. However, there is no truly comparative decrease in quality for a second hand digital file (unless as a result of corruption during the file transfer) so, in the absence of some distinguishing feature, a second hand copy will be perfectly identical to the original in all respects, except for price. In economic terms the competitive sale of homogeneous products that are perfect substitutes for each other is referred to as “pure price competition”. In this case, authors of digital works will be placed in direct competition with copies of their works which are identical in quality, but sold at a cheaper price or even swapped for free. Such a market place could be economically destabilising to the publishing industry.
DEVELOPMENT OF A SECOND-HAND DIGITAL MARKETPLACE
As we have discussed, the strength with which the CJEU has expressed its commitment to online-offline equivalence with respect to computer programs suggests that they may very well come to a similar conclusion on exhaustion in relation to digital media covered by the InfoSoc Directive. This will allow the development of a second hand digital media market place. The CJEU appears to envisage that the development of such a market place will require the application of appropriately targeted TPMs that ensure that once sold the original copies become unusable, while simultaneously not frustrating the effect of exhaustion on first sale or distribution. The use of appropriately targeted TPMs could also mitigate some of the impact of “pure price competition”.
In view of the progression of case law and in response to the 2011 Digital Opportunity A Review of Intellectual Property and Growth Report (aka the Hargreaves Review after the Report’s author Professor Ian Hargreaves), the UK Intellectual Property Office (the UKIPO) has proposed amendments to the CDPA. One of these amendments would create a private copying exception to permit an individual who has acquired a copy of a copyright work to make a further copy for non-commercial ends and to be entitled to transfer the original copy to another person, provided that he/she then destroys the duplicate or provided that the duplicate becomes unusable as a result of the function of a TPM. This amendment would be in keeping with the development or foreseeable development of copyright law, in particular in relation to exhaustion, following the UsedSoft decision.
It is generally recognised that the speed at which law and regulations move lags behind the development of technology, which has already moved into new formats such as “cloud”-based computing. How relevant will the legal issues surrounding digital files, whether as copies or originals be, when we stop “owning” copies of software on our hard drives and instead make use of such software via the cloud?
Spotify is an everyday example of cloud computing. Spotify enables users to “stream” Spotify’s online libraries of music. Once again, access to the media is via an online account, negating the need to buy and download music onto your own hard drive. Reliability of internet access is limiting step of cloud computing, but as the quality, speed, consistency and reliability of access improves, it is likely that we will increasingly migrate away from copies of digital files. But where will this leave the relevancy of the UsedSoft decision and the development of second hand digital markets? Probably limited to digital copies, but new thinking may change.
This article was previously published in Lawyer Monthly magazine