On September 10, 2010, the U.S. Court of Appeals, Ninth Circuit issued a muchawaited ruling on appeal in Vernor v. Autodesk, No. 09-35969, 2010 U.S. App. LEXIS 18957, addressing whether software purchasers are owners or licensees of the copies of the software in their possession. The court held that “a software user is a licensee rather than an owner of a copy of the software where the copyright owner (1) specifies that the user is granted a license; (2) significantly restricts the user’s ability to transfer the software; and (3) imposes notable use restrictions.”

The distinction between owner and licensee can be critical to software publishers because owners have certain rights not afforded to mere licensees under copyright law.

Background and Lower Court Ruling

Timothy Vernor is an individual who offered lawfully made packages of Autodesk’s AutoCAD software for sale on eBay. When Autodesk sent eBay a DMCA take-down notice, Vernor countered and eventually sued for declaratory relief.

The copies at issue were originally provided subject to terms of an Autodesk software license agreement, which included restrictions on the transfer of the Autodesk software. Since the copies at issue were lawfully made, if Vernor and his predecessor transferee were deemed owners of the copies, they would plainly be allowed — pursuant to the first sale-doctrine — to sell their copies to others without violating Autodesk’s distribution right. But if they were merely licensees, they would not have the right to re-sell the software. The lower court held that the initial transfer of the software from Autodesk was a sale, not a license.

Three-Prong Test for Software: a License or a Sale

The Ninth Circuit overturned the lower court’s decision, siding with Autodesk and concluding that the first-sale-doctrine did not apply because Vernor was not an owner of the copies of the software he possessed.

Purporting to reconcile a group of earlier Ninth Circuit decisions which suggested varying tests, the Vernor court adopted a three-pronged test to determine whether software is licensed or sold: “First, we consider whether the copyright owner specifies that a user is granted a license. Second, we consider whether the copyright owner significantly restricts the user’s ability to transfer the software. Finally, we consider whether the copyright owner imposes notable use restrictions.”

The Autodesk software license agreement described itself as a license and the agreement specifically included limitations on the transfer of the software. On the critical issue of whether the agreement imposed “notable use restrictions,” the court noted that it barred use outside the Western Hemisphere; modifying, translating, or reverse-engineering the software; removing any proprietary marks; and defeating any copy protection device. The court therefore concluded that “Autodesk’s direct customers are licensees of their copies of the software rather than owners.…” This, the court held, had two ramifications: Vernor could not invoke the first sale-doctrine, nor could he assert an essential step defense on behalf of his customers. That defense provides that “the owner of a copy” of software does not infringe by making a copy (e.g., loading the program into RAM) if it is “created as an essential step” in the use of the program in a machine.

Policy Arguments

Autodesk argued that the limitations on licensees are essential to the continuing success and overall good of the software industry, for example, by allowing for a tiered pricing structure for different markets, including the examples of reduced pricing for students, and lowering prices for everyone by spreading costs among a large number of purchasers. An amicus favoring Autodesk argued that because there is often no feasible way for a consumer to return a copy to the copyright owner, the ability to possess a copyrighted work indefinitely — the critical distinguishing point between sales and licenses, in the view of the lower court — should not compel a finding of a first sale. Other amici on the other hand, argued that ruling against Vernor would seriously hurt libraries and the creation of secondary markets for copyrighted works. They raised the spectre of the software industry’s licensing practices being “adopted by other copyright owners, including book publishers, record labels, and movie studios,” which could ultimately change the way third party materials and content are accessed and consumed by the public. But the Ninth Circuit declined even to comment on these arguments. There were “serious contentions on both sides,” the court observed, “but they do not alter our conclusion that our precedent...requires the result we reach.”

Implications of Vernor

Vernor provides a template for software licensors who wish to make sure that their software is licensed with certain restrictions (and not deemed to have been “sold”) — assuming the Ninth Circuit ruling stands and other circuits agree with its reconciliation of the cases on this issue. The first two requirements of Vernor’s three-prong test — calling the agreement a license and imposing transfer limitations — will be satisfied whenever the issue is posed, so the key issue under the Ninth Circuit’s ruling always will be whether the agreement imposes “notable use restrictions.” But Vernor does not make clear what use restrictions are necessary to satisfy its third prong, other than that the restrictions set forth in Autodesk’s Software License Agreement are sufficient. Possibly, the Ninth Circuit’s forthcoming opinions for two recent first sale-doctrine decisions heard on appeal, MDY Industries v. Blizzard Entertainment, Inc., 89 U.S.P.Q.2d 1015 (D. Ariz. July 14, 2008) and UMG Recordings, Inc. v. Augusto, 558 F. Supp.2d 1055 (C.D. Cal. 2008), will help clarify this issue.

Blizzard is the creator and operator of World of Warcraft (WoW), a multiplayer online role-playing game. MDY sold a program called WoWGlider, which played the game for its owner while the owner was away from the computer and enabled a user to progress more quickly in the game. Blizzard sued MDY for copyright infringement claiming, for example, that MDY knew that the use of WoWGlider was against the terms of the end-user license agreement between Blizzard and its users (and therefore copyright infringement) and that MDY caused the infringement by selling WoWGlider. One of MDY’s defenses was an ownership defense under 17 U.S.C. § 117 — that an owner is permitted to make a copy of software if so doing is an “essential step” of using the software. The district court held the restrictions imposed by the end-user license agreement meant that users of WoW were licensees, not owners, so their conduct was not protected by § 117.

In contrast, UMG Recordings creates and distributes promotional CDs to music industry insiders. The CDs bear labels stating that the CD is property of the record company, is licensed to the intended recipient for personal use only, and that resale and transfer of possession are not permitted. Augusto was not a music industry insider, but obtained numerous promotional CDs from music shops and resold the CDs online through eBay, a fact pattern remarkably similar to Vernor. UMG alleged that Augusto violated UMG’s exclusive right to distribute and sell promotional CDs and therefore is liable for copyright infringement. However, Augusto asserted that his conduct was protected by the first sale-doctrine. The court agreed with Augusto, holding that the initial transfer from UMG was not a license based on the economic realities of the act of distribution. The court noted that UMG had no intent to regain possession of the CDs and received no recurring benefits from the recipient’s possession of the CDs, such as a license fee or an agreement to promote the music. Based on these considerations, the court characterized the distribution of the promo CDs as a sale or gift, not a license, immunizing Augusto’s resale. However, in light of the Vernor ruling, it seems that if the agreement between UMG and Augusto comprises the elements of the Vernor three-prong test, we can likely assume that Augusto on appeal will follow Vernor. Seemingly, the critical issue will be whether Vernor’s requirement of “notable use restrictions” will be satisfied by the “personal use only” restriction. Such a holding could have far-reaching implications for other classes of works.

Conclusion

The Vernor three-prong test is not necessarily limited to software licensing. Under Vernor, owners of any kind of content or material may be in a position to try prohibition of certain actions in their agreements. Certainly, the terms held sufficient in Vernor for license status — bars on reverse engineering, removal of trademarks, and attempts to thwart copy protection — are common in the software industry, and various other restrictions (present or to be adopted) may qualify as “notable.” It will be interesting to see how other industries outside of the software industry react to this decision and if any of their practices will change as a result.

Vernor’s counsel has indicated that he intends to ask a full panel of eleven judges in the Ninth Circuit to review the September 10 decision en banc before considering a possible appeal to the U.S. Supreme Court.