Grokster, the Supreme Court and the Impact on Risk

What does the ruling this week by the U.S. Supreme Court in the Grokster case mean for producers and their technology clients? The case had been both anticipated and feared in the technology sector, which for two decades has looked back to an earlier Supreme Court decision involving the Sony Betamax for protection against certain types of copyright infringement claims. There is an axiom that bad facts make bad law. As the Grokster case headed to the Supreme Court, the facts were pretty bad, and technology companies were concerned whether the Sony case would survive intact, whether they would face new risks, greater potential liabilities.

The Background

Grokster and co-defendant StreamCast had jumped into the breach after the fall of Napster. They had sought a share of Napster’s customers after the popular peer-to-peer file sharing company was brought down by an earlier court decision. But Grokster, StreamCast and other companies offering second-generation file sharing software had tried to protect themselves from the same fall that Napster had taken.

Their software was designed to operate without the companies themselves being involved as a central clearinghouse or index in the file sharing process. Once computer users had downloaded the software, they could share files among themselves without any involvement by StreamCast or Grokster. Those two companies hoped this would insulate them from legal liability. The software wasn’t inherently wrongful; it could be used for legitimate, legal purposes. How could Grokster and StreamCast be responsible for how others used their software once they possessed it, the companies argued.

The facts were bad. Literally billions of files where shared across peer-to-peer networks each month. Studies indicated 90 percent of the files shared were copyrighted, suggesting an enormous number of copyright violations taking place. There was no doubt that most of the file sharing did constitute copyright violations by the computer users. Parts of the entertainment industry had been financially injured and were fighting as if for their survival.

The Supreme Court had ruled 21 years before that Sony was not responsible for customers who used its video recorder to make copies, even if the copies were illegal. The recorders were capable of substantial noninfringing uses, the court said, and Sony wasn’t responsible if their products were used illicitly after the sale had taken place.

The Sony case was critically important as a shield to innovators of some technologies who didn’t want to have to worry about being held responsible for how their products might be used. The defense of the Sony case now fell to two companies that had facilitated, though not actively participated in, copyright infringements on a massive scale.

Casting aside the analysis of the Ninth Circuit Court of Appeals, which had ruled that Sony protected Grokster and StreamCast, the Supreme Court essentially found Sony to be inapplicable to the Grokster case. That was because in Sony the court felt the defendant had not promoted and encouraged use of its product to commit infringements. The situation was different in Grokster.

The Verdict

The court found the record replete with evidence that Grokster and StreamCast had unlawful objectives and, though they had not actively infringed, they had essentially encouraged others to do so, and they could be held liable for the actions of the others. The ruling was 9-0.

Despite the finding that the Sony principle did not apply in this case because of the wrongful intent of the defendants, an interesting exchange took place in two concurring opinions. In one, three justices argued for a view of Sony that would be narrow, affording less protection in situations where Sony was relied upon. In the second concurrence, three other justices argued for a broader view of Sony.

What It Means

So what is the bottom line for technology companies? For one thing, the case doesn’t do nearly the damage that could have been done and it left Sony intact, an important protection for technology companies.

The case may even hasten a transition in the file sharing arena to legitimate business models, a process begun in earnest after the fall of Napster. This is not to suggest illicit file sharing will go away. It probably never will. But the case may be one more nudge to all concerned to continue the move toward legitimate pay services.

On the other hand, the case raised new concerns and considerations for some technology companies, particularly those whose product or service can be used for making unauthorized copies.

Sony is an important decision for protecting developers and manufacturers of some kinds of technology. Though emerging relatively unscathed, Sony nonetheless looks a bit shaky.

Bear in mind that Sony itself was a 5-4 decision. In Grokster, we saw a 3-3 split in the concurrences, with three other justices sitting on the sidelines. How might they vote in the next case where the Sony principle does come into play? (The chief justice, who some expect to retire soon, voted with the group favoring a narrow interpretation of Sony.)

Technology companies should be aware that their ordinary communications, e-mails, exchanges with customers, advertisements, etc. may all be looked at someday in determining whether they promoted an illicit use for their products. Ill intent, when clearly shown, is likely to be punished.

Some of the facts the court relied upon in concluding Grokster and StreamCast had unlawful objectives are unsettling. Examples: The court’s observation that “Grokster’s name is an apparent derivative of Napster.” The court’s statement that Grokster received income by selling advertising and that the more its software is distributed, the more money it makes off of advertising, combined with the observation that users seeking Top 40 songs are more numerous than persons seeking non-copyrighted material.

Those parts of the opinion seem to reflect an unusual willingness by the court to hold these defendants responsible. While Grokster and StreamCast are unpopular defendants in a legal context, statements like these can be used in future cases against mainstream defendants, an example of the axiom about bad facts making bad law.

And perhaps of greatest concern to technology developers is the court’s reference to the fact that neither defendant made an effort to design their products to filter out copyrighted material. The notion of courts second-guessing product designs is a considerable concern.

What Happens Next

Companies may face a more fact-intensive examination of intent and objectives. That kind of lawsuit can make discovery more expensive, it can lead to more cases being filed for the purpose of going through the discovery process to see what’s there, and such a suit can be more difficult to defend. And summary adjudications may be more difficult to achieve in such cases.

Tech companies should be aware that someday a court may perform a balancing test of the product’s legitimate and illegitimate uses, and the standards that will be applied in that test are not entirely clear.

Predictability has gone down for developers, and their insurers, meaning that risk has gone up.

What To Do

The bottom line? Companies should go through a process to make sure their noses are clean in terms of any type of record being created, to make sure there is no evidence that they have wrongful intent in developing, distributing and supporting their product. It’s a good thing to be doing anyway; we’ve just been reminded of that.

Mainstream companies will probably continue to look to Sony and try to safely ensconce themselves within whatever level of protection it provides, to make sure their product is capable of significant noninfringing uses when it’s a product that facilitates copying. But they may not be quite as comforted by Sony as they were before.

Those are additional reasons for some companies to consider adding E&O coverage that includes copyright coverage to their risk management portfolio. Insurers won’t be interested in covering file sharing companies, but insurance can be a resource to mainstream companies that have become a bit more uncomfortable with the risk environment, helping them to defray some risk.