1997 Niva Elkin-Koren

Niva Elkin-Koren is a Lecturer at Haifa University School of Law. J.S.D., 1995, Stanford Law School; LL.M., 1991, Harvard Law School; LL.B., 1989, Tel-Aviv University 1989. I wish to thank Zipora Dekel, Sandy Kadar, Guy Mundlak, and Steve Wiezner for their helpful comments on earlier drafts. I also wish to thank the participants of the 13th annual conference of the European Association of Law and Economics, Haifa August 1996, and the University of Amsterdam Institute for Information Law Colloquium at which I presented earlier drafts of this paper. I am grateful to Ariel Olsewer for his valuable research assistance.

1. In ProCD Inc. v. Zeidenberg 86 F.3d 1447 (7th Cir. 1996) [hereinafter "ProCD II"]. 1996 U.S. App. LEXIS 14951.

2. Databases cannot be protected by copyright law unless the database is sufficiently creative to meet constitutional standards. See Feist Publications, Inc. v. Rural Tel. Serv. Co., Inc., 499 U.S. 340, 344-61 (1991). In essence, copyright law protects the creator's original and creative contributions, such as selection, coordination, and arrangement, but not the underlying facts. See id. at 358-59.

3. See Pamuela. Samuelson, Will the Copyright Office Be Obsolete in the Twenty-First Century? 13 CARDOZO ARTS & ENT. L.J. 55, 60-61 (1994), 60-61; see also, Maureen A. O'Rourke, Copyright Preemption After the ProCD Case: A Market-Based Approach, BERKELEY TECH. L.J. 53, 53-56 (1997).

4. ProCD II, 86 F.3d at 1449-50.

5. See id. at 1450.

6. See id.

7. See id.

8. See ProCD, Inc. v. Zeidenberg, 908 F. Supp. 640, 645 (W.D. Wis. 1996), rev'd, 86 F.3d 1447 (7th Cir. 1996) [hereinafter "ProCD I"].

9. See ProCD II, 86 F.3d at 1450.

10. Shrinkwrap licenses would normally include provisions regarding proprietary rights, warranties, and limitations on users' rights. See generally Mark A. Lemley, Intellectual Property and Shrinkwrap Licenses, 68 S. CAL. L. REV. 1239 (1995).

11. For example, "Copyright ã 1970 by Publishing House Inc. All rights reserved."

12. See Lemley, supra note 10, at 1241.

13. See 17 U.S.C. § 107 (1994).

14. See 17 U.S.C. §§ 106, 106A (1994). Note, that some software vendors seek to avoid the provisions of section 117 of the 1976 Copyright Act, by defining the transaction as a license rather than a sale of a copy. Section 117 authorizes owners of copies of computer programs to make copies to the extent it is an essential step in the utilization of the program. See 17 U.S.C. § 117 (1994).

15. See 17 U.S.C. § 202 (1994).

16. ProCD I, 908 F. Supp. at 644. The district court held that placing the package of software on the shelf is an offer and that paying the asking price and leaving the store with the goods is acceptance. Id. at 651-52. Therefore, tThe contract formed by this exchange includes only the terms on which the parties have agreed, namely, the terms that were explicit at the time of the transaction. Id. at 652-55. The court concluded that Any terms that purchasers could not inspect were not binding. the terms of the license were not presented to potential purchasers at the time of the purchase, and therefore defendant did not have the opportunity to inspect those terms. ("I conclude that because defendants did not have the opportunity to bargain or object to the proposed user agreement or even review it before purchase and they did not assent to the terms explicitly after they learned of them, they are not bound by the user agreement.") Id. at 655 (emphasis added). The Ccourt further noted that users should be given a fresh opportunity to review any terms to which they are bound. This is because licensors reserve the right to modify the terms of their shrinkwrap licenses in future versions. Therefore, the Ccourt did not consider prior purchases of the same product as a sufficient opportunity to inspect the terms of the license. Id. at 654-55. Finally, the Ccourt relied on the proposal of the American Law Institute to amend UCC § 2-203 to make standard form contracts enforceable under certain circumstances. The Ccourt concluded that under current law, and until the amendment is made effective, shrinkwrap licenses are not binding. Id. at 655-56.

17. Id. at 658.

18. Id. The legal doctrine under which the court held the license unenforceable was the preemption doctrine. See discussion infra Part III.Ato which I return later.

19. ProCD II,1996 U.S. App. LEXIS 14951 86 F.3d at 1452:

A vendor as a master of the offer, may invite acceptance by conduct, and may propose limitations on the kind of conduct that constitutes acceptance. A buyer may accept by performing the acts the vendor proposes to treat as acceptance. And that is what happened. ProCD proposed a contract that a buyer would accept by using the software after having an opportunity to read the license at leisure.

20. Id. at 1455.

21. Id.

22. Id. However, the court appeared to narrow its holding when it stated The Court sought to narrow its holding "[W]e think it prudent to refrain from adopting a rule that anything with the label 'contract' is necessarily outside the preemption clause: the variations and possibilities are too numerous to foresee." ) Id. Yet the court also stated, "But whether a particular license is generous or restrictive, a simple two-party contract is not '"equivalent to any of the exclusive rights within the general scope of copyright'" and therefore may be enforced." Id. In a later decision, Judge Easterbrook further elaborated this doctrine regarding contract formation. In Hill v. Gateway 2000, Inc., 105 F.3d 1147 (7th Cir. 1997), the court held that "[a] contract need not be read to be effective; people who accept take the risk that the unread terms may in retrospect prove unwelcome." Id. at 1148. This article does not argue that no bargain should be enforced unless both parties had the opportunity to read the terms before the transaction became effective. It does suggest, however, that the low level of assent recognized by the court as sufficient for contract formation makes contract claims equivalent to copyright claims. Therefore, standard form contracts that rely upon this low level of assent should be subject to the preemption doctrine.

23. As I shall argue below, I disagree with this perception of copyright law. The primary function of copyright law is to define initial endowment. Copyright law is not a default rule in the economic sense. First, it does not reflect the most efficient allocation among the parties. Default rules are designed to reflect the parties' expectations in order to minimize transaction costs. See David Charny, Hypothetical Bargains: The Normative Structure of Contract Interpretation, 89 MICH. L. REV.iew 1815, 1841-42 (1991).. BBut see Ian Ayres & Robert Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 YALE L.J.ournal 87, 126 (1989) (suggesting that in particular contexts penalty default rules are likely to be more efficient, since they are designed to give at least one party--- typically the party with superior information-an incentive to contract around the default rule and therefore to choose affirmatively the contract provision both parties prefer.). Copyright law cannot reflect the most efficient bargain of the parties. This is because of the potential for a "public good" market failure in any market for information. Such market failure, on which copyright policy rests, prevents efficient transactions from occurring. Second, copyright law defines initial endowment. Whether these rights should be governed by the law of property or the law of torts is a question addressed below.

24. 17 U.S.C. § 102 (1994).

25. See 17 U.S.C. § 106 (1994).

26. I use the term "Iinformation" to refer to any "work of authorship,", namely works that are the "subject matter" of copyright law. See 17 U.S.C. § 102 (1994).

27. "Non-eexcludability" means that excluding non-payers (free-riders) from using the information is either impossible or inefficient. In other words, given a good for which the marginal exclusion cost isare greater than the marginal cost of provision, spending resources to exclude non-payers is inefficient. See Peter S. Menell, Tailoring Legal Protection for Computer Software, 39 STAN. L. REV.iew 1329, 1337 (1987) [hereinafter Menell, Tailoring Legal Protection]; see generally William M. Landes & Richard A. Posner, An Economic Analysis of Copyright Law, 18 J. LEGAL STUD.ies 325 (1989); Peter S. Menell, P., An Aanalysis of the Scope of Copyright Protection for Application Programs, 41 STAN. L. REV.iew 1045, 1059??? (1989).

28. See Menell, Tailoring Legal Protection, supra note 27, at 1337.

29. According to the neoclassical economic model, government intervention in the market is justified only to the extent that it is necessary to remedy a market imperfection. Information products, such as books or computerized telephone listings, exhibit one of these market imperfections. Specifically, information products are "public goods." A "public good" has two distinct characteristics: non-excludability and non-rivalrousness. Id.

30. If everyone is allowed to copy ProCD's software, then the marginal cost per copy will be low since the cost of a floppy disk and the time necessary for copying are negligible. Therefore, Iif competitors are allowed to copy the product freely, then its price would go down to the marginal cost. This price drop would allow many users who value the product at such a cost to use it. As noted by the court, however, the product cost $10 million to develop. ProCD II, 86 F.3d at 1449. ProCD would need to charge more than the marginal cost of creating a copy in order to recoup such an investment. Copyright law allows ProCD to prevent unauthorized copies and to sell at a price higher than the marginal cost.

31. See William W. Fisher III, Reconstructing the Fair Use Doctrine, 101 HARV. L. REV.iew 1659, 1702 (1988) ("'[D]""eadweight loss'" is measured by the total of the consumer surplus that would have been reaped by the excluded consumers and the producer surplus that would have been reaped by the copyright owner had he sold that work to them.").

32. Other societal costs are those ofinclude maintaining the copyright system (registration) and using the legal system to deter copyright infringements and to enforce owners'' rights. See Mennell, Tailoring Legal Protection, (1987), supra note 27, at 1340.

33. See iId. at 1337.

34. Landes &and Posner refer to this phenomenon as "cost of expression." See Landes & Posner, supra note 27, at 327. Compare this analysis with Landes &and Posner's similar discussion of the consequences of providing copyright protection to ideas, which they argue may increase the cost of creating works and consequently may reduce the number of works being created. Id., at 349.

35. This proposition may generally explain the development of arts and science, but the extent to which new creation uses prior art may differ from one market to another. The refining of existing programs or the use of prior art may be more common in the software industry then in the visual arts.

36. See Landes & Posner, supra note 27, at 326.

37. See Robert A. Kreiss, Accessibility and Commercialization in Copyright Theory, 43 UCLA L. REV. 1, 2-4 (1995).

38. See 17 U.S.C. §§ 107-120 (1994).

39. The concept of the "public domain" refers to the entire universe of works and uses that are not protected by copyright law.

40. The 1976 Copyright Act imposes compulsory licenses in several industries. See, e.g., 17 U.S.C. §§ 111, 115, 116 (1994). For example, Ccopyright owners cannot prohibit the preparation of a phonorecord using a composition once it haswas first been authorized for distribution on a phonorecord. A performer may obtain a compulsory license to make a phonorecord using the composition. See 17 U.S.C. § 115 (1994).

41. One such provision under the 1976 Copyright Act provides special privileges to libraries. See 17 U.S.C. § 108 (1994).

42. See 17 U.S.C. §§ 107-120 (1994).

43. See 17 U.S.C. § 107 (1994) ("Limitation on exclusive rights: Fair Use").

44. ProCD II, 86 F.3d at 1453.

45. See 17 U.S.C. § 301 (1994). Preemption doctrine guarantees a homogeneous federal copyright law system that does not leave any vague areas between Sstate and Ffederal protection. Similar considerations led to parallel provisions under the European Economic Community Directives. Preemption doctrine also seeks to preventthe modification of the federalcopyright regulatory scheme by state legislation. The following discussion will focus only on the second consideration.

46. ProCD II, 86 F.3d at 1453.Court of Appeals citing from the Supreme Court in Recently, the Second Circuit gave an expansive reading to the preemption doctrine under § 301. In rejecting a partial preemption theory whereby the district court held that plaintiff could assert both federal copyright claims for infringement of a broadcast and state law misappropriation of rights in the underlying event, the Second Circuit held that:

Congress, in extending copyright protection only to the broadcasts and not to the underlying events, intended that the latter be in the public domain. Partial preemption turns that intent on its head by allowing state law to vest exclusive rights in material that Congress intended to be in the public domain and to make unlawful conduct that Congress intended to allow.

National Basketball Ass'n v. Motorola, Inc., 105 F.3d 841, 849 (2d Cir. 1997). Under this approach, copyright law defines not only rights in copyrighted works, but also the appropriate scope of the public domain.

47. 17 U.S.C. § 301(a) (1994).

48. ProCD I, 908 F. Supp. at 658.

49. The district court found the ProCD license to be "an attempt to avoid the confines of copyright law and of Feist." . ProCD I, 908 F. Supp. at 659 (citing Feist Publications, Inc. v. Rural Tel. Serv. Co., 499 U.S. 340 (1991)). In Feistephon, Inc., 499 U.S. at 362, the Supreme Court held that telephone listings are not protected by copyright law. ProCD tried to achieve, through a contract, the protection denied by the copyright law.

50. SinceBecause contractual rights affect only their parties to the bargain and "strangers may do as they please," contracts cannot create "exclusive rights." ProCD II, 86 F.3d at 1454. The court of appeals makes somewhat contradictory statements on this issue. At one point, the court states:

[W]e think it prudent to refrain from adopting a rule that anything with the label 'contract' is necessarily outside the preemption clause: the variations and possibilities are too numerous to foresee. National Car Rental likewise recognizes the possibility that some applications of the law of contract could interfere with the attainment of national objectives and therefore come within the domain of § 301(a).

Id. at 1455 (citing National Car Rental System, Inc. v. Computer Associates Int'l, Inc., 991 F.2d 426 (8th Cir. 1992)). Nevertheless, at another point, the court states that "whether a particular license is generous or restrictive, a simple two-party contact is not 'equivalent to any of the exclusive rights within the general scope of copyright' and therefore may be enforced." Id. (quoting 17 U.S.C. § 301(a) (1994)).

51. Id.

52. Id. at 1452.

53. The metaphor used by Goldstein to describe this environment is the:

celestial jukebox, a technology-packed satellite orbiting thousands of miles above Earth awaiting a subscriber's order-like a nickel in the old jukebox, and the punch of a button-to connect him to any number of selections from a vast storehouse via a home or office receiver that combines the power of a television set, radio, CD player, VCR, telephone, fax, and personal computer.


54. The rights of owners are protected by a property rule-no one can take the entitlement of a copyright owner to her work unless she sells it willingly and at the price she finds appropriate. Copyright owners are able to receive injunctive relief to prohibit any intervention in their rights. See 17 U.S.C. § 502 (1994).

55. See Wendy Gordon, An Inquiry into the Merits of Copyright: The Challenges of Consistency, Consent, and Encouragement Theory, 41 STAN. L. REV.iew 1343, 1416-17 (1989).

56. See MICHAEL TREBILCOCK, THE LIMITS OF FREEDOM OF CONTRACT 9 (Cambridge: Harvard University Press, 1993), at 9.

57. That is, of course, unless another law provides the owner with a monopoly over the use of a recipe (such as patent law).

58. For a discussion of this distinction, see L. RAY PATTERSON & STANLEY W. LINDBERG, THE NATURE OF COPYRIGHT, A LAW OF USERS' RIGHTS 181-86 (Georgia: University of Georgia Press, 1991) p. 181-86. Publishers, however, seek to expand their power by "acting on a belief that any use of the work is the use of the copyright and vice versa." Id. at 182-83. Patterson &and Lindberg demonstrate their argument by analyzing the provisions of common copyright licenses and copyright notices, including the license of the Copyright Clearance Center ("CCC"). The CCC license purports to license any use of published works notwithstanding the provisions of § 107 ("Fair Use") and § 108 ("Limitations on Exclusive Rights: Reproduction by Libraries and Archives"), which specifically exclude certain uses from the monopoly of the copyright owner. Id. at 183-84.

59. "License" refers to the legal permission to engage in some activity. A license may be unilateral. Licensing the copyrights should, however, be distinguished from licensing the use of a work.

60. ProCD I, 908 F. Supp. at 645.

61. See supra note 49.

62. ProCD II, 86 F.3d at 1450.

63. Compare this to the analysis of the district court in the ProCD I case regarding the application of the preemption theory:

Rightful owners should be able to define the limits of permissible copying or modification of their works. It is only when a contract erects a barrier on access to information that under copyright law should be accessible that ¤section 301 operates to protect copyright law from individually crafted evasions of that law.

ProCD I, 908 F. Supp. at 658.

64. See Trebilcock, supra note 56, at p.6.

65. A transaction is considered Ppareto Ssuperior if it makes one party better off while making no other worse off.

66. See Guido Calabresi & Douglas Melamed, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral, 85 HARV. L. REV.iew 1089, 1111 (1972).

67. Several commentators have attempted to suggest criteria for determining the validity of use restrictions in shrinkwrap licenses. See, e.g., RAYMOND T. NIMMER, THE LAW OF COMPUTER TECHNOLOGY: RIGHTS, LICENSES, LIABILITIES ¶ 7.24 (1992) (the validity of restraints should be determined in light of the entire transaction); Maureen .A. O'Rourke, Drawing the Boundary Between Copyright and Contract: - Copyright Preemption of Software License Terms, 45 DUKE L.J. 479, 545-551 (1995) (antitrust considerations).

68. ProCD II, 86 F.3d at 1455.

69. Id. at 1453. 1996 U.S. App. LEXIS 14951.

70. Id. at 1450.

71. See Feist Publications, Inc. v. Rural Tel. Serv. Co. Inc., 499 U.S. 340, 363-64 (1991).

72. This point was acknowledged by the court of appeals: "Someone who found a copy of SelectPhone (trademark) on the street would not be affected by the shrink-wrap license-though the federal copyright laws of their own force would limit the finder's ability to copy or transmit the application program." Id. at 1454.

73. The availability of perfect substitutes for works of information is controversial. See, e.g.,for instance, Landes and& Posner, supra note 27, at 328.

74. Users' attitudesapproach towards their use privileges may not be clearly deduced from their behavior because of lax enforcement by since license restrictions were never enforced by copyright owners. Therefore, users have not been required to advocate strongly their desire to retain their use rights. In fact, only recently have copyright owners sought enforcement, andthe ProCDcase II is the first opinion that explicitly holds such licenses valid. Consequently, users' attitudes may change. The uniformity of licenses may also reflect disparities in bargaining power. Individual users simply do not have the necessary bargaining power to change standard industry contractual provisions.

75. See Sega Enterprises. Ltd. v. Accolade, Inc., 977 F.2d 1510, 1520-27 (9th Cir. 1992) (holding that disassembly of the object code of a copyrighted computer program is "fair use" when disassembly is the only way to gain access to ideas and functions embodied in the computer program).

76. See Landes and& Posner, supra note 27, atp. 359.

77. "Notice on the outside, terms on the inside, and a right to return the software for a refund if the terms are unacceptable (a right that the license expressly extends), may be a means of doing business valuable to buyers and sellers alike." ProCD II, 86 F.3d at 1451. 1996 U.S. App. LEXIS 14951

78. See Robert Berring, Chaos, Cyberspace and Tradition: Legal Information Transmogrified, BERKELEY TECH. L.J. 189, 203-07 (1997) (discussing the possible decline of libraries in response to the wide availability of on-line information).

79. But see Eric Schlachter, The Intellectual Property Renaissance in Cyberspace: Why Copyright Law Could Be Unimportant, BERKELEY TECH. L.J. 16, 21-31 (1997) (discussing on-line distribution methods that give large amounts of information free to all users).

80. See Pamela Samuelson, supra note 3, at13 Cardozo Arts & Ent LJ 55, 60-61 (1994) (suggesting that technological and contractual fencing may replace copyright protection for intellectual property).