Prof. Randal C. Picker, The University of Chicago Law School
September 14, 2010

Last Friday, the Ninth Circuit decided an important case about the scope of the first-sale doctrine in copyright as applied to computer software.  In Vernor v. Autodesk, the court concluded that the documents in question created a license rather than a sale of the underlying software with the consequence that copyright’s first-sale doctrine did not apply.  Early commentary – at least of the 140-character kind on Twitter – is largely critical.  The case is one of statutory interpretation and, for the Ninth Circuit, figuring out what some of its earlier software cases had said.  The case raises some broad issues regarding copyright and secondary markets, but there is a narrower issue regarding software upgrades embedded in the case and that is the one I want to focus on here.

The facts are detailed, but to simplify: Autodesk produces high-end computer-aided design software and turns over copies of that software for cash.  Note that I didn’t say Autodesk sells the software, as that is the relevant question for the first-sale doctrine.  In the spirit of Fred Khan, I will refer to this transfer for now as a “banana.”  Autodesk’s software has gone through many versions and two are relevant to this situation.  Autodesk “bananaed” a number of copies of AutoCAD Release 14 to one of its customers – CAT – who in turn eventually bananaed that software to Timothy Vernor.  In turn, Vernor was bananaing the software on eBay.  Autodesk believed that Vernor’s bananaing was a copyright infringement; Vernor defended under the first-sale doctrine of Section 109 and what the Ninth Circuit calls the “essential step defense” under Section 117.

We need a little more granularity.  The software that Autodesk had bananaed to CTA included documents that imposed a number of limitations on what CTA could do with the software.  CTA was barred from transferring the software without Autodesk’s consent; barred from reverse-engineering it; and limited in other ways (including a term separating commercial markets and educational markets).  The documentation also required CTA to destroy prior versions of the AutoCAD software if CTA upgraded from an old version.

Eventually, CTA wanted to upgrade from Release 14 to Release 15.  New licenses from Autodesk were going for $3,750 a pop but the upgrade price for an existing user was only $495.  Unsurprisingly, CTA chose to upgrade.  More surprisingly – but I am a naïve soul – CTA then chose to sell its Release 14 copies to Vernor.  After a good chunk of analysis, the Ninth Circuit ultimately concluded that the documents in question created a license in favor of CTA rather than a sale, and that therefore CTA did not receive the benefits of either the first-sale doctrine or the essential-step doctrine.  Parsing the statutes and the Ninth Circuit’s precedent is a task for another day.  I have five hypotheticals.

Case 1 is our baseline.  A firm wants software and gets it in a banana transaction and pays the relevant fee.  After a while, the firm decides that it would rather have a competitor’s software and does another deal and pays another fee.  What can the firm do with the software it would now like to discard?  If we were talking about a novel rather than software – and now think a paper-based novel rather than an e-book – the answer would be clear.  The first-sale doctrine makes it possible for the owner of a physical copy of the book to sell that book in the used book market without the permission of the copyright holder.

Implementing this kind of secondary markets regime is tricky.  The copyright holder of course sees the secondary market as a missed opportunity for sale.  It has software or novels ready to sell and its original transaction has the potential for creating a competitor to it.  Moreover, if the software seller is separating markets – selling at one price to the educational market and a second price to commercial markets – secondary sales put pressure on that separation.  That segmentation can be socially useful.  Not always, but sometimes.

Moreover, unlike novels, software sellers and digital purveyors generally fear that the secondary market sale will actually just be copying, where the seller will retain an original and simply dump off a copy in the secondary market.  We can have an extended discussion about the merits of the secondary markets but that really isn’t my issue here.  Assume for now that we treated my baseline case as we would the novel and generally permitted sales of software in the secondary markets.

That gets us to Case 2.  The software company is the only show in town and new versions of the software compete with old versions.  The software firm does not offer an upgrade path: If you want the new version, you have to pay list price even if you have the old version.  As before, our bananaer gets software in the initial transaction and pays.  Eventually the software firm issues an update and our software user bites the bullet and pays full price for the new version.  They then sell the old version in the secondary market.  There seems to be no reason not to treat Case 2 as we did Case 1, so if we permit secondary market transactions in used software when switching to a competitor’s software, we should also permit them when the software user pays full price for a new version of the original software.

Now consider Case 3.  Our software firm issues software and the software user pays.  Eventually, the software firm is prepared to release additional functionality but rather than selling that as a full new version it simply offers it as a freestanding addition.  Of course, only pre-existing customers would buy that software, as it would be worthless without the old version of the software.  No secondary market issues at all are raised in this transaction.

Case 4 is Case 3 except that at the point of buying the additional software, our software user decides to make a copy of the original software and sells that in the secondary market.  That is a straightforward copyright violation and the software user has no plausible defense under the first-sale doctrine because it is keeping the original software and not giving it up.

Finally, in Case 5, at the point that the software vendor has additional functionality, it releases an updated version of the software.  It sells that software to new customers at a high price but offers an upgrade path and a much lower price to pre-existing customers.  Our software user pays the upgrade price to get the new software but then turns around and sells the old software in the secondary market.

Whatever we think about the statutory interpretation questions in Autodesk and whatever we think about the general question of whether we should have, say, a secondary market in iTunes songs, we should have a firm sense of how Case 5 should come out.  The low upgrade price is the equivalent of the sale of the freestanding incremental software in Case 3.  There may be good reasons of software management that it is more sensible to distribute the software as a whole rather than in piecemeal functionality but the economics of the transaction should be treated as equivalent.  When the software user in turn pays the low upgrade price and then sells the old version of the software, we have now replicated Case 4.  You can’t both keep and sell the old version, unless you are paying full price for new version as in Case 2.

There are still lingering legal niceties.  For example, should we think of this sale as a copyright infringement or a contract violation?  But we need to recognize that the upgrade case is a distinctive case in the secondary market debates over the first-sale doctrine.  There is no sense that the Ninth Circuit appreciated that and its analysis seems perfectly general as to the question of ownership versus license – hence the gnashing of teeth in some quarters – but the analysis here suggests that the court gets the upgrade case right, even if it didn’t fully appreciate that that was what was before it.