After ReDigi, Will NFTs Enable A Digital Resale Market

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Entrepreneurs have long dreamed of a digital resale market Imagine if music lovers could resell their unwanted digital music downloads with a click of a mouse or if college students could just as easily dispose of four years of digital textbooks. To date, the Copyright Act has derailed that marketplace.

Capitol Records, LLC v. ReDigi Inc., 934 F. Supp.2d 640 (S.D.N.Y. 2013), aff’d, 910 F.3d 649 (2d Cir. 2018), is the poster child. ReDigi, knowing it would be sued for copyright infringement by the record companies, created elaborate technology to permit the resale of sound recordings ReDigi thought would neither unlawfully copy the MP3 file being sold nor violate the distribution right. ReDigi was wrong. The district court found that ReDigi’s technology violated the reproduction and distribution rights; and the Second Circuit affirmed on the reproduction prong. Judge Leval, writing for the circuit court expressed the hope that other technology may be developed that might “lawfully effectuate a digital first sale.”910 F.3d at 659.

Are NFTs that hoped-for answer? They may be as explained below. But first let’s find out why ReDigi failed to build an online “used record store” that passed copyright muster.

ReDigi Hoped to Win Court Approval

Here is an outline of ReDigi’s technology:

Train running on track raised on columns against a scenic background.
Photo by B K on Unsplash

ReDigi’s Software

ReDigi created a sales process that “migrated” a seller’s digital music file from the seller’s computer, data packet by data packet, onto the defendant’s server called a “Cloud Locker”, where the music could then be transferred to the buyer’s computer. 934 F.Supp.2d at 645. ReDigi argued this process was analogous to a train running from one station to another. Id.

Redigi’s Arguments in The District Court

ReDigi asserted no there was no reproduction because the data packets or file never existed in two places at once during its migration from buyer to server to seller. ReDigi further argued the first sale doctrine protected its digital resale and therefore there was no unlawful distribution. That doctrine, codified in § 109 of the Copyright Act, requires the seller sell the same “material object” as the seller initially purchased. ReDigi asserted it satisfied that requirement because its technology enabled the resale of the same sound recording (or material object) the user had initially bought.

The District Court’s Decision

The court was unpersuaded. It found that ReDigi’s sales process violated the reproduction right by creating copies of the copyrighted sound recordings contained in new “phonorecords” or material objects. Judge Sullivan invoked the “laws of physics,” stating, “[i]t is simply impossible that the same ‘material object’ can be transferred over the Internet.” Id. at 649. The court added, “[t]he fact that a file has moved from one material object – the user’s computer – to another – the ReDigi server- means that a reproduction has occurred.” Id. at 650.  The district court concluded:

Because the reproduction right is necessarily implicated when a copyrighted work is embodied in a new material object, and because digital music files must be embodied in a new material object following their transfer over the Internet, the Court determines that the embodiment of a digital music file on a new hard disk is a reproduction  within the meaning of the Copyright Act.

Id. at 649-50.

ReDigi distinguished C. M. Paula Co. v. Logan, 355 F. Supp. 189 (N.D. Tex. 1973). There defendant used a chemical process to lift images from greeting cards and place them on ceramic tiles for resale. In contrast, ReDigi stated that defendant had lifted the copyrighted print, or material object … from the greeting card and transferred [it] in toto.” Id. at 650-51.

The district court also found defendant violated the distribution right, rejecting the first sale defense. The court noted that defense is limited “to [the same] material items, like records, that the copyright owner put into the stream of commerce.” 934 F. Supp.2d at 655. But here defendant had distributed “reproductions of the copyrighted code embedded in new material objects.” Id. (emphasis in original).

The Second Circuit Affirms on the Reproduction Right

The Second Circuit affirmed liability finding unlawful reproduction, never reaching the distribution issue. 910 F.3d at 656, 659.

The circuit court, echoing the finding below, held that ReDigi’s software made new MP3 files even though in the migration process, from the owner’s hard drive to ReDigi’s server and then to a third party’s computer, only one copy of the digital file being transferred ever existed. The circuit court stated, “[a]t each of these steps, the digital file is fixed in a new material object ‘for a period of more than transitory duration.’ The fixing of the digital file in ReDigi’s server, as well as in the new purchaser’s device, creates a new phonorecord, which is a reproduction.” Id. at 657 (citations omitted).

The Second Circuit dismissed the argument that affirming liability would chill the online marketplace for used recordings. The court may have been mindful of the admonition in Star Athletica, LLC v. Varsity Brands, Inc., 137 S. Ct. 1002, 1010 (2017), that a copyright case does not require “a free-ranging search for the best copyright policy, but rather depends solely on statutory interpretation.”

ReDigi will not be developing new technology to lawfully permit a digital first sale. In the district court litigation ReDigi stipulated to the entry of judgment for $3,500,000. Capitol Records, LLC v. Redigi Inc., Docket No. 12-cv-00095 (S.D.N.Y. Jan 06, 2012) (Dkt. 222). It also attempted to reorganize through a Chapter 11 proceeding in Bankruptcy Court in the Southern District of Florida; but that proceeding was converted to one under Chapter 7 and was eventually dismissed. See ReDigi Inc., Docket No. 16-bk-20809 (Bankr. S.D. Fla. Aug 03, 2016) (Dkt. 481).

NFTs May Satisfy the First Sale Doctrine

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If not ReDigi, will NFTs be the tool to lawfully carry out a digital first sale? The answer is “maybe so.” Let’s examine why.

First, for those (most of us) who are still stumbling through the metaverse, what is an NFT?

NFTs Explained

An NFT is a non-fungible or unique token that is coded during the creation or minting process with a digital string of letters and numbers (sometimes referred to as its “fingerprint” or “signature”). The string cannot be reproduced or copied. The token contains a link to an asset, either physical or digital. The unit of uncopyable, coded data identifying the NFT is stored on a blockchain or digital ledger which records ownership and validates authenticity. The NFTs can be sold or traded in accordance with “smart contracts” that govern the transfer.

The non-fungible token is separate and distinct from the underlying asset. Unless a sales agreement states otherwise, the NFT buyer does not acquire ownership of the original asset or the copyright in that work. Ownership of the asset’s intellectual property remains with the creator.

First Sale Doctrine Requirements

To gain the protection of the first sale doctrine the threshold question is whether NFTs are copyrightable. Are they simply a receipt of a purchase or something more?

NFTS May Be copyrightable

I suggest that NFTs may be copyrightable. Here’s why. Feist tells the amount of creativity needed for a copyrighted work “is extremely low; even a slight amount will suffice.”499 U.S. 340, 345 (1991). The unique alphanumeric signature of each NFT may qualify. A computer’s object code is copyrightable. Williams Electronics, Inc. v. Artic Int’l, Inc., 685 F.2d 870, 877 (3d Cir. 1982). Why not an NFT.

No Reproduction

Further, to gain § 109 protection, the NFTs sold must be the same or, in copyright parlance, the “particular copy,” not a reproduction. Again, NFTs may qualify. In contrast to the MP3 files in ReDigi, the sale of an NFT does not generate a reproduction. Instead, the seller sells the same token or “particular copy” he or she bought; and the buyer obtains the exact same uncopyable string of letters and numbers that was sold. Further, because a sale of an NFT does not, unless otherwise specified, include the sale of any linked, copyrightable asset, the NFT sale will not result in an unauthorized reproduction of that asset.

NFTs May be a “Copy”

Moreover, the “particular copy” sold in a § 109 sanctioned first sale may be a “material object.” Such an object is, in turn, defined in § 101 of the Copyright Act to include a work that is fixed “by any method now known or later developed, and from which the work can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device.” An NFT is fixed by a “method” “later developed”–the minting process. In addition, the NFTs unit of data may be “perceived” “with the aid of a machine,”–blockchain technology.

Moreover, as Williams noted, “Congress opted for an expansive interpretation” of ‘copy” in § 101 “to accommodate technological advances.” 685 F.2d at 877. Williams cited to the Copyright Act’s legislative history:

Under the bill it makes no difference what the form, manner, or medium of fixation may be–whether it is in words, numbers, notes, sounds, pictures, or any other graphic or symbolic indicia, whether embodied in a physical object in written, printed, photographic, sculptural, punched, magnetic, or any other stable form, and whether it is capable of perception directly or by means of any machine or device ‘now known or later developed.’

685 F.2d at 877, n. 8, citing to H.R.Rep.No. 94-1476, at 52; S.Rep.No. 94-473, at 51, U.S.Code Cong. & Admin.News 1976, at 5665.

NFTs appears to satisfy this broad Congressional definition of “copy.” An NFTs unique signature of “numbers” and letters can reasonably be called a “graphic or symbolic indicia.”

RedBox Does Not Bar An Argument That An NFT May Be a “Copy”

Those who argue that an NFT may not be entitled to the protection of the first sale doctrine rely on Disney Enterprises, Inc. v. Redbox Automated Retail, LLC, 2018 U.S. Dist. LEXIS 69103 (C.D. Cal. Feb. 20, 2018). See for example Simon J. Frankel’s excellent article, What Copyright Lawyers Need To Know About NFTs, Bloomberg Law (July 16, 2021), https://news.bloomberglaw.com/ip-law/what-copyright-lawyers-need-to-know-about-nf (subscription required).

In Redbox, the court found a download code was simply “an option to create a physical copy at some point in the future;” and the code only became a “particular material object” after the “code is redeemed and the copyrighted work is fixed onto the downloader’s physical hard drive. Id. at *26. But here in contrast a NFT is not an option; it is instead a material object from the moment it is minted. In other words, an NFT does not need to be downloaded before it can be monetized.

In sum, if an NFT’s resale is protected by the first sale doctrine, as it may be, its value is likely to increase. Stay tuned for the litigation that will decide whether the sale of an NFT is sheltered by the first sale doctrine in § 109 of the Copyright Act.

Comments welcome to andrew@ipinbrief.com.