EU court rules software transfer is a sale

One month ago, the Court of Justice of the European Union (CJEU) added its authoritative voice to the long-lasting debate on the legal nature of the transfer of software copies. Does the transfer constitute a license or a sale? A license, say most courts in the United States, but also some national courts in the E.U., where the case law is comparatively scarce. A sale, said the CJEU in the judgment of 3 July 2012 (UsedSoft GmbH v Oracle International Corp).

The Court thus sided with most – but not all – of the legal commentators on both sides of the Atlantic. Those who will not be happy with the judgment are the software companies whose products are at issue. The looming question among the observers in the wake of the UsedSoft decision is – what business model and technological measures will companies concoct in the coming period in order to adjust to the legal regime now solidified in Europe.

Copyright exhaustion

Before delving into the details of the Court’s decision, a few preliminary notes about software licensing and the so-called copyright exhaustion are in order. A fundamental principle of copyright law is that ownership of copyright differs from ownership of a copy in which the copyright work is embodied. A person owns a copy of a musical CD, but (s)he does not own the copyright to the song. When the copyright owner sells, or in another way disposes of, a copy of the work, the lawful acquirer is then free to sell it to a third person, and the third person to a fourth, etc. After the first lawful transfer, the owner is deemed to have exhausted his distribution right – one of the several economic rights belonging to a copyright owner.

Thanks to the exhaustion rule, a student may sell a copy of a textbook he purchased or otherwise lawfully obtained. However, the exhaustion of the distribution right does not affect the copyright owner’s reproduction rights, so the student will not be allowed to reproduce the textbook in order to sell additional copies.

Applied to software, this means that the purchaser of a copy of the software owns that copy, whereas the copyright remains with the author of the software (or a third person to whom the original owner assigned the copyright in software). The copyright owner is the only one who may reproduce, or authorize reproduction, of the software. The owner of a copy of the software may not make copies (with some exceptions which can be disregarded for the present purposes) but may sell the copy – just like the student from the previous example may sell his copy of the textbook.

Software transfer – sale or license?

As an empirical matter, however, it turns out that there is a significant difference between books and other articles embodying copyright, on the one hand, and software copies, on the other. When a person purchases software, in virtually all instances the software company owning the software labels the transaction as a license rather than a sale. The contracts, which are often contracts of adhesion, typically state that “Licensor hereby grants to Licensee a non-exclusive, non-transferable license to use the software for an unlimited period”, or contain a similar phrase. Under the agreements as drafted by the software companies, no sale takes place. The colloquial “purchaser” of a software copy is not really a buyer, but a licensee. As a licensee, he may use the copy perpetually but he cannot sell it.

A majority of the U.S. courts have accepted this qualification of the software-related transfer agreements. Most famously, the U.S. Court of Appeals for the Ninth Circuit decided in September 2010, in the case Vernor v. Autodesk, that

software user is a licensee rather than an owner of a copy 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.

Vernor v. Autodesk, 621 F.3d 1102 (9th Cir. 2010), at 1111.

In contrast, the CJEU looked into the following definition of sale:

According to a commonly accepted definition, a ‘sale’ is an agreement by which a person, in return for payment, transfers to another person his rights of ownership in an item of tangible or intangible property belonging to him

(para. 42 of the judgment UsedSoft v. Oracle), and concluded that the purported license of software clearly is a sale. This is so because the customer receives his copy of the work after making a single payment and can indefinitely hold a software copy. It follows that the customer is a buyer – not a mere licensee – and he is free to resell the copy.

UsedSoft v. Oracle – facts and legal findings

The facts in the particular case before the CJEU were as follows: Oracle – a world’s leader in database software – distributes the software in dispute in 85 percent of the cases through downloads from the internet. The user obtains the right to store the intangible copy of the program permanently on a server and to allow a certain number of users to access it by downloading it to the main memory of their work-station computers. Oracle offers group licenses for the software for a minimum of 25 users each. The German company UsedSoft acquired some licenses forming part of the group license from those customers of Oracle who purchased the group license but had less than 25 users. UsedSoft then resold the acquired licenses to various purchasers who downloaded the copies of the software (purchased from UsedSoft) directly from Oracle’s website (paras. 20-26 of the judgment).

Oracle objected to this practice and launched judicial proceedings in Germany. The case reached the Federal Court of Justice, which stayed the proceedings and asked the CJEU to rule on the contentious legal issues involved.

The first purported “sale” in this chain of transactions is the one between Oracle and the first customer who downloaded the software from Oracle's website. UsedSoft argued that the transaction at issue was a sale, and that Oracle, having exhausted its distribution right, cannot oppose further sale of the copies. Oracle argued that the initial download was subject to a license agreement and therefore did not amount to the transfer of ownership in the intangible copy.

The CJEU sided with UsedSoft. The Court first established that the transaction is a sale. It then went on to conclude – against the arguments put forward by the European Commission in its written observations – that for the applicability of exhaustion doctrine it makes no difference whether the copy was made available to the customer in a tangible (CD-ROM or DVD) or intangible form (download from Oracle’s website). This conclusion is warranted by common sense and economic reality (para. 61); it is also in line with Directive 2009/24/EC of the European Parliament and of the Council of 23 April 2009 on the legal protection of computer programs (paras. 53-60).

It is interesting, considering the dichotomy between license and a sale, that a number of courts in the U.S. have examined the argument adopted by the CJEU, that the receipt of payment in exchange for giving away – for an unlimited period – the right to use the copy amounts to a sale. Some courts, including the first-instance court in the Vernor v. Autodesk case, accepted that argument. Other courts, including the appellate court in Vernor v. Autodesk, rejected that reasoning as overly simplistic. While the courts belonging to that school of thought accept that the mere labeling of a transaction as a “license” is not dispositive, they combine the labeling with a few other factors to reach the conclusion that the transaction at issue is not a sale. As the quoted passage from the Ninth Circuit’s Vernor v. Autodesk suggests, the critical factors are the significance of the restriction on the user’s ability to transfer the software, and the weight of the use restrictions.

Of course, the overall reasoning of the CJEU is anything but simplistic. For example, the judgment includes nuanced statements the purpose of which is to strike a proper balance between the legitimate interests of the customers and the software copyright owners. The Court took great pains to make sure its judgment is restricted to addressing the distribution right only. The reproduction right of a software copyright owner remains unscathed. It goes without saying that the owner of a copy cannot make additional copies for the purpose of selling them. The important distinction made by the Court is that, where the customer has acquired the right to use a greater number of copies of the software than he needs, he is not allowed to resell in the secondary market the non-used copies while continuing to use the remaining one(s). The first acquirer must delete his own copy or make it unusable at the time of the resale (paras. 69-70). In appreciation of the fact that it is difficult to verify whether such a copy has been made unusable, the Court explicitly authorized the supplier to make use of technical protective measures (such as product keys) to ensure that the copy remaining in the hands of the reseller is rendered unusable (paras 79 and 87).

Policy considerations at stake

The CJEU did not entertain any policy considerations when reaching its decision in UsedSoft v. Oracle.

However, there are a myriad of reasons why software companies have insisted on qualifying the relevant transactions as licenses and on that basis restricting transfers of copies of the work. As Autodesk argued in the case before the Ninth Circuit, such practice

(1) allows for tiered pricing for different software markets, such as reduced pricing for students or educational institutions; (2) increases software companies’ sales; (3) lowers prices for all consumers by spreading costs among a large number of purchasers; and (4) reduces the incidence of piracy by allowing copyright owners to bring infringement actions against unauthorized resellers.

Vernor v. Autodesk, at 1114-15. The first three arguments are all related to the desire of the software companies to prevent those who acquire software at a lower price from reselling it to businesses and other high-end customers at a price that is somewhere in between the price paid by the acquirer and the price at which the high-end customers could obtain the product on the primary market.

Those on the other side of the policy divide retort that the qualification of software transactions as licenses, with the concomitant restriction on resale, hinders the creation of secondary markets for copyrighted works at which consumers could purchase copyrighted works at below-retail price.

There are quite a few ways in which the difference between sale and license plays out as a practical matter. If the underlying transaction is a license, it means that a business that sells its assets cannot sell the copies of the software it owns. Transferring copies in breach of copyright may expose the purported licensee to criminal prosecution.

How would it play out in Serbia?

If a Serbian court were to pronounce on the matter, nothing in the current legislation would prevent it from taking the same approach as the CJEU. Serbian copyright law has embraced the doctrine of exhaustion. Article 21(3) of the Law on Copyright and Related Rights (2009) states in this respect:

The right of an author to place copies of the work on the market shall not affect any owner of a copy of the work who has legally acquired in Serbia that copy from the author or a person authorized by the latter (exhaustion of the right). The owner who has legally obtained the copy of a work from its author or the authorized person may freely dispose of the copy.

Especially relevant in the context of software acquisition, the definition of a “copy of the work” in the Law on Copyright and Related Rights is not restricted to tangible copies only. Therefore, copies of software lawfully downloaded from the internet may count as copies purchased by the downloader and falling under the regime of exhaustion.