United States: Does Lender Liability Exist For Copyright Infringement?

To what extent and under what circumstances will a lender be held accountable for the infringement of a copyright by its debtor? This question may now come before the United States District Court for the District of Hawaii. So far, existing case law offers very little concrete guidance. But a recent proliferation of secondary liability theories for copyright infringement makes one thing clear: lenders should take precautions in lending to parties with business models that depend upon technology that may be the subject of a copyright dispute.

Wayne Berry, a software developer, filed suit against Deutsche Bank Trust Company Americas and JPMorgan Chase Bank (together, the "Lenders") for vicarious and/or contributory copyright infringement of his copyright in the software program Freight Control System 1993 or "FCS 1993." See Berry v. Deutsche Bank Trust Co. Americas., CV07-00172 (D. Haw., complaint filed March 29, 2007). Berry alleged that FCS 1993, which controls and monitors the packing and shipping of freight, was unlawfully used by the defendants’ borrower, Fleming Companies, Inc. ("Fleming").

The controversy had begun years earlier, when Berry filed a direct infringement suit against Fleming. According to Berry’s complaint in the current action, the defendant lenders were lead agents of certain syndicated credit facilities that Fleming executed in 2002. Berry alleged that in fall 2002, he sent letters to each of the lenders warning them of Fleming’s infringing activities. The lenders allegedly denied the infringement. In March 2003, a jury found that Berry held a valid copyright in FCS 1993 and that Fleming had engaged in willful infringement of that copyright.

On April 1, 2003, shortly after the jury verdict finding infringement, Fleming filed a voluntary petition for bankruptcy. At that time, Fleming owed the lenders approximately $604 million, and the lenders ceased funding under the existing credit facilities. To avoid shutting down, Fleming sought and obtained from the defendant lenders (and apparently some but not all of the participating pre-petition lenders) an additional $50 million of working capital.

The Berry complaint alleges two sets of facts that may give rise to liability: (1) the pre-petition lending, during which the lenders were put on notice of possible infringement by their debtor and yet, empowered by the then existing loan covenants, exercised control over the debtor to continue infringing operations; and (2) the post-petition lending, which occurred subsequent to the jury verdict of infringement and filing for chapter 11 protection, when certain lenders advanced an additional $50 million to sustain the infringing operations.

Although the copyright statute does not provide for secondary liability for infringement, case law has long recognized such liability based on basic tort principles.

Vicarious liability for copyright infringement exists when the defendant possesses the right and ability to supervise the infringing conduct and has an obvious and direct financial interest in the exploitation of the copyrighted materials.

Contributory infringement may (among other circumstances) exist where a party who, with knowledge of the infringing activity, induces, causes, or materially contributes to the infringing conduct of another, or was in a position to control the use of copyrighted works by others and authorized the use without the permission from the copyright owner.

The Supreme Court, in MGM Studios, Inc. v. Grokster, Ltd., 545 U.S. 913 (2005) set forth the additional theory of inducement liability, holding that a defendant will be secondarily liable for acts of infringement if it "distributes a device with the object of promoting its use to infringe copyright, as shown by clear expression or other affirmative steps taken to foster infringement…." Id. at 918-19.

Applying these theories of secondary liability to lenders is not simple. On the one hand, it seems clear that simply lending money to an infringer alone, without more, cannot give rise to secondary liability. But to the extent that a lender also can and does exert some degree of control over the infringing party’s infringement, the law becomes less clear.

A lender’s liability in this context will be a purely factual inquiry: When and under what circumstances would a lender assume and/or exercise enough control over the business or strategic operations of its debtor to be considered to be supervising, inducing, causing or materially contributing to an infringing activity of its debtor?

The secondary liability of parties supplying funding to an infringing entity has been addressed at least once before, in connection with the Napster cases. See, UMG Recordings, Inc. v. Bertelsmann AG, 222 F.R.D. 408 (N.D. Cal. 2004). In that case, the complaint against investors Bertelsmann and Hummer Winblad survived a motion to dismiss.

Holding that the plaintiffs had stated a claim against the investors, the court specifically relied on the plaintiffs’ allegations that "the defendants Bertelsmann and Hummer Winblad—as entities exercising full control over Napster’s operations—were directly responsible for the infringing activity perpetrated by Napster’s on-line users; more than merely knowing of and contributing to the infringing activity, they are alleged to have specifically ordered that such activity take place." Bertelsmann, 222 F.R.D. at 413.

The court, however, expressly declined to address the question of whether "mere financial support of a contributing and vicarious infringer such as Napster—without more direct involvement—would give rise to a claim for contributory or vicarious infringement against the party providing the funding." Id. at 414.

There are obviously many legal and factual differences between the roles of creditors and the roles of investors, particularly venture capitalists whose purpose and intent from the outset is to be involved with the strategic direction and operations of the primary enterprise. Lenders generally are held at more of an arms’ length from the details of the borrower’s operations, and it is unsurprising that the Berterlsmann court viewed the roles of Hummer Winblad and Bertelsmann in Napster’s operations with a degree of skepticism.

Should the Berry court issue any substantive rulings on the merits of Berry’s complaint, it will be instructive to direct lenders. In the meantime, lenders should be wary of lending to any enterprise with a business model that is a likely target for a copyright infringement suit. Lenders should be sure to seek legal advice regarding the structure of any such lending activity, and should involve counsel at the first hint of copyright infringement claims against any of their existing borrowers.

This article is presented for informational purposes only and is not intended to constitute legal advice.