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A Supreme Slap at Grokster & Co.

By Lorraine Woellert Peer-to-peer (P2P) technology doesn't steal music, people do. But woe to companies that exist to encourage that theft.

That's the word from a unanimous Supreme Court, which on June 27 found that file-swapping services could be held liable for copyright infringements if their bottom line depends on it and they take steps to protect or bolster that revenue. In a 24-page opinion heavy on common sense and lacking in apocalyptic pronouncements, the court said MGM Studios (MGM) could sue Grokster Ltd. and Morpheus parent StreamCast Networks, both makers of popular P2P technology, if their networks were used to steal music, movies, and other protected content -- but only if evidence of unlawful intent exists on the part of the software makers.

"PYRRHIC VICTORY." In other words, bad actors can be held liable for contributory infringement of music and movies. Good actors -- Apple (AAPL) and its iPod comes to mind -- can't (see BW Online, 6/28/05, "Dancing to the Digital Beat"). "One who distributes a device with the object of promoting its use to infringe liable for the resulting acts of infringement by third parties," Justice David Souter wrote for the court. In this case, the record was "replete with evidence" that Grokster and StreamCast each "took active steps to encourage infringement."

Hollywood is crowing about its blockbuster win in the case, with Mitch Bainwol, chairman of the Recording Industry Association of America, calling it a win for "moral clarity." But Richard Taranto, who argued the case on behalf of Grokster and StreamCast, called the opinion "notable" for its "lack of clarity."

True, much remains to be hammered out by the courts. But the content industry might not like the results. There was little subtlety when it came to Grokster and StreamCast's behavior, making them easy targets for Hollywood & Co. However, the entertainment industry might find itself in an uphill fight should it decide to go the next step and take on companies that operate in a gray area by giving lip service to copyright protection and urging their customers -- with a wink and a nudge -- not to steal. For Hollywood, "this is a pyrrhic victory at best," says Gigi Sohn, president of Public Knowledge, a group that supported Grokster's side. "P2P will live on."

NO BLANKET CONDEMNATION. The Grokster case is a fitting coda to the Supreme Court's landmark 1984 opinion in Sony Corp. v. Universal City Studios. In that case, a 5-4 court found that Sony (SNE) couldn't be held responsible if its customers used the company's Betamax VCRs to copy movies and TV programs. The opinion protected any technology from infringement liability as long as it's "merely capable" of "substantial, noninfringing use." The language created a legal safe harbor that fostered many of today's popular consumer gadgets.

When the court took up Grokster, tech companies and cyber-libertarians feared the worst -- that Betamax would be overturned and any technology that could be used to illegally copy content could be sued out of existence -- or never see the light of day. They also fretted that the court might set a quantitative test that would define "substantial noninfringing use."

That anxiety was so great that investment in some fledgling technologies slowed to a trickle while venture capitalists waited for the case's outcome. But the worst didn't come to pass. Notably absent from the Grokster opinion is any condemnation of file-swapping networks at all. In fact, the court took pains to point out the technology has legitimate uses, including distribution efficiencies for libraries, universities, and governments.

EASY TARGETS. That's great news for the tech sector. The Supreme Court left Betamax intact -- no technology can be held liable for infringing just because it can -- and set a fairly low bar for innovators to clear if they want to keep on the copyright straight and narrow. Companies simply have to play by some basic rules to keep copyright lawyers at bay, such as not advertising their products' capability to infringe.

"They struck a good balance," says Michael A. Malcolm, chairman and CEO of Kaleidescape, a Mountain View (Calif.) company that builds home-viewing systems for DVDs. "The situation with Grokster and StreamCast was pretty egregious. We've always done everything the right way to be a good actor."

It was no accident that Grokster and StreamCast were the defendants in this case -- they were handpicked by Hollywood because they made the content industry's case so easy to argue. StreamCast developed an ad campaign touting itself as a Napster alternative, and one exec boasted in an e-mail that the company had positioned itself to capture the flood of Napster's 32 million users when that site went dark.

MORE ROUNDS AHEAD. Grokster designed its Web site to attract downloaders searching for Napster. Both companies relied on heavy Web traffic -- generated mostly by visitors in search of free music -- to support ad sales, which made up the bulk of their revenue. Grokster even issued a newsletter promoting its ability to offer particular songs.

Neither Grokster nor StreamCast were passive victims of gangs of drive-by infringers. They actively encouraged illegal downloads because their bottom lines depended upon it, the court found.

Although the opinion gives lower courts a set of guidelines for deciding similar disputes, the fight is far from over. Both sides are wary of giving any ground, and with the case headed back to a lower court for trial, Grokster and its side vow to keep battling. "The court will agree that StreamCast has not induced or otherwise satisfied the test the Supreme Court has announced," predicts Fred von Lohmann, an intellectual-property attorney with the nonprofit Electronic Frontier Foundation, which had supported Grokster. "They've created a new theory of liability, one that will tie up courts for some time." Woellert is a correspondent in BusinessWeek's Washington bureau

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