As we suspected, the response from the entertainment community has been swift, and the company has since received a barrage of cease and desist letters from television networks, movie studios, sports leagues, broadcasters, syndicators and others in the entertainment industry alleging that the operation of the service as currently conducted amounts to copyright infringement. In response, the company has now filed a complaint for declaratory judgment in Seattle district court alleging that by complying with the Act’s compulsory licensing scheme in Section 111 “it has not infringed any of the copyrights owned by the any of the Defendants.”

We will obviously keep an eye on future developments as this complaint now moves its way through the court system and the entertainment industry’s forthcoming response.

Unlike other online content distributors, the start-up has allegedly sidestepped negotiating with the copyright holders for the license of its programming, and has instead elected to wager its future on a seemingly liberal interpretation of certain provisions of the Copyright Act (the “Act”), which permit qualifying “cable systems” to rebroadcast over-the-air television signals upon the payment of certain statutorily mandated revenues. Specifically, the Act’s compulsory licensing scheme (see Section 111) allows cable systems to carry distant broadcast signals while compensating copyright owners for the public performance of their works, without the transaction costs associated with marketplace negotiations for the carriage of copyrighted programs, and instead requires that the cable system remit a fixed portion of their revenues for the retransmission of such programming to the copyright holders. Based on statements from ivi, Inc.’s management, the company has already taken steps to comply with the requirements under Act, and is apparently taking the position that its service does, in fact, qualify as a “cable system”.

The company’s current position appears to be in part attributable to the Act’s expansive definition of a “cable system”, which includes “any facility… that receives signals transmitted or programs broadcast by one or more television broadcast stations licensed by the Federal Communications Commission, and makes secondary transmissions of such signals or programs by wires, cables, microwave, or other communications channels to subscribing members of the public who pay for such service.”  The legislative intent behind the foregoing definition and the enactment of the statutory licensing scheme over 30 years ago (decades before the advent and commercialization of the Internet) was to benefit traditional cable and satellite companies operating in a heavily-regulated industry under the jurisdiction of the FCC, including a slew of rules and requirements under the Communications Act, such as programming exclusivity, sports blackouts, network non-duplication, signal quota, must-carry, and others.  The statute was not designed to provide a means for Internet-based services like “ivi tv” to avail themselves of the statutory licensing scheme by labeling themselves a “cable system” on the one hand, while at the same time finding refuge from the corresponding restrictions on MVPDs under the Communications Act because the regulation of programming retransmitted via the Internet falls outside the scope of the FCC’s jurisdiction.

This approach has been attempted before, albeit unsuccessfully.  A similar start-up, iCravetv.com played an analogous tune in 2000. Hailed as the first service to put a broad range of ordinary TV stations on the Internet–from the Simpsons to Major League Baseball games–the Toronto-based service launched to international press and huge amounts of Web traffic. They too made similar arguments regarding the contours of compulsory licensing under Canadian copyright law, but failed to quash a swift petition for a temporary restraining order initiated by United States movie studios, television studios, sports leagues and broadcasters and the iCraveTV.com service agreed to permanently shut its doors.  Notably, the petition for the temporary restraining order called the business venture “one of the largest and most brazen thefts of intellectual property ever committed in the United States.” 

Since the iCraveTV case, the U.S. Copyright Office’s Register of Copyright has repeatedly reiterated that the compulsory licensing scheme under Section 111 of the Act is inapplicable to Internet transmissions:  “..[T]he section 111 license does not and should not apply to Internet transmissions” and that “if there is to be a compulsory license covering such retransmissions, it will have to come from newly enacted legislation and not existing law.”  Most poignantly, the Copyright Office has explicitly stated that it opposes any circumstance (as in the case of “ivi tv” or iCraveTV.com) where “any online content aggregator would have the ability to use a statutory license to sidestep private agreements and [be] free from any of the limitations imposed on cable operators and satellite carriers by the Communications Act and the FCC’s rules.”   In fact, the Copyright Office openly opposes an Internet statutory license that would permit any website on the Internet to retransmit television programming without the consent of the copyright owner, stating that “such a measure, if enacted, would effectively wrest control away from program producers who make significant investments in content and who power the creative engine in the U.S. economy.”

In addition, the Copyright Office has also warned that any possible expansion of the statutory licenses to the Internet will implicate and may contradict certain international obligations, including various bilateral and multilateral trade agreements that prohibit statutory licensing of television signals over the Internet.  Specifically, the U.S. has obligations under the Berne Convention, the WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs), and WIPO Copyright Treaty that relate to broadcasting and Internet transmissions, including several free trade agreements with foreign nations which contain the obligation that “…neither Party may permit the retransmission of television signals (whether terrestrial, cable, or satellite) on the Internet without the authorisation of the right holder or right holders, if any, of the content of the signal and of the signal…”

Against this backdrop, even if Ivi is able to successfully defend any copyright infringement claims and challenges to its current position regarding the applicability of the compulsory licensing provisions under Section 111 of the Act, we suspect (and Ivi has even suggested) that, like  iCraveTV, the company may be on the wrong end of a barrage of claims asserted by television networks, movie studios, sports leagues, broadcasters, syndicators and others in the entertainment industry alleging that the operation of the service as currently conducted amounts to and/or results in unfair competition, tortious interference with contractual relationships, trademark infringement and dilution, false designation of origin or false representation with regard to sponsorship or authorization, etc. Additionally, until and unless Congress decides to amend the Act to clarify the legislative intent concerning the scope of the compulsory license under Section 111, any challengers to the law will need to be in a position to withstand the full weight of the United States entertainment industry which drives a substantial portion of the U.S. economy.

We will obviously keep an eye on future developments in connection with this fledgling service and the entertainment industry’s forthcoming response.

In this case, Friskit’s patents covered technology related to creating a playlist from an on-demand server and causing the songs on the playlist to be played back in sequence.  Friskit claimed that Real’s multimedia player and subscription services infringed these patents.  Real moved for summary judgment, asserting that Friskit’s patents were invalid because they were obvious.  Real’s initial motion was denied, but following the Supreme Court’s intervening decision in KSR, Real renewed its motion and the district court granted it.

On appeal, the Federal Circuit affirmed the trial court’s decision that Friskit’s design would have been obvious to one skilled in the art.  The court found that there were only insignificant differences between the prior art and Friskit’s design, given the advanced state of knowledge in the art at the time the patent applications were filed.  As the court said, “All of the essential components of the claimed invention . . . pre-dated the patents-in-suit.”

While acknowledging that it did not invent streaming media, playlists or media players, Friskit claimed that its patents “deliver the glue to put existing technologies in a single application.”  The Federal Circuit rejected this argument based on the Supreme Court’s holding in KSR that the predictable use of prior art elements according to their established functions is likely to be within the grasp of one of ordinary skill in the art.  Since the prior art disclosed methods of “programmatic control”, and the benefits of network control of local processes were well known at the time of the invention, it was a “trivial” step to Friskit’s design. 

The Federal Circuit also found that any evidence of secondary considerations too weak to rebut a finding of obviousness.  The Federal Circuit discounted arguments of commercial success because Friskit did not show that the products’ success was attributable to a non-obvious subject matter.  Additionally, copying by the accused infringer had little persuasive value in the absence of evidence of failed development efforts by the infringer.  Finally, Friskit did not present any evidence that its design involved any “technical challenge to one of ordinary skill in the art once market forces had created a demand for integrated, streaming media services.”

KSR has led to wide-scale reexamination of the validity of issued patents, both in litigation and transactional contexts.  The framework established by KSR raises the bar for those trying to enforce patents that do not substantially advance the technologies encompassed in the patents.

  Royalty Rate Analysis

After months of hearings, testimony and deliberations, on October 2, 2008, the United States Copyright Royalty Board (CRB) announced newly established rates for royalties to be paid to writers and composers (as opposed to performers) whose musical compositions are made and distributed as sound recordings (i.e., phonorecords), including via (1) physical recordings (e.g., CDs, tapes, vinyl, etc.), (2) permanent digital downloads, (3) ringtones, (4) limited/tethered digital downloads and (5) interactive streaming.

 These new rate determinations, which will remain in effect until December 31, 2012, break new ground. Following a drawn-out battle between the National Music Publishers’ Association (NMPA) (representing song writers and composers) and the Recording Industry Association of America (RIAA) and the Digital Media Association (DiMA) (representing the record labels and digital music retailers, respectively), the CRB established, for the first time, a rate for the distribution of ringtones (24¢ per delivery), while surprisingly maintaining the same rates for the distribution of physical recordings and permanent downloads of digital recordings that had been in effect since January 1, 2006 (9.1¢ per delivery). The rates for the distribution of sound recordings as limited/tethered downloads (i.e., downloads that only play a fixed number of times or for a fixed period of time) and as interactive streams (i.e., online digital streams of recordings selected by an end user on an on-demand basis), both of which had been slated for resolution by the CRB among the other rates at the outset of the lengthy proceedings, were actually negotiated to a consensus by the parties during the hearings, and their settlement was adopted by CRB, subject to ratification following public comment.

The announcement of the rates for limited downloads and interactive streaming of recorded music are of the utmost importance to both the publishers and the record labels alike because, prior to the announcement of the proposed rates, any service seeking to offer limited downloads and/or interactive streaming of recorded music was required to negotiate a royalty rate with individual writers, publishers or mechanical royalty collections agencies such as Harry Fox. In other words, copyright ownership in a sound recording alone (or obtaining a license from the owner, typically a record label) does not allow for the distribution of that recording without first obtaining a license from the song writer or publisher owning and/or controlling the copyright in the musical composition contained therein. Section 115 of the Copyright Act, also known as the “mechanical compulsory license”, however, provides a mechanism whereby a licensee (typically retailers or record labels) may be automatically granted a license to distribute sound recordings containing songs that they neither own nor control simply by adhering to the terms of the compulsory license and paying the rates set by the CRB. In other words, the express permission of song writers and publishers is not required to make and distribute sound recordings incorporating their musical compositions, provided that the licensee pays the applicable rates and complies with the terms of the statute.

As evidenced over the last two years, the trend among social networking websites (e.g., MySpace, etc.) and other digital entertainment websites (e.g., imeem, last.fm, etc.) has been the inclusion of digital music in forms other than traditional webcasting or internet radio (i.e., non-interactive streaming, where the end user does not select each individual sound recording) in favor of a more personalized user experience. Obtaining a license to provide interactive streaming, however, has thus far been both a lengthy and expensive process, but now website publishers will only be required to negotiate licenses with the sound recording owners or providers and pay the required mechanical license fees and the applicable public performance fees without the need to negotiate a separate licensing arrangement with the publishers.

The new mechanical royalty rates for limited downloads and interactive streaming are unlike the statutory rate structure for physical recordings, permanent digital downloads, and ringtones, all of which are all based on per unit calculations (i.e., “penny rates” or a fixed amount per distribution). Instead, these new rates are based on a percentage of revenue formula, with varying rates based on the business model of the service offering the musical recordings, including subscription-based and ad-supported models. In other words, the amount due to each publisher whose work is incorporated in a sound recording selected by an end user for streaming or downloading is a certain pro-rata percentage of revenue earned by the service or digital platform.

   The calculations are relatively complex, requiring multiple steps that vary according to the type of service. For all service models described in the proposed rate settlement, however, the calculation begins with a determination of monthly “service revenue” for the applicable accounting period, or all revenue recognized by the service from end users from the provision of the licensed activity, including subscription fees, sponsorships, commissions and third party advertising in connection with the interactive streaming and limited downloads offered on the service. The service revenue is then multiplied by the applicable percentage, which is identical across the all service models (10.5%). This amount is then subject to increase based on the applicable minimum payment amounts if the percentage of service revenue fails to exceed the minimums according to the type of service (i.e., whether music subscription fees are charged or whether the service is free or ad-supported).

For example, in the case of music subscriptions services (4 of the 5 service models), the applicable minimum payment is the greater of (a) a fixed amount for each paying subscriber ($.15-$.80) or (b) a fixed percentage of the amount paid by the service to the owners of the sound recordings (i.e., licensing fees paid to the recording labels and content aggregators) for the rights to steam and offer downloads of the recordings (17-22%). In the case of free or ad-supported models, the only applicable minimum is the fixed percentage of the amount paid to the owners of the sound recordings (18%-22%). Ultimately, the total amount due to the publishers is the percentage of service revenue or the applicable minimum payment amount (which ever is greater), less all public performance fees paid by the service provider to the applicable performing rights organizations for the rights to stream the applicable recordings.

These first time mechanical rates for music on ad-supported and free services represent a significant shift in the digital music space. First, it effectively removes any fixed payment obligation on such services (i.e., no penny rates based on the amount of subscribers, downloads, or streams) other than 10.5% of service revenue or the fixed percentage paid to the owners of the sound recordings. Second, the absence of fixed dollar minimums provides much-needed flexibility for new business models to emerge and should allow them to continue to exist, as many would cease to be profitable if required to remit fixed dollar amount minimums when all revenue generated is dependent on alternate sources, including the receipt of advertising dollars.

Once the proposed rates are ratified, expect to see increased streaming activity in the digital music space among purveyors of online content, especially social networking websites. In fact, within a few days of MySpace’s recent launch of its streaming music functionality, MySpace Music, the service had already well surpassed one billion streams, providing further evidence that a per stream or subscriber/member minimum would be cost prohibitive.

If this is in fact the case, the publishers now sit squarely in the driver’s seat for determining the future of purely ad-supported business models in the digital music space, many of which cannot exist if required to make any sort of minimum payment per transaction or subscriber. Once such a rate is set by the CRB, each individual business unable to accept a minimum payment will then be forced to negotiate directly with each individual publisher for each music track, and face not only enormous advance payment demands, but an endless nightmare of tracking down each individual publisher (which for some music tracks may be 5 or more) and securing a licensing arrangement that does not involve any such minimum.

The enormity of this time and money consuming endeavor will certainly turn many current and future purveyors of digital music away from the distribution of on-demand streaming music and conditional downloads which, in comparison to the permanent downloads, do not earn enough revenue given their ephemeral nature to warrant a fixed payment amount other than a percentage of what they actually generate.

Ad-supported music distribution services offering streaming music, limited downloads, or both, should be extremely concerned at this latest development. While it is certainly encouraging to see the sides agreeing on some of the rates at issue, the publishers have been fervently opposed to any rates purely based on a percentage of revenue given the enormous difficulty in accounting for the many different business models, alternative accounting systems and various deductions and other methods of calculating revenue. As such, the publishers have continuously pushed for a minimum calculation for determining the monies they are owed, whether based on plays, streams, downloads or subscribers (e.g., a penny rate or amount per individual subscriber) in order assure themselves revenue without the need to confront and investigate every business model turning to compulsory licenses.

[TO BE CONTINUED]