ISMT 520 Lecture #2: Software and Copyright Law Dr. Theodore H. K. Clark Associate Professor and Director of MSc Program in IS Management Department of Information & Systems Management Hong Kong University of Science & Technology and Visiting Associate Professor of Operations & Information Management (Information Economics and Strategy Group) The Wharton School of the University of Pennsylvania

HKUST Business School 2 Software Law Protected by copyright, not by patent laws Stronger that patents in some ways, but weaker in others Longer protected life than patent Immediate copyright protection upon creation Fair use doctrine as defense Does not protect idea, only expression Stops exact copying, not functional duplication

HKUST Business School 3 Software as Expression Justification for applying copyright to software is that it is an expression like that of an artist’s novel or a painting This raises question regarding applicability of freedom of speech for software and code US constitution protects freedom of speech US government tried to stop publishing of encryption code as security law violations Academics claimed code was protected speech

HKUST Business School 4 Utilitarian versus Artistic Value Patents are normally designed to protect useful products and innovations Copyright is normally designed to protect artistic expression that is not utilitarian Software is the most notable exception, and there have been some efforts to develop new laws or rights to protection of software Mostly, these have been resisted by both courts and legislature. Why? Are new laws needed?

HKUST Business School 5 Commission on New Technological Uses (CONTU) Impossible in 1978 to establish precise line Copyrightable expression of programs Un-copyrightable processes that they implement Subjective boundary of where this line is drawn is critical to value of protections Shifting and unstable foundation Case law is still relatively immature for software Legislature rules may be shifting as well Public policy likely to affect evolution

HKUST Business School 6 Substantially Similar Copying Exact copying clearly prohibited by law However, even this was once uncertain! See Franklin vs. Apple case for early example of legal debate on copyright application to software Reverse engineering, in theory, not violation of copyright, which protects expression only Substantially similar copying less clear Micro-code hardwired on chips a “gray area” Mathematics formula can not be copyrighted

HKUST Business School 7 Look and Feel and Copyright File Structure, Screen Outputs, and Subroutine Performance in Whelan Case Unclear exactly what meet criteria, but total was enough for court to find violation of copyright Generally, visible aspects observable by judge more likely to be persuasive than file structures Arnstien – bifurcated substantial similarity Is there substantial similarity to conclude usage of copyrighted code (derivative works prohibited)? Does it appear to lay observer copying was illicit?

HKUST Business School 8 Editing of Copyright Materials Right to edit and then resell is in dispute Is this like taking a book and highlighting or making notes in the margin, and then selling the book as value added work due to comments? Alternatively, is this like copying look and feel and making a derivative work which is not authorized under copyright law (Midway) Digital Millenium Copyright Act (DMCA) Strict prohibition on breaking software encryption

HKUST Business School 9 Introduction to Group Project CleanFilms.com, Inc. and CleanFlicks, Inc. business was editing movies to REMOVE offensive scenes Nothing is added, with less than 5% of material removed Edited movies were rented locally or on subscription basis via the internet and mail (like Netflicks online) CleanFilms and CleanFlicks LOST a three year litigation and was forced to close down its operations NewCompany wants to enter the business They have hired your team to give them business advice Suggest a business model that can survive future litigation

HKUST Business School 10 Copyright Law Issues in Dispute Right of company to edit Hollywood movies Copyright protection of expression Is removal of some material a derivative work? No damages claimed or requested No loss of income to Hollywood from editing But, could there be a claim of future income loss? See Midway case – might reserve right to future sales Injunction sought and issued to prohibit editing and resale or rental of movies to customers

HKUST Business School 11 Group Project Assignment What cases can you find providing useful precedent for courts in making a decision on this case? Based on precedents and statutory copyright law, how would you put forth a strong argument: First, to support CleanFilms and CleanFlicks position Second, to support the position of Hollywood studios How might a new company AVOID being subject to the court ruling in this prior case already decided? How could new company be set up as a business model to reduce likelihood of future negative ruling? Would a non-profit business model be useful? Why?

HKUST Business School 12 Group Project Assignment (p.2) What international business or legal opportunities and issues should a company be aware of when considering entering this edited movie business? How might new technology innovations in movie delivery affect this edited movie business? Is this likely to be a niche business occupied by mice that operate on the edge of or outside the law, or a business dominated by a few large elephants? How might a small company build and maintain a competitive advantage in this business without breaking the law and in spite of large firms that may be interested in this as a future business opportunity?

HKUST Business School 13 CleanFilms History: Background Company started in 2002, by 26 year old marketing executive that had left a declining dot.com business Based on vision of offering higher quality (e.g. differentiated) entertainment at a premium price Based on Netflix online rental e-business model Lawsuit filed shortly after start-up by Hollywood 2 million invested in business startup, but due to litigation risks and slow than expected growth, founding shareholders and CEO sold business in 2005 New owners bought business for 50% of asset value

HKUST Business School 14 CleanFilms History: End Game After years of minimal profits, increased efficiencies and sales focus increased profits to $50,000 / month Litigation risk was minimized via sale and leaseback of DVD original movies, providing most of the cash for the purchase, and profits in 10 months more than paid by all the debt incurred in the company buyout Lawsuit with Hollywood was lost 10 months later AFTER LOSING, negotiated settlement agreement which allowed the company to sell all its existing inventory over two months and then shut down firm Made $1 million profits AFTER losing the lawsuit

HKUST Business School 15 Group Project Assignment: Future Prior owners of CleanFilms and CleanFlicks can not re-enter business due to settlement agreement Company owning DVD assets, purchased under sale and lease-back in September 2005, has low cost assets and purchased one edited copy of edited movie, before judgment and agreement, which would cost about $200,000 to recreate for any new firm considering entering this business ($80 per movie) Owners of this company want advice on what they should do, but prior CleanFilms owners can not give advice to them under settlement agreement terms Therefore, they want advice from your team instead