IP Law Daily Copyright Act preempts California’s Resale Royalty Act
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Friday, April 15, 2016

Copyright Act preempts California’s Resale Royalty Act

By Cheryl Beise, J.D.

The California Resale Royalty Act (CRRA) has been struck down by the federal district court in Los Angeles as preempted by the federal Copyright Act. The court concluded that the CRRA “stands in conflict with the first sale doctrine” of Section 109 of the Copyright Act. The court also held that the plaintiffs’ claims for unpaid royalties under CRRA were independently preempted under Section 301 because they were “not qualitatively different from garden-variety copyright claims.” Three related putative class actions brought by artists and their representatives against fine art resellers were dismissed (Estate of Robert Graham v. Sotheby’s Inc., April 11, 2016, Fitzgerald, M.).

The CRRA

The CRRA requires the seller of fine art to pay the artist a five percent royalty as long as “the seller resides in California or the sale takes place in California.” Cal. Civ. Code §986(a). Sales of fine art less than $1000 are expressly excluded from the statute. The CRRA applies not only to sellers but also their agents. If the artist is not located within 90 days of the sale, the royalty must be paid to the California Arts Council. An artist may sue to recover the royalty and reasonable attorneys’ fees.

In 2011, the Estate of Robert Graham and others filed putative class action lawsuits for recovery of unpaid royalties, punitive damages, attorney fees, and injunctive relief under the CRAA against auction houses, online marketplace operator eBay, Inc., and other defendants.

Four years ago, the court partially dismissed the actions, concluding that the CRRA’s regulation of sales outside California violated the dormant Commerce Clause of the United States Constitution. The Ninth Circuit, sitting en banc, affirmed the district court’s holding, but determined that the unconstitutional portion of the CRRA—the portion applying to out-of-state sales—could be severed from the remaining provisions.

Presently before the court were motions to dismiss filed by the remaining defendants, Sotheby’s, Inc., and Christies, Inc., and eBay Inc. The defendants contended that the CRRA is preempted under the Copyright Act of 1976. Because the CRRA regulates secondary transactions of fine art by permitting artists to recover unwaivable royalties from resellers, the defendants argued that the state law frustrates the purpose of the first sale doctrine, codified in Section 109(a) of the Copyright Act. In addition, the defendants argued that the plaintiffs’ claims were independently preempted under the express preemption clause of Section 301(a) of the Copyright Act because they were not qualitatively different from copyright claims. The defendants also asserted that the CRRA violates the Takings Clause of the Fifth Amendment.

Copyright Act Preemption

Two types of preemption applied in this case: conflict preemption and express preemption. Conflict preemption invalidates a state law that actually conflicts with federal law or frustrates the purpose of a federal law. Express preemption applies when a “preemption clause” in a federal statute expressly displaces a state law.

First sale doctrine. The first sale doctrine, codified in Section 109(a) of the Copyright Act, provides that the owner of a lawfully made particular copy of a copyrighted work “is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy.”

The plaintiffs contended that the first sale doctrine “does not restrict the copyright holder’s right to contractually limit subsequent distribution nor does it preclude a state legislature from enacting legislation pertaining to subsequent distributions.”

The court agreed that copyright holders are permitted to exercise control over downstream markets in exchange for a wide variety of contractual benefits to resellers. However, in the court’s view, the plaintiffs erred in analogizing limitations on downstream sales imposed by contract to those imposed by state law. “No authority supports the proposition that states can eliminate the first sale doctrine, and imbue copyright holders with unprecedented market power, simply because a reseller can enter into a distribution agreement with the copyright holder,” the court said. As the court explained:

It is precisely the protection afforded by § 109(a) that permits resellers to gain contractual benefits in exchange for their distribution rights. Without § 109(a), copyright holders would not need to bargain for downstream control; they would simply sue for copyright infringement as soon as their products entered secondary markets. Any state laws that conflict with the first sale doctrine, therefore, necessarily transfer market power from resellers to copyright holders.

In examining the CRRA, the court reasoned that the five percent royalty obligation acts as a disincentive for art investors to resell their art, thereby restricting the secondary markets for fine art in California. “That result both undercuts the purpose of the first sale doctrine and inhibits the uniformity Congress sought to achieve by enacting the Copyright Act,” the court said. In enacting Section 109, Congress intended to keep downstream sales of copyrighted works free from restrictions imposed by copyrighted holders.

Thirty-five years ago, the Ninth Circuit, in Morseburg v. Balyon, 621 F.2d 972 (9th Cir. 1980), held that the first sale doctrine codified in the 1909 Copyright Act did not preempt the CRRA. The Morseburg court analogized the royalty imposed on resellers to taxes imposed on the proceeds from the sales of art.

Even though the first sale doctrine in Section 109 of the 1976 Copyright Act is substantially identical to the 1909 Act, the court nevertheless determined that it was not bound to follow Morseburg because “recent decisions of the Supreme Court and the Ninth Circuit have so eroded Morseburg that it is no longer represents a binding interpretation of the first sale doctrine and the CRRA.” For example, in Quality King Distributors, Inc. v. L’anza Research Int’l, Inc., 523 U.S. 135, 137 (1998), the Supreme Court described Section 109(a) as having “broad reach” and warned against a “cramped reading” of the statutory language. InKirtsaeng v. John Wiley & Sons, Inc., 133 S. Ct. 1351, 1366 (2013), the Court found it “absurd” that “the copyright owner [could] exercise downstream control even when it authorized the import or first sale.”

Even more on point, last year the Ninth Circuit rejected Morseburg’s premise that the CRRA constitutes a mere “regulation of [sale] proceeds” similar to “state-imposed taxes”; instead, the court concluded that the state law restricts “conduct among private parties.” Sam Francis Foundation v. Christies, Inc., 784 F.3d 1320, 1324 (9th Cir. 2015) (cert. denied).

Because the CRRA “disrupts Congress’s efforts to balance the interests of copyright holders and downstream consumers,” the court concluded that it is preempted.

Express preemption. Section 301(a) of the Copyright Act preempts state laws that “fall within the subject matter of copyright” and seek to protect rights that are equivalent to a copyright holder’s exclusive rights protected by Section 106. The plaintiffs did not dispute that works of “fine art” constitute “pictorial, graphic, [or] sculptural works” within the scope of Section 102 of the Copyright Act.

The plaintiffs, however, argued that the CRRA created an “additional right” to a royalty a portion of money earned in a sale of artwork, not on copying, not on distribution and not on the sale itself. The court disagreed. A state law can be preempted even if it is not coextensive with the Copyright Act and instead creates an exclusive right Congress explicitly declined to create, the court explained.

The plaintiffs also urged the court to follow Baby Moose Drawings, Inc. v. Valentine, (C.D. Cal. 2011), in which the district court concluded that the CRRA was not completely preempted under Section 301(a) for the purposes of removal jurisdiction. The court declined to do so because Baby Moose did not analyze the CRRA’s relation to the first sale doctrine, but instead relied on the legislative history of the Visual Artists Rights Act of 1990 (VARA), which amended some portions of the Copyright Act and created a special preemption section, Section 301(f). There was no basis to find that Section 3012(f) precluded preemption of the CRRA under Section 301(a).

The court therefore concluded that the CRRA was preempted under Section 301(a), regardless of whether Morseburg is still binding precedent. The plaintiffs’ claims for violations of the CRRA, and its claims for unfair competition based on those claims, were accordingly dismissed.

Although the remaining issues were mooted by the court’s preemption finding, the court nevertheless addressed them for the sake of completion.

Takings Clause

The court rejected the defendants’ argument that the CRRA violated the Takings Clause of the Fifth Amendment of the U.S. Constitution. The CRRA does not inhibit property rights that have traditionally enjoyed constitutional protection, but transfers certain interests in intellectual property from downstream owners to original artists. Thus, the alleged “property interest” in the disputed royalties belonged to the plaintiffs, not the defendants or their clients, the court reasoned. The court noted that it could be argued that the Takings Clause prohibits imposition of royalties on the first resale of art that was purchased from the artist prior to the enactment of the CRRA in 1976, but that had not been alleged by the defendants.

Because the defendants never possessed property interests in the entire resale value of the artwork they purchased, California’s redistribution of that interest was not an infringement on traditional property rights. “The CRRA may be preempted, but it is not invalid under the Takings Clause,” the court said. The defendants’ motion was denied.

Plausibility

The defendants contended that the plaintiffs’ claims had to be dismissed because they failed to identify specific art sales that gave rise to the royalty requirement under the CRRA. However, all that was required at the pleading stage was to allege that the defendants sold the plaintiffs’ artwork in California without paying royalties. The court also rejected the defendants’ argument that the plaintiffs’ claims were time-barred by the CRRA’s three-year statute of limitation.

Punitive Damages

The court granted the defendants’ motion to dismiss the plaintiffs’ prayer for punitive damages under the CRRA and California’s Unfair Competition Law (UCL). The CRRA does not contain a punitive damages provision and Civil Code section 3294—California’s catch-all punitive damages provision—was not applicable to the action because there was no common law analog that could support an award of punitive damages.

Liability under CRRA—Sotheby and eBay

eBay argued that it should be dismissed from the suit because it was not subject to the CRRA. The court agreed that eBay was neither a “seller” nor an “agent” for those who sold goods on its platform. “eBay is a platform that permits sellers and buyers to interact with one another—not an agent,” the court said. eBay’s motion was granted, but with leave to amend.

Sotheby argued that it should be dismissed from the action because the plaintiff’s failed to allege sufficient facts to show that Sotheby had sold any artwork subject to the CRRA. The court denied the motion, finding that the factual dispute was better resolved at the summary judgment phase.

The case is Nos. CV-11-08604-MWF-FFM, CV-11-08605-MWF-FFM, and CV-11-08622-MWF-PLA.

Attorneys: Eric M. George (Browne George Ross LLP) for Estate of Robert Graham. Angela L. Dunning (Cooley LLP) for Sotheby’s, Inc., Christies Inc., and eBay Inc.

Companies: Sotheby’s, Inc.; Christies Inc.; eBay Inc.

MainStory: TopStory Copyright CaliforniaNews

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