United States: Certain Provisions Of California Resale Royalty Act Are Preempted By The Copyright Act

On April 11, 2016, in Estate of Robert Graham, et al. v. Sotheby's, Inc., D.C. No. 2:11-cv-08604-MWF-FFM (C.D. Cal. 2016), U.S. District Court Judge Michael Fitzgerald concluded that certain provisions of the California Resale Royalty Act (CRRA) are preempted by the Copyright Act of 1976.

The CRRA requires a seller of fine art to pay the artist a 5 percent royalty from the proceeds of a sale "as long as the seller resides in California or the sale takes place in California." Cal. Civ. Code § 986(a). Fine art is defined as "an original painting, sculpture, or drawing, or an original work of art in glass." Id. § 986(c)(2). Under the CRRA, sellers and their agents (including an auction or a gallery, dealer, broker, museum, or other person acting in such a capacity) have an obligation to locate and pay the artist after a resale is executed. If the seller or agent fails to comply, the artist may sue to recover the royalty due as well as reasonable attorneys' fees. The sale of some fine art, including works valued under $1,000, are excluded from the royalty requirement. 

The First Sale Doctrine

Specifically, the CRRA stands in direct conflict with the first sale doctrine, codified in 17 U.S.C. section 109(a), which provides that "the owner of a particular copy ... lawfully made under this title ... is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy." 17 U.S.C. § 109(a). This doctrine effectively prohibits copyright holders from exercising downstream distribution control of their products and preserves the "robust secondary markets" available to sellers by "leaving buyers of goods free to compete with each other when reselling or otherwise disposing of those goods." Estate of Graham at 7 (quoting Kirtsaeng v. John Wiley & Sons, Inc., 133 S.Ct. 1351, 1352 (2013)).

The primary goal of the first sale doctrine is to create a mechanism wherein a copyright owner's statutory right to control a copyrighted item's distribution is exhausted once the owner places that item into the stream of commerce by selling it. Quality King Distributors, Inc. v. L'anza Research Int'l, Inc., 523 U.S. 135, 137 (1998). In Estate of Graham, the court drew an analogy between the function of the first sale doctrine and that of the patent exhaustion doctrine, which prevents a patent holder from collecting a double royalty, once from a licensee and once from a purchaser of the licensee's product under the same patent. The first sale doctrine intentionally shifts market power "away from copyright holders and toward competition in order to advantage the consumer." Estate of Graham at 7. Conversely, the CRRA provides a form of copyright protection referred to as droit de suit (the right to follow), which is recognized in many jurisdictions, including France, Germany and Italy. Estate of Graham at 9-10 (citing to Nimmer on Copyright, section 8C.04[A][1] (2015) .) However, instead of adopting droit de suit,Congress expressly enacted section 109 to deliberately hold open the freedom of sellers to resell goods for whatever price a subsequent buyer deems appropriate, "without regard to the wishes of the copyright holder." Estate of Graham at 7, 10.

Regulation of Sellers, Not Proceeds

In Estate of Graham, the court adopted the perspective that the CRRA's royalty requirements regulated the conduct of the seller, rather than merely regulating the final proceeds of sale. Thus, the requirements served to restrict the transactions and did not merely act as a tax on the seller's income. Because the CRRA's royalty requirements are non-waivable and cannot be limited by contract, the obligation creates problems for certain sellers who may not have the ability to easily locate an artist. For example, an auction house must determine independently how much the seller originally paid for the work, ascertain whether the artist is a citizen of the United States and locate the artist to arrange the royalty payment. [12] "All of this information must be obtained through third parties, and auction houses have no means to verify its accuracy." With regard to certain sellers, the CRRA "clouds each art transaction with uncertainty and, practically speaking, restricts the transfer of artworks contrary to section 109(a)." Estate of Graham at 13.

As a result, the CRRA would appear to incentivize collectors and auction houses to relocate outside California to avoid its resale restrictions. Because the 5 percent royalty obligation prevents sellers from obtaining the full value of fine art in the secondary market, "a California art investor would lose money if she were to resell the art for less than 105% of the original purchase price." Estate of Graham at 9. Judge Fitzgerald's holding seeks to preserve the "delicate distribution of rights between copyright holders and downstream resellers" as intended by Congress, thereby protecting the sanctity of secondary markets of fine art. Estate of Graham at 12.

Significant Implication for Online and Virtual Platforms

It also is noteworthy that the court in Estate of Graham found eBay, one of the parties in the suit, to be an improper defendant in such an action brought pursuant to the CRRA. Since the Act regulates only sellers and their agents, a platform such as eBay is not subject to the royalty requirements. In affirming that it is "virtually common knowledge that Defendant eBay is not a seller of goods ... [nor] an agent for sellers of goods," the court drew a distinction between direct sellers and online platforms through which goods are sold. Estate of Graham at 34.

This characterization of what constitutes a seller will hold increasingly significant implications as forums for the sale of fine art transition to online and virtual platforms. Due to the fast-accelerating development of consumer and commercial virtual reality technology, determining the scope of a "seller" under the CRRA is crucial for online platforms seeking to provide a virtual medium for fine art transactions. To assess liability and ensure compliance with the Act − should the CRRA's royalty requirements survive a Ninth Circuit review − a software platform or other online forum facilitating fine art sales will have to consider whether a court would find it to be a seller. In deciding so, a court would look at factors such as whether the entity temporarily held title to the goods offered for sale on its platform; whether it entered into binding contracts with the purchaser on behalf of a seller; or whether it took physical possession of the goods at some point during the transaction occurring on its platform.

Ninth Circuit Review

The CRRA is a veteran in regard to constitutional challenges, having the Ninth Circuit deem certain of its provisions unconstitutional for violating the dormant Commerce Clause. See Sam Francis Found. v. Christies, Inc., 784 F.3d 1320 (9th Cir. 2015), cert. denied, 136 S. Ct. 795, 193 L. Ed. 2d 710 (2016). However, the Ninth Circuit held that the Act's offending provision was severable from the remainder of the statute, leaving the royalty requirements of section 986 intact. In light of the most recent statutory challenge to the CRRA in Estate of Graham, a second trip to the Ninth Circuit for review is likely.

Ultimately, this decision stands for the notion that states do not have the authority to eliminate the first sale doctrine and "imbue copyright holders with unprecedented market power." Estate of Graham at 8. Such a transfer of power "disturbs the equilibrium Congress created in the Copyright Act and subjects those state laws to preemption." Estate of Graham at 9.

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