Napster Case

Napster is an online service that allows computer users to share high-quality digital copies (MP3s) of music recordings via the Internet. The San Mateo-based company doesn’t actually store the recordings on its own computers, but instead provides an index of all the songs available on the computers of members currently logged onto the service. Napster therefore functions as a sort of clearinghouse that members can log onto, search by artist or song title, and identify where MP3s of interest are so that they can download them from another user’s computer hard drive. Napster has become one of the most popular sites on the Internet, claiming some 15 million users in little more than a year. Indeed, so many students were downloading songs from Napster, that many universities were forced to block the site from their systems in order to regain bandwidth.

From the beginning, Napster’s service has been almost as controversial as it has popular. Barely a year after its launch, it was sued by the Recording Industry Association of America (RIAA), which represents major recording companies such as Universal Music, BMG, Sony Music, Warner Music Group, and EMI. The RIAA claimed that, by allowing users to swap music recordings for free, Napster’s service violated copyright laws. The RIAA also sought an injunction to stop the downloading of copyrighted songs owned by its members as well as damages for lost revenue. The RIAA argued that song swapping via Napster and similar firms has cost the music industry more than $300 million in lost sales. A few months after the RIAA lawsuit was filed, Metallica, a heavy metal band, and rap star Dr. Dre filed separate lawsuits accusing Napster of copyright infringement and racketeering. Lars Ulrich, Metallica’s drummer, told a Senate committee that Napster users are basically stealing from the band every time they download one of its songs.

On July 26, 2000, U.S. District Judge Marilyn Patel granted the RIAA’s request for an injunction and ordered Napster to stop making copyrighted recordings available for download, which would have effectively shut down the service by pulling the plug on its most popular feature. However, on July 28, 2000, just nine hours before Napster would have had to shut down, the 9th Circuit Court of Appeals stayed that order, granting Napster a last-minute reprieve until the lawsuits can be tried in court.

In its battle with the RIAA, Napster turned to three past rulings on copyright infringement to support its defense: Sony Betamax, the 1992 Audio Home Recording Act, and the 1998 Digital Millennium Copyright Act. In the Sony Betamax case, the Motion Picture Association of America (MPAA) filed suit against Sony out of fears that its new video recording technology would unlock the door for widespread film production. Although a lower court found Sony guilty of copyright infringement, the U.S. Supreme Court overturned the decision, stating that a new technology must be “merely capable of substantial non-infringing uses in order to be protected by law.” Because Napster’s MP3 technology has legitimate uses, Napster argued that it should have the same protections as Sony.

Napster also sought to apply the 1992 Audio Home Recording Act (AHRA), which permits people to copy music for personal use. The law, enacted in response to the development of digital audiotape recorders, was passed before the Internet revolution. Napster supporters contended that the law applies to music downloads because the music is being copied is for personal use, not redistribution for profit. Many others, however, including the U.S. Justice Department, disagreed because this act was based on digital audiotapes, not Web music.

The 1998 Digital Millennium Copyright Act (DMCA) grants immunity to Internet service providers for the actions of their customers. Napster attorneys argued that the company has broad protection from copyright claims because it functions like a search engine rather than having direct involvement with music swapping. However, according to the legal community, “Napster does not take the legal steps required of search engines in dealing with copyright violations.”

Despite its claims, Napster was found guilty of direct infringement of the RIAA’s musical recordings, and the ruling was upheld on appeal on February 12, 2001. The District Court of Appeals refuted all of Napster’s defense tactics and ordered the company to stop allowing its millions of users to download and share copyrighted material without properly compensating the owners of the material. The court determined the Audio Home Recording Act was irrelevant because it did not address the downloading of MP3 files or digital audio recording devices. The court also rejected Napster’s reliance on the Digital Millennium Copyright Act, stating simply that it does not include contributory infringers.

In response to the ruling, Hank Barry, CEO of Napster and Shawn Fanning, Napster’s founder, released statements to the public. They claimed they remain committed to finding an industry-supported solution to the controversy, such as a membership-based service. They also acknowledged negotiations with Bertelsmann AG to expand and improve Napster with the goal of prohibiting pirated music transfers and counting the number of song downloads in order to properly reimburse their artists.

A few days later, Napster offered $1 billion to the recording industry to settle the lawsuit. Under the proposal, $150 million would be paid annually for the first five years to Sony, Warner, BMG, EMI, and Universal, with $50 million allotted annually for independent labels. However, record industry executives refused to accept Napster’s proposal, saying they were not willing to settle for anything less than shutting down Napster. The service was not shut down at that point, however, because doing so could have violated the rights of artists who had given Napster permission to trade their music. But, the company was required to block all songs on a list of 5,000 provided by the RIAA.^**

In late September 2001 Napster agreed to pay $26 million for distribution of unauthorized music in the past and made a proposal that could let songwriters and musicians distribute their music on Napster for a fee.    This agreement could cover as many as 700,000 songs but Napster still needs an agreement before the company can legally distribute it.

However, with failed attempts to reach a suitable compromise with the recording industry and litigation expenses mounting, the company filed for Chapter 11 reorganization in June 2002 as a last grasp effort to try and reach a deal with Bertelsmann AG, Napster's strategic partner.

The final nail in the coffin for Napster came on September 3, 2002, when a Delaware bankruptcy judge blocked the sale of the company to Bertelsmann, ruling that negotiations with the German media company had not been made at arms length and in good faith.  Bertelsmann had agreed to pay creditors $8 million for Napster's assets.  According to the bankruptcy petition, the company had assets of $7.9 million and debts of $101 million as of April 30, 2002.

Shortly after the judge's ruling, Napster laid off nearly all of its 42-person staff and proceeded to convert its Chapter 11 reorganization into a Chapter 7 liquidation, closing its doors forever. 

Questions for Discussion

1.         Based on the facts in the Napster case, who do you think should have control over intellectual property—the artists or distributors of their works? How did the legal system answer this question?

2.         Can Napster’s existence be defended on the basis of the idea that other online music services will take its place if it is forced to shut down?

3.         While there are many legal issues in this case, identify the characteristics of Napster’s service that made it so successful. What can other dotcoms learn from Napster’s success?