VC Investors Prevail in Copyright Infringement Claims involving Veoh Networks

A series of recent decisions dismissing copyright claims allow Veoh Networks and its investors to breathe a short sigh of relief. The first decision last August, in a case brought by adult site IO Group, ruled that Veoh was entitled to the safe harbor under the DMCA and was not infringing. In December, in a different case brought by Universal Music, the court again sided with Veoh, finding that is was entitled to the safe harbor even though, technically, its streaming process did result in some “copying” within the meaning of the Copyright statute.

Most recently, in early February, a sharply worded decision by the Central District of California dismissed Universal Music’s claims against Veoh investors (Shelter Capital, Spark Capital and Torrante) for contributory and vicarious copyright infringement. UMG Recordings v. Veoh Networks Inc., 2009 WL 334022 (C.D.Cal). (The investors were added as defendants a year after the initial action against Veoh was filed). This decision is potentially significant because it shows a court’s unwillingness to pierce the corporate veil and go after deeper pockets in the copyright context – something that many investors have feared since the 2004 Napster case against Hummer Winblad – and presents a bit of a roadmap on how future claims may be constructed (and how to hedge against them).

After the Napster fallout and the lawsuits against Bertelsmann and Hummer Winblad resulting from their investment in Napster, many investors grew fearful that an investment in a user generated content (UGC) based business, such as Youtube or Veoh, could expose them to “aiding and abetting” claims for copyright infringement. In fact, it quickly became market for many investors to expand the scope of their indemnification agreements to demand that their portfolio companies indemnify the investors as shareholders, and not just the investor directors who served on the boards of these companies. Three years later, these concerns are finally coming to roost, albeit in a different economic, social and technological marketplace.

Per the roadman in Bertelsmann, the plaintiffs in Veoh alleged that the investors “controlled” Veoh by holding three of five board seats, providing all of their operational capital and making decisions all of the Company’s major decisions, including those relating to its content offerings. Assuming all that to be true, the court rejected the claims on the ground that they could not state a claim. The following are some nuggets from the decision:

> Membership on a Board of Directors necessarily and inherently entails making almost all these [operational] decisions. "To allow for derivative copyright liability merely because of such membership could invite expansion of potential shareholder liability for corporate conduct, without meaningful limitation."

> There is no common law duty for investors (even ones who collectively control the Board) “to remove copyrighted content,” in light of the DMCA.

> The court extensively distinguished the Bertelsmann decision, thereby limiting its future application, on a number of specific facts absent here. Most importantly, in that case the investors proceeded to invest and control Napster after the liability issues had been going on for two years and then did not stop the conduct after taking over. Therefore, prospective investors in a company where a copyright lawsuit is actually pending would be well advised to consider whether the indemnification agreement (which they are probably ultimately paying for) is going to serve its ultimate purpose.

> The court dismissed the vicarious liability claim – which requires a defendant to have a direct financial interest in the infringing conduct – by holding that a “profit from their investments through the sale of Veoh to a potential acquiring company or through a public offering… is too far removed from the alleged infringement to be considered a “direct” financial interest.” This should be compared against potential direct benefits mentioned by the court, such as where investors may receive fees paid by customers or advertisers, or even a dividend or distribution from those revenues. Therefore, investors considering a recapitalization or an early distribution of profits should consider this issue as part of their analysis.