NFT Marketplaces and Secondary Copyright Liability

Sarah Law | April 6, 2022

 

Introduction

Along with the growing fascination with Non-Fungible Tokens (NFTs) is a growing concern over legal liability for all activities involved. In the exchange of NFTs, there are typically three players involved: the creator (or seller); the buyer; and the marketplace through which the sale occurs. When it comes to the intellectual property contained in the NFT, any work that infringes on another’s rights or property creates liability on the creator of the NFT. However, there is also the possibility that the marketplace through which the NFT was bought and sold could bear liability as well. Under copyright law, secondary liability exists to give remedy when the party who is primarily liable cannot fulfil their legal obligations to the copyright holder.

Already, copyright concerns are proving to be on the forefront of creators’ minds. In February 2022, Larva Labs, creators of the now famous CryptoPunks, filed a DMCA takedown request to OpenSea, where original faulty versions of the NFTs (V1) were being sold in rewrapped smart contracts.[1] These V1 punks were identical to the versions that are today famously worth billions of dollars (V2).[2] In compliance with the DMCA and at the request of Larva Labs, OpenSea removed the allegedly infringing content.[3] However, it appears the conflict will end here as Yuga Labs recently acquired the IP rights to the CryptoPunks and has stated they have no intention of taking the dispute further.[4] These events show however, that as online service providers, NFT marketplaces should be aware of what they are potentially exposing themselves to. Furthermore, intellectual property holders should be aware of all potential avenues for recourse when their property is infringed upon.

 

The DMCA Safe Harbor

It is important to first understand how an NFT marketplace could fall under the Digital Millennium Copyright Act (DMCA) safe harbors. Because of the internet is so unique, these safe harbors were created in 1998 to shield internet service providers from traditional liability. If the internet service provider falls under one of the DMCA safe harbor categories, they will not be held liable for others’ infringing activities that take place on their platforms. There are already some NFT marketplaces in their Terms of Service that use language to suggest they fall under the protection of those safe harbors.[5]

NFT marketplaces will likely try to avail themselves using §512(c) of the DMCA for passive storage.[6] When NFTs are sold via these marketplaces, there are actual file size guidelines for what can be stored on the platform and the creators using the platforms have control over the NFT they have posted.[7] However, there could be situations where an NFT platform would need to seek protection under §512(d) for linking users to another online location.[8] Regardless, both provisions have a caveat where online service providers cannot avail themselves of the DMCA safe harbors if they are receiving a “financial benefit directly attributable” to the infringing activity.[9] If an NFT infringed on another’s copyright, the infringing activity would be the sale and purchasing of the NFT itself. It is unclear whether the marketplaces would satisfy the financial benefit requirement, but the system of receiving fees for sales, either from the buyers or the sellers, could cost the platforms the ability to rely on the DMCA safe harbors.[10]

This financial benefit is only an issue however if there is also a “right and ability to control” the infringing activity. In 2012, the 2nd Circuit clarified what this meant by explaining the statute, “‘requires something more than the ability to remove or block access to materials posted on a service provider’s website.’”[11] For example, a monitoring program which gave users detailed instructions about layout, design, and content was found to constitute “something more” than just the ability to block and remove content.[12] That substantial influence over the actions of the users is what rose to the necessarily level of “right and ability to control” for purposes of the DMCA.[13] For NFT platforms, there are some that curate the content that is sold on their sites. These are the platforms which are most likely to fail that DMCA safe harbor requirements due to the level of influence they are exerting over their users. If the DMCA safe harbors do not apply, the elements for secondary liability still need to be met.

Contributory Liability

Contributory liability occurs when actors, while not directly infringing on the copyright themselves, knowingly assist or encourage the infringing activity. There are two elements to finding contributory infringement: (1) knowledge of the infringing activity, and (2) material contribution to the infringing activity.[14] To the first element, courts have articulated a test for websites where the first element is met when there is “. . . actual knowledge that specific infringing material is available using its system” and the site fails to remove that infringing material from its system.[15] This test comes from Napster where the music sharing platform was found contributorily liable for copyright infringement that was taking place by its users.[16] Napster knew that there was infringing activity on their platform and failed to remove the infringing material from its system.[17] While they would not have been liable for contributory infringement for the general possibility of infringement via their platform, they knew about specific infringing activity and failed to remedy those violating works.[18]

To illustrate the second element, in Fonovisa in 1996, contributory copyright infringement was found against a swap meet flea market where infringing CDs were being sold by one of the vendors.[19] There was no question that the market knew there was infringing activity occurring in their market.[20] The debate in the courts was whether the flea market had materially contributed to the activity.[21] The flea market argued that had a “passive” role in the activity because they merely provided the space on the market grounds.[22] The Court found however that the market had indeed materially contributed to the infringing activity because “. . . it would be difficult for the infringing activity to take place in the massive quantities alleged without the support services provided by the swap meet. These services include, inter alia, the provision of space, utilities, parking, advertising, plumbing, and customers.”[23] The swap meet was found to be contributorily liable.[24]

Following this example from Fonovisa, it is possible plaintiffs could show that the NFT marketplaces have knowledge of specific infringing materials and refused to remove those materials. Under Napster, the marketplaces cannot be broadly held liable simply because there is a possibility that infringing activity can take place.[25] That would ignore another doctrine established by Sony that system operators cannot be held liable for products that are used for non-infringing activity as well as infringing activity.[26] However, the marketplaces would satisfy the first element of contributory infringement in situations where they are made aware of infringing activity and do not remove the infringing work from their system.

The second element of contributory infringement likely would be easily met as, following the holding of Fonovisa, the NFT marketplaces materially contribute to infringing activity. When compared to the swap meet, there appear to be many similarities between the two business structures. Each creates a location where buyers and sellers can meet.[27] They are providing an area where potentially infringing activity can take place, without which, “. . . it would be difficult for the infringing activity to take place. . . these services include, inter alia, the provision of space, utilities . . . and customers.”[28] The only difference is that the swap meet was physical and NFT marketplaces are virtual. Depending on the facts of potential cases, and the ability of plaintiffs to adequately argue the first element, NFTs marketplaces possibly can be held liable under contributory infringement.

Vicarious Liability

Vicarious liability occurs when actors, while not directly infringing, are liable because they benefit from the infringing work and have the right or authority to prevent the infringement.[29] As the Fonovisa court described, “[t]he test was more clearly articulated in a later Second Circuit case as follows: ‘even in the absence of an employer-employee relationship one may be vicariously liable if he has the right and ability to supervise the infringing activity and also has a direct financial interest in such activities.’”[30]

In Fonovisa, the swap meet was found to be vicariously liable for the infringing activity because even though they did not control the actual actions of the offending vendors, they had the ability to revoke their contracts to the market grounds.[31] This shows the ability to control the infringing activity.[32] As to the financial benefit, the swap meet charged daily rental fees, admission fees, and parking, food, and services payments.[33] While each of these fees was relatively low, they still show that the swap meet was financially benefitting from the vendors who sold the infringing CDs.[34]

It is very likely that NFT marketplaces can be held vicariously liable for infringing works that are sold via their platforms. Their terms of service often already tell users that they are able to take down works that they believe violate copyright laws or right of publicity laws.[35] That establishes the first element of control over infringing activity. Just as how the swap meet could revoke vendor contracts, so too could an NFT marketplace remove infringing material or block users from their platform. The second element is also met because the NFT marketplaces make money off the transactions between the buyers and sellers.[36] There are various business models, but each has direct financial gain from the trading of NFTs on their platforms.[37] Some marketplaces charge a commission of a sale, others buyer or seller fees, but all of which accrue from permitting the infringing activity to take place.[38] The more activity on their sites, infringing or noninfringing, the more money they make.

Public Policy Considerations

In the new, exciting, and lucrative world of blockchain, bitcoin, and NFTs, it makes sense that participants may not be aware of the legal implications of their actions. Marketplaces want to be able to benefit from the excitement, but it is unclear as to how they are protected and what they need protection from. However, the DMCA safe harbors may not apply for a platform where there is direct financial benefit from actual buying and selling of NFTs that potentially infringe on others’ copyrighted material. As a matter of policy, when a marketplace is benefitting directly from the buying and selling of the works, they are not functioning in a passive manner. They have the ability to monitor those things which directly contribute to their profit margins and therefore a level of responsibility to guarantee the works are not infringing on another’s rights.

Placing a level of responsibility for copyright secondary liability could have an immediate and unfortunate effect of slowing down NFT markets. However, the enormous benefit would be greater buyer and seller security and trust in the markets for such products. It is only a matter of time before buyers realize the risk posed by fraudulent copyright usage in the NFTs they bought and the demand for NFTs subsequently drops. It is to the benefit of the marketplaces that they recognize this risk now, correct their role in monitoring NFTs for copyright infringement, and establish trust with their buyers that the works they are purchasing will not create issues for them in the future. The immediate cost is a slower market, but the greater and long-lasting benefit is stability that the marketplaces can grow upon.

Conclusion

NFTs can violate others’ copyrighted works. To shield themselves from liability of such infringing works, the NFT marketplaces appear to be shielding themselves with DMCA safe harbor provisions. However, there is a possibility that the DMCA safe harbors cannot be used by NFT marketplaces because those platforms directly receive financial benefits from the infringing activity, which could disqualify them under §512(c)(1)(B) and §512(d)(2). Even if the marketplaces fail to meet the requirements for a DMCA safe harbor, potential plaintiffs will still have to establish secondary liability. While contributory infringement is possible, it may be difficult to prove that a marketplace satisfies the first element of actual knowledge about a specific infringing activity and failure to remove it from the system. Vicarious liability, however, may be easier for potential plaintiffs to prove because the sites’ Terms of Service may already include language asserting the authority and right to remove infringing works, and the marketplaces’ fee structures create a direct financial benefit from the buyers, sellers, and transactions.

[1] Edward Lee, The Two CryptoPunks, V1 and V2: Can V1 and V2 CryptoPunks Coexist or Will Copyright Tear Them Apart? (Feb. 11, 2022) (paper at 5-6). Available at SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4032777; Lachlan Keller, OpenSea delists CryptoPunks V1 after DMCA notice from Larva Labs, Yahoo (Feb. 9, 2022), https://www.yahoo.com/video/opensea-delists-cryptopunks-v1-dmca-044140725.html.

[2]  Edward Lee, The Two CryptoPunks, at 5.

[3] Id. at 6.

[4] Edward Lee, V1 Punks Prevail in Copyright Dispute, nou nft (Mar. 14, 2022), https://nounft.com/2022/03/14/v1-punks-dmca-controversy-with-larva-labs-over-yuga-reportedly-plans-on-ending-dispute-with-v1-punks/.

[5] See Terms of Service, OPENSEA, https://opensea.io/tos (last visited Mar. 12, 2022).

[6] 17 U.S.C. §512(c)(1). See Non Fungible Token (NFT) platforms must secure Metadata in their ERC-721/ERC-1155 implementations, Medium (Dec. 7, 2019) https://medium.com/@showcaseteam/non-fungible-token-nft-platforms-must-secure-metadata-in-their-erc-721-erc-1155-implementations-88f55e987fc7 (last visited Nov. 20, 2021); Kyle Tut, Who Is Responsible for NFT Data?, Medium (Apr. 6, 2020) https://medium.com/pinata/who-is-responsible-for-nft-data-99fb4e8147e4 (last visited Nov. 20, 2021).

[7] AlexWGomezz, Minting Your NFT: File Size Upload Limitations and Restrictions, Cyber Scrilla, https://cyberscrilla.com/minting-your-nft-file-size-upload-limitations-and-restrictions/ (last visited Nov. 23, 2021).

[8] 17 U.S.C. at §512(d)(1).

[9] Id. at §512(c)(1)(B), (d)(2).

[10] See Edward Lee, Decoding the DMCA Safe Harbors, 32 Colum. J.L. & Arts 233, 239 (2009) (quoting Perfect 10, Inc. v. CCBill LLC, 488 F.3d 1102, 1117-18 (9th Cir. 2007)). But see Feingold v. RageOn, Inc., 472 F. Supp. 3d 94, 102 (S.D.N.Y. 2020); Venus Fashions, Inc. v. ContextLogic, Inc., No. 3:16-cv-907-J-39MCR, 2017 U.S. Dist. LEXIS 155748, at *74 (M.D. Fla. Jan. 17, 2017); Liam Kemp, How Do NFT Marketplaces Make Money?, Coinformant (Sept. 14, 2021) https://coinformant.com.au/how-do-nft-marketplaces-make-money/ (last visited Nov. 20, 2021). For a full analysis of the applicability of DMCA Safe Harbors to NFT marketplaces, you may read the post, NFT Marketplaces and the DMCA Safe Harbors at https://studentorgs.kentlaw.iit.edu/ckjip/nft-marketplaces-and-the-dmca-safe-harbors/.

[11] Viacom Int’l, Inc. v. YouTube, Inc., 676 F.3d 19, 38 (2d Cir. 2012) (quoting Capitol Records, Inc. v. MP3tunes, LLC, 821 F. Supp. 2d 627, 645 (S.D.N.Y. 2011)).

[12] Id. (citing Perfect 10, Inc. v. Cybernet Ventures, Inc., 213 F. Supp. 2d 1146, 1173 (C.D. Cal. 2002)).

[13] Id.

[14] A&M Records v. Napster, Inc., 239 F.3d 1004, 1019 (9th Cir. 2001).

[15] Id. at 1021.

[16] Id. at 1022.

[17] Id.

[18] Id. at 1021-22.

[19] Fonovisa, Inc. v. Cherry Auction, Inc., 76 F.3d 259, 261 (9th Cir. 1996)

[20] Id. at 264.

[21] Id.

[22] Id.

[23] Id.

[24] Id. at 265.

[25] See Napster at 1021-22, supra note 14.

[26] Sony Corp. v. Universal City Studios, Inc., 464 U.S. 417, 442 (1984).

[27] See Fonovisa at 261, 264, supra note 19.

[28] Id. at 264.

[29] See Fonovisa at 262, supra note 19.

[30] Id.

[31] Id.

[32] Id. at 263

[33] Id.

[34] Id.

[35] See, e.g., Terms of Service, OPENSEA, supra note 1.

[36] Liam Kemp, How Do NFT Marketplaces Make Money?, Coinformant (Sept. 14, 2021) https://coinformant.com.au/how-do-nft-marketplaces-make-money/ (last visited Nov. 20, 2021)

[37] Id.

[38] Id.