Second-hand Software Issues: Litigation at Tokyo District Court and Request to Fair Trade Committee

October 5, 1998

Second-hand Software Issues: Defendant Lawyers for Osaka itigation
Second-hand Software Issues: Plaintiff Lawyers for Tokyo Litigation
1. Relevant Facts on Second-hand Video Game Software Issues
No one argues that the approval of a maker is required to re-sell a product once the maker has manufactured it and put it into a stream of commerce. Free circulation of products is essential for a free economy.

But a group of people are arguing that, for one product, such approval is required for subsequent transactions, even after the sale by the maker. The product is computer video game software.

On January 14 of 1998, the Computer Entertainment Software Association ("CESA"), an association of video game software makers, together with the Association of Copyright on Computer Software (""ACCS") and the Japan Personal Computer Association ("JPCA"), initiated an "ILLEGAL SECOND-HAND SOFTWARE DESTRUCTION CAMPAIGN" based upon the argument that video game is a "movie" under the Copyright Act and that distribution right attaches to it (Section 26 of Copyright Act). Under the Copyright Act of Japan, no distribution right is given to any copyrighted work other than "Movie". We think that the argument is without foundation and the campaign is unfair. Our reasons are discussed later in this release.

Immediately after the start of the "Campaign", on January 20, the Fair Trade Commission ("FTC") issued an order to Sony Computer Entertainment Co. Ltd. ("SCE"), one of the active members of CESA, because restrictions imposed by SCE on its merchant purchasers regarding dealing in second-hand software violated the Anti-Monopoly Law.

"Concerning the Order against Sony Computer Entertainment Co. Ltd."

SCE, however, contested the order; the administrative proceeding is currently pending.

"Concerning commencement of the administrative proceeding against Sony Computer Entertainment Co. Ltd."

CESA and other entities are presently continuing the Campaign and supporting the litigation by CESA members to prevent retailers of video game software from selling second-hand video game software. Two suits have been brought one in Tokyo in June and the other in Osaka in July.

In order to defend the cases in Osaka ("Osaka Litigation"), we, 20 lawyers, have formed a group of defendant lawyers and are assisting with the litigation.

#Osaka District Court, Heisei 10 (wa) 6978, (21 Civil

Department)Prohibitory injunction action based on distribution rights
Plaintiff: Software maker (Capcon Co. Ltd. and five other companies)
Defendant: Software distributor (Act Co. Ltd. and one company)

The defendants in the Osaka Litigation are Act Co. Ltd.("Act"), a member of the Association of Retailers of TV Video Game Software ("ARTS"), and a franchisee of Act, both being fully supported by ARTS. Since the plaintiffs were wrong as to the identity of the franchisee, an additional suit was brought against the franchisee.

The first pleadings were heard at 1:30 p.m., September 3, 1998. The second pleading date was set for 3:00p.m., November 19, 1998.

A defendant in the Tokyo Litigation ("Litigation against Doo") is Doo Co. Ltd., an affiliate of a mass-supplier of electric products and not a member of ARTS.

#Tokyo District Court, Heisei 10 (wa) 12874, (46 Civil Department)
Prohibitory injunction action based on distribution rights.
Plaintiff: Software maker (Capcom Co. Ltd. and four other companies)
Defendant: Software distributor (Doo Co. Ltd.)

Judging from our observation up to now of the litigation against Doo, the allegations by the defendant were not very extensive. The allegations and evidence which should be made and submitted to the court may not be provided and; as a result, we feel the court may reach its judgment without adequate information.

2. Commencement of the Tokyo Litigation
It became our concern that a judgment rendered in the litigation against Doo without presentation of sufficient allegations and evidence could become a precedent which may wrongly and adversely affect the Osaka Litigation. And we think it important to have a case in Tokyo to fully litigate this significant issue, since it is fundamentally related to the future copyright law. It is essential that we have a voice against the movement to enlarge the types of copyrighted works which enjoy distribution rights.

It happened that Josho Co. Ltd. ("Josho"), a member of ARTS, received a warning from Enix Co. Ltd.("Enix"), a member of CESA, based on "distribution right", not to resell video game software. We are therefore representing Josho as plaintiff in a suit in the Tokyo District Court, requesting a declaratory judgment against defendant Enix that the latter cannot prohibit such sales based on the alleged "distribution rights".("Tokyo Litigation")

#Tokyo District Court, Heisei (wa) 22568 (46 Civil Department)
Request for declaration of no prohibitory rights based on distribution rights
Plaintiff: Software distributor (Josho Co. Ltd.)
Defendant : Software maker (Enix Co. Ltd.)

Josho is a member of ARTS and ARTS fully supports this litigation. All the members of the defendant lawyer group in the Osaka Litigation will assist with the Tokyo Litigation. The first pleading date was set at 1:15 p.m., November 12, 1998.

3. Request to FTC for Order
CESA and its members have taken various measures to prevent wholesalers and retailers from selling second-hand software. Josho and Act submitted a request with the FTC for an order against Enix and CESA not to act in violation of the Anti-Monopoly Law. We will briefly explain the facts and applicable law of the case.

1. Josho sells new and second-hand video game software, and Act is a franchisor of a franchising system selling new and second-hand software under the name of "WANPAKU KOZO."

Enix is a company which develops, manufactures and sells TV video game software such as Dragon Quest, and CESA is an association whose purpose is research, promotion and education concerning entertainment software used in the home. Enix and numerous other video game software makers are members of CESA.

2. Enix previously had taken a system in which Enix had developed and manufactured the software to be operated at Play Station and other video game machines and sold all manufactured units to SCE and other hardware makers. SCE and the hardware makers then resold them to wholesalers and retailers, including Josho and Act.

From around December 1997, Enix changed the distribution system to a direct sales system, and began selling directly to retailers or franchisors. Enix sent to video game software distributors, including Josho and Act, purchase and sale agreement forms, which have clauses stating that "distributor shall sell the software to consumers who use them in their home", "distributor shall make best efforts to cooperate with the business policy of Enix" and "distributor shall not sell second-hand software products". The forms warn that violation of these provisions will lead to revocation of contract and suspension of delivery.

Since Act was quite sure that the sale of second-hand video game software is legal, it informed Enix that Act could not enter into a contract which has a second-hand sales prohibition clause. On July 23, 1998 before its scheduled release date, Act had ordered 5000 units of "Start Ocean Second Story". Enix did not supply Act with a single unit after release of the software.

Josho also requested the withdrawal of the second-hand sales prohibition clause, which was denied. Josho had no other choice for procurement of the software but to advertise for purchase of the software from the other merchants and received in turn the warning, which prohibits sales of second-hand software and requests an apology.

Enix engaged in tie-in sales. When Enix received an order for Dragon Quest, it allocated a unit of the popular software to the ordering wholesaler, if the latter purchased seven units of "Pockemon Pencil" developed and distributed by Enix.

3. CESA specified the "NO RESALE" mark and, together with JPCA and ACCS, prohibited second-hand software sales without sound legal basis, putting advertisements in newspapers and video game software journals that sale of second-hand software is illegal, and encouraging its members to place a statement about the second-hand sales prohibition on video game software packages and advertising materials.

These actions of CESA are to encourage the prohibition of legally permitted sales of second-hand software and caused the one-sided, unfair contract arrangement by Enix.

4. The conduct by Enix described above constitutes abuse of superior position and imposes restrictive trade terms, which are subject to Section 2.9.4 of the Anti-monopoly Law and Section 13 of General Directive, Restrictive Trade Terms, as well as Section 2.9.5 of the Law and Section 13.3 and Section 13.4 of General Directive, Abuse of Superior Position.

(Reference to text of the relevant Law and General Directive. Translation omitted.)

5. The conduct by CESA described above, as that of a trade association, is subject to Section 8.1.5 of the Anti-Monopoly Law, which prohibits encouraging members to engage in conduct which constitutes an unfair trade practice.

(Reference to text of the relevant Law. Translation omitted.)

6. Therefore, Josho and Act have requested FTC to issue an advisory order against Enix to:

(1) Cease conduct which requires retailers not to distribute second-hand software and conduct which enforces compliance with such requirement.
(2) Cease conduct which requires retailers to sell only to consumers who will use the software in their homes and conduct which enforces compliance with such requirement.
(3) Delete provisions in the distribution agreement requiring or enforcing the conduct prohibited in paragraphs (1) and (2)
(4) Desist from refusing to make an agreement with or supply video game software to a distributor because the distributor disagrees with provisions whose prohibition is sought in paragraphs (1) and (2)
(5) Desist from restraining sales price of retailers to their customers

And against CESA to:

(1) Cease the "Illegal Second-hand Software Destruction Campaign"
(2) Destroy and prohibit the use of the "NO RESALE" marks, pamphlets and documents used for the Campaign, close the homepage.
(3) Cease encouraging the placement of statements about the prohibition of second-hand sales.

We will continue to follow the administrative proceedings against SCE and file the necessary materials with the FTC.

4. Problems with the Arguments Which Assert the Illegality of Second-hand Software Sales
CESA side argues as follows:
a. Video game software is categorized as "Work of a Movie"
b. "Work of a Movie" has unrestricted "distribution rights"
c. Therefore, any sales of second-hand computer video game software, without approval of the copyright holder, are illegal, since such software has unrestricted "distribution rights."

If either of premises (a) or (b) is false, the conclusion (c) is invalid. The assertion of (b) relates to new software as well as second-hand software, so it means, according to the allegation by CESA, that the copyright holder can completely control, to the end, the whole process of the stream of commerce.

(1) Computer video game software is not "Work of a Movie."
a. Computer video game software does not satisfy the requirement of "Work of a Movie."(Since the reasoning involves very detailed analysis, we do not describe it here; however, it does not meet the requirements, "expression in a manner that causes a visual or audio-visual effect similar to that of a movie" and "expression fixed in a tangible".)
b. Every provision must be interpreted in accordance with the legislative purpose thereof. Section 26 of the Copyright Act grants distribution rights only to Work of a Movie to protect the manner of distribution specific to theater movies; video game software, whose manner of distribution is different from that of theater movies, cannot be interpreted as a "Movie" under Section 26 whose copyright has "distribution rights."

(2) There is a limitation on "distribution rights"
a. It is the worldwide common understanding and global standard that "distribution" in the context of "distribution rights" means to put a product into the stream of commerce (the first sale) or that distribution rights are extinguished after the first sale (the first sale doctrine).
(Detailed references to treaties and laws in other countries are omitted. There is a discussion based on other considerations concerning cross-border distribution of copyrighted works.)

See: "Distribution rights and their limitations- situations in foreign countries (tentative version)"
b. The Supreme Court of Japan held, in the case of BBS (July 1, 1997), that the distribution rights of a patent extinguishes upon the first sale; The reasoning of the case suggests that the distribution rights to copyrighted work should likewise extinguish on the first sale.(There is no reason to give stronger protection to copyright as opposed to patent. The fact that is no statutory provision stipulating "extinguishing of distribution rights to patented products ", was no bar to the courts decision; it would thus be unreasonable to deny the extinguishment of distribution rights to copyrighted work because there is no statutory provision to that effect.)

See July 1, 1997 Third Forum of the Supreme Court (Minshu51.6. p2299, Hanrei-jiho1612.p3)

Note: The text of the decision has not been translated.

(3) The Japanese legal system generally presumes that sales of second-hand computer video game software are legal.

a. Free circulation of merchandise is essential under the Japanese legal system which is based on a free economy system. The Anti-Monopoly Law thus prohibits unfair trade restriction and unfair trade practices. Contractual prohibition of second-hand computer video game software sales violates the Anti-Monopoly Law.
b. Protection of the environment and measures to counter global warming are increasingly important. It is strictly required, under the fundamental environment law and fundamental environment policy, to encourage reuse of second-hand products; the second-hand product market furthers this basic legal policy concerning environmental law. To prohibit the sales of second-hand software is against the environment protection, an essential concern of human beings.
c. The Second-hand Business Act presumes that the sale of second-hand software is legal. ( Section 15.1.1 of the Second-hand Business Act, Section 16.2.2 of the implementing rules of the Second-hand Business Act.)

Note: The text of the Act has not been translated.

(4) There is no Rational Basis or Justification for the Argument Alleging the Sales Illegal There are various arguments made by the group which believes such sales are illegal, alleging that the interests of the software makers are harmed, but such arguments are devoid of a rational basis or justification. The principal reasons are as follows:

a. Argument that opportunities to sell new software are lost by the sales of second-hand software and that software makers are damaged (Lost Opportunity Theory)

It is unlikely that sales of new software would increase without the second-hand software market. For example, children, the main customers of the video game software, often trade in second-hand software to purchase other new software with their allowance and the money obtained from the trade-in, so their power to purchase new software would decrease without the second-hand software market.

There is some video game software, so-called "damned games," which the purchasers have found no fun in playing with them. Without the second-hand software market, the sales of new software would be restricted since customers must assume the risk of being stuck with a "damned game."

It cannot be denied that in some aspects, the second-hand software market increases sales of new software. It is said that the new automobile market and the second-hand automobile market co-exist in harmony, and the same is true of the software market.

b. Argument that the huge investment necessary to develop software cannot be recouped due to the second-hand software market (Un-recoupability of Investment Theory)

This Theory cannot withstand scrutiny, first of all, because it is based on argument discussed above(a). Apart from this, in a free economy system, there is no guarantee that the investment made for the development of a product will definitely be recouped. Everything, including the price and the recoupability of the investment, is up to the consumer.

Some point out that the software makers spend too much on development of video game software. No one would agree that software makers may spend any amount on software development and that recoupment of the money must be guaranteed in any case. It is the responsibility of the maker, as a business entity, to determine the price of a product, in connection with its quality, in such a way as to attract customers.

c. Argument that the price of new software must be high due to the second-hand software market, which is detrimental to users at large. (High Price Theory)

This Theory is also based on argument (a) above, which, as we have shown, lacks merit. Apart from this, pricing is a matter of the sellers discretion. It simply has to be subject to the consumer's judgment based on the relation of price to value.

d. Argument that the second-hand market undermines the incentive of a maker to develop software and that the video game software industry will decline. (Decline of Development Incentive and Industry Theory)

This is not persuasive, since a second-hand software market has existed for quite some time, and development and marketing of software has been conducted very actively. Markets, whether for software or other products, will just survive where players who intend to develop products, based on the price to value consideration of consumers, wish to come in the industry.

(5) Conclusion
There is no reasonable ground to give, only in Japan and contrary to the world wide understanding and global standard, special protection to video game software, granting the rights to control the market without limitations. If Japan grants special protection to video game software, its position will be anomalous, and international economic disputes may occur.

In the same vein, there is no reasonable ground to give special protection solely to video game software (without giving similar protection to other copyrightable works) in Japan. (Other than with respect to video game software, there have been no arguments that second-hand sales must be prohibited, although some products have similar circulation. These include books which are copyrightable works, automobiles, household electrical devices etc. which are products incorporating computer software and various products which employ patented technology as well as dresses or clothes which are subject of registered trade marks.)

See "Copyright and Second-hand Software Issues - Questions on Copyright Practice", Yasuyuki Fujita (Attorney at Law), Eisuke Fuimoto (Attorney at Law), Hideo Ogura (Attorney at Law), published on October 20, 1998 by System Five Co. Ltd. (tel 03-5340-1221).

5. Public Announcement
Since the issues and results of the Osaka Litigation and the Tokyo Litigation are related to the copyright system itself and to the future amendment of the Copyright Act, we, the lawyers defending the retailers, would like the public at large to take an interest in the arguments and process of the litigation.

We will provide information concerning the proceedings at each hearing date to the extent possible.

Information about the procedure and substance of the Osaka Litigation and Tokyo Litigation is also widely distributed by ARTS which supports the retailers. ARTS will provide the information on the Internet, so please visit the home page.

"Report on ARTS related litigation"

Yasuyuki Fujita, Esq. will deal with all public relations matters. Please contact Mr. Fujita if you have any question on the legal issues in this litigation.
Yasuyuki Fujita, Attorney at Law
Prime Law Office
Address: Koujimachi 6-6-1, Koujimachi masuo Bldg. 5th Floor
Chiyoda-ku, Tokyo, 102-0083
Tel: 03-3221-7251 Fax: 03-3221-7257
E-mail: y.