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Universal, EMI Sue Napster Investor

Record labels say firm enabled infringement. Critics say the move may deter venture capitalists.

April 23, 2003|Joseph Menn | Times Staff Writer

Unable to extract their pound of flesh from bankrupt Napster Inc., two of the five major record labels are suing the venture capitalists who backed the defunct song-swapping service that turned music industry economics upside down.

Universal Music and EMI filed a federal lawsuit against Hummer Winblad Venture Partners and two of the San Francisco firm's general partners, Hank Barry and John Hummer, in Los Angeles on Monday. The suit claims that they contributed to the copyright violations by Napster's tens of millions of users.

In addition to seeking $150,000 per violation, the suit asks for punitive damages. It also is intended to dissuade investment in any of the song-swapping services that have risen in Napster's place.

"Businesses, as well as those individuals or entities who control them, premised on massive copyright infringement of works created by artists should face the legal consequences for their actions," the record labels said in a statement.

The suit may mark the first time an outside party has targeted a venture firm for wrongdoing by a company in which it invested. "I don't know if this has ever happened before," said Jeanne Metzger, vice president of the National Venture Capital Assn.

The trade group and others warned that even if the labels lose the case, the fact that they sued will deter institutional investors from taking on a high level of risk with new companies.

"It's going to create an enormous amount of reluctance to get involved in anything that could draw litigation from the content industries," said Silicon Valley intellectual property lawyer Mark Radcliffe.

Barry and Hummer didn't respond to telephone and e-mail messages seeking comment Tuesday. Barry served as Napster's chief executive for more than a year, and both men sat on Napster's board.

The suit claims that Hummer Winblad knew Napster was enabling massive infringement and that the firm controlled Napster's activities with its general partners in the chief executive and director positions and through its $13-million investment in May 2000. The investment was made five months after the record industry -- including the two labels -- sued Napster for enabling infringement. Napster filed for bankruptcy protection in June 2002.

Lawyers not involved in the case said Hummer Winblad has two reasonable defenses. First, Napster hadn't yet lost the record industry suit when the firm invested. Second, directors and investors are rarely held liable for the acts of their companies. In those cases in which individuals are held responsible, they typically own 100% of the company at fault.

The suit "is stretching contributory infringement way beyond where it's ever gone," said Wayne State University copyright law professor Jessica Litman. "I assume the purpose is to enhance the already significant chill discouraging people from investing in businesses that challenge the business models of the entrenched market leaders in the entertainment industry."

Indeed, a federal lawsuit filed by a music producer against Barry, Hummer Winblad and others was dismissed after a judge found that the accusations -- similar to those in the record labels' suit -- were too vague and that there was nothing in the copyright law to punish people who assist an entity that assists others in breaking the law.

"Courts have consistently held that liability for contributory infringement requires substantial participation in a specific act of direct infringement," U.S. District Judge Marilyn Hall Patel wrote in that case.

But the two record labels may have evidence of specific actions by the venture firm's principals. And Hummer Winblad could be hurt by the fact that Napster lost most of its court battles.

The plaintiffs have "a reasonable shot at the officer. I think the director is a little tougher, and the shareholder theory is really tough," said Radcliffe, who represents technology and entertainment firms.

Barry and Hummer anticipated that they might be sued and tried to negotiate protection from legal consequences when German media firm Bertelsmann was planning to buy Napster early last year. Those talks foundered, and Bertelsmann itself has been sued for its investment in Napster.

The venture capital trade association complained that with such actions against investors, "the ability of entrenched industries to deter investment in next-generation technologies has profoundly anti-competitive and anti-innovative implications."

But not everyone agreed that the labels' suit will change how Silicon Valley firms invest. As the suit notes, other venture firms had deep concerns about Napster's legality and didn't invest.

"Top firms don't take their cue from Hummer," said Steve Lisson, publisher of InsiderVC.com.

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