April 2007

4th Circuit Intellectual Property Case Affects Realty

By Chris Burti, Vice President and Legal Counsel, Statewide Title, Inc.

We have often commented on the increasing complexity of real property law and the breadth of legal knowledge required of competent practitioners. Only a decade ago we altered the practice of listing those required areas of knowledge in favor of reciting the last three areas of which a competent practitioner could reasonably remain in ignorant bliss. Until the North Carolina Legislature created a procedure effective June 1, 2002 for docketing worker’s compensation awards without intervention of court and enforcing them as liens pursuant to NCGS 97-87, employment law was one of those three. The Fourth circuit opinion of Christopher Phelps & Assoc., LLP v. Galloway , No 05-2266, decided 2/12/07 now eliminates intellectual property from the list of non-relevant areas.

The defendant, Galloway, began construction of a home on Lake Wylie . He used architectural plans copyrighted by the plaintiff, Christopher Phelps & Associates, LLC, without permission.  The plaintiff filed this action seeking injunctive relief, disgorgement of profits, and damages for copyright infringement. The facts as presented by the Court in the opinion follow verbatim:

R. Wayne Galloway, in anticipation of retirement, planned to build his "dream home" on a lot that he owned on the North Carolina side of Lake Wylie , southwest of Charlotte , North Carolina . Displeased with the design work done by an architect whom he had hired, Galloway went with his son-in-law to view the designs of homes on Lake Norman , an expensive residential area about 30 miles north of Lake Wylie , where his son-in-law was working as an iron-work subcontractor. There, Galloway saw a French-country style house that he liked. His son-in-law approached the builder of the house, Simonini Builders, Inc., and asked the superintendent for a copy of the plans. The superintendent said that Galloway would have to speak with the owner, Mrs. Gina Bridgeford, because "she purchased the plans, they were actually drawn for her."

Galloway contacted Mrs. Bridgeford, who gave Galloway her consent for use of the plans "as long as you don’t build in our area." As to her authority to give consent, Mrs. Bridgeford testified at trial, "I felt with all we had paid, we owned the CHRISTOPHER PHELPS & ASSOC. v. GALLOWAY 3 plans at that time." Galloway assured Mrs. Bridgeford that he would not build in the area, telling her that he planned to build on Lake Wylie about 30 miles away. With Mrs. Bridgeford’s permission, the superintendent at Simonini Builders gave Galloway a copy of the plans for "The Bridgeford Residence." Each page of the plans included the copyright notice, in small print, of the designing architect as follows: © 2000 Copyright — Christopher Phelps & Assoc., L.L.C.

These plans are protected under the federal copyright laws. The original purchaser of this plan is authorized to construct one and only one home using this plan. Modifications or reuse of this plan is prohibited. Galloway altered the plans only to cover the name and address of "The Bridgeford Residence" with the name and address of "The Galloway Residence," and then he copied them for constructing his house.

Phelps & Associates, which designed the Bridgeford Residence, is an architectural firm in Charlotte , North Carolina , that designs upscale custom houses. It created the design for the Bridgeford Residence as a variation of its earlier design — "The Bell and Brown Residence." Bell and Brown had commissioned and paid Phelps & Associates for the earlier design, but ultimately decided not to build the house. Phelps & Associates modified the Bell and Brown design somewhat for the Bridgefords by moving a dormer window, changing the front entry and reconfiguring part of the floor plan, and removing the basement. The Bridgefords paid Phelps & Associates $20,000 for The Bridgeford Residence design, and the Bridgefords built their house on Lake Norman in accordance with that design.

Acting as his own general contractor, Galloway began construction of his house in September 2001, using the Phelps & Associates plans for the Bridgeford Residence. During the course of construction, some of the subcontractors checked back with Phelps & Associates for clarification, particularly with respect to the windows. Phelps & Associates did not then know that the construction was being pursued without permission. Galloway’s framing contractor, who had been asked to do some work for Galloway’s brother-in-law using pirated Christopher Phelps & Assoc. V. Galloway Phelps & Associates plans, surmised that Galloway did not have permission to use the plans and approached Galloway to warn him that he could "get in trouble constructing a copyright plan." Galloway "shrugged his shoulders and said something to the effect: ‘They’ve got to find me, catch me first.’"

Through rumors from subcontractors, Phelps & Associates learned in early 2003 that Galloway was constructing a house using its designs. After confirming that fact, Phelps & Associates sent Galloway a cease and desist letter in July 2003. Upon receipt of the letter, Galloway stopped construction on his house, which was then over half completed. Thereafter, in August 2003, Phelps & Associates registered its plans for The Bridgeford Residence with the Copyright Office and then commenced this action against Galloway for copyright infringement. In its suit, Phelps & Associates sought compensatory damages, disgorgement of Galloway’s profits (claimed as the difference between the value of Galloway ’s house and his provable expenses in constructing it), and injunctive relief.

With respect to compensatory damages, Christopher Phelps, the principal of Phelps & Associates, testified at trial that if Galloway had come to him and asked Phelps & Associates to design "a house like the Bridgeford house," Phelps & Associates would have charged Galloway $20,000 — the same fee that it had charged Mrs. Bridgeford. Christopher Phelps made clear, however, that he would not have sold Galloway the actual Bridgeford Residence design, but something different, as Phelps & Associates prided itself on designing "custom homes." With respect to Galloway’s profits, Phelps & Associates presented expert testimony that Galloway ’s house would be worth $1.1 million when completed. With this estimated value, Galloway would have realized over $200,000 in profits if he were to sell the completed house.

Galloway testified at trial that he would have made no profit in the house had he sold it — he had spent more on the house than it was worth. He estimated that if he completed the house, he would show a loss of about $160,000…

As a result of the evidence presented at trial, the jury awarded the $20,000 fee that Phelps & Associates traditionally charged for such plans and it found that Galloway had made no profits to disgorge. The district court found that the jury verdict had made the plaintiff "whole” and declined to grant any injunction. The plaintiff’s appeal sought a new trial on the issue of damages and an “injunction prohibiting the future lease or sale of the infringing house and mandating the destruction or return of the infringing plans”.

Much of the discussion in the opinion centers on the effect or lack thereof of registration in this instance. While this may be of interest to intellectual property attorneys, real property practitioners are likely to benefit little from an analysis of this issue. This is particularly true in as much as the court determined that the error in that regard was harmless. There are also evidentiary issues regarding profits or lack thereof. The Court states: “In addition to its actual damages, the law allows a copyright holder to recover all profits of the infringer resulting from copyright infringement. An infringer’s profits consist of the amount of the infringer’s gross revenues from the infringing activity less the expenses of producing the infringing work”. The significance of the discussion of these issues to real property practitioners is that the Court equates ‘market value’ with ‘gross revenues’ and profit in this context is measured as the difference in the market value of the structure and the cost of building it. The plaintiff does not have to wait for a sale to be entitled to a disgorgement of profit if there is any equity over the cost of production.  

The plaintiff also argued that “First, the completed house is an infringing copy of Phelps & Associates’ copyrighted work. See 17 U.S.C. § 101. Second, as the copyright holder, Phelps & Associates has the exclusive right to lease or sell its copyrighted work. See id. § 106(3). Therefore, Galloway may never lease or sell the house without infringing Phelps & Associates’ copyright. See id. § 501(a). Because it is likely that Galloway will lease or sell his house, it is likely that he will infringe Phelps & Associates’ copyright, and this likely infringement should be foreclosed by a permanent injunction.” The Court categorized the argument as a “syllogism”.

Under the facts presented in this case, the 4^th Circuit determined that the District Court could not issue a permanent injunction prohibiting the defendant from ever leasing or selling the house as requested by the plaintiff. “Not only would such an injunction unduly restrain the alienation of real property, it would violate the "first sale doctrine" in 17 U.S.C. § 109(a), which we hold authorizes Galloway to sell or otherwise dispose of the house as a copy for which the remedies in a copyright action have been paid.”

The Court noted that other injunctive relief might be available when applying the general principles of equity delineated in eBay Inc. v. MercExchange, L.L.C., 126 S. Ct. 1837 (2006), a case decided after the District Court denied relief in this case. In that case the Supreme Court of the United States unanimously determined that an injunction should not automatically be issued upon a finding of patent infringement and that it should not be denied simply because the plaintiff did not practice the patented invention. Instead, the court must weigh the four factors traditionally used to determine whether to issue an injunction when requested. Those factors are;

(1)   Whether the plaintiff has suffered an irreparable injury.

(2)   Whether the remedies available at law are inadequate to compensate for that injury.

(3)   Whether a remedy in equity is warranted, balancing the hardships between the parties, and

(4)   Whether the public interest would be served by a permanent injunction.

Justice Kennedy, in a separate concurring opinion joined by Justices Stevens, Souter and Breyer, wrote:

"In cases now arising trial courts should bear in mind that in many instances the nature of the patent being enforced and the economic function of the patent holder present considerations quite unlike earlier cases. An industry has developed in which firms use patents not as a basis for producing and selling goods but, instead, primarily for obtaining licensing fees. ... For these firms, an injunction, and the potentially serious sanctions arising from its violation, can be employed as a bargaining tool to charge exorbitant fees to companies that seek to buy licenses to practice the patent. ..." 

It might be suggested that the 4^th Circuit may be disposed to consider the view espoused in the Kennedy minority as suggesting that the relief to be crafted should be tailored narrowly to avoid misuse of the judicial system in cases such as this one. The Circuit Court notes that the Supreme Court held that even upon a satisfactory showing, “whether to grant the injunction still remains in the ‘equitable discretion’ of the court. “Rejecting Phelps & Associates’ claim to an automatic injunction or an "entitlement" to one,” the Court applied the traditional equity principles to the plaintiff’s requests for injunctive relief to determine whether the district court abused its discretion. The Court determined that “injunctive relief is not foreclosed by the award of damages in this case.”  Therefore, the Court remanded the case back to the District Court “for the limited purpose of reconsidering other equitable relief, such as an order requiring Galloway to destroy the infringing plans or return them to Phelps & Associates.”

Fortunately for real property practitioners, the Court determined that while “the lease or sale of an infringing copy is generally a violation of the exclusive rights given to a copyright holder, the ‘first sale doctrine’ of 17 U.S.C. § 109(a) creates an exception as it applies to the particular copy in this case, Galloway’s house. Section 109(a) provides that ‘notwithstanding [the copyright holder’s exclusive rights], the owner of a particular copy . . . lawfully made under this title, or any person authorized by such owner, is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy.’” Since the construction of the house, as an infringement of the copyright, was subjected to Copyright Act remedies in this action, the defendant owner is entitled to "sell or otherwise dispose" of it without further liability after satisfying the judgment. “Just as a converter of property obtains good title to the converted property after satisfying a judgment for conversion, so does an infringer obtain good title to the physical copy after satisfaction of the judgment under the Copyright Act. See Restatement (Second) of Torts § 222A, cmt. c (‘When the defendant satisfies the judgment in the action for conversion, title to the chattel passes to him, so that he is in effect required to buy it at a forced judicial sale’).”

Lest any of our readers be left wondering which area of law remains of which a real property practitioners might remain blissfully ignorant we will suggest…Admiralty law. However, the careful attorney should note that in Bradshaw v. Unity Marine, 147 F.Supp.2d 668, 670 (S.D.Texas, 2001; Kent, D.J.), a claim grounded in Admiralty filed against the vessel and the plaintiff’s employer made by a sailor alleging an injury during ingress or egress between a vessel and a dock. The claim was dismissed. While the court made short shrift of the claim, one must heed the metaphor concerning the camel’s nose under the tent. The Court’s opinion was, to say the least, entertaining. While the Circuit Court of appeals caused it to be withdrawn, it is highly recommended reading and may still be read at:
http://nylawblog.typepad.com/suigeneris/2006/10/comedic_break_1.html

      Dirt Tales From The Deed Vault

By John Dillard, Vice President and Legal Counsel, 
Statewide Title Exchange Corporation

The following fact situation is true, except for the names of the parties involved and the city.  This is a continuation of a series of articles Statewide Title has instituted to bring actual problem areas to its customers of claims or potential claim situations that have actually occurred in the industry as a part of our education on claims reduction.   

Joe Homeowner was a professor at a local university in Carolina City .  He decided to take a sabbatical from teaching and go to Europe for two years to live and teach at a university there in a teaching exchange program.  Since his wife, Sally, was going to accompany him they decided to see if they could lease their house for the two years they would be gone.  They listed their house with a local realtor who promised to find them a tenant who would take care of their home while they were away.  In short order, the realtor made good on her promise and found the perfect tenant, someone new to the community who was looking to rent for a couple of years and then buy a home.  A lease agreement was executed and recorded, so Joe and Sally Homeowner packed their bags and departed for Europe .   

The two years seemed to go by quickly.  Joe and Sally returned to Carolina City after his teaching obligation was completed.  When they returned to their home they were surprised to find someone was living there.  They were more surprised to find that the person living in their home claimed to be the owner and had been living there for almost the entire two year period they had been away.  The new owner, Ted New Buyer, even produced a deed with his name on it as grantee.  The seller on the deed was none other than Tom Tenant, whom the Homeowners had leased to a little more than two years earlier.  Joe and Sally made an appointment to see their attorney, who promised to look into things and did so by examining title to their property.  What he discovered was that, within a few days of Tom Tenant signing the lease for their property, a deed was placed on record from Joe and Sally Homeowner conveying their house to Tom Tenant.  Tom Tenant, in turn, sold the house to New Buyer.  

Investigating the matter further, their attorney discovered that Tenant had told the neighbors that he had bought the house from Joe and Sally and had moved to Carolina City on a job transfer, but that the job he had been promised had not materialized as promised.  He was, therefore, forced to sell the home he had just bought below market value since he no longer had a job.  Because of the story they had been told, the neighbors were not suspicious of the turnover in occupancy in the house.  

Tenant was nowhere to be found.  New Buyer had put several thousand dollars out of his savings as down payment toward the purchase with the remainder financed with a mortgage by First Carolina City Bank.  New Buyer and the Bank had title insurance policies.  Since the deed was forged, the title company reimbursed New Buyer and the Bank for their losses, and the home was returned to Joe and Sally Homeowners.

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Last Updated: Friday, March 30, 2007