Petition for Writ of Certiorari — Nintendo of America, Inc. v. Lewis Galoob Toys, Inc.

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i Supreme Court, U.S.

J No. FILED

== 9-9-9-§-3-5-u-6 1994

In The

OFFICE OF THE CLERK

Supreme Court of the United States

October Term, 1993

NINTENDO OF AMERICA INC.,

Petitioner,

Vv.

LEWIS GALOOB TOYS, INC.,

Respondent.

Petition For A Writ Of Certiorari

To The United States Court Of Appeals

For The Ninth Circuit

PETITION FOR A WRIT OF CERTIORARI

ROBERT H. BORK

1150 17™ Street, N.W.

Washington, D.C. 20036

(202) 862-5852

JOHN J. KIRBY*

MUDGE ROSE GUTHRIE

ALEXANDER & FERDON

180 Maiden Lane

New York, New York 10038

Telephone: (212) 510-7000

Attorneys for Petitioner

Nintendo of America Inc.

*Counsel of Record

QUESTIONS PRESENTED

As the price of obtaining a restraining order or

preliminary injunction, a litigant must post security from

which its opponent may recover costs and damages if the

latter is subsequently found to have been “wrongfully”

enjoined or restrained. Fed. R. Civ. P. 65(c).

The circuit courts of appeals have employed three

different standards in deciding when the enjoined party is

entitled to recover damages from an injunction bond. The

Court of Appeals for the Ninth Circuit has now created a

four-way conflict among the federal circuits concerning the

meaning of “wrongfully.”

The Ninth Circuit held in this case that the enjoined

party is always entitled to execution on the security unless it

has been guilty of intentional deception or misconduct. In

sharp contrast, the Fifth. Seventh, Tenth, Eleventh, District

of Columbia, and Federal Circuits hold that a range of

equitable factors, such as the enjoined party's failure to

mitigate damages, are to be considered. These circuits differ

sufficiently on the extent of allowable judicial discretion that

they may be characterized as in conflict on that issue. Yet a

fourth position, one of strict or automatic liability, has been

adopted by the Second and, perhaps, the Third Circuits, so

that an enjoined party that later wins the case is conclusively

proved to have been wrongfully enjoined.

Two questions are presented:

1. Which of the four conflicting rules devised by

the courts of appeals should govern exoneration of or

—S

execution on security posted to obtain a preliminary

injunction or restraining order?

2. On the undisputed facts of this case, where

respondent did not even try to mitigate damages, was

petitioner entitled, as a matter of law, to exoneration of

its bond?

“**

TABLE OF CONTENTS

Page

QUESTIONS PRESENTED .........--+--+:: i

TABLE OF AUTHORITIES .......-.2202e00- v

Le GR Se ra er ee 2

pg EE ane ee Sr ae cr eee a 2

STATUTORY PROVISION INVOLVED ........ 3

STATEMENT OF THE CASE ...........--:- 3

A. Statement of Facts ......5.2-2 ee eees 4

B. Proceedings Below ..........--+-+:> 5

REASONS FOR GRANTING THE PETITION .... 9

I. CERTIORARI SHOULD BE GRANTED TO

RESOLVE THE CONFLICT AMONG THE

CIRCUITS REGARDING THE STANDARD FOR

EXECUTION ON SECURITY GIVEN TO OBTAIN

A PRELIMINARY INJUNCTION OR

RESTRAINING ORDER. ..........+-++:-: 11

A. Upon An Application For Execution On Security

Pursuant to Rule 65(c), The Court Should

Consider All Relevant Factors To Determine

Whether There Is A Good Reason To Deny or

Reduce The Award of Damages ......... 14

B. The Erroneous Standard Applied By The Ninth

Circuit Rejected Any Consideration Of The

TABLE OF CONTENTS (Continued)

Page

Equitable Factors Emphasized By The Large

Waasormy OF me Cie. ow we tw 17

Il. CERTIORARI SHOULD BE GRANTED

BECAUSE THE CONSTRUCTION OF

RULE 65(c) Is OF GREAT IMPORTANCE

EN PRA EAEISAEEORN et 23

CAIRNS 6 nu oe ewes ob ee ee eee 27 :

TABLE OF AUTHORITIES

CASES

American Bible Society v. Blount, 446 F.2d 588 (3d

ie GOIN sien Se ER EE St 13

Apple Computer, Inc. Vv. Formula Int’l Inc., 725 F.2d

521 (9th Cir. 1984) .....---- eee eee eee: 25

Blumenthal v. Merrill Lynch, Pierce, Fenner & Smith,

Inc., 910 F.2d 1049 (2d Cir. 1990) .....-----: 13

Canal Authority of State of Florida v. Callaway, 489

F.2d 567 (Sth Cir. 1974) ....--- +e ee ees 24

Coyne-Delaney v. Capital Devel. Bd.. 717 F.2d 385 (7th

Cie MOET gc alia a ea ee EL passim

Crowley v. Local No. 82, 679 F.2d 978 (1982), rev'd on

other grounds, 467 U.S. 526 (1984) .....---- 24

Fogerty v. Fantasy, Inc.. 114 S. Ct. 1023 (1994) ... 13

H&R Block, Inc. v. McCaslin, 541 F.2d 1098 (Sth Cir.

1976), cert. denied, 430 U.S. 946 sf) BPN eae 11

Johnson Controls, Inc. v. Phoenix Control Systems, Inc. ,

886 F.2d 1173 (9th Cir. 1989) .......------ 25

Lewis Galoob Toys, Inc. v. Nintendo of America Inc.,

780 F. Supp. 1283 (N.D. Cal. 1992), aff'd, 964 F.2d

965 (9th Cir. 1992). cert. denied, 113 S. Ct. 1582

Ue ea Wk ol a PE RD = Ee

TABLE OF AUTHORITIES (Continued)

Page

National Kidney Patients Ass'n v. Sullivan, 958 F.2d

1127 (D.C. Cir. 1992), cert. denied, 113 S. Ct. 966

(GONEe 484040 6448868 ee 11, 12, 15, 21

Nintendo of America Inc. v. Lewis Galoob Toys, Inc..,

16: Fide 1652 th Cie. 1996) 550505 BNE occ 2,8

Page Communications Engineers, Inc. v. Froehlke, 475

F.2d 994 (D.C. Cir. 1973) ..... 11, 14-16, 19-20

State of Ala. ex rel. Siegelman v. U.S. E.P.A., 925 F.2d

sar the Ca: SOSE) 6 ok ocean aoe 12, 16

State of Kan. ex rel. Stephan v. Adams, 705 F.2d 1267

(To A «| Pp ee Co |

Universal City Studios, Inc. v. Sony Corp. of America,

659 F.2d 963 (9th Cir. 1981), rev'd on other

grounds, 464 U.S. 417 (1984) ............ 25

Warren v. Stoddart, 105 U.S. 224 (1881)... ..... 21

Wayne Chemical, Inc. v. Columbus Agency Service

Corp... 567 F.2d 692 (7th Cir. 1977) ........ 24

Zenith Radio Corp. v. U.S.. 823 F.2d 518 (Fed.

Ce. 1967) ak er OA Se 12, 16, 22

STATUTES

i? U.S.C. § 097 Gage. 990e ice eens 4-6, 7, 16

vii

TABLE OF AUTHORITIES (Continued)

Page

, Pie La ey. |) ree ee ee 2

Red. R. Civ. BP. G6lG) 0 we ec ccc ec seces passim

MISCELLANEOUS

Cardozo. The Nature of the Judicial Process

SD CUTS cc 2 sas 0 0-6 b 0d tbe oes es 9

Note, Jnterlocutory Injunctions and the Injunction Bond,

73 Harv. L. Rev. 333 (1959) .......-.--- 21, 24

Note, Recovery For Wrongful Interlocutory Injunctions

Under Rule 65(c). 99 Harv. L. Rev. 828 (1986) . 9

Williston on Contracts § 1039 (3d ed. 1967) ...... 21

Wright and Miller, Federal Practice and Procedure:

Civil 8 2947 (1973) . 0. ce cee ee wees 24

No.

In The

Supreme Court of the United States

October Term, 1993

NINTENDO OF AMERICA INC..,

Petitioner,

LEWIS GALOOB TOYS, INC.,

Respondent.

Petition For A Writ Of Certiorari

To The United States Court Of Appeals

For The Ninth Circuit

PETITION FOR A WRIT OF CERTIORARI

Petitioner, Nintendo of America Inc.,' petitions for a

writ of certiorari to review the judgment of the United States

Court of Appeals for the Ninth Circuit. |

' All parties who appeared below are listed in the above

caption. Pursuant to Rule 29.1] of the Rules of this Court,

petitioner Nintendo of America Inc. states that it is a wholly-

owned subsidiary of Nintendo Co., Ltd., a Japanese corporation.

Nintendo of America Inc. has no subsidiaries that are not wholly-

owned.

OPINIONS BELOW

The opinion of the Court of Appeals is reported at 16

F.3d 1032 (9th Cir. 1994). The Court of Appeals denied a

petition for rehearing and suggestion for rehearing en banc

in an unreported order. The District Court opinion is

unreported. *

JURISDICTION

The judgment of the Court of Appeals was entered on

February 17, 1994. A timely petition for rehearing and

suggestion for rehearing en banc were denied on March 21,

1994. This Court has jurisdiction to review the judgment of

the Court of Appeals by writ of certiorari pursuant to 28

U.S.C. § 1254(1).

The opinion of the Court of Appeals is reprinted at pages

A-| to A-18 of the appendix to this brief. The order denying

rehearing and rehearing en banc is reprinted at page A-19 of the

appendix. Also contained in the appendix are the substantive

decisions on the merits of the Ninth Circuit in Lewis Galoob Tovs,

Inc. v. Nintendo of America Inc. , 964 F.2d 965 (9th Cir. 1992),

cert. denied, 113 S. Ct. 1582 (1993), reprinted at pages A-20 to

A-35 of the appendix. and of the District Court. 780 F. Supp.

1283 (N.D. Cal. 1992), reprinted at pages A-36 to A-67 of the

appendix. The Ninth Circuit's unpublished decision affirming the

preliminary injunction is reprinted at pages A-68 to A-74 of the

appendix.

STATUTORY PROVISION INVOLVED

This petition involves Federal Ruie of Civil

Procedure 65(c):

preliminary injunction shall issue except upon

the giving of security by the applicant, in

such sum as the court deems proper, for the

payment of such costs and damages as may be

incurred or suffered by any party who is

found to have been wrongfully enjoined or

restrained. No such security shall be required

of the United States or of an officer thereof.

The provisions of Rule 65.1 apply to a

surety upon a bond or undertaking under this

rule.

STATEMENT OF THE CASE

This case presents a four-way conflict among the

circuits on an important and recurring issue. The tssue

concerns litigants’ rights to security posted in order to obtain

a temporary injunction or restraining order when the party

enjoined or restrained ultimately prevails in the lawsuit. The

answer given will profoundly influence the course of

thousands of litigations. If. as the court below held, the party

preliminarily enjoined may automatically execute on the

bond unless shown to have acted in bad faith, even litigants

fully entitled to relief will be deterred from seeking

temporary injunctions or restraining orders, and no party

enjoined or restrained will have any incentive to mitigate

damages. The same result will follow if, as two courts of

appeals have held, the right to execute is absolute. Very

different consequences will follow if, as six courts of appeals

have held, the right to execute is conditioned by equitable

considerations such as the enjoined party’s failure to mitigate

damages. A uniform rule of decision is critical.

A. Statement of Facts

Petitioner, Nintendo of America Inc. (“Nintendo”),

manufactures and sells a home video game system and video

game cartridges. The audiovisual portions of the cartridges

are protected by copyrights owned by Nintendo. Respondent,

Lewis Galoob Toys, Inc. (“Galoob”), manufactures and sells

a device, “Game Genie,” which has the capacity of altering

the games played on the Nintesido system and cartridges,

e.g., by making a video game character nin faster or jump

higher.

Galoob approached a well-known intellectual property

law firm for advice as to whether Game Genie violated any

of Nintendo’s intellectual property rights. That firm prepared

an opinion which suggested that the altered audiovisual

works created by the Game Genie fit within the limited

exception to a copyright owner's exclusive rights provided

by Section 117 of the Copyright Act. 17 U.S.C. § 117

(Supp. 1992). See CR 315, Ex. B at 2-4.° Armed with this

* Citations to “CR __~ are to the Clerk’s Records in the

district court.

opinion, Galoob contacted Nintendo and inquired about

obtaining a license for the Game Genie. Nintendo stated its

view that Game Genie infringed Nintendo's copyrighted

video game audiovisual works, which were not within the

purview of Section 117, and advised Galoob that it would

not grant a license.

B. Proceedings Below

On May 17, 1990, Galoob filed a complaint seeking

a declaratory judgment that Game Genie did not violate any

of Nintendo’s video game copyrights. After commencement

of Galoob’s action, Nintendo filed this lawsuit alleging

relief. In opposing such relief, Galoob admitted that the

Game Genie created derivative works and relied on Section

117 of the Copyright Act as a basis for non-infringement.

6/8/90 RT at 5:5 - 6:3, 11:21-22, 12:3-17, 13:14-23 and

14:7-23; 6/29'90 RT at 18:4-23.°

Following a hearing, the district judge issued the

temporary injunction, holding that. on the record presented,

Nintendo was likely to prevail on the issue of copynght

infringement. He found that Game Genie produces “what can

only be termed [infringing] derivative works.” 6/29/90 RT

at 34:14 - 35:5. The judge rejected Galoob’s Section 117

* Citations to “RT __~ are to the Reporter's Transcripts of the

hearings in the district court.

defense, finding that Section 117, “by its plain language,

does not apply to this situation.” Jd. at 35:6-11.°

Galoob retained new counsel, who filed an appeal

based not only on the Section 117 defense but various new

defenses including “fair use.” Galoob also asserted for the

first time that the Game Genie did not create infringing

derivative works because the effects caused by Game Genie

were allegedly not fixed in a tangible medium of expression

and were not original. See CR 315 Ex. F at 17-19, 25-30.

Although neither of these defenses had been raised below,

Galoob argued to the Ninth Circuit, in a brief filed on

August 10, 1990, that the record was fully developed for a

reversal of the preliminary injunction based on these

defenses. Galoob opening brief in Appeal No. CA 90-15936

at 16, n.9.

In a decision issued on January 24, 1991, the Ninth

Circuit refused to consider the new defenses raised by

Galoob, applying the established rule that “a_ federal

appellate court will not review issues on appeal that were not

raised in the Court below.” (A-72) The Court also rejected

Galoob’s invitation to apply the “narrow and discretionary

exception” permitting “consideration of issues of law that do

not require factual determinations beyond those in the

record.” (Jd.) The court refused to do so on the grounds,

inter alia, that the new defense required findings of fact not

made by the district court.

* After the preliminary injunction was issued, the case was

transferred to another district judge.

Despite this rejection, Galoob did not move in the

district court to modify or dissolve the preliminary injunction

and thereby obtain the findings of fact essential to its new

defenses. Instead, while the action was proceeding toward

trial, Galoob simply filed a series of motions to increase the

preliminary injunction bond which Nintendo had posted

pursuant to Fed. R. Civ. P. 65(c). Over Nintendo's

opposition, the original bond of $100,000 was raised to $5

million and then to $15 million. |

In ruling on Nintendo's copyright infringement claim

after trial, the district court acknowledged that the issues

presented were “difficult and novel.” 7/3/91 RT at 4. See

also A-49. Ultimately, however, the court accepted the

contention of Galoob’s new counsel that Game Genie did not

create infringing derivative works and was a “fair use.”

(A-50 - S51) These were among the new defenses that the

Ninth Circuit had refused to consider in its January 24, 1991

decision. Conversely, Galoob’s defense at the preliminary

injunction stage, Section 117, was expressly not reached by

the court and formed no part of the decision on the merits.

7/3/91 RT at 13:13-16. The district court vacated the

preliminary injunction on July 12, 1991.

Nintendo appealed the district court's determination

of the copyright issues. The Ninth Circuit affirmed the

district court’s judgment. 964 F.2d 965 (9th Cir. 1992), cert.

denied, 113 S. Ct. 1382 (1993).

On September 11, 1991, Nintendo filed a motion to

exonerate the preliminary injunction bond on the grounds

~ mare or tee

that it was inappropriate and inequitable to impose liability

on the bond in this case. Galoob cross-moved for execution

on the bond. Without requiring Galoob to reply or allowing

Nintendo to reply, the district court summarily denied

Nintendo’s motion and, after an expedited damages hearing,

awarded the entire amount of the $15 million preliminary

injunction bond to Galoob. CR 317.

The Ninth Circuit affirmed the award, 16 F.3d 1032

(9th Cir. 1994). The court held that a party is “wrongfully

enjoined” under Rule 65(c) “when it turns out the party

enjoined had the right all aiong to do what it was enjoined

from doing.” (A-11) The court then noted that “there

appears to be some variance in how other circuits” determine

when to allow a wrongfully enjoined party to execute a

bond. (/d.) It decided to “join what appears to be the

majority” and to find a “rebuttable presumption” in favor of

execution. (A-12) The court then concluded that Nintendo

had not rebutted this presumption because it had not shown

that Galoob had engaged in deception or misconduct in

opposing the request for injunctive relief. (A-14 - 15)

On March 21, 1994, the Ninth Circuit denied

Nintendo's petition for rehearing and suggestion for

rehearing en banc. (A-19)

REASONS FOR GRANTING THE PETITION

This case merits review because the Ninth Circuit has

brought additional confusion to issues — in the application

of Rule 65(c) — that have long been the subject of widely

divergent analyses by courts and commentators.

In all of the stages of the existing process

of recovering on injunction bonds, courts

have departed from or given conflicting

interpretations of rule 65(c). They have

thereby greatly decreased the value of the rule

as a means of providing consistent guidelines:

they have transformed the federal law of

injunction bonds into “a field within which

judicial judgment moves untrammeled by

fixed principles.” [Citing B. Cardozo, The

Nature of the Judicial Process 128 (1921).]

This state of the law has allowed, and

continues to allow, unjust results.

Note, Recovery For Wrongful Interlocutory Injunctions Under

Rule 65(c). 99 Harv. L. Rev 828, 846 (1986).

The writ should issue for two reasons. First, although

nominally adopting what it characterized as the “majority

view” of the circuit courts, the Ninth Circuit’s approach is,

in fact, at odds with both versions of that view, as well as

with the minority view. and creates yet a fourth standard that

has not been recognized or applied by any other circuit.

Confusion reigns and unjust results necessarily follow. A

uniform interpretation of Rule 65(c). which only this Court

can provide, is needed.

Second, the Ninth Circuit's error is a matter of great

significance in the conduct of federal litigation. Interlocutory

injunctions are an essential form of relief in many cases. It

is important that parties not be deterred from seeking such

relief by the prospect of losing substantial sums of money

(here $15 million) should the injunction later be dissolved

even though the enjoined party utterly failed to mitigate

damages, as Galoob did here. It is equally important that the

enjoined party who later prevails recover damages only

where those damages are not traceable to its own conduct.

Here, Galoob chose to present its new defenses for the first

time on an appeal from the issuance of the temporary

injunction rather than presenting them to the district court in

a motion to modify or dissolve the injunction. That appeal

stripped the district court of jurisdiction for seven months,

during which damages accumulated. But even after its appeal

had been denied, Galoob did not seek relief from the district

court on the basis of its new defenses but kept obtaining

increases in the amount of Nintendo's bond. Awarding

execution on the bond despite Galoob’s failure even to

attempt to mitigate its damages produced not merely a

palpably unjust result but a mile that seriously damages the

utility of interlocutory injunctions.

Kk.

CERTIORARI SHOULD BE GRANTED TO

RESOLVE THE CONFLICT AMONG THE

CIRCUITS REGARDING THE STANDARD FOR

EXECUTION ON SECURITY GIVEN TO OBTAIN A

PRELIMINARY INJUNCTION OR RESTRAINING

ORDER.

Rule 65(c) requires the provision of security as a

condition of obtaining a preliminary injunction but addresses

execution upon the security only by allowing recovery of

damages and costs by a litigant who was “wrongfully”

enjoined.

A clear majority of federal circuits require courts to

exercise equitable discretion in allowing execution upon a

bond. But there is a conflict between the circuits upon the

extent of that discretion. Two circuits have taken the view

that Rule 65(c) does not limit the broad discretion of the trial

court, in the exercise of its equity powers, to avoid any

injustice between the parties. H&R Block, Inc. v. McCaslin,

541 F.2d 1098 (Sth Cir. 1976). cert. denied, 430 U.S. 946

(1977): State of Kan. ex rel. Stephan v. Adams, 705 F.2d

1267 (10th Cir. 1983).° In denying damage awards, these

* The District of Columbia Circuit appeared to take a similar

view in Page Communications Engineers, Inc. v. Froehlke, 475

F.2d 994 (D.C. Cir. 1973), but later made clear in National

Kidney Patients Ass'n v. Sullivan, 985 F.2d 1127 (D.C. Cir.

1992). cert. denied, 113 5. Ct. 966 (1993), that it approved of

Coyne-Delaney v. Capital Devel. Bd., 7\7 F.2d 385 (7th Cir.

1983), and that Page would have come out the same way under

a re

courts emphasized that the plaintiff had acted in good faith

in seeking an injunction.

Other courts allowing equitable discretion disagreed

with the broad exercise of discretion approved by the Fifth

and Tenth Circuits and required more rigorous analysis.

Coyne-Delaney v. Capital Devel. Bd., 717 F.2d 385 (7th

Cir. 1983), perhaps the most influential of the decisions in

this group, affirmed the responsibility of courts to consider

a range of equitable factors but cautioned that, if an award

of damages is to be denied, the analysis of equitable factors

must yield an objective “good reason” to do so. See also

State of Ala. ex rel. Siegelman v. U.S. E.P.A., 925 F.2d 385

(1ith Cir. 1991); Zenith Radio Corp. v. U.S., 823 F.2d 518

(Fed. Cir. 1987). The District of Columbia Circuit expressed

agreement with Coyne-Delaney and stated that a successful

defendant enjoys a “rebuttable presumption” of entitlement

to damages. National Kidney Patients Ass'n v. Sullivan, 958

F.2d 1127 (D.C. Cir. 1992), cert. denied, 113 S. Ct. 966

(1993). These courts discounted the importance of good faith

on the part of a plaintiff as a justification for denying the

award of damages. Good faith, they reasoned, was to be

expected and only its absence would be of particular

significance.

Finally, at the other end of the spectrum, the Second

Circuit, and perhaps the Third. adopted a position that left

no discretion to the trial court. /.¢.. assuming the only issue

to be “whether, in hindsight in light of the ultimate decision

that method of analysis.

on the merits after a full hearing, the injunction should not

have issued in the first instance.” Blumenthal v. Merrill

Lynch, Pierce, Fenner & Smith, Inc. 910 F.2d 1049, 1054

(2d Cir. 1990); American Bible Society v. Blount, 446 F.2d

588, 595 n.12 (3d Cir. 1971).

In this case, the Ninth Circuit declined to impose

absolute liability, as Galoob requested, and indicated that it

would follow the majority view. In fact, however, the Ninth

Circuit ignored the key element of the majority view that

mandates consideration of the full range of relevant factors.

On the contrary, it focused on a single issue: whether

respondent Galoob had been guilty of intentional deception

or misconduct in opposing, appealing from, and failing to

seek the lifting of the preliminary injunction. Finding that

Galoob was not guilty of such misconduct, the court of

appeals upheld the district court's award of damages. (A-14)

The standard applied by the Ninth Circuit is so

narrow and restrictive as to be of little practical value;

indeed, it will usually produce the results of the minority

strict-liability rule. Ironically, as a majority of the circuits

decided that a plaintiff's good faith was not sufficient reason

to deny an award of damages, the Ninth Circuit decided that

a defendant's good faith was sufficient reason to award

damages. By doing so, the Ninth Circuit effectively created

a dual standard for plaintiffs and defendants, one comparable

to the dual standard recently rejected by this Court in

another copyright action. Fogerty v. Fantasy, Inc.. 114 S.

Ct. 1023 (1994). Moreover. any approach that turns entirely

on the absence of bad faith, whether on the part of the

plaintiff or the defendant, is sure to produce unjust results by

foreclosing examination of other obviously relevant factors.

One of those factors is certainly the defendant's failure to

mitigate damages when that could easily have been done.

An examination of the relevant factors in the present

case will demonstrate that there was indeed “good reason”

to eliminate or, at a minimum, greatly reduce, the award of

damages to Galoob. Apart from demonstrating the gross

inequity of the result here, such an examination will point up

the grave risk to future plaintiffs if the unique standard

created by the Ninth Circuit is not rejected along with the

automatic damages standard of the Second and Third

Circuits.

A. Upon An Application For Execution On

Security Pursuant to Rule 65(c), The Court

Should Consider All Relevant Factors To

Determine Whether There Is A Good Reason

To Deny or Reduce The Award of Damages

In Page v. Froehlke, supra, the court faced a

Situation identical in its equities to the present case. The

court held that it was “bound to effect justice between the

parties, avoiding any result that would be inequitable or

oppressive for either party.” 475 F.2d at.997. The court then

exonerated the plaintiff from liability on a preliminary

injunction bond on the ground that the defendant had in its

possession, but did not produce at the preliminary injunction

hearing, a pertinent document. The court observed that “the

injunction might not have issued if the [defendant] had

timely filed the comparative cost study, an important and

relevant document.” Jd. at 997.

In National Kidney Patients Ass'n v. Sullivan, supra,

the District of Columbia Circuit, in discussing its earlier

decision in Page v. Froehlke, pointed out that the failure of

the defendant to have producéd the comparative cost study

at the preliminary injunction hearing was comparable to a

failure to mitigate damages which Coyne-Delaney had said

was a “good reason” for not allowing the enjoined party to

recover damages under the bond. 958 F.2d at 1134.

In Coyne-Delaney v. Capital Devel. Bd., supra, the

Seventh Circuit held that damages should be awarded

pursuant to Rule 65(c) unless there appeared to be a “good

reason” not to do so. Nevertheless, the Court was at pains

to emphasize the duty of the trial court “to consider the full

range of factors relevant under that standard.” 717 F.2d at

392. In particular, the court emphasized that:

A good reason for not awarding such damages

would be that the defendant has failed to mitigate

damages. Id.

The court also pointed out that a change in the applicable

law, subsequent to the preliminary injunction hearing, was

a “legitimate consideration” in the determination of whether

to award damages. /d.

The Seventh Circuit was careful to point out that the

test to be applied was not the judge's unguided, subjective

sense of fairness. Instead, “the ingredients of a proper

decision are objective factors . . . accessible to the judgment

of a reviewing court.” Jd. The court reversed the denial of

damages by the district court and remanded the case for a

reevaluation of the equities.

This case is strikingly similar to the facts and

rationale of Page and to Coyne-Delaney’s reasoning. Here,

much as in Page, Galoob withheld its real defenses from the

district court until trial on the merits. The district court had

no occasion to consider the legal defenses that ultimately

prevailed at trial. Galoob’s decision not to present those

arguments was also a plain failure even to attempt to

mitigate damages within the meaning of Coyne-Delaney.

Subsequent cases were similarly explicit in their

insistence upon a careful examination by the trial court of all

relevant factors. For example, in Zenith Radio Corp. , supra,

the Federal Circuit upheld a decision of the Court of

International Trade to deny damages on the basis of five

“equitable factors” including a change in the law that had

deprived the trial court of jurisdiction over the plaintiff's

Claim. In State of Ala. ex rel. Siegelman v. U.S. E.P.A.,

supra, the Eleventh Circuit held that the equitable factors

considered by the district court did not justify a refusal to

award any damages but should be considered in determining

the amount of an award.

In short, the “majority view” identified by the Ninth

Circuit carries with it not only a presumption favoring the

award of damages but a clear mandate for a thorough

examination of all relevant factors to determine whether

equity requires that the award be denied or reduced. As will

be shown below, it is precisely such an examination that the

district court and the Ninth Circuit failed to make.

B. The Erroneous Standard Applied By The Ninth

Circuit Rejected Any Consideration Of The

Equitable Factors Emphasized By The Large

Majority Of The Circuits.

Nintendo’s appeal to the Ninth Circuit stressed that

the procedural history of the case made the award of

damages to Galoob grossly inequitable. Indeed, the record

demonstrated that any damages sustained by Galoob were the

product of its own reappraisal of the substantive law,

procedural misjudgment. and tactical decision. Most

important, Galoob steadfastly refused to take any step to

mitigate its damages by bringing its new defenses to the

attention of the trial court.

Galoob had and took a full opportunity. after

Nintendo rejected its request for a license, to study the

legality of its Game Genie device before it initiated its

action. See CR 315. Ex. B at 2-4. With the full benefit of

controlling the timing and place of the litigation, Galoob

admitted at the preliminary injunction hearing that the Game

Genie created derivative works and relied solely on Section

117 of the Copyright Act as a purported basis for non-

infringement. 6/8/90 RT at 5:5 - 6:3, 11:21-22, 12:3-17,

13:14-23 and 14:7-23; 6/29/90 RT at 18:4-23.

After the hearing, the district court granted

Nintendo's motion, finding that the Game Genie produces

“what can only be termed derivative works,” rejecting

Galoob’s Section 117 defense, and finding a likelihood of

Nintendo’s succeeding on the merits. 6/29/90 RT at 34:14 -

35:11. In July 1990, the case was transferred to another

judge, and Galoob retained new counsel. Galoob did not

institute any action in the district court to seek relief from

the injunction; instead, in August 1990, Galoob chose to file

an appeal that raised a host of new defenses including the

contentions that the Game Genie did not create derivative

works and that it represented a “fair use” under the

Galoob’s decision to appeal the granting of the

preliminary injunction, and not present its new defenses to

the district court, was pivotai: because it deprived the district

court of jurisdiction, the appeal would leave the injunction

in effect for the next seven months. Galoob’s counsel was

not unaware of the rule against federal appellate review of

issues not raised below but gambied that they could persuade

the Ninth Circuit to make an exception to that rule. The

Ninth Circuit declined and Galoob’s gamble failed, to the

injury, perversely enough, of Nintendo.

Even after the decision by the Ninth Circuit on

January 24, 1991, Galoob declined to present its new

defenses to the district court and to seek a dissolution of the

preliminary injunction. On the contrary, Galoob elected to

Stand mute on the underlying issues while filing a series of

successful motions over many months to increase Nintendo’s

bond from $100,000 to $15,000,000. See CR 48-52, CR 89-

100.

The Ninth Circuit opinion on the award of damages

under the injunction bond is devoid of any equitable analysis

of this history. Rather, the court embarked on a search for

evidence of bad faith or deceit on Galoob’s part (A-14):

Nintendo’s argument that Galoob failed to

assert all of its defenses at the time Nintendo

sought the preliminary injunction raises the

scepter [sic] of bad faith on the part of

Galoob. The essence of this argument is that

Galoob took advantage of Nintendo by

initially making its case appear to be worse

than it really was, thus lulling Nintendo into

obtaining the preliminary injunction. The

implication of the argument is that Galoob

cunningly got the court to raise the amount of

the bond on two successive occasions, finaily

pushing it up to $15 million. while concealing

the hole cards it intended to play at the time

of trial. Nintendo argues it would be

inequitable to permit Galoob to recover

damages when it pursued such wily litigation

tactics. In support of the argument, Nintendo

relies on Page Communications Eng’rs, Inc.

v. Froehlke, 475 F.2d 994 (D.C. Cir. 1973).

The Ninth Circuit's analysis misread both Page v.

Froehlke and Nintendo's argument. As previously indicated,

Page did tum on the failure of the defendant to have

produced an important document at the preliminary

injunction hearing. And Nintendo did contend that Page

presented a strong analogy to the present case. But Page did

not involve — and Nintendo never claimed that it involved

— any intentional misconduct on the part of the defendant.

On the contrary, in Page it was the fact that the

document in question was not provided, not the bad faith of

the enjoined party in failing to provide it, that required

exoneration of the bond. The court recognized the

importance of the fact that the district court did not have

before it the complete picture of the case at the preliminary

injunction stage because of the omission on the part of the

enjoined party. Irrespective of whether that omission was

accidental or intentional, Page held, consistent with the

majority rule, that it would be “inequitable and a perversion

of justice” to allow the enjoined party to execute on the

bond. 475 F.2d at 997.

For its part, Nintendo specifically disclaimed that

Galoob’s subjective intent in withholding defenses was

dispositive. See Nintendo's Reply Brief at 9-10. If the court

had concluded that Galoob acted in bad faith, that should, of

course, have been conclusive and required exoneration, just

as bad faith on the part of Nintendo would have been

conclusive in requiring execution.’ Absent bad faith on the

part of either party, however, the court was required to

examine all of the equitable factors.

"As the Ninth Circuit observed (A-13):

{I]f a party obtains a preliminary injunction in bad

faith, that party “flunks [the good faith test and]

the presumption in favor of enforcement [of the

bond] congeals virtually into a rock.” National

Kidney, 958 F.2d at 1135.

Contrary to the implication by the Ninth Circuit, Nintendo never

argued that its good faith was an independent ground for

exoneration. It merely pointed out that it has met that essential

prerequisite.

The Ninth Circuit's preoccupation with bad faith led

it to overlook or ignore the more obvious teachings of Page

and other decisions reflecting the majority view. For

example, as previously indicated, it is well recognized that

a defendant's failure to mitigate its damages is grounds to

deny or reduce an award. Coyne-Delaney v. Capital Devel.

Bd., 717 F.2d at 392; National Kidney Patients Ass’n v.

Sullivan, 958 F.2d at 1134; Note, Interlocutory Injunctions

and the Injunction Bond, 73 Harv. L. Rev. 333, 346 (1959)

(the duty of mitigation means that the defendant “must move

to dissolve the order as soon as possible”).*

The present case presents a failure to mitigate that

could hardly be clearer. Assuming that Galoob had not

become aware of its defenses at the time of the preliminary

injunction hearing — despite ample opportunity to have done

so — it was demonstrably aware of them by August when

they vere raised in Galoob’s brief to the Ninth Circuit. And

even if one could somehow justify Galoob’s decision to

attempt to raise those defenses for the first time before the

Ninth Circuit, the rejection of the defenses by the Ninth

Circuit, because those defenses had not been urged below,

‘ As this Court long ago held in the breach of contract context,

if a party “can save himself from a loss arising from a breach of

[contract] at a trifling expense or with reasonable exertions, it is

his duty to do it, and he can charge the delinquent with such

damages only as with reasonable endeavors and expense he cculd

not prevent.” Warren v. Stoddart. 105 U.S. 224 (1881). See also

Williston on Contracts § 1039 (3d ed. 1967), regarding mitigation

of damages.

made unmistakable Galoob’s duty to present them to the

district court.

Similarly, the Ninth Circuit failed to consider the

importance given, under the majority view, to a change in

the applicable law subsequent to the preliminary injunction

hearing. See Zenith Radio Corp.. supra; Coyne-Delaney v.

Capital Devel. Bd., supra. In this case, Galoob effected a

dramatic metamorphosis in the theories of its defense. That

transformation in Galoob’s view of what law controlled the

case is Closely analogous to a court decision or statute which

altered the law after the issuance of a temporary injunction.

Both types of changes must be brought to the attention of the

district court. The “change in the law” applicable to

Nintendo's claims led directly to Galoob’s ultimate success.

Such a change, effected by the defendant itself, merits even

greater weight than a change imposed by a neutral third

party, i.e., a court or legislature.”

¥ Compare the comment of Judge Posner in Covne-Delaney,

717 F.2d at 392-93:

We do not believe that a change in the law is always a

good ground for denying costs and injunction damage to

a prevailing party. but it is a legitimate consideration,

perhaps especially where the prevailing party is a state

agency that benefitted from a change in the law of its

state. In a sense, this is a case where one state agency (the

Board) is seeking to benefit from the confusing signal sent

out by another state agency (the court system) — though

we do not mean to suggest that the Illinois Supreme Court

was rushing fraternally to the aid of another state agency

when it reversed Polyvend.

In Zenith Radio Corp.. supra, the Federal Circuit upheld the

denial of injunction bond damages where the “change in the law™

The standard for execution on an injunction bond

badly requires clarification. Under the proper standard,

failure to mitigate damages requires exoneration rather than

execution.

Il.

CERTIORARI SHOULD BE GRANTED

BECAUSE THE CONSTRUCTION OF

RULE 65(c) Is OF GREAT IMPORTANCE

IN FEDERAL LITIGATION

If the unique approach of the Ninth Circuit is

permitted to go uncorrected, or if the automatic liability

rules of the Second and Third Circuits are allowed to stand,

there will likely be adverse consequences far beyond those

jurisdictions. Given the divergent views of the various

circuits with respect to Rule 65(c), it clearly has the potential

to influence, and distort, the law. The decision here, that all

equitable factors other than the defendant's good faith are

irrelevant, will, at a minimum, reinforce the minority view

of strict liability espoused by the Second Circuit and, it

appears, by the Third as well.

The importance of injunctive relief to the litigation

process is beyond argument:

was a ruling in another case. on an issue of first impression, that

there was no jurisdiction to entertain Zenith’s lawsuit. 823 F.2d

at 520-21.

Although the fundamental faimess of

preventing irremediable harm to a party is an

important factor on a preliminary injunction

application, the most compelling reason in

favor of [granting a preliminary injunction] is

the need to prevent the judicial process from

being rendered futile by defendant's action or

refusal to act.

Canal Authority of State of Florida v. Callaway, 489 F.2d

567, 573 (Sth Cir. 1974) (quoting Wright and Miller,

Federal Practice and Procedure: Civil § 2947 (1973))

(alteration in original). It follows that imposition of undue or

unwarranted burdens on the obtaining of an injunction

threatens the very integrity of the process. Indeed, the

avoidance of undue burdens made many courts at common

iaw reluctant to require a bond in the first instance. See

Note, Jnterlocutory Injunctions and the Injunction Bond,

supra p. 20, at 336.'° The requirement of a bond under the

Federal Rule is now well settled.'' Nevertheless, the

“The injunction bond appears to be the result of the inter-

action of two major competing considerations[:]. . . the tradition-

al reluctance to penalize a plaintiff for resorting to the judicial

process or to make him pay a price for his remedy [and] . . . the

extreme caution which often permeates judicial proceedings and is

reflected in their elaborate safeguards. . . .~ /d.

'' Under appropriate circumstances, the Federal requirement

may be relaxed. Wavne Chemical, Inc. v. Columbus Agency

Service Corp., 567 F.2d 692, 701 (7th Cir. 1977) (in suit to

enforce rights under a group medical poiicy, indigence of party

excuses bond requirement): Crowley v. Local No. 82, 679 F.2d

978, 1000-01 (1982), rev'd on other grounds, 467 U.S. 526

(1984) (district court did not err in refusing to require union

avoidance of undue burdens must remain a matter of serious

and legitimate concer.

The unfortunate consequence of imposing such a

burden by adoption of either the Ninth Circuit’s approach or

the automatic liability view, may be felt in any of the myriad

circumstances under which injunctive relief is sought. But

nowhere is the potential harm more serious than in actions

under the Copyright Law. Injunctive relief is vital to the

protection of intellectual property. And the availability of

preliminary relief is especially important. As Nintendo

pointed out in its brief to the Ninth Circuit, the Copyright

Law recognizes that importance by providing a presumption

of irreparable injury to copyright owners who, in seeking

preliminary relief, establish a likelihood of success on the

merits. See, e.g., Johnson Controls, Inc. v. Phoenix Control

Systems, Inc., 886 F.2d 173, 1174 (9th Cir. 1989): Apple

Computer, Inc. v. Formula Int’l Inc., 725 F.2d 521 (9th Cir.

1984).'°

members to post bond where absence of security would not impose

significant burden on defendants, plaintiffs were less able to afford

security, and bond requirement would affect enforcement of

statutory labor rights).

'2 Nintendo also noted that a copyright owner is generally

entitled to an injunction to halt any infringement, citing Universal

City Studios, Inc. v. Sony Corp. of America, 659 F.2d 963, 976

(9th Cir. 1981), rev'd on other grounds, 464 U.S. 417 (1984).

The Ninth Circuit observed that Universal Ciry had involved a

permanent injunction and concluded that “public policy does not

advocate the liberal issuance of preliminary injunctions in

however, was mistaken. As reflected by the authorities cited in the

In a field such as copyright law, where the governing

legal principles are extraordinarily complex and frequently

changing, the implications of the standard adopted by the

Ninth Circuit are particularly disturbing. As interpreted by

the Ninth Circuit, Rule 65(c) will go far beyond the

rationale, adopted by the Ninth Circuit, of discouraging

“flimsy claims.” A copyright owner who furnishes security

to obtain injunctive relief will know that he is at risk not

only from defenses presented at the preliminary injunction

stage but from any defense that later occurs to the alleged

infringer at any time prior to, or perhaps even during, the

trial. Such a standard, we submit, can only have a chilling

effect upon bona fide efforts of copyright owners to protect

the fruits of their creative labors.

text, an application for preliminary relief, like an application for

permanent relief, will be granted upon a showing of infringement,

i.e., because of public policy considerations. the element of

irreparable injury need not be demonstrated.

CONCLUSION

For the foregoing reasons, the petition for a writ of

certiorari should be granted.

Dated: June 17, 1994

Respectfully submitted,

Robert H. Bork

1150 Seventeenth Street, N.W.

Washington, D.C. 20036

(202) 862-5851

John J. Kirby

Counsel of Record

Mudge Rose Guthrie Alexander &

Ferdon

180 Maiden Lane

New York, New York 10038

(212) 510-7000

Attorneys for Petitioner

a 2 = eT an

A-1

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

NINTENDO OF AMERICA, INC.,

Plaintiff-Appellant, No. 92-16364

D.C. No.

™ CV-90-01440-FMS

Lewis GALOoos Toys, INC., OPINION

Defendant-Appellee.

Appeal from the United States District Court

for the Northern District of California

Fern M. Smith, District Judge, Presiding

Argued and Submitted

December 14, 1993—San Francisco, California

Filed February 17, 1994

Before: Donald P. Lay", Cynthia Holcomb Hall and

David R. Thompson, Circuit Judges.

“ Hon. Donald P. Lay, Senior Circuit Judge for the Eighth Circuit,

sitting by designation.

A-2

Opinion by Judge Thompson

SUMMARY

Civil Litigation and Procedure/Interim Relief —

Preliminary Injunctions/Interim Relief

The court of appeals affirmed a district court judgment. The

court held that a defendant who was wrongfully enjoined was

entitled to have the full amount of the injunction bond executed in

its favor.

Several years after appellant Nintendo of America, Inc. began

selling a home video game system called the Nintendo

Entertainment System (NES), appellee Lewis Galoobd Toys, Inc.

announced its intention to begin selling the Game Genie, an

electronic device allowing NES owners to change aspects of NES

video games. A month later, Nintendo brought a copyright

infringement action against Galoob. Nintendo obtained a

preliminary injunction against the sale of the Game Genie. The

district court required Nintendo to post a $15 million bond as

security for the injunction.

At trial, Galoob asserted additional legal theories that it liad

not asserted at the preliminary injunction hearing. Galoob

prevailed at trial, and the district court vacated the injunction.

The district court held a “lost sales” hearing to determine the

number of Game Genie sales Galoob lost because of the

injunction. Galoob’s evidence included a comparison of the Game

Genie to another NES accessory, the Nintendo Advantage, for

A-3

which sales figures were available. The court, assuming that the

Game Genie was at least as attractive to NES owners as was the

Nintendo Advantage, determined that Galoob lost 1.6 million

Game Genie sales due to the injunction. The district court also

held a “profits hearing” to determine Galoob’s net profit margin.

Galoob called an economist who testified regarding its profit

margin. The district court awarded Galoob the entire amount of

the bond after finding that the injunction caused Galoob at least

$15 million in damages. Nintendo appealed.

[1] A party has been wrongfully enjoined when it turns out

that the party enjoined had the right all along to do what it was

enjoined from doing. [2] In this case, Galoob was wrongfully

enjoined.

[3] There is a rebuttable presumption that a wrongfully

enjoined party is entitled to have the bond executed and recover

provable damages up to the amount of the bond. [4] Galoob’s

litigation conduct did not preclude it from recovering on the bond.

There was no indication in the record that Galoob sandbagged

Nintendo into prevailing on its application for the preliminary

injunction, knowing all the while that it could have defeated that

application.

[5] Galoob established with reasonable certainty that it was

damaged by the issuance of the injunction. [6] The district court’s

method of calculating the number of lost sales was not erroneous;

the court repeatedly used the most conservative ends of available

ranges in calculating the number. [7] Thus, Galoob was entitled to

have the full amount of the bond executed in its favor.

A-4

COUNSEL

John J. Kirby, Jr., Mudge Rose Guthrie Alexander & Ferdon,

New York, New York; and William E. Trautman, Brobeck,

Phleger & Harrison, San Francisco, California, for the plaintiff-

appellant.

Jerome B. Falk, Jr., Howard, Rice, Nemerovski, Canady,

Robertson & Falk, San Francisco, California, for the defendant-

appellee.

OPINION

THOMPSON, Circuit Judge:

Nintendo of America, Inc. appeals the execution of a $15

million bond in favor of Lewis Galoob Toys, Inc. Nintendo posted

the bond as security for a preliminary injunction against Galoob in

a copyright infringement action Nintendo later lost. The district

court awarded Galoob the entire amount of the bond after finding

the injunction caused Galoob at least $15 million in damages.

Nintendo argues the district court erred in three ways: First,

by not weighing equitable considerations before deciding to

execute the bond; second, by improperly findirg the injunction

harmed Galoob; and third, by improperly calculating the amount

of Galoob’s damages.

We have jurisdiction under 28 U.S.C. § 1291, and we affirm.

A-5

FACTS

The Nintendo Entertainment System (“NES”) was the most

popular home video game system in the United States from the

late 1980s until the early 1990s. Its manufacturer, Nintendo of

America, Inc., began selling the NES in 1986. By 1991 Nintendo

had sold over thirty million units in the United States.

Several years after Nintendo introduced the NES, Lewis

Galoob Toys, Inc. announced its intention to begin selling the

Game Genie, an electronic device allowing NES owners to change

aspects of NES video games. For example, the Game Genie would

permit a video game character to run faster, jump higher, or

become immortal.

At the time of Galoob’s announcement of the Game Genie, in

May 1990, NES product sales were at or near their peak.

Nintendo sold nearly fifteen million NES video games that year,

exceeding any other year’s sales. Consumer interest in the Game

Genie was similarly intense. Immediately after the product

announcement, Galoob received orders for over 550,000 Game

Genies, and expected to sell well over a million units in 1990.

Expert witnesses later testified Galoob could have sold as many as

6.5 million units over the product’s lifetime.

Only one month after Galoob’s announcement, however,

Nintendo obtained a preliminary injunction against the sale of the

Game Genie. Nintendo’s lawsuit and request for a preliminary

injunction responded to an earlier lawsuit filed by Galoob in which

Galoob sought a declaratory judgment that its Game Genie did not

violate any of Nintendo’s intellectual property rights.

At the hearing for the preliminary injunction, Galoob asserted

that the Game Genie fell under an exception to rights provided to

A-6

a copyright owner by the Copyright Act. Specifically, Galoob

contended that the Game Genie allowed an “adaptation . . .

created as an essential step in the utilization of [a] computer

program,” which 17 U.S.C. § 117 states is a permissible use of

a copyrighted work. The district court granted the injunction,

believing at the time it was likely “Nintendo will prevail on its

claims that Galoob [has infringed] Nintendo’s copyright rights;

[and] that Nintendo will suffer immediate and irreparable harm as

well as the loss of profits.”’ The district court required Nintendo

to post a $100,000 bond as security for the injunction. This

amount was later raised to $5 million and then to $15 million.

Nintendo resisted these increases, but nevertheless posted bond in

the increased amounts.

At the copyright infringement trial, Gaioob asserted additional

legal theories it had not asserted at the preliminary injunction

hearing. It contended that the Game Genie was a fair use of

Nintendo’s copyrights under 17 U.S.C. § 107 and that the game

did not create infringing derivative works. Galoob prevailed at

trial and in July 1991 the district court vacated the injunction.’

The injunction had been in effect approximately one year.

In August 1991, Galoob began selling the Game Genie. It

sold about one million units in the United States that year and

expected to sell as many as 800,000 in 1992. In September 1991,

' We affirmed the district court’s order granting the preliminary

injunction in an unpublished memorandum disposition filed January 24,

1991. See Nintendo of Am., Inc. v. Lewis Galoob Toys, Inc. , 923 F.2d

862 (9th Cir. 1991)(unpublished disposition).

? We affirmed the judgment in May 1992. Lewis Galoob Toys, Inc. v.

Nintendo of Am., Inc., 964 F.2d 965 (9th Cir. 1992), cert. denied, 113

S. Ct. 1582 (1993).

A-7

the district court ordered the execution of the bond in favor of

Galoob “in an amount to be determined by the Court.”

In December 1991, the court held a “lost sales” hearing to

determine the number of Game Genie sales Galoob lost because of

the injunction. To establish the number of lost sales, Galoob

presented evidence comparing the Game Genie to another NES

accessory called the “Nintendo Advantage.” The Advantage is a

joystick, manufactured and sold by Nintendo. The Advantage

permits NES owners to more easily control the characters in video

games. The Advantage reached a “market penetration” of ten

percent, meaning one Advantage was sold in the United States for

every ten NESs. Galoob also presented studies explaining the

“Canadian multiplier method,” which showed that, in general, a

product will seil ten to twelve times as well in the United States

as in Canada. Galoob estimated it would sell 190,000 Game

Genies in Canada by the end of 1991.

In response to Galoob’s assertion of lost sales, Nintendo

argued that annual NES sales did not provide a reliable indicator

of Game Genie demand. Although annual sales of the NES

declined in 1991, the “installed base” or number of NES systems

owned in the United States, increased. By the end of 1990, there

were 26 million NES systems in the United States, and by the end

of 1991, there would probably have been more than 30 million.

One of Galoob’s marketing documents showed that 93 percent of

all NES consoles ever sold were still in use at the end of 1991. On

the basis of this evidence, Nintendo contended there was actually

an increase in the number of potential Game Genie customers

since the district court imposed the injunction.

The district court determined Galoob lost at least 1.6 million

Game Genie sales. In arriving at this number, the district court

assumed the Game Genie was at least as attractive to NES owners

A-8

as was the Nintendo Advantage. Because the NES’s installed base

was 30 million at the end of 1991, and the Advantage’s market

penetration was ten percent, Galoob should have sold at least three

million Game Genies, or ten percent of 30 million, over the

product’s lifetime had the court not issued the injunction. To check

the accuracy of this estimate, the court applied the Canadian

multiplier method, using the estimated total Canadian Game Genie

sales of 190,000 and a multiplier of eleven. The resulting

2,090,000 was, in the court’s view, “very close to 3 million,” and

satisfied the court its estimating method was reasonable.

Noting testimony that four million more NES units would be

sold in 1992, the district court then added another ten percent, or

400,000 units. to the figure of three miliion and concluded Galoob

would have sold 3.4 million Game Genies over the product’s

lifetime. The court subtracted the one million Game Genies

Galoob actually sold in 1991 and the estimated 800,000 it would

sell in 1992. The court concluded Galoob lost 1.6 million Game

Genie sales due to the injunction.

This conclusion was based on estimates the court determined

were reasonable. The court stated: “I think that these calculations

are conservative. I have tried in estimating to take basically the

bottom end of everybody’s range, and if you want to tell me why

that isn’t fair, I’m certainly willing to listen.”

The district court also held a “profits hearing.” At this

hearing Galoob established that the average net wholesale price for

the Game Genie was $34.28. Nintendo does not contest this

figure, but does contest the district court’s finding that Galoob’s

net profit margin was 27.6 percent. The district court applied this

percentage to the average net wholesale price to determine

Galoob’s net profit on each Game Genie (27.6 x $34.28 — $9.46).

A-9

To establish its net profit margin percentage, Galoob called

an economist. He testified that Galoob’s profit margin was 42.74

percent. In arriving at this figure, the economist deducted variable

costs allocable to Game Genie sales, but not fixed costs which he

described as costs that would have been incurred regardless of

Game Genie sales.

Nintendo contested the economist’s determination of Galoob’s

profit margin percentage by challenging his categorization of

variable and fixed costs. Nintendo presented an accountant who

examined financial data for the Galoob company as a whole and

concluded an extra 18.77 percent should be deducted from

Galoob’s economist’s figure of 42.74 percent.

In determining that Galoob’s profit margin was 27.6 percent,

the court began with the testimony of Galoob’s economist that

Galoob’s profit margin was 42.74 percent. The court stated the

economist’s method in calculating this figure was a “rational and

reliable one.” The court agreed with Nintendo’s contention,

however, that four categories of Galoob’s costs, namely, salaries

and benefits, travel and entertainment, promotion, and interest,

had to be taken into consideration in arriving at the profit margin.

It disagreed with Nintendo’s contention that as much as 18.77

percent should be deducted from the economist’s profit margin

figure, but nevertheless lowered the profit margin to 32.74

percent.

Nintendo also disputed the proper allocation of other costs,

such as “reworking the Game Genie, tooling, packaging, TV

origination, and contract R & D.” The court included these factors

in its calculations, “[a]ssuming, without deciding, that Nintendo

is correct in each of these contentions,” and further reduced the

profit margin from 32.74 percent to the final figure of 27.6

percent.

A-10

By multiplying the 1.6 million unit sales lost by the net

wholesale price of $34.28, times the 27.6 percent profit margin,

the district court found Galoob suffered at least $15,138,048 in

lost profits due to the injunction. The court also calculated Galoob

lost $315,569 in interest it would have earned on its loss profits

and $480,000 in costs it incurred “when [Galoob] ceased

production and distribution and thereafter recommenced those

activities upon dissolution of the injunction.” Because the total of

these amounts exceeded the $15 million bond Nintendo posted, the

district court awarded Galoob the entire amount of the bond, plus

costs, under Federal Rule of Civil Procedure 65.1. This appeal

followed.

STANDARD OF REVIEW

We review de novo a district court’s decision to execute a

bond. Matek v. Murat, 862 F.2d 720, 733 (9th Cir. 1988)(noting

the conflict between “abuse of discretion” and “de novo”

standards of review among circuits but choosing the latter). An

allegation that a district court ignored legal procedure raises a

question of law we also review de novo. Anderson v. United

States, 966 F.2d 487, 489 (9th Cir. 1992). A district court’s

computation of damages is a finding we review under the clearly

erroneous standard. Stephens v. City of Vista, 994 F.2d 650, 655

(9th Cir. 1993); Lum v. Honolulv 963 F.2d 1167, 1170 (9th

Cir.), cert. denied, _ U.S. ____, 113 S. Ct. 659 (1992); Galindo

v. Stoody Co., 793 F.2d 1502, 1516 (9th Cir. 1986).

A-11

DISCUSSION

The first issue we consider is whether Galoob was wrongfully

enjoined. We conclude it was. We then consider what standard we

should apply to ascertain whether the district court erred in

determining that Galoob was entitled to damages. Finally, we

consider whether the district court erred in computing the amount

of damages.

Rule 65(c) of the Federal Rules of Civil Procedure provides:

No restraining order or preliminary injunction shall issue

except upon the giving of security by the applicant, in

such sum as the court deems proper, for the payment of

such costs and damages as may be incurred or suffered

by any party who is found to have been wrongfully

enjoined or restrained.

Fed. R. Civ. P. 65(c).

[1] Under this rule, before a court may execute a bond, it

raust find the enjoined or restrained party was “wrongfully

enjoined or restrained.”* This circuit has yet to define wrongful

enjoinment. We hold today that a party has been wrongfully

enjoined within the meaning of Rule 65(c) when it turns out the

party enjoined had the right all along to do what it was enjoined

from doing.‘ See Blumenthal v. Merrill Lynch Pierce, Fenner &

3 Because this case involves a preliminary injunction rather than a

temporary restraining order, we use the term “wrongfully enjoined”

rather than “wrongfully restrained.”

* We prefer the wording of Rule 65(c), which speaks in terms of a

party who has been “wrongfully enjoined,” rather than the wording in

some cases in other circuits which refers to an injunction as having been

A-12

Smith, Inc., 910 F.2d 1049, 1954 (2d Cir. 1990)(“A party has

been ’wrongfully enjoined‘ under Fed. R. Civ. P. 65(c) if it is

ultimately found that the enjoined party had at all times the right

to do the enjoined act.”).

[2] Here, Nintendc obtained a preliminary injunction

enjoining Galoob from selling the Game Genie. As it turned out,

Galoob prevailed in the underlying litigation. The district court

held Galoob could sell the Game Genie and vacated the

preliminary injunction. We affirmed on appeal. Galoob Toys, 964

F.2d 965. Thus, Galoob was wrongfully enjoined.

[3] This brings us to the next question: Is Galoob entitled to

have the bond executed in its favor? Although there seems to be

some variance in how other circuits respond to this question, we

join what appears to be the majority and hold there is a rebuttable

presumption that a wrongfully enjoined party is entitled to have

the bond executed and recover provable damages up to the amount

of the bond. See, e.g., National Kidney Patients Ass’n v. Sullivan,

958 F.2d 1127, 1134 (D.C. Cir. 1992)(a “defendant injured by a

wrongfully issued preliminary injunction is presumptively entitled

to recovery on the injunction bond”), cert. denied, 113 S. Ct. 966

(1993)

We believe this rule is sound. By adhering to this standard,

the party enjoined will usually recover damages, thus discouraging

parties from requesting injunctions based on tenuous legal

grounds. See Coyne-Delaney Co. v. Capital Dev. Bd., 717 F.2d

“wrongfully issued.” Fed. R. Civ. P. 65(c). A court that complies with

the applicable law in issuing a preliminary injunction does not

“wrongfully” issue it. Indeed, in an earlier appeal in this case we upheld

the district court’s issuance of the preliminary injunction. See Nintendo,

923 F.2d 862 (unpublished disposition).

A-13

385, 392 (7th Cir. 1983)(“... [this test] discourages the seeking of

preliminary injunctions on flimsy (though not necessarily

frivolous) grounds.”). Furthermore, a presumption that damages

will be awarded from the bond assures district court judges that

defendants will receive compensation for their damages in cases

where it is later determined a party was wrongfully enjoined. See

Note, Recovery for Wrongful Interlocutory Injunctions Under Rule

65(c), 99 Harv. L. Rev. 828, 838 n.36 (1986). Moreover,

demands on judicial resources may be relieved to some extent,

because a defendant who can recover damages against a

preliminary injunction bond will be less likely to file a separate

malicious prosecution action. See generally Note Interlocutory

Injunctions and the Injunction Bond, 73 Harv. L. Rev. 333

(1959). Finally, this standard provides an equitable means by

which courts can decline to impose damages on the rare party who

has lost a case on the merits but nevertheless should not suffer the

execution of the preliminary injunction bond.

Nintendo argues it rebutted this presumption. Nintendo

points out it acted in good faith in bringing its copyright

infringement lawsuit, Galoob failed to assert defenses to the

preliminary injunction it could have asserted at the preliminary

injunction hearing, public policy favors the issuance of injunctions

in intellectual property infringement suits, and to award Galoob

$15 million imposes a punitive sanction against Nintendo. We

consider each of these arguments in turn.

We reject Nintendo’s good faith argument. Good faith in the

maintenance of litigation is the standard expected of all litigants.

That a party lives up to this standard simply means the party did

what it ought to have done. On the other hand, if a party obtains

a preliminary injunction in bad faith, that party “flunks [the good

faith test and] the presumption in favor of enforcement [of the

A-14

-ond] congeals virtually into a rock.” National Kidney, 958 F.2d

at 1135.

Nintendo’s argument that Galoob failed to assert all of its

defenses at the time Nintendo sought the preliminary injunction

raises the scepter of bad faith on the part of Galoob. The essence

of this argument is that Galoob took advantage of Nintendo by

initially making its case appear to be worse than it really was, thus

lulling Nintendo into obtaining the preliminary injunction. The

implication of the argument is that Galoob cunningly got the court

to raise the amount of the bond on two successive occasions,

finally pushing it up to $15 million, while concealing the hole

cards it intended to play at the time of trial. Nintendo argues it

would be inequitable to permit Galoob to recover damages when

it pursued such wily litigation tactics. In support of this argument,

Nintendo relies on Page Communications Eng’rs, Inc. v. Froehlke,

475 F.2d 994 (D.C. Cir. 1973).

Page Communications is inapposite. There, the court

declined to award damages to an enjoined defendant in a contract

action. The defendant earlier agreed to produce “all ‘records

relating to the evaluation of proposals submitted’ by the various

offerors, and all ‘documents setting forth the basis for award.’”

Page Communications, 475 F.2d at 996. Although this language

described a particular report the defendant possessed, the

defendant intentionally declined to produce the report. In granting

the injunction for the plaintiff, the district court believed

erroneously it had examined all the relevant evidence. Because the

defendant was responsible for the missing evidence, and because

the district court would probably not have granted the injunction

had it seen the report, the court concluded that in light of these

circumstances, it would be inequitable to assess damages against

the plaintiff. Jd. at 997.

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[4] Here, Galoob did not fail to produce evidence. It did not

deceive the court. There is no indication in the record that Galoob

sandbagged Nintendo into prevailing on its application for the

preliminary injunction, knowing all the while that it could have

defeated that application. Those facts simply are not in this case.

All that appears is that Galoob had additional defenses it asserted

at the time of trial, defenses it had not asserted at the preliminary

injunction hearing. And while it is true Galoob persuaded the

court on two successive occasions to increase the amount of the

bond, thus raising the stakes of the game, it is also true that

Nintendo called these raises by putting up additional amounts of

the bond. We conclude Galoob’s litigation conduct does not

preclude it from recovering on the bond.

Nintendo’s public policy argument is premised on its assertion

that public policy favors the issuance of injunctions in intellectual

property infringement lawsuits. This assertion is correct only

when a permanent injunction is sought once infringement has been

established. See, e.g., Universal City Studios, Inc. v. Sony Corp.

of Am., 659 F.2d 963, 976 (9th Cir. 1981) (“We note that, as a

general rule, a copyright plaintiff is entitled to a permanent

injunction when liability has been established and there is a threat

of continuing violations.”) (emphasis added), rev’d on other

grounds, 464 U.S. 417 (1984). Public policy does not advocate

the liberal issuance of preliminary injunctions in copyright

infringement actions.

We reject Nintendo’s argument that the district court awarded

punitive damages by executing the bond in favor of Galoob. The

damage award was not punitive, but compensatory. Every dollar

the court awarded to Galoob compensated it for the injury it had

suffered because of the injunction. Cf Coyne-Delaney, 717 F.2d

at 392.

ee oes

A-16

We next consider whether the district court erred in

determining that Galoob suffered at least $15 million in damages

by reason of the issuance of the injunction. Nintendo argues the

court failed to require Galoob to meet any burden of proof in

establishing its damages. The record belies this contention. In its

order directing entry of partial judgment, the district court stated,

“Galoob has proved by a preponderance of the evidence that it

sustained actual injury as a result of the wrongful issuance of the

preliminary injunction.” The court explicitly named the standard

it applied to Galoob and ernlicitly stated Galoob met that burden.

Nintendo challenges this finding. It argues Galoob failed to

prove with reasonable certainty that it suffered any damage. See

Palmer v. Connecticut Ry. & Lighting Co., 311 U.S. 544, 561

(1941) (“Certainty in the fact of damage is essential.”).

According to Nintendo, Galoob was not damaged by the injunction

because the injunction only delayed Game Genie sales, it did not

prevent them permanently. That is, although NES owners who

wanted to purchase the Game Genie in 1990 could not do so

because of the injunction, they most likely waited a year until the

injunction was lifted, and then bought the product anyway.

[5] We reject this argument. It is premised largely on

speculation, and as the district court stated, it “defies common

sense.” Galoob established with reasonabie certainty that it was

damaged by the issuance of the injunction.

The next question is: Did the district court err in computing

the amount of damages Galoob suffered? “The district court’s

computation of damages . .. is . . . insulated from review unless

clearly erroneous.” Laborers Clean-Up Contract Admin. Trust

Fund v. Uriarte Clean-Up Serv., Inc., 736 F.2d 516, 520 n.2

(1984); see also Lum, 963 F.2d at 1170 (upholding damage award

where the award was “not extreme or outrageous”).

A-17

Throughout its calculation of damages, the district court chose

figures favoring Nintendo. The court assumed the Game Genie

would sell only as well as the Nintendo Advantage, even though

the Advantage was, in its opinion, “not as versatile or long-lasting

a peripheral” as the Game Genie. When the court checked the

accuracy of its estimate of lost sales, using the Canadian multiplier

method, it chose a figure of 190,000 Canadian sales, which was

“at the conservative end of the level,” and used a multiplier of

eleven, which was far below the multiplier of thirty-eight that the

Advantage enjoyed. The court also adopted Galoob’s highest

estimate of its anticipated 1992 sales. It then deducted this high-

end estimate, together with Galoob’s actual 1991 sales, from the

total sales it determined Galoob would have made “but for” the

issuance of the injunction.

[6] In sum, in determining the number of lost sales, the

district court repeatedly used the most conservative ends of

available ranges. While it is true that Galoob did not likely lose

exactly 1.6 million sales of the Game Genie, it is reasonably

certain it lost at least that amount. The district court’s method of

calculating the number of lost sales was not erroneous.

With regard to the court’s finding that Galoob’s profit margin

for the Game Genie was 27.6 percent, the court began with the

“rational and reliable” estimate of Galoob’s economist that the

profit margin was 42.74 percent, considered the evidence and

contentions of the parties and

A-18

reduced that figure to 27.6 percent. It did not clearly err in

making this funding.

CONCLUSION

[7] Galoob was wrongfully enjoyed from selling the Game

Genie. As a result, it was presumptively entitled to recover

damages. Nintendo did not rebut this presumption. Galoob

proved with reasonable certainty it was damaged by the injunction.

The district court did not err in finding Galoob’s damages

exceeded the $15 million amount of the bond. Galoob was

entitled to have the full amount of the bond executed in its favor.

AFFIRMED.

A-19

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

NINTENDO OF AMERICA, INC.,

Plaintiff-Appellant, No. 92-16364

D.C. No.

« CV-90-01440-FMS

Lewis GALoos Toys, INC., ORDER

Defendant-Appellee.

Before: LAY*, HALL and THOMPSON, Circuit Judges.

The panel, as constituted above, has unanimously voted to

deny the petition for rehearing. Judges Hall and Thompson voted

to reject the suggestion for rehearing en banc, and Judge Lay so

recommended.

The suggestion for en banc rehearing has been circulated to

the full court, and no judge of the court has requested a vote on

the suggestion for rehearing en banc. Fed. R. App. P. 35(b).

The petition for rehearing is DENIED, and the suggestion for

a rehearing en banc is REJECTED.

“ Hon. Donald P. Lay, Senior Circuit Judge for the Eighth Circuit,

sitting by designation.

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A-20

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

Lewis GALoosB Toys, INC.,

No. 921-16205

Plaintiff-Appellee, D.C. No.

CV-90-1586 FMS

¥;

NINTENDO OF AMERICAN, INC., AMENDED

OPINION

Defendant-Appellant.

NINTENDO OF AMERICA, INC.,

Plaintiff-Appellee,

D.C. No.

v. CV-90-1586 FMS

Lewis GALoos Toys, INC.,

OPINION

Defendant-Appellant.

Appeal from the United States District Court

for the Northern District of California

Fern M. Smith, District Judge, Presiding

Argued and Submitted

March 12, 1992 - San Francisco, California

Filed May 21, 1992

Amended August 5, 1992

A-21

Before: Jerome Farris and Pamela Ann Rymer, Circuit Judges,

and David V. Kenyon,” District Judge.

Opinion by Judge Farris

COUNSEL

Thomas G. Gallatin, Jr., Mudge, Rose, Guthrie, Alexander &

Ferdon, New York, New York, for the defendant-appellant.

Jerome B. Falk, Jr., Howard, Rice, Nemerovski, Canady,

Robertson & Falk, San Francisco, California, for the plaintiff-

appellees.

OPINION

FARRIS, Circuit Judge:

Nintendo of America appeals the district court’s judgment

following a bench trial (1) declaring that Lewis Galoob Toys’

Game Genie does not violate any Nintendo copyrights and

dissolving a temporary injunction and (2) denying Nintendo’s

request for a permanent injunction enjoining Galoob from

marketing the Game Genie. Lewis Galoob Toys, Inc. v. Nintendo

of America, Inc., 780 F. Supp. 1283 (N.D. Cal. 1991). We have

appellate jurisdiction pursuant to 15 U.S.C. § 1121 and 28 U.S.C.

§§1291 and 1292(a)(1). We affirm.

~ Honorable David V. Kenyon, United States District Judge for the

Central District of California, sitting by designation.

A-22

FACTS

The Nintendo Entertainment System is a home video game

system marketed by Nintendo. To use the system, the player

inserts a cartridge containing a video game that Nintendo p:oduces

or licenses others to produce. By pressing buttons and

manipulating a control pad, the player controls one of the game’s

characters and progresses through the game. The games are

protected as audiovisual works under 17 U.S.C. § 102(a)(6).

The Game Genie is a device manufactured by Galoob that

allows the player to alter up to three features of a Nintendo game.

For example, the Game Genie can increase the number of lives of

the player’s character, increase the speed at which the character

moves, and allow the character to float above obstacles. The

player controls the changes made by the Game Genie by entering

codes provided by the Game Genie Programming Manual and

Code Book. The player also can experiment with variations of

these codes.

The Game Genie functions by blocking the value for a single

data byte sent by the game cartridge to the central processing unit

in the Nintendo Entertainment System and replacing it with a new

value. If that value controls the character’s strength, for example,

then the character can be made invincible by increasing the value

sufficiently. The Game Genie is inserted between a game cartridge

and the Nintendo Entertainment System. The Game Genie does not

alter the data that is stored in the game cartridge. Its effects are

temporary.

A-23

DISCUSSION

1. Derivative work

The Copyright Act of 1976 confers upon copyright holders

the exclusive right to prepare and authorize others to prepare

derivative works based on their copyrighted works. See 17 U.S.C.

§ 106(2). Nintendo argues that the district court erred in

concluding that the audiovisual displays created by the Game

Genie are not derivative works. The court’s conclusions of law are

reviewed de novo. See Rozay’s Transfer v. Local Freight Drivers,

Local 208, 850 F.2d 1321, 1326 (9th Cir. 1988), cert. denied,

490 U.S. 1030 (1989). Its findings of fact are reviewed for clear

error. See id.

A derivative work must incorporate a protected work in some

concrete or permanent “form.” The Copyright Act defines a

derivative work as follows:

A “derivative work” is a work based upon one or

more preexisting works, such as a translation, musical

arrangement, dramatization, fictionalization, motion

picture version, sound recording, art reproduction,

abridgment, condensation, or any other form in which a

work may be recast, transformed, or adapted. A work

consisting of editorial revisions, annotations,

elaborations, or other modifications which, as a whole,

represent an original work of authorship, is a “derivative

work.”

17 U.S.C. § 101 (emphasis added). The examples of derivative

works provided by the Act all physically incorporate the

underlying work or works. The Act’s legislative history similarly

A-24

indicates that “the infringing work must incorporate a portion of

the copyrighted work in some form.” 1976 U.S. Code Cong. &

Admin. News 5659, 5675. See also Mirage Editions, Inc. v.

Albuquerque A.R.T. Co., 856 F.2d 1341, 1343-44 (9th Cir. 1988)

(discussing same), cert. denied, 489 U.S. 1018 (1989).

Our analysis is not controlled by the Copyright Act’s

definition of “fixed.” The Act defines copies as “material objects,

other than phonorecords, in which a work is fixed by any

method.” 17 U.S.C. § 101 (emphasis added). The Act’s definition

of “derivative work,” in contrast, lacks any such reference to

fixation. See id. Further, we have held in a copyright infringement

action that “[iJt makes no difference that the derivation may not

satisfy certain requirements for statutory copyright registration

itself.” Lone Ranger Television v. Program Radio Corp. , 740 F.2d

718, 722 (9th Cir. 1984). See also Paul Goldstein, Derivative

Rights and Derivative Works in Copyright, 30 J. Copyright Soc’y

U.S.A. 209, 231 n.75 (1983) (“the Act does not require that the

derivative work be protectable for its preparation to infringe”). Cf.

Kalem Co. v. Harper Bros., 222 U.S. 55, 61(1911) (finding the

movie “Ben Hur” infringed copyright in the book Ben Hur even

though Copyright Act did not yet include movies as protectable

works). A derivative work must be fixed to be protected under the

Act, see 17 U.S.C. § 102(a), but not to infringe.

The argument that a derivative work must be fixed because

“la] ‘derivative work’ is a work,” 17 U.S.C. § 101, and “[a]

work is ‘created’ when it is fixed in a copy or phonorecord for the

first time,” id., relies on a misapplication of the Copyright Act’s

definition of “created”:

A work is created’ when it is fixed in a copy or

phonorecord for the first time; where a work is prepared

over a period of time, the portion of it that has been

A-25

fixed at any particular time constitutes the work as of

that time, and where the work has been prepared in

different versions, each version constitutes a separate

work.

Id. The definition clarifies the time at which a work is created. If

the provision were a definition of “work,” it would not use that

term in such a casual manner. The Act does not contain a

definition of “work.” Rather, it contains specific definitions:

“audiovisual works,” “literary works,” and “pictorial, graphic and

sculptural works,” for example. The definition of “derivative

work” does not require fixation.

The district court’s finding that no independent work is

created, see Galoob, 780 F. Supp. at 1291, is supported by the

record. The Game Genie merely enhances the audiovisual displays

(or underlying data bytes) that originate in Nintendo game

cartridges. The altered displays do not incorporate a portion of a

copyrighted work in some concrete or permanent form. Nintendo

argues that the Game Genie’s displays are as fixed in the hardware

and software used to create them as Nintendo’s original displays.

Nintendo’s argument ignores the fact that the Game Genie cannot

produce an audiovisual display; the underlving display must be

produced by a Nintendo Entertainment System and game cartridge.

Even if we were to rely on the Copyright Act’s definition of

“fixed,” we would similarly conclude that the resulting display is

not “embodied,” see 17 U.S.C § 101, in the Game Genie. It

cannot be a derivative work.

Mirage Editions is illustrative. Albuquerque A.R.T.

transferred artworks from a commemorative book to individual

ceramic tiles. See Mirage Editions, 856 F.2d at 1342. We held

that “[b]y borrowing and mounting the preexisting, copyrighted

individual art images without the consent of the copyright

A-26

proprietors... [Albuquerque A.R.T.] has prepared a derivative

work and infringed the subject copyrights.” Jd. at 1343. The

ceramic tiles physically incorporated the copyrighted works in a

form that could be sold. Perhaps more importantly, sales of the

tiles supplanted purchasers’ demand for the underlying works. Our

holding in Mirage Editions would have been much different if

Albuquerque A.R.T. had distributed lenses that merely enabled

users to view several artworks simultaneously.

Nintendo asserted at oral argument that the existence of a

$150 million market for the Game Genie indicates that its

audiovisual display must be fixed. We understand Nintendo’s

argument; consumers clearly would not purchase the Game Genie

if its display was not “sufficiently permanent or stable to permit

it to be perceived. . . for a period of more than transitory

duration.” 17 U.S.C. § 101. But, Nintendo’s reliance on the

argument also proves too much; the existence of a market does

not, and cannot, determine conclusively whether a work is an

infringing derivative work. For example, although there is a

market for kaleidoscopes, it does not necessarily follow that

kaleidoscopes create unlawful derivative works when pointed at

protected artwork. The same can be said of countless other

products that enhance, but do not replace, copyrighted works.

Nintendo also argues that our analysis should focus

exclusively on the audiovisual displays created by the Game

Genie, i.e., that we should compare the altered displays to

Nintendo’s original displays. Nintendo emphasizes that

“*[aJudiovisual works’ are works that consist of a series of related

images . . . regardless of the nature of the material objects . . .

in which the works are embodied.” 17 U.S.C. § 101 (emphasis

added). The Copyright Act’s definition of “audiovisual works” is

inapposite; the only question before us is whether the audiovisual

A-27

displays created by the Game Genie are “derivative works.” The

Act does not similarly provide that a work can be a derivative

work regardless of the nature of the material objects in which the

work is embodied. A derivative work must incorporate a protected

work in some concrete or permanent form. We cannot ignore the

actual source of the Game Genie’s display.

Nintendo relies heavily on Midway Mfg. Co. v. Artic Int'l,

Inc. , 704 F.2d 1009 (7th Cir.), cert. denied, 464 U.S. 823 (1983).

Midway can be distinguished. The defendant in Midway, Artic

International, marketed a computer chip that could be inserted in

Galaxian video games to speed up the rate of play. The Seventh

Circuit held that the speeded-up version of Galaxian was a

derivative work. Jd. at 1013-14. Artic’s chip substantially copied

and replaced the chip that was originally distributed by Midway.

Purchasers of Artic’s chip also benefited economically by offering

the altered game for use by the general public. The Game Genie

does not physicaliy incorporate a portion of a copyrighted work,

nor does it supplant demand for a component of that work. The

court in Midway acknowledged that the Copyright Act’s definition

of “derivative work” “must be stretched to accommodate speeded-

up video games.” /d. at 1014. Stretching that definition further

would chill innovation and fail to protect “society’s competing

interest in the free flow of ideas, information, and commerce.”

Sony Corp. of America v. Universal Studios, Inc., 464 U.S. 417,

429 (1984).

In holding that the audiovisual displays created by the Game

Genie are not derivative works, we recognize that technology often

advances by improvement rather than replacement. See Christian

H. Nadan, Note, A Proposal to Recognize Component Works: How

a Teddy Bears on the Competing Ends of Copyright Law, 78 Cal.

L. Rev. 1633, 1635 (1990). Some time ago, for example,

computer companies began marketing spell-checkers that operate

A-28

within existing word processors by signalling the writer when a

word is misspelled. These applications, as well as countless others,

could not be produced and marketed if courts were to conclude

that the word processor and spell-checker combination is a

derivative work based on the word processor alone. The Game

Genie is useless by itself. It can only enhance, and cannot

duplicate or recast, a Nintendo game’s output. It does not contain

or produce a Nintendo game’s output in some concrete or

permanent form, nor does it supplant demand for Nintendo game

cartridges. Such innovations rarely will constitute infringing

derivative works under the Copyright Act. See generally Nadan,

supra, at 1667-72.

2. Fair use

“The doctrine of fair use allows a holder of the privilege to

use copyrighted material in a reasonable manner without the

consent of the copyright owner.” Narell v. Freeman, 872 F.2d

907, 913 (9th Cir. 1989) (citations omitted). The district court

concluded that, even if the audiovisual displays created by the

Game Genie are derivative works, Galoob is not liable under 17

U.S.C. § 107 because the displays are a fair use of Nintendo’s

copyrighted displays. “whether a use of copyrighted material is a

‘fair use’ is a mixed question of law and fact. If the district court

found sufficient facts to evaluate each of the statutory factors, the

appellate court may decide whether defendants may claim the fair

use defense as a matter of law.” Abend v. MCA, Inc., 863 F.2d

1465, 1468 (9th Cir. 1988), aff'd sub nom. Stewart v. Abend, 495

U.S. 207 (1990).

Section 107 codifies the fair use defense:

A-29

In determining whether the use made of a work in any

particular case is a fair use the factors to be considered

shall include -

(1) the purpose and character of the use, including

whether such use is of a commercial nature or is for

nonprofit educational purposes;

(2) the nature of the copyrightec. work;

(3) the amount and substantiality of the portion used

in relation to the copyrighted work as a whole;

(4) the effect of the use upon the potential market

for or value of the copyrighted work.

The factors are nonexclusive, see Fisher v. Dees, 794 F.2d 432,

435 (9th Cir. 1986), and section 107 does not indicate how much

weight should be ascribed to each.

Much of the parties’ dispute regarding the fair use defense

concerns the proper focus of the court’s inquiry: (1) Galoob or (2)

consumers who purchase and use the Game Genie. Nintendo’s

compiaint does not allege direct infringement, nor did it try the

case on that theory. The complaint, for example, alleges only that

“Galoob’s marketing advertising [sic], promoting and selling of

Game Genie has and will contribute to the creation of infringing

derivatives of Nintendo’s copyrighted . . . games.” (emphasis

added). Contributory infringement is a form of third party

liability. See Melville B. Nimmer & David Nimmer, 3 Nimmer on

properly focused on whether consumers who purchase and use the

Game Genie would be infringing Nintendo’s copyrights by

creating (what are now assumed to be) derivative works.

Nintendo emphasizes that the district court ultimately

addressed its direct infringement by authorization argument. The

A-30

court concluded that, “(bjecause the Game Genie Joes not create

a derivative work when used in conjunction with a copyrighted

video game, Galoob does not ’authorize the use of a copyrighted

work without the actual authority from the copyright owner.’”

Galoob, 780 F. Supp. at 1298 (quoting Sony, 464 U.S. at 435

n.17). Although infringement by authorization is a form of direct

infringement, this does not change the proper focus of our inquiry;

a party cannot authorize «nother party to infringe a copyright

unless the authorized conduct would itself be unlawful.

Nintendo disputes this conclusion. According to Nintendo, a

party can unlawfully authorize another party to use a copyrighted

work even if that party’s use of the work would not violate the

U.S. at 449, for example, the Court considered whether consumers

were using the Betamax for a commercial or noncommercial

purpose even though Sony itself obviously was acting in its own

commercial self-interest. Professor Nimmer similarly concludes

that, “to the extent that an activity does not violate one of those

five enumerated rights [see 17 U.S.C. § 106], authorizing such

activity does not constitute copyright infringement.” 3 Nimmer on

The district court concluded that “a family’s use of a Game

Genie for private home enjoyment must be characterized as a non-

commercial, nonprofit activity.” Galoob, 780 F. Supp. at 1293.

Nintendo argues that Game Genie users are supplanting its

commercially valuable right to make and sell derivative works.

Nintendo’s reliance on Harper & Row Publishers, Inc. v. Nation

Enters., 471 U.S. 539, 562 (1985), is misplaced. The

commercially valuable right at issue in Harper & Row was the

right of first publication; Nation Enterprises intended to publish

the copyrighted materials for profit. See id. at 562-63. See also

Sony, 464 U.S. at 449 (“If the Betamax were used to make copies

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for a commercial or profit-making purpose, such use would

presumptively be unfair.”). Game Genie users are engaged in a

non-profit activity. Their use of the Game Genie to create

derivative works therefore is presumptively fair. See Sony, 464

U.S. at 449.

The district court also concluded that “[tJhe [Nintendo]

works’ published nature supports the fairness of the use.” Galoob,

780 F. Supp. at 1293. Nintendo argues that it has not published

the derivative works created by the Game Genie. This argument

ignores the plain language of section 107: “the factors to be

considered shall include . . . the nature of the copyrighted work.”

The argument also would make the fair use defense unavailable in

all cases of derivative works, including “criticism, comment, news

reporting, teaching . . . , scholarship, or research.” 17 U.S.C. §

107. A commentary that incorporated large portions of For Whom

the Bell Tolls for example, would be undeserving of fair use

protection because the incorporated portions would constitute an

unpublished derivative work. This cannot be the law.

The district court further concluded that the amount of the

portion used in relation to the copyrighted work as a whole

“cannot assist Nintendo in overcoming the presumption of fair

use.” Galoob, 780 E Supp. at 1293. The video tape recorders at

issue in Sony allowed consumers to tape copyrighted works in

their entirety. The Supreme Court nevertheless held that, “when

one considers . . . that [video tape recording] merely enables a

viewer to see such a work which he had been invited to witness in

its entirety free of charge, the fact that the emire work is

reproduced does not have its ordinary effect of militating against

a finding of fair use.” 464 U.S. at 449-50 (citations omitted).

Consumezs are not invited to witness Nintendo’s audiovisual

displays free of charge, but, once they have paid to do so, the fact

that the derivative works created by the Game Genie are

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comprised almost entirely of Nintendo’s copyrighted displays does

not militate against a finding of fair use.

Nintundo would distinguish Sony because it involved copying

copyrighted works rather than creating derivative works based on

those works. In other words, the consumers in Sony could lawfully

copy the copyrighted works because they were invited to view

those works free of charge. Game Genie users, in contrast, are not

invited to view derivative works based on Nintendo’s copyrighted

works without first paying for that privilege. Sony cannot be read

so narrowly. It is difficult to imagine that the Court would have

reached a different conclusion if Betamax purchasers were

skipping portions of copyrighted works or viewing denouements

before climaxes. Sony recognizes that a party who distributes a

copyrighted work cannot dictate how that work is to be enjoyed.

Consumers may use a Betamax to view copyrighted works at a

more convenient time. They similarly may use a Game Genie to

enhance a Nintendo Game cartridge’s audiovisual display in such

a way as to make the experience more enjoyable.

“The fourth factor is the "most important, and indeed, central

fair use factor.’” Stewart, 495 U.S. at 238 (quoting 3 Nimmer on

“Nintendo has failed to show any harm to the present market for

its copyrighted games and has failed to establish the reasonable

likelihood of a potential market for slightly altered versions of the

games at suit.” Galoob, 780 F. Supp. at 1295. Nintendo’s main

argument on appeal is that the test for market harm encompasses

the potential market for derivative works. Because the Game Genw

is used for a noncommercial purpose, the likelihood of future

harm may not be presumed. See Sony, 464 U.S. at 451. Nintendo

must show “by a preponderance of the evidence that some

meaningful likelihood of future harm exists.” Id. (emphasis

supplied).

A-33

Nintendo’s argument is supported by case law. Although the

upon the potential market for or value of the copyrighted work,”

17 U.S.C. § 107(4) (emphasis added), we held in Abend that

“[a]lthough the motion picture will have no adverse effect on

bookstore sales of the [underlying] novel - and may in fact have

a beneficial effect - it is ’clear that [the film’s producer] may not

invoke the defense of fair use.’” 863 F.2d at 1482 (quoting 3

Nimmer on Copyright § 13.05[B], at 13-84). We explained: “’If

the defendant’s work adversely affects the value of any of the

rights in the copyrighted work... the use is not fair even if the

rights thus affected have not as yet been exercised by the

plaintiff.’” Jd. (quoting 3 Nimmer on Copyright § 13.05[B], at 13-

84 to 13-85 (footnotes omitted)). The Supreme Court specifically

affirmed our finding that the motion picture adaptation “impinged

on the ability to market new versions of the story.” Stewart, 495

U.S. at 238.

Still, Nintendo’s argument is undermined by the facts.

The district court considered the potential market for derivative

works based on Nintendo game cartridges and found that: (1)

“Nintendo has not, to date, issued or considered issuing altered

versions of existing games,” Galoob, 780 F. Supp. at 1295, and

(2) Nintendo “has failed to show the reasonable likelihood of such

a market.” Jd. The record supports the court’s findings. According

to Stephen Beck, Galoob’s expert witness, junior or expert

versions of existing Nintendo games would enjoy very little market

interest because the original version of each game already has been

designed to appeal to the largest number of consumers Mr. Beck

also testified that a new game must include new material or “the

game player is going to feel very cheated and robbed, and [the]

product will have a bad reputation and word of mouth will

probably kill its sales.” Howard Lincoln, Senior Vice President of

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Nintendo of America, acknowledged that Nintendo has no present

plans to market such games.

The district court also noted that Nintendo’s assertion that it

may wish to re-release altered versions of its game cartridges is

contradicted by its position in various other lawsuits:

In those actions, Nintendo opposes antitrust claims by

using the vagaries of the video game industry to rebut

the impact and permanence of its market control, if any.

Having indoctrinated this Court as to the fast pace and

instability of the video game industry, Nintendo may not

now, without any data, redefine that market in its

request for the extraordinary remedy sought herein. . .

While board games may never die, good video games

are mortal.

Galoob, 780 F. Supp. at 1295. The existence of this potential

market cannot be presumed. See Sony, 464 U.S. at 451. See also

Wright v. Warner Books, Inc., 953 F.2d 731, 739 (2d Cir. 1991)

(affirming district court’s finding of no reasonable likelihood of

injury to alleged market because “[p]laintiff has offered no

evidence that the project wil! go forward”). The fourth and most

important fair use factor also favors Galoob.

Nintendo’s most persuasive argument is that the creative

nature of its audiovisual displays weighs against a finding of fair

use. The Supreme Court has acknowledged that “fair use is more

likely to be found in factual works than fictional works. Stewart,

495 U.S. at 237. This consideration weighs against a finding of

fair use, but it is not dispositive. See Sony, 464 U.S. at 448 (fair

use defense is an “equitable rule of reason”). The district court

could properly conclude that Game Genie users are making a fair

use of Nintendo’s displays.

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3. Temporary and permanent injunction

Galoob has not violated the Copyright Act. Nintendo

therefore is not entitled to a temporary or permanent injunction.

AFFIRMED.

RYMER, Circuit Judge, concurring in the judgment:

I concur in the judgment for reasons stated by the district

court, Lewis Galoob Toys, Inc. v. Nintendo of America, Inc. , 780

F. Supp. 1283 (N.D.Cal.1991).

A-36

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

No.

LEwis GALOoB Toys, INC., C-90-1440 FMS

No.

Plaintiff (s), | | C-90-1586 FMS

VS.

NINTENDO OF AMERICA, INC.,

Defendant (s)."|_ MEMORANDUM

OF DECISION

AND RELATED AND

CONSOLIDATED ACTIONS (Filed

JULY 12 1991)

PEGS FRY IG TESTE AED IG BH RINNE LEN OM OE OS

INTRODUCTION

These two consolidated suits test the scope of copyright

protection for audio-visual games (video games). Nintendo of

America, Inc. (“Nintendo”) markets and sells home video games

harawa-e systems and compatible video game cartridges. The

audio-visual portions of the game cartridges in suit are protected

by registered copyrights held by Nintendo.

Lewis Galoob Toys, Inc. (“Galoob”) markets and sells toy

products. Galoob has a license to market a video game accessory

known as the Game Genie Video Game Enhancer (“Game

Genie”), which attaches to a video game cartridge and allows the

player to temporarily alter certain attributes of the video game. It

is sold for personal consumer use only, not for video game

arcades. The Game Genie does not create a separate copy of the

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original video game, does not make permanent changes to the

original game work, and can only be used when attached to the

original game.

Nintendo contends that the Game Genie creates a derivative

work as defined in 17 U.S.C. § 101, and that Galoob is therefore

either a direct c. contributory infringer of Nintendo’s copyrights

in the original video games in suit.

For the reasons set forth below, the Court finds to the

contrary and vacates the pending preliminary injunction forthwith.

SUMMARY OF RULINGS

This case has included one and one-half years of litigation, a

two-week trial, and extensive briefing of all issues, both pre- and

post-trial. After careful consideration of the evidence and briefing

submitted by both sides, and for the reasons set forth below, this

Court rules as follows:

1) Use of the Game Genie by consumers to temporarily alter

copyrighted video games for their own enjoyment does not create

a derivative work under 17 U.S.C. § 101. Because the consumers

are not direct infringers, Galoob is not a contributory infringer.

2) In the alternative, even if the Game Genie did create a

derivative product, the doctrine of “fair use” enables consumers

to use the Game Genie for their personal enjoyment, 17 U.S.C. §

107, and therefore allows Galoob to sell it.

3) Galoob’s use of copyrighted video games for purposes of

testing or marketing the Game Genie does not violate any of

Nintendo’s rights under the Copyright Act.

AP GORDO LISE LY SINS DIMEN SDS IPE ELST IES ORNS PE ELL A EIEN D INGEN

Sern

an ae

AML eT A HASEENO NTL 5 EIA REE NAN LINE AUG BIOS RY RMB IDI ae

A-38

4) On this record, injunctive relief is not appropriate for

either side.

PROCEDURAL BACKGROUND

On May 17, 1990, Galoob filed « complaint for declaratory

relief against Nintendo, seeking a declaratory judgment that the

Game Genie does not violate or contribute to the violation of any

of Nintendo’s video game copyrights. Galoob also sought an

injunction prohibiting Nintendo from interfering with the

marketing of the Game Genie, and permanently enjoining

Nintendo from modifying the Nintendo Entertainment System

(“NES”) in order to make it incompatible with the Game Genie.

Nintendo responded by filing its own complaint for an

injunction prohibiting Galoob from all facets of marketing the

Game Genie, on the grounds that it contributorily infringed

Nintendo’s registered copyrights in various video games. Nintendo

also claimed violation of the trademark laws.

On July 2, 1990, this Court (per Schnacke, J.) issued a

preliminary injunction in favor of Nintendo; the injunction was

affirmed by the United States Court of Appeals for the Ninth

Circuit on February 27, 1991.

Both actions were transferred on July 6, 1990 to the

undersigned, who consolidated them and held a bench trial on the

sole issue of whether or not the Game Genie infringes any of

Nintendo’s copyrights. Nintendo claims that Galoob has wilfully

and deliberately infringed, both directly and contributorily,

Nintendo’s copyrights in its audio-visual game cartridges. Galoob

seeks a declaration that use of the Game Genie by individuals in

their own homes does not constitute infringement of Nintendo’s

copyrights, and that Galoob’s marketing, distribution, and sale of

A-39

the Game Genie is therefore not contributory infringement of those

copyrights. In addition, Galoob seeks a declaration that its own

use of the Game Genie for testing and marketing purposes does

not constitute direct infringement.

PARTIES

Galoob is a corporation organized and existing under the laws

of Delaware, with its principal place of business in South San

Francisco, California. Nintendo is a Washington state corporation,

with its principal place of business at Redmond, Washington, and

is a wholly owned subsidiary of Nintendo Company, Ltd., of

Japan. Galoob and Nintendo are the only two parties to these

consolidated actions. No individual consumers of the Game Genie

have been named as defendants, although it is their use of the

Game Genie that allegedly constitutes the primary infringing

activity.

JURISDICTION AND VENUE

This civil action arises under the Copyright Act, as amended

17 U.S.C. § 101 et seq.; the Lanham Act, 15 U.S.C. § 1051 et

seq.; and California law. This Court has subject matter jurisdiction

pursuant to 17 U.S.C. § 501; 15 U.S.C. § 112i; and 28 U.S.C.

§ 1331, 1332, and 1338.

Venue is proper in this district pursuant to 28 U.S.C. § 1391

and 1400(a).

A-40

FINDINGS OF FACT AND CONCLUSIONS OF LAW

I. PRODUCTS

This suit involves the interplay of three products, the

Nintendo Entertainment System, Nintendo copyrighted video

games and the Game Genie.

A. The Nintendo Entertainment System

Nintendo markets and sells video game hardware systems.

The system is known as the Nintendo Entertainment System

(“NES”) and is designed for playing video games in the home.

Nintendo has sold in excess of 25,000,000 of these systems in the

United States. Nintendo also markets and sells video game

cartridges, and licenses third parties to market and sell video

games which are compatible with Nintendo’s hardware. The video

games are displayed on a home television.

The NES includes a microprocessor-based console, the

“control deck,” which houses two processing units: the central

processing unit (“CPU”), which controls the overall operation of

the system, and the picture processing unit (“PPU”), which

generates the pictures for display on the television. The control

deck is connected to the television.

B. Video Games

The video games which may be played on the NES control

deck are both audio-visual works and computer programs. The

audio-visual works and game programs are permanently stored on

ROMs (i.e., Read Only Memory chips) contained in game

cartridges.

A-41

Nintendo owns valid and subsisting registered copyrights in

the audio-visual programs contained in many of its video games,

including those in suit.

Each game typically has a theme and a goal. For example, a

game might consist of the main character’s attempt to obtain a

certain level of points before he is defeated by hostile forces.’ In

an attempt to reach that point goal, he has a certain number of

chances (“lives”) in which to [sic] must overcome obstacles, battle

adversaries, and travel through various levels (“worlds”). Each

time he overcomes an obstacle or reaches a new world, additional

points are added to the score. On the other hand, each time he is

defeated by a villain and/or obstacle, he loses a chance or life. If

he loses all of his lives before obtaining a certain number of

points, the game ends, and he must start again.

More than 500 different video games have been produced and

offered for sale for use with the NES Control Deck. In addition to

those owned and copyrighted directly by Nintendo, hundreds of

games have been produced by some 71 other companies. Sixty-

three of the non-Nintendo producers of video games have licenses

from Nintendo, and an additional eight do not.

Players can buy various devices (“interactive devices”) which

connect to the NES control deck and allow the player to influence

various aspects of the game being played. Changes include

speeding up certain aspects of the game, skipping one or more

levels of play, etc. Interactive devices which may be used with the

NES control deck include devices marketed as the “Control Pad,”

“NES Advantage,” “Power Glove,” “NES Max,” and “Turbo

Blaster.” Light guns may also be used by players for playing

male.

For reasons that remain obscure, the protagonists are generally

A-42

certain games. Nintendo markets and sells, or licenses others to

sell, such interactive devices for use with the NES control deck.

The NES video game cartridges contain two separate

memories: one memory (the “program memory”) is connected to

the CPU when the game cartridge is physically inserted into the

control deck; the other memory (the “character memory”) is

connected to the PPU when the game cartridge is physically

inserted into the control deck.

In order to play an NES video game, the player inserts a

game cartridge into the control deck. The player begins game play

and interacts with the video game by manipulating buttons on the

standard controller, which is sold with the NES and which attaches

to the control deck.

The game’s action is performed on the television screen.

Players use the controller (which contains a four-way control pad,

for directional control, and four other buttons labeled “start,”

“select,” “A” and “B”) to guide the actions of “their” character

in an attempt to reach the game’s goal, as described earlier.

The copyrights allegedly infringed in this suit are for the

audio-visual portion of the video game cartridges manufactured by

Nintendo. The games are only compatible for play on the NES;

they have a retail list price of approximately $40 to $50 each.

C. The Game Genie

Galoob is in the business of marketing and selling toy

products in the United States. Galoob obtained a license to market

the Game Genie from Codemasters Software Co., Ltd., a United

Kingdom corporation, and Camerica, Ltd., a Canadian

corporation. The Game Genie, the accused product, allows players

A-43

to alter certain attributes of video games, in ways similar to the

interactive devices and published codes described supra at 7-8 and

infra at 35.

The Game Genie can function in combination with any NES-

compatible game cartridge. Six licensed producers of copyrighted

Nintendo-compatible games, as well as Nintendo itself, are known

to object to the use of the Game Genie with their copyrighted

games. It is not known whether the nontestifying Nintendo-

licensees or the eight nonlicensed producers of NES-compatible

games object or consent to the use of the Game Genie with their

copyrighted games, nor is it known how many of the games of

Nintendo licensees or nonlicensee producers have registered

copyrights.

At this time, the Game Genie is configured both electronically

and physically to plug into NES control decks and NES-compatible

video game cartridges only; it has no other use.

The Game Genie is designed to fit between the NES control

deck and NES-compatible video game cartridges. When a Game

Genie is used (i.e., when a game cartridge has been attached to a

Game Genie and the Game Genie is then inserted into a control

deck), it has two modes of operation: a programming or “set-up”

mode, and a game play mode.

If une game cartridge is detached from the Game Genie during

operation, all audio-visual displays of the game cease. Likewise,

if a game cartridge inserted into a control deck without the Game

Genie is removed from the control deck, all game audio-visual

displays cease. The Game Genie cannot be used unless it is

physically attached to a video game cartridge and then inserted

into an NES control deck.

A-44

During the Game Genie’s set-up mode, a display appears on

the television screen and the player is presented With the choice of

entering from one to three codes into the Game Genie. Each code

can be six to eight letters in length, and each letter may be chosen

from among sixteen available letters of the alphabet. Although

there are billions of possible codes, a maximum of three codes can

be entered for any single play of a game. When code selection is

complete, the player presses the “select” button on the controller,

the set-up mode screens display disappears, and the Game Genie

shifts into its “game play mode.” In this mode, the game begins,

and the player plays the game with the alterations allowed by the

Game Genie codes the player has entered. If no code has been

entered, the Game Genie has no influence on game play, and the

game plays exactly as it would if no Game Genie were attached.”

If the game player inputs one, two, or three codes into the

Game Genie, each entered code causes the CPU to receive

different data than it would if the Game Genie were not attached

and activated by the game player.

* The Game Genie interprets each of the codes a player selects to

refer to a particular "address" in the game cartridge program ROM and

the data that are stored there. As the game proceeds, the CPU inquiries

that are directed to the game cartridge’s program ROM pass through the

Game Genie. If an inquiry is directed to an address that matches one of

the codes the player has selected, the Game Genie substitutes the data it

has stored for the data that the game cartridge would otherwise transmit

to the CPU. (For example, assume the CPU asks for the initial number

of lives and the game cartridge has the number "three" at the address

corresponding to initial "lives." If the player has selected a code for six

lives, the Game Genie would substitute data signifying six lives and send

that data to the CPU.)

Each Game Genie code can substitute only a single byte of data

at a single address. Thus, of the million or so inquiries per second that

the CPU directs to the game cartridge, the Game Genie can interrupt and

change relatively few.

A-45

Galoob has prepared a booklet intended to be distributed with

the Game Genie entitled “Programming Manual and Code Book”

(“Code Book”). The Game Genie Code Book instructions

expressly encourage players to alter listed codes and to create

various effects by programming their own codes. The effects of all

codes, whether devised by Galoob or by the players themselves,

are temporary in nature, and will last only until the player unplugs

the game or resets in order to start a new game.

There are approximately 1,660 listed codes in the Game

Genie code book, allowing various categories of temporary

changes to be created with the use of the Game Genie. Some

permit the player to choose where to begin the game, i.e. at a

higher level of the game rather than at the beginning. Other codes

allow the player to increase or decrease the number of chances the

player has to complete the game or the amount of time in which

those chances can be exercised. Others allow a player to advance

more quickly through the game by skipping certain obstacles.’

The Game Genie cannot be used to play or do anything unless

a separate game cartridge is also used. It can neither substitute for

an NES game cartridge, nor can it reproduce or copy an

independent version of the game. The effects of the Game Genie

last only for the temporal period in which a particular sequence of

play continues. Its effects vanish as the player ends a sequence of

play by disconnecting the power to the game or by resetting and

starting over. The Game Genie codes cannot change the plot,

theme, or characters of any game. The vast majority of the Game

Genie codes alter the rules of the game or method of play. See

infra at 18-19.

> Such effects are paralleled by Nintendo's hardware, pass-words, and

"secrets," discussed infra at 35.

A-46

The Game Genie is marketed for use by consumers as an

accessory to their home video system. It is not intended to be used

in connection with any public performance of a video game, e.g.

in an arcade setting. Cf Midway Mfg. Co. v. Artic Int’l. Inc. , 704

F.2d 1009 (7th Cir. 1983), cert. denied, 464 U.S. 823 (1983). No

evidence was presented of any such actual or potential public

performance.

Il. SCOPE OF COPYRIGHT PROTECTION

Article I, Section 8, of the Constitution provides: “The

Congress shall have Power . . . To promote the Progress of

Science and useful Arts by securing for limited Times to Authors

and Investors the exclusive Right to their respective Writings and

Discoveries.” As new technological developments have occurred,

Congress has responded by fashioning new rules of copyright.

a general reluctance to expand those protections, absent explicit

legislative guidance. See, e.g., Teleprompter Corp. v. Columbia

Broadcasting System, Inc., 415 U.S. 394, 414 (1974). While there

are sound historical and policy reasons for this consistent

deference to Congress, Congress cannot immediately respond to

each invention that hits the market. The courts must therefore use

their best judgment to construe the meaning of certain words

consistent with Congressional intent. Sony Corp. v. Universal City

Studios, Inc., 464 U.S. 417, 456 (1984).

complete control over all possible uses of the protected work. As

stated in Sony, 464 U.S. at 429:

The monopoly privileges that Congress may authorize

are neither unlimited nor primarily designed to provide

A-47

a special private benefit. Rather, the limited grant is a

means by which an important public purpose may be

achieved. It is intended to motivate the creative activity

of authors and inventors by the provision of a special

reward, and to allow the public access to the products of

their genius after the limited period of exclusive control

has expired.

Congress appears to have made reward to Nintendo a

consideration of the copyright law, but not the only one.

A. Derivative works

The Copyright Act gives the holder exclusive rights to use

and authorize the use of the work in five qualified ways, including

the preparation of derivative works based upon the copyrighted

work. 17 U.S.C. § 106(2). Nintendo alleges that the Game Genie

is a derivative work. This Court does not agree.

Section 101 of the 1976 Copyright Act defines a derivative

work as “a work based upon one or more preexisting works such

as a translation, musical arrangement, dramatization,

fictionalization, motion picture version, sound recording, art

reproduction, abridgement, condensation, or amy other form in

which a work may be recast, transformed, or adapted” (emphasis

added).

Nintendo relies heavily on Midway Mfg. Co. v. Artic Int’l.,

Inc., 704 F.2d 1009 (7th Cir. 1983), cert. denied, 464 U.S. 823

(1983) in claiming that the Game Genie is a derivative work. That

reliance is misplaced. As Midway noted, “It is not obvious from

[the language of section 101] whether a speeded up video game is

a derivative work.” Jd. at 1014. If it was doubtful as to whether

or not the product in that case was a derivative work, the

uncertainty is far greater regarding the Game Genie. In Midway,

ee oe ee aon ee a re

A-48

the allegedly infringing product was a printed circuit board which

could be used to speed up the rate of play - how fast the sounds

and images changed - of one of plaintiff's video games

(“Galaxian”), licensed for use in a play-for-pay arcade setting.

Under those circumstances, the Seventh Circuit found that

speeding up that specific game increased the licensee’s revenue by

making the game more challenging and decreasing the time it took

to complete a game, i.e., more games could be played in a given

time period, generating more income for the licensee.

Acknowledging that the copyright owners of that video game

would be anxious to obtain that extra revenue, the court found that

commercial licensees were not implicitly authorized to use the

speeded up circuit boards; therefore, the suppliers of those circuit

boards contributorily infringed because the speeded version of the

game was a derivative work. 704 F.2d at 1014.

Based on those facts, Midway held that the “amount by which

the language of section 101 must be stretched to accommodate

speeded up video games is . . . within the limits with which

Congress wanted the new act to operate.” /d., (emphasis added).

The result appeared to be based on the equities of that situation.

Under those facts, the court was willing to “stretch” the acceptable

definition of a derivaiive work. Midway’s result, if not its analysis,

appears to have turned on the fact that the licensee arcade owner,

not the copyright holder, was making money from the public

performance of the altered game, a violation of section 106(4)

(copyright holder has exclusive right “to perform the copyrighted

work publicly”).*

The alleged infringer in this case is not a commercial

licensee, but rather a consumer utilizing the Game Genie for

* This Court expresses no view as to whether commercial arcade use

of the Game Genie would be an unauthorized showing under section 106.

A-49

noncommercial, private enjoyment. Such use neither generates a

fixed transferable copy of the work, nor exhibits or performs the

work for commercial gain. See §§102, 106(4).

Whether or not video games modified by the Game Genie

constitute derivative works is a difficult question. Viewing the

behind tha. Act, this Court concludes that inherent in the concept

of a “derivative work” is the ability for that work to exist on its

own, fixed and transferable from the original work, i.e., having

a separate “form”. See § 101 (derivative work definition). The

Game Genie does not meet that definition.

As explained supra, a Game Genie allows a player to choose

one to three modifications in the rules of a game, during a limited

sequence of play. Once the Game Genie and its attached game

cartridge are disconnected from the NES, or the power is turned

off, those changes disappear and the video game reverts to its

original form. No independent, fixed work is created.

In construing the phrase “derivative work” in light of

technological change which has rendered its literal meaning

ambiguous, the Court looks to the “basic purpose” of the

labor against the need for “broad public availability of literature,

music, and the other arts.” Twentieth Century Music Corp. v.

Aiken, 422 U.S. 151, 156 (1975). The Game Genie is a tool by

which the consumer may temporarily modify the way in which to

play a video game, legally obtained at market price. Any

modification is for the consumer’s own enjoyment in the privacy

of the home. Such a process is analogous in purpose, if not in

technology, to skipping portions of a book, learning to speed read,

fast-forwarding a video tape one has purchased in order to skip

portions one chooses not to see, or using slow motion for the

A-50

opposite reasons. None of those practices permanently modifies or

alters the original work, none produces a separate work which can

then be transferred in any way, none replaces the original work,

and none deprives the copyright holder of current or expected

revenue.

Both parties agree that it is acceptable, under the copyright

laws, for a noncopyright holder to publish a book of instructions

on how to modify the rules and/or method of play of a

copyrighted game. Once having purchased, for example, a

copyrighted board game, a consumer is free to take the board

home and modify the game in any way the consumer chooses,

whether or not the method used comports with the copyright

holder’s intent. The copyright holder, having received expected

value, has no further control over the consumer’s private

enjoyment of that game.

Because of the technology involved, owners of video games

are less able to experiment with or change the method of play,

absent an electronic accessory such as the Game Genie. This

Should not mean that holders of copyrighted video games are

entitled to broader protections or monopoly rights than holders of

other types of copyrighted games, simply because a more

sophisticated technology is involved. Having paid Nintendo a fair

return, the consumer may experiment with the product and create

new variations of play, for personal enjoyment, with-out creating

a derivative work. Cf. Midway, 704 F.2d at 1013-14 (arcade use

is a derivative work, because “[vJideo game copyright owners

would like to lay their hands on some of that extra revenue”).

For these reasons, this Court finds that the Game Genie does

not create a derivative work protected by the copyright laws.

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B. Fair use.

Had the Court found that the Game Genie was a derivative

work, Galoob would still be exempt from liability under the

doctrine of “fair use.” In making this finding, the Court has relied

extensively on Sony v. Universal, supra, as well as the trial court’s

opinion in that matter.

As the Supreme Court stated in Sony, “[aJny individual may

reproduce a copyrighted work for a ’fair use’; the copyright owner

does not possess the exclusive right to such a use.” 464 U.S. at

433. “The doctrine of fair use allows a holder of the privilege to

use copyrighted material in a reasonable manner without the

consent of the copyright owner.” Narell v. Freeman, 872 F.2d

907, 913 (9th Cir. 1989). Determination of fair use requires

analysis under an “equitable rule of reason.” Sony, at 464 U.S. at

448 (quoting H.R. Rep. No. 94-1467, reprinted in 1976 U.S.

Code Cong. & Admin. News at 5679}. “The copyright law, like

the patent statutes, makes reward to the owner a secondary

consideration.” Sony, 464 U.S. at 429 (quoting Fox Film Corp. v.

Doyal, 286 U.S. 123, 127 (1932)).

Sony - the only pronouncement by the Supreme Court on fair

use in the contributory infringement context - involved facts

analogous to those here. In Sony, holders of copyrights for certain

television programs sued the manufacturer of the Betamax video

tape recorder (video cassette recorder, or VCR) for contributory

infringement. Those copyright holders (like Nintendo) sought to

enjoin Sony (like Galoob) from manufacturing and selling an

electronic device, claiming that purchasers of that device were

using it to infringe copyrights. One use of the device was

recording unauthorized copies of copyrighted television programs

to “time shift” on-the-air broadcasts. The Supreme Court found

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the consumers’ use of Sony’s product for time shifting purposes

to be a “fair use” of the copyrighted programs.

Fair use is a privilege against a direct infringement claim (17

U.S.C. §107), and is a privilege held in the first instance by the

alleged direct infringer - i.e., by the person playing the video

game. Just as application of the fair use doctrine in Sony resulted

in substantial economic gain for Sony and other VCR

manufacturers, the fair use doctrine applied to this case will

benefit Galoob. Sony makes clear, however, that it is the fairness

of the family’s use of its video game, not some evaluation of the

commercial “fairness” of Galoob’s product, that must guide the

Court’s analysis.

In examining the fairness of the family’s use, the Court is

guided statutorily by 17 U.S.C. §107, through which Congress,

in 1976, codified the common law doctrine of fair use.’ Section

107 enumerates four non-exclusive “factors to be considered” in

assessing fair use; they are intended to guide but not to limit

analysis. H.R. Rep. No. 94-1476 at 5680: see also Harper & Row

Publishers, 471 U.S. at 539, 560 (1985) (four factors “not meant

to be exclusive”). In determining whether the use made of a work

in any particular case is a fair use, the factors to be considered

shall include:

(1) the purpose and character of the use, including whether

such use is of a commercial nature or is for nonprofit educational

purposes;

* That statute was merely "intended to restate the present judicial

doctrine of fair use, not to change, narrow or enlarge it in any way."

H.R. Rep. No. 94-1476, supra, at 5680. Congress had "no disposition

to freeze the doctrine in the statute, especially during a period of rapid

technological change." /d.

A-53

(2) the nature of the copyrighted work;

(3) the amount and substantiality of the portion used in

relation to the copyrighted work as a whole; and

(4) the effect of the use upon the potential market for or

value of the copyrighted work.

1. The First Factor: A Family’s “Non-Commercial”

Home Use Of Its Video Games Creates A Presumption

Of Fair Use.

The first factor is “the purpose and character off the use,

including whether such use is of a commercial nature or is for

nonprofit purposes.” 17 U.S.C. §107(1). If the consumer were

making a commercial or profit-making use of the copyrighted

work, that use would be presumptively unfair. Sony, 464 U.S. at

449. “The contrary presumption is appropriate here, however, ...

because time-shifting for private home use must be characterized

as a non-commercial, nonprofit activity.” Sony, 464 U.S. at 449.

Likewise, a family’s use of a Game Genie for private home

enjoyment must be characterized as a non-commercial, nonprofit

activity. The game owner is simply playing the game purchased

for personal enjoyment, not exploiting the game in some

commercial venture. The first factor therefore establishes a

presumption of fair use, which could be overcome only by

Nintendo’s direct proof of injury.°

* Although Nintendo emphasized the "productive use” doctrine, Sony

minimized the importance of that doctrine by reversing the Ninth

Circuit's conclusion that time-shifting “was not a fair use because it was

not a ‘productive use.’" Sony 464 U.S. at 427; see also Fisher,

Reconstructing The Fair Use Doctrine, 101 Harv. L. Rev. 1661, 1684

(1988) ("The most drematic change wrought by Sony and Harper & Row

in the fair use doctrine was the subordination of the idea of

productivity”).

A-54

The Midway decision does not analyze the commercial use of

such products vis-a-vis private home use. By contrast, this Court

finds a convincing and persuasive analogy in the trial court’s

analysis of legislative intent in Universal City Studios v. Sony

Corp. of America, 480 F. Supp. 429 (C.D. Cal. 1979). That

court, in discussing whether or not home recording of copyrighted

works violated the Copyright Act, quoted the following from the

House Report accompanying the 1971 Amendment:

“Specifically, it is not the intention of the Committee to

restrain the home recording, from broadcasts or from tapes or

records, of recorded performances, where the home recording is

for private use and with no purpose of reproducing or otherwise

capitalizing commercially on it.” H. Rep. No. 487, 92nd Cong.,

First Sess. 7, reprinted in 1971 U.S. Code Cong. & Admin. News

at 1566-1572.

Further citations to the Congressional Record acknowledged

a reluctance to interpret or enforce the Copyright Act by carrying

the-air recording. /d., at 445. While the Game Genie is a different

device than a video home recorder, it involves the same policy

decision, i.e., whether Congress wishes to Carry copyright

enforcement into the home.

2. The Second Factor: The Published “Nature” Of Video

Games Supports Fair Use.

The second factor considers “the nature of the copyrighted

work.” 17 U.S.C. §107(2). The courts have traditionally inquired

whether the work is published, with unpublished works gaining

more protection. 3 Nimmer §13.05[A][2], at 13-75 to 13-79. “The

fact that a work is unpublished is a critical element of its ’nature’”

Suggesting that pre-publication exploitation of the work would be

ei PRL i Tea ne age et

A-55

unfair. Harper & Row, 471 U.S. at 564 (unfair to scoop key

excerpts of unpublished manuscript without author’s consent). By

contrast, Nintendo has already published millions of copies of its

games to anyone willing to pay the purchase price. Only after

acquiring a published copy of the game may its owner use it in

combination with the Game Genie. The works’ published nature

supports the fairness of the use.

3. The Third Factor: Because Game Owners Have The

Right To Use The Games They Purchase, Their Use

Does Not Weigh Against Fair Use.

The third factor in the fair use analysis is the “amount and

substantiality of the portion used in relation to the copyrighted

work as a whole.” 17 U.S.C. §107(3). Again, the Sony decision

is dispositive. Sony recognized that the reproduction of an entire

work ordinarily weighs against the claim of fair use. 464 U.S. at

450. In Sony, however, because the VCR owner “had been invited

to witness [the television program] in its entirety free of charge,

the fact that the entire work is reproduced does not have its

ordinary effect of militating against a finding of fair use.” Jd. at

449. Likewise, in this action a game owner who has fairly

acquired a Nintendo game has a right to use the entire work. The

game owner’s rights are equal to, if not greater than, those of the

user in Sony, who did not pay for the product being used. Because

the game owner is entitled to use the entire work, no matter what

the “amount and substantiality” of his use, the third factor cannot

assist Nintendo in overcoming the presumption of fair use.

4. The Fourth Factor: Nintendo Has Not Proven Harm

The last and “undoubtedly the singie most important” factor

is the “effect of the use upon the potential market for or value of

the copyrighted work.” Harper & Row, 471 U.S. at 566; 17

U.S.C. §107(4). To defeat fair use under this factor “requires

A-56

proof either that the particular use is harmful, or that if it should

become widespread, it would adversely affect the potential market

for the ceryrighted work.” Sony, 464 U.S. at 451.

Nintendo bears the burden of proving that these particular

uses will have an adverse effect on the market for the copyrighted

Nintendo games. Sony, 464 U.S. at 451. It has not met that

burden, for the reasons explained below.

a. Nintendo Has Not Shown That The Game Genie

Supplants, Rather Than Suppresses, The Market

For The Copyrighted Works.

The fourth fair use factor looks primarily to whether a use

“supplants any part of the normal market for a copyrighted work.”

H.R. Rep. No. 83, 90th Congress, Ist Sess. 33, 35 (1967), as

quoted in Marcus v. Rowley, 695 F.2d 1171, 1177 (9th Cir.

1983). Nintendo cannot demonstrate that use of the Game Genie

“fulfills the demand for the originals of the copyrighted games at

issue. Fisher v. Dees, 794 F.2d 432, 438 (9th Cir. 1986)

(emphasis in original). Widespread use of the Game Genie cannot

supplant the market for the games in suit. The Game Genie cannot

operate without a game cartridge. Significantly, Nintendo does not

contend that families will buy fewer new games because they are

using their Game Genie with old ones. The Game Genie does not

compete for sales with the original copyrighted works for which

Nintendo claims infringement.

Nintendo’s claim is that the Game Genie will indirectly harm

its overall market because it will make people enjoy their games

less, and thereby generally reduce demand for Nintendo’s

copyrighted games. Nintendo had the burden of proof on that issue

and failed to meet it.

A-57

A fair use will frequently suppress demand for a work, but as

long as it does so without supplanting demand, the indirect

detrimental effect on the market is not the subject of copyright

protection. An obvious example is an unfavorable book or movie

review containing quotations from the copyrighted work, along

with criticism which may suppress demand. This capacity to injure

does not impede a finding of fair.use. See Fisher v. Dees, 794

F.2d at 438. Another example is a parody, which “may quite

legitimately aim at garroting the original, destroying it

commercially as well as artistically.” Jd. at 437. As the Ninth

Circuit holds, however, “the economic effect of [the use] with

which we are concerned is not its potential to destroy or diminish

the market for the original - any bad review can have that effect -

but rather whether it fulfills the demand for the original. Biting

criticism suppresses demand; copyright infringement usurps it.”

Id. at 438 (emphasis in original).

The Second Circuit applied this principle in Consumers Union

of U.S. Inc. v. General Signal Corp., 724 F.2d 1044 (2d Cir.

1983), cert. denied 469 U.S. 823 (1984). There, defendant’s

advertisements quoted the favorable rating of its product by

Consumer Reports, a copyrighted magazine. In an argument

reminiscent of Nintendo’s claim that it will lose “goodwill” as a

result of the Game Genie, Consumer Reports alleged that the value

of its magazine was diminished because its reputation for

independence would suffer as a result of being perceived as

endorsing defendant’s product. The Second Circuit rejected

plaintiff's argument in no uncertain terms:

The Copyright Act was not designed to prevent such

indirect negative effects of copying. The fourth factor is

aimed at the copier who attempts to usurp the demand

for the original work. The copyright laws are intended

to prevent copiers from taking the owner’s intellectual

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A-58

property, and are not aimed at recompensing damages

which may flow indirectly from copying.

724 F.2d at 1051 (citations omitted).

Nintendo argues that its market may be affected by

Suppression of demand rather than supplanting of it. That injury,

even if it were likely, does not defeat fair use.

b. Nintendo Has Not Shown Any Injury To The

Relevant Market For The Copyrighted Works.

Nintendo has likewise failed to prove an adverse effect on the

relevant market for the copyrighted works at issue. Most of

Nintendo’s original copyrighted works are no longer on the

market, including the vast majority for which the Galoob Code

Book lists codes. The Game Genie cannot affect sales of products

no longer available.’

Nintendo also seeks relief for harm that may occur in the

future, on the grounds that the Game Genie may decrease demand

for sequels or slightly altered versions of Nintendo games.

Nintendo has not, to date, issued or considered issuing altered

versions of existing games. Nintendo argues, however, that should

such a market develop within the copyright period, it is entitled to

decide if such games are appropriate and to reap the resulting

revenues. In theory, Nintendo is correct; however, it has failed to

show the reasonable likelihood of such a market. Nintendo’s video

games are expensive toys; each retails in the $40 to $50 range.

There is neither evidence nor reason to believe that a consumer

” Furthermore, even if the Game Genie published code books for up-

to-the-minute games, Nintendo has not shown that consumers would be

less likely to buy the games simply because code books for current games

were available.

re ee

A-59

who owns the original game would invest a similar amount in a

slight variation thereof.

In addition, Nintendo’s assertion that it may wish to re-release

altered versions of the games in suit 10, 20 or 30 years from now

(much as Parker Brothers recently did with “Monopoly”) is at

odds with the position taken by Nintendo in various other lawsuits

pending before this Court. In those actions, Nintendo opposes

antitrust claims by using the vagaries of the video game industry

to rebut the impact and permanence of its market control, if any.

Having indoctrinated this Court as to the fast pace and instability

of the video game industry, Nintendo may not now, without any

data, redefine that market in its request for the extraordinary

remedy sought herein. Nintendo has failed to show any harm to

the present market for its copyrighted games and has failed to

establish the reasonable likelihood of a potential market for

slightly altered versions of the games at suit. While good board

games may never die, good video games are mortal.

c. Nintendo Has Not Shown That Any Uses Of The

Game Genie Would Have A Deleterious Effect On

Sales.

The only empirical evidence of market reaction to the Game

Genie is the Canadian study, which indicates that the Game Genie

will enhance, not detract from, Nintendo’s sales. See Sony, 464

U.S. at 423-24, 452-53, n.36-37 (relying on consumer survey to

determine market impact). During February of this year, 6 months

after introduction of the Genie in Canada, a market research firm

polled 300 Canadian owners of the Game Genie, aged 8 or older.

A-60

The survey failed to reveal any detrimental effect to the Nintendo

market. *®

Nintendo objected to the survey on various grounds, including

the fact that Canadians, not Americans, were polled. Nintendo’s

criticisms go to the weight of the survey, not its admissibility.

Nintendo offered no meaningful evidence that consumer research

in the United States is performed differently from that conducted

in Canada, or that consumers who play video games in the United

States have different tastes or attitudes than do video game players

in Canada. Nintendo has access to its own sales data for the nine

months Game Genie has been on sale in Canada. Nevertheless, it

produced neither statistical evidence of lost sales nor any Canadian

retailer testimony of adverse impact from Game Genie on the

demand for Nintendo games. The Court is influenced by

Nintendo’s failure to proffer any empirical evidence of a negative

market impact or potential impact from the Game Genie. The only

reasonable inference for the trier of fact is that no such impact

exists.

Nintendo failed to take advantage of other opportunities to

show lost sales. For instance, Nintendo uses ongoing focus groups

as part of its continuing marketing and quality control. It could

have used those groups to test the effect of Game Genie use on

attitudes about Nintendo games. It did not. Since Nintendo had the

* 72% of the respondents believe that the Game Genie makes video

games more fun. 45% enjoy playing their games morc than before they

had a Game Genie, 53% enjoy their games the same, only 2% enjoy

their games less. |

52% are more interested in buying new video games since they have had

the Game Genie, and only 2% are less interested.

29% of the respondents play their Nintendo games more often than

before they had a Game Genie, 67% play their games the same amount,

and only 4% play their games less often.

A-61

incentive, opportunity and ability to proffer such evidence, its

failure to do so gives rise to the contrary inference, i.e., that there

are no material differences between the Canadian and American

markets, and that the Game Genie has had no detrimental impact

on Nintendo’s sales in Canada.

Galoob’s evidence on sales was persuasive. In additional [sic]

to the survey data, Galoob proffered expert testimony from Glenn

Rubenstein, a member of Nintendo’s “target” market (males

between 8 and 14 years old). He has been a serious player of

video games for several years and spends as many as 30 hours per

week with this avocation. He has written numerous magazine and

newspaper articles critiquing variouS video games, including

Nintendo’s. Rubenstein’s opinion is that the Game Genie would

encourage rather than discourage enthusiasm over video games in

general, because it allows players to explore new ways of playing

a game, thereby making the game more accessible to players of

differing abilities. This would likely increase the use of a video

game in a multi-player family, providing more value per consumer

dollar. The Court found his testimony more convincing than that

of Nintendo’s employees and experts.

For these reasons, the Court is unconvinced that the Game

Genie will decrease Nintendo’s sales.

d. Harm To The Nintendo Culture Is Not Cognizable

Under Copyright Law.

Nintendo’s main objection to and claimed damage from the

Game Genie is the potential detriment to the “Nintendo Culture,”

a concept discussed at length by Nintendo’s attorneys and

witnesses. This culture, the apex of Nintendo’s marketing strategy,

is a mind-set intentionally created by Nintendo in its consumers.

Like most cults, fads or addictions, it thrives when fueled by

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A-62

constant peer pressure. Nintendo fears that, by allowing users to

change the rules of Nintendo games, the Game Genie will upset

the inculturation process that Nintendo has designed into its

products, thereby lessening the value of membership in “the

culture” and reducing product loyalty. Having rescued the video

game industry from the shambles of the early 1980’s, Nintendo

argues that it is now entitled to decide how its games should be

enjoyed, by whom, and under what circumstances, even after the

consumer has paid full price.

According to Nintendo, the Game Genie will harm the

Nintendo culture in two distinct ways. First, it argues that the use

of the Game Genie allows players to modify Nintendo’s carefully

crafted games in such a way that ultimate user satisfaction will be

diminished, leading to an over-all decline in the video game

industry. Nintendo called several witnesses, including its own

game designers and two behavior modification psychologists, each

of whom opined that 1) Nintendo’s games are designed to provide

ultimate satisfaction; 2) tampering with Nintendo’s design in any

way thwarts the “challenge of the game”, or its “playability” ,

thereby resulting in lesser enthusiasm for video games in general,

and Nintendo games in particular; and 3) this reduced enjoyment

may lead to the drastic decline in the video game market similar

to that which occurred in the early 1980’s, even if it does not

diminish revenue for the particular games in suit.? Neither the

” For instance, Nintendo’s expert Professor Gregory Loftus declared:

The majority of Nintendo’s players belong to a loose sodal

confederation that might collectively be called the ’Nintendo culture.’

This culture includes talking about Nintendo video games with friends,

comparing scores and achievements,... and getting high scores

published. The operation of the Nintendo culture rests entirely on the

games being challenging. . . .

Being part of the Nintendo culture would no longer be enjoyable or

meaningful, and sales of Nintendo video games would decline. ... Were

A-63

Nintendo employees nor the behaviorists provided empirical data

upon which to support the claim that Nintendo is better able to

judge when a player is having fun than is the player herself.

There is no doubt that Nintendo revitalized the video game

industry, nor is there any doubt that it produces a carefully

controlled and well-made product which is impressively marketed.

Nevertheless, those achievements do not give Nintendo a right to

expand its copyright protection beyond that granted under the

Moreover, Nintendo’s argument that any device that makes

game play easier will injure its market for video games is

undermined by its own behavior. It is significant that Nintendo

markets publications and devices that make similar modifications

available. For example, Nintendo publishes “passwords” enabling

game owners to start game play at different levels or worlds and

with different powers. Nintendo Power magazine” contains

“secret” codes which allow game owners to skip to portions of

games they enjoy, or to gain additional lives. Nintendo also

markets an interactive device called the “NES Advantage,” which

can substitute for the controller included with the standard

Nintendo system. Among the advantages that NES Advantage

provides are the options of slow motion play and extra fire power

to make game play easier. These are similar to options that Game

Game Genie use [sic] to become prevalent, the photographing of a

particular screen [to show a high score] would not be indicative of any

skill or achievement, and this socially-reinforcing practice would fall

by the wayside.

G. Loftus narr. stmnt at 3; see also P. Main narr. stmnt at 3; H. Lincoln

narr. stmnt at 17; H. Phillips narr. stmnt at 6.

'0 The magazine is copyrighted by Nintendo of America.

;

A-64

Genie makes available to players. The fact that Nintendo offers

consumers the ability to temporarily alter the images of their

games undercuts Nintendo’s arguments that such alterations are

likely to create disincentive for the purchase of additional video

games. If Nintendo believed this, it would not market accessories

which it feared would lead to the demise of its multibillion dollar

share of the video game industry."'

Nintendo has attempted to achieve in this litigation what it

could not achieve in the market - the “exclusive right to modify

game play as it alone sees fit and to maintain game play in its

original state.” Nintendo’s Reply Memo. In Supp. Prelim. Injunc.

at 17-18. This Court does not interpret the Copyright Act as

bestowing such broad monopoly powers. The Copyright Act

protects authorship, not market psychology.

5. Fair Use Summarized.

To summarize the four fair use factors, then, the non-

commercial nature of the player’s home use of the Game Genie

creates a presumption of fair use under Sony. The published nature

'' Indeed, Nintendo’s chief marketing officer, Peter Main, contradicts

the theory that Nintendo asserts in this case. In the analysis he presented

at a 1989 Nintendo sales meeting, Mr. Main stated:

Let's not forget that key category called accessories. Good accessories

are important for several reasons including . . . because they give

added value to our software by giving a NES player a whole new

experience and sense of game play when he replays a piece of software

with one of the accessor[ies]. And all that adds up to increased

consumer satisfaction which brings them back for more. Two of the

strongest performers in this regard are the Max and Advantage

controllers. .

Text of speech delivered at the 1989 SCES sales meeting, June 2, 1989,

Ex. G-364 (emphasis added).

A-65

of video games supports the fairness of a consumer’s transitory

alterations of those images. Because the game owner has the

indisputable right to use his or her entire game, the amount of his

or her use cannot weigh against fairness. Further, Nintendo has

failed, in three respects, to carry its burden to prove injury: It has

not shown that any use supplants demand for its works, that any

actual or reasonably likely market is injured, or that use of the

Game Genie in ways that arguably infringe Nintendo’s copyrights

would diminish the overall demand for Nintendo games. Lacking

proof that either actual or likely markets for the copyrighted works

are liable to be affected, Nintendo has failed to satisfy the fourth

fair use factor.

In short, even were the Court to find that the use of the Game

Genie allows players to produce a derivative work, the shield of

fair use is available and would provide a complete defense to any

claim of direct infringement against the game players. Absent

direct infringement, there is no contributory infringement.

Il. DIRECT INFRINGEMENT

Because the Game Genie does not create a derivative work

when used in conjunction with a copyrighted video game, Galoob

does not “authorize the use of a copyrighted work without actual

authority from the copyright owner.” Sony, 464 U.S. at 435 n.17.

All of the cases Nintendo cites on this point deal with unauthorized

public performances for profit, § 106(4), not private, non-

commercial use. Further, Galoob is not liable as a direct infringer

for testing, demonstrating, and marketing the Game Genie, or for

developing codes for use with the Game Genie.

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IV. INJUNCTIVE RELIEF

Even had this Court found that the Game Genie infringes

Nintendo’s copyrights, a permanent injunction in favor of

Nintendo would not be the appropriate remedy because:

1) Any presumption of immediate and irreparable harm

resulting from the alleged infringement was rebutted;

2) The presence of the Game Genie in the market benefits

the public by expanding personal consumer utilization of

purchased games; and

3) Assuming infringement, adequate remedies exist at law.

CONCLUSION

For the reasons stated above, the Court orders declaratory

relief as follows: (1) the use of a Game Genie by consumers, for

non-commercial use, does not violate Nintendo’s rights under the

nor a direct infringer.

The pending preliminary injunction enjoining Galoob from

exercising all commercial activities associated with its license for

the Game Genie should be and is hereby DISSOLVED.

This Court will not stay the lifting of the injunction, pending

appeal, because further equitable relief for Nintendo is

unwarranted. Any request for a stay should be addressed to the

Ninth Circuit Court of Appeals.

A-67

The parties are ordered to appear before this Court on

Monday, August 19, 1991 at 2:30 p.m., to discuss further

proceedings in this matter.

SO ORDERED.

DATED: July 12, 1991

/s/ Fern M. Smith

FERN M. SMITH

United States District Judge

A-68

(The decision of the Court is referenced in a “Table of

Decisions Without Reported Opinions” appearing in the Federal

Reporter [923 F.2d 862].)

NINTENDO OF AMERICA INC., a Washington

corporation, Plaintiff-Appellee,

LEWIS GALOOB TOYS, INC., a Delaware

corporation, Defendant-Appellant.

No. 90-15936.

United States Court of Appeals, Ninth Circuit

Argued and Submitted Sept. 12, 1990.

Decided Jan. 24, 1991.

Appeal from the United States District Court for the Northern

District of California, No. CV-90-1586 RHS; Robert H.

Schnacke, District Judge, Presiding.

AFFIRMED.

Before FLETCHER, BOOCHEVER and WIGGINS, Circuit

Judges.

MEMORANDUM

Lewis Galoob Toys, Inc. (“Galoob”) appeals the district

court’s grant of a preliminary injunction in favor of Nintendo of

A-69

America, Inc. (“Nintendo”), enjoining Galoob from producing or

marketing its product, the Game Genie. We have jurisdiction

pursuant to 28 U.S.C. § 1292(a)(1). We affirm.

Nintendo makes and sells the Nintendo Entertainment System,

a home video game system. To use the system, a player inserts

into the system’s control deck a cartridge containing one of the

games that Nintendo produces or licenses others to produce. The

game is then displayed on a connected television screen. By

moving buttons and a joystick on the controller, the player

controls the actions of one of the game’s characters and progresses

through the video game.

The Game Genie is a hardware device manufactured by

Galoob that can be attached to a game cartridge before it is

inserted into the Nintendo control deck. The Game Genie allows

the player to alter certain features of the Nintendo game by

choosing up to three codes from a large number of Game Genie

codes. For each of the codes entered by the player, the Game

Genie blocks the value for a single data byte sent by the game

cartridge to the central processing unit in the Nintendo controller

and replaces it with a new value. For example, if the cartridge

sends a data byte setting the number of lives for the player’s

character at 3, the Game Genie might, depending on the codes

chosen by the player, substitute the value 6, thereby giving the

character 6 lives rather than 3 in which to complete the game.

The player can also change the color of certain features of the

audiovisual display, change the speed at which the character

moves, allow the character to float above obstacles and alter

myriad other features of the Nintendo game.

The Game Genie makes no change in the data stored in the

game cartridge. Its inteyseption and substitution of data takes

place only as long as it is atiached to the game cartridge and the

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controller’s power is on. The individual changes that the user

makes through entering codes therefore alter the audiovisual

display temporarily but do not change it or the Nintendo game

permanently.

Nintendo contends that the alterations made by Game Genie

to the audiovisual displays of its games violates its copyrights. It

contends that Game Genie alters the audiovisual expression in

these games, in violation of Nintendo’s exclusive rights to control

derivative works. On issuing the preliminary injunction below,

the district court accepted Nintendo’s arguments, finding that

Nintendo would likely prevail on the merits of its claim that

Galoob had infringed on Nintendo’s copyright and that the balance

of hardships tipped decidedly in Nintendo’s favor.

Our review of a preliminary injunction is limited. Johnson

Controls, Inc. v. Phoenix Control Sys., 886 F.2d 1173, 1174 (9th

Cir. 1989). We review de novo the correctness of the legal

Standards employed by the district court in evaluating the

plaintiff's likelihood of success on the merits. Dumas y.

Gommerman, 865 F.2d 1093, 1095 (9th Cir. 1989). However, we

will reverse the district court’s issuance of a preliminary injunction

only if the district court abused"its discretion, or based its decision

on an erroneous legal standard or clearly erroneous findings of

fact. Johnson Controls, 886 F.2d at 1174; Dumas, 865 F.2d at

1095. We will not reverse merely because we would have reached

a different result from that reached by the district court. Big

Country Foods, Inc. v. Board of Educ. , 868 F.2d 1085, 1087 (9th

Cir. 1989).

To sustain the grant of the preliminary injunction, we must

find that the district court did not abuse its discretion in .

determining that Nintendo showed either a likelihood of success on

the merits and the possibility of irreparable injury, or that serious

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questions going to the merits were raised and the balance of

hardships tipped sharply in its favor. Johnson Controls, 886 F.2d

at 1174. The test for granting a preliminary injunction is viewed

as a continuum in which the degree of irreparable harm required

increases as the probability of success on .he merits decreases.

Id.; Dumas, 865 F.2d at 1095. Thus, “[i]f the balance of harm

tips decidedly toward the [moving party], then the [moving party]

need not show as robust a likelihood of success on the merits as

when the balance tips less decidedly.” Brenda v. Grand Lodge of

Int’l Ass’n of Machinists, 584 F.2d 308, 315 (9th Cir. 1978).

In the district court, the only issues raised and discussed by

Galoob as defenses to Nintendo’s copyright infringement claim

were: (1) whether use of the Game Genie failed to constitute an

unauthorized derivative work because Nintendo had authorized

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