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Two weeks ago, the Federal Circuit Court of Appeals limited the factors a district court may consider in determining the amount of attorneys’ fees to award in an “exceptional” patent infringement case. Lumen View Tech., LLC v. Findthebest.com, Inc. (January 22, 2016) 2016 U.S. App. LEXIS 1087.

Lumen was the exclusive licensee of a patent covering a method for facilitating bilateral and multilateral decisionmaking. The method required analyses of preference data from two groups of people. Findthebest.com (FTB) offered a website with a search feature called “AssistMe” that gave the user information on products and services related to the user’s specific input.

Lumen sued FTB in the Southern District of New York for patent infringement. FTB’s counsel told Lumen on several occasions that FTB’s search method did not use a bilateral or multilateral process. Lumen ignored FTB’s statements, and filed its infringement contentions before obtaining any discovery. FTB then filed a motion for judgment on the pleadings on the grounds that the patent was invalid under 35 U.S.C. §101 as directed to an unpatentable abstract idea. The district court ruled in favor of FTB and dismissed the case. FTB then filed a motion seeking a determination that the case was “exceptional” under 35 U.S.C. §285 and for recovery of its attorneys’ fees on that grounds.

The district court ruled that the case was exceptional and that FTB was entitled to fees. The court awarded FTB the lodestar amount with a multiplier of two, for a total of about $300,000. The court found that the multiplier was justified in order to deter Lumen from filing similar frivolous lawsuits in the future. The court said that the lodestar amount was too small, because the case had been resolved at an early stage, to be an effective deterrent, and so chose to use the multiplier of two.

On appeal, the Federal Circuit affirmed the district court’s exceptional case ruling. The determination of whether a case is “exceptional” is within the district court’s discretion. The test is the “totality of the circumstances” test set forth by the Supreme Court in Octane Fitness, LLC v. ICON Health & Fitness, Inc., 134 S.Ct. 1749 (2014). The appellate court explained that a district court may find a case exceptional based on the strength of a party’s litigation position (considering the facts and the law) or on the unreasonableness of a party’s litigation conduct. The district court had based its finding on the fact that Lumen did not conduct any pre-filing investigation or infringement analysis, and that Lumen’s own claim construction required the use of preference data from multiple parties. The appellate court held that the district court had not abused its discretion in finding the case exceptional:

“The allegations of infringement were ill-supported, particularly in light of the parties’ communications and the proposed claim constructions, and thus the lawsuit appears to have been baseless. Claim construction was unnecessary before finding noninfringement in this case, especially because Lumen View conceded that the claims require preference data from multiple parties.”

As to the district court’s fee award, the Federal Circuit vacated the award and remanded the case. Lumen had argued on appeal that the district court had impermissibly based its enhancement of the lodestar on the need for deterrence, a factor that was already considered in the finding of an exceptional case.

The appellate court explained that the district court has the discretion to decide the amount of reasonable attorneys’ fees to be awarded under §285. In certain cases, the court may enhance the lodestar amount to consider factors that are not covered by the lodestar. For example, the lodestar may be enhanced when the attorney’s time or hourly rate does not reflect the “true market value” of the work performed because the attorney was particularly specialized or because extraordinary litigation expenses were incurred. Factors that are unrelated to the performance of the prevailing party’s counsel, however, are not appropriate in enhancing the lodestar.

In this case, the appellate court held found that the district court had not justified its decision to enhance the lodestar two-fold. According to the court, deterrence cannot be considered in deciding the amount of attorneys’ fees to be awarded under §285. The court vacated the fee award and remanded the case to the district court for further consideration of the amount to be awarded.

The Ninth Circuit’s recent decision in the case of Dolby Systems, Inc. v. Christenson, focuses primarily on the issue of which party bears the initial burden of proof with regard to a “first sale” defense in a copyright infringement action. As the reader will see, however, this case really provides a cautionary tale as to the consequences a party may face when it plays games during discovery.

Adobe, a software publisher and the copyright holder for titles such as the “Photoshop” series sued Christenson in October 2009 alleging copyright and trademark infringement. (This column will not address the trademark issues.) Christenson ran a website on which he “re-sells” Adobe software, which he purchases from third party distributors apparently without Adobe’s authorization. Adobe claimed that it does not sell its software, but merely licenses them and that Christenson infringed on its copyrights when he “re-sold” its titles. Christenson claimed that his activities were protected under the First Sale Doctrine, claiming that he lawfully purchased the software from third parties, who had also “purchased” the software from Adobe.

Adobe’s lawsuit against Christenson was apparently quite contentious. The Ninth Circuit observed that the lower court proceedings were “punctuated by discovery disputes, sanctions and multiple rulings on the admissibility and exclusion of evidence.” Both parties filed cross-motions for summary judgment. The District Court, after excluding certain evidence offered by Adobe because it had not been produced during discovery, granted summary judgment in Christenson’s favor as to the copyright infringement claim after recognizing that the First Sale Defense applied. Adobe appealed this finding to the Ninth Circuit.

The Ninth Circuit began by first recognizing that Adobe had established a prima facie case of copyright infringement. That is, Adobe had to “prove ownership of a valid copyright and violation by Christenson, the alleged infringer, of at least one of the exclusive rights conferred by the Copyright Act.”   The Ninth Circuit found that Adobe had provided admissible evidence that “established ownership of valid copyrights with a long list of computer software.” The Court then noted that the Copyright Act confers several rights on copyright owners, “including the right of distribution” and that it was undisputed that Christenson had sold copy of Adobe’s copyrighted works on his website without Adobe’s authorization. The Ninth Circuit concluded that “Adobe easily established a prima facie case of copyright infringement.” But that did not end the analysis. The Court then turned to Christenson’s defense under the First Sale Doctrine.

In a copyright infringement action, a defendant may raise the affirmative defense of the First Sale Doctrine which essentially provides that “the owner of a particular copy … lawfully made under this title, or any person authorized by such owner, is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy.… “ (17 U.S.C. §109(a).) The Ninth Circuit recognized the purpose of this defense is to limit a copyright owner’s exclusive distribution rights to the “first sale” only and that once the copyright owner has placed the item into the stream of commerce, the owner “has exhausted [its] exclusive statutory right to control its distribution.” However, it was unclear under prior precedent as to who bore the burden of proof with regard to the First Sale Doctrine. Furthermore, the Ninth Circuit recognized that in digital copyright cases, such as the one before it involving the transfer of software, one crucial factor is to distinguish between a “sale” and a “license.” For more than a century, the U.S. Supreme Court has recognized that the sale of an item can create a defense to a copyright claim while the mere granting of a license will not.

After reviewing the history of the Copyright Act and the amendments thereto, including the issue of the First Sale Defense, the Ninth Circuit recognized that the distinction between a “sale” and a “license” is not always so clear and that it had previously recognized that some software “licensing” agreements actually created a sale. The Ninth Circuit reasoned that to determine whether it was in fact a license, the copyright owner must specify: (1) that it is granting a license; (2) that the license significantly restricts the user’s ability to transfer the software; and (3) that there are notable use restrictions imposed on the user. If a copyright holder cannot satisfy these factors, a court is likely to find that a sale of the software has taken place instead of the granting of a license.

Normally, a defendant raising an affirmative defense bears the burden of proof in establishing the applicability of that defense. The Ninth Circuit concluded that this rule is no different for a defendant asserting the First Sale Defense. That is, the Ninth Circuit held “the party asserting the First Sale Defense bears the initial burden of satisfying the statutory requirements” in that it must show ownership through a lawful acquisition. In essence, “the party asserting a First Sale Defense must come forward with evidence sufficient for a jury to find lawful acquisition of title through purpose or otherwise to genuine copies of the copyrighted software.” Once the defendant has made that showing, “the burden shifts back to the copyright holder to establish such a license or the absence of a sale.”

The Ninth Circuit concluded that this burden shifting procedure made sense because “the copyright holder is in a superior position to produce documentation of any license and without the burden shifts the First Sale Defense would require a proponents prove a negative, i.e., that the software was not licensed.” The court found that this approach was both fair and comported with the legislative history concerning the Copyright Act.

Turning to the case before it, the Ninth Circuit agreed with the lower court that it was undisputed that the defendant had produced evidence that he had lawfully purchased genuine copies of the Adobe software from third party suppliers, i.e. the defendant produced copies of invoices showing his purchases of the software.

Adobe argued that the defendant could not have lawfully acquired the software products because it always licenses its software and does not sell copies of it. However, the Ninth Circuit held that the burden of proof on this issue shifted back to Adobe to come forward with admissible evidence to prove the existence of the claimed licenses. The Ninth Circuit recognized that normally Adobe would produce copies of the specific license agreements so that the court could determine whether in fact a true license had been granted. The Ninth Circuit continued that putting the burden on Adobe of providing copies of the license agreements was not an undue burden since “Adobe and Adobe alone knows the parties with whom it contracts.”

As explained above, there had been a litany of discovery disputes, which apparently included Adobe’s refusal to produce copies of its licensing agreements during discovery. That is, Adobe refused to produce the agreements it had with the “sellers” of the software to Christensen. In fact, it appears that Adobe delayed until after the close of discovery and only in opposing the defendant’s summary judgment motion, to produce these documents. However, the trial court refused to consider this evidence because it had not been produced during discovery and the Ninth Circuit found that it was not error to do so. Given that Adobe, as a result of the exclusion of this evidence, could not come forward with admissible evidence to show that it had granted a license with respect to the software products “re-sold” to the defendant, the Court held that the defendant had met its burden of establishing the First Sale Defense and affirmed the dismissal of Adobe’s copyright infringement claim.

While the Adobe v. Christenson case helped clarify the burdens of proof when the defense of the First Sale Doctrine is raised in a copyright infringement claim, the moral of the case appears that a plaintiff should not “play games” during discovery. Reading between the lines, it is clear that had Adobe timely produced the licensing agreements at issue, it is unlikely that Christenson would have been entitled to summary adjudication of the copyright infringement claims. In fact, Adobe may have even been entitled to judgment in its favor without the necessity of a trial.

In business, there are numerous opportunities for pitfalls, mistakes and errors and they come up in all different legal areas – from basic formation issues to labor and employment to intellectual property. Mistakes and missteps involving intellectual property can be particularly problematic because IP is a company asset; it constitutes a part of (often a significant part of) a company’s valuation. In my 20 years working with start-up companies – and even fully grown-up companies, I have seen mistakes involving company intellectual property prove to be disastrous. With careful planning and good counsel, these mistakes are completely avoidable.

#1. Failure To Transfer the IP From The Founder Into the Company. It is a foundational item for any company – if the company is being formed around a piece of IP or if a piece of IP is intended for use by a company, the company should make sure the founder that owns the IP must contribute it to the company. While a very basic issue, this problem plagues more start-ups than you can imagine. Most often it happens during the informal, pre-formation time frame when founders are kicking around an idea and developing code and no one has consulted a lawyer. Conflict between the founders develop and there is a divergence of opinion on the value brought to the table by the non-developer founders; the developers decide to split with the IP and form a new company. While this will likely generate lawsuits just as soon as the developer’s company is in a financing round, the non-developer founders will very likely not receive as much as they would have had the IP been properly assigned to the company.

How to Avoid This Pitfall: As soon as the project morphs from “dorm-room chit chat” to something real, it’s time to bring in the lawyer and get the material terms of the deal down on paper and make sure the IP is or will be properly assigned to the company.

#2. Entanglements With a Founder’s Former or Present Employer. Most entrepreneurs working on a start-up still keep a day job in order to pay the bills. This can present a problem, especially for a technical founder. If a founder uses their employer’s facilities, computers, equipment, or other technology during company time to develop a new invention for the start-up, this could raise serious issues over IP ownership, especially if the technology is in the same field as the employer. Additionally, it’s very common for employment agreements to include a clause vesting IP ownership with the employer where IP is created using company equipment or facilities.

How to Avoid This Pitfall: In California, an employee is the owner of any inventions developed entirely on his/her own time without using the employer’s equipment, supplies, facilities or trade secret information except where (i) the invention relates to the employer’s business, or research or development of the employer; or (ii) results from work performed by the employee for the employer. Founders that are still employed (or just your ordinary moonlighter) should not use their employer’s equipment or facilities to work on their start-up or side project. Additionally, the start-up should not be in a line of business that relates to that of the founder’s employer.

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Taylor Swift has been in the news a lot over the last year or so. She is phenomenally successful. Her hit album “1989” concert tour was the highest grossing tour in the world in 2015 (over $250 million) and the highest grossing tour ever in North America (smashing the previous record held by the Rolling Stones’ 2005 tour).

As she said in a Wall Street Journal Op/Ed piece in 2014, Swift believes songs are valuable art that should be paid for. Swift means what she says. She protects her intellectual property. She has become a strong voice for music artists in the fight against those who distribute music for free without permission (otherwise known as copyright infringers), especially Internet music streaming services. When it comes to copyright, Swift has proven herself to be a force to be reckoned with in the music industry – she is not afraid to go after anyone.

For example, in late 2014, Swift’s team directed China’s largest music streaming services to take down her entire catalog of music from all free services. In a country where free music is almost viewed as an entitlement, Swift took her music out of the picture.

Also in 2014, Swift got into a dispute with Spotify, a commercial streaming music service. Swift objected to the very low royalty rates (less than one cent per stream) that Spotify pays for the music it streams, with most of the royalty going to the record labels, not the artists. Swift insisted on certain conditions for Spotify to stream her music, but Spotify refused to agree. So, Swift pulled her music from Spotify.

In June 2015, Swift took on Apple. Apple had planned to begin offering a new music streaming service. During a three-month trial period, Apple intended to offer subscribers the service for free. Apple wasn’t going to pay the musicians, writers, or producers any royalties during this period. Swift wrote Apple a letter, telling them they could not use her “1989” album, and asking Apple to pay for the music it intended to stream. After all, she pointed out, artists don’t ask Apple for free iPhones. Without even filing a lawsuit, Swift got her way. Apple agreed to pay all those whose music they streamed, and “1989” was included.

More recently, Swift ended up on the other side of a copyright battle. In October 2015, a songwriter named Jessie Braham, representing himself, sued Swift and Sony/ATV for copyright infringement in the U.S. District Court for the Central District of California. The plaintiff alleged that Swift’s hugely successful song, “Shake It Off,” from her “1989” album, infringed a song Braham had written. Specifically, Braham alleged that Swift’s lyric “haters gonna hate, hate, hate, hate, hate” was stolen from his 2013 song entitled “Haters Gone Hate.” Braham sought $42 million in damages.

Before any appearance in the case could be made by Swift or Sony/ATV, the court, on its own motion, dismissed the case. The plaintiff had requested to appear in forma pauperis (without paying court fees), giving the court the right to review the complaint to determine if it stated a claim. The court applied the same standard used for a motion to dismiss under Federal Rules of Civil Procedure, Rule 12(b)(6).

In order to state a claim for copyright infringement, a plaintiff must allege both that they own a valid copyright and that the defendant copied original elements of the plaintiff’s copyrighted work. The court found that Braham had alleged a valid copyright for his song, as he had registered the copyright for the song. As to the second requirement, however, the court found the plaintiff’s allegations lacking.

In his complaint, Braham referred to a 22-word phrase from his song that he claimed Swift had stolen, alleging that she repeated the phrase 70 times and that it comprised 92% of “Shake It Off.” The court listened to “Shake It Off” and reviewed the plaintiff’s lyrics, and did not find any such phrase. The court noted that the two songs had different melodies and were of different genres. The court performed her own Internet research and found that the plaintiff’s lyric “haters gone hate,” and another phrase the plaintiff had said was stolen, “players gone play,” had been used in many other works by other authors. Therefore, the court held that the plaintiff’s allegedly stolen phrases were not original and could not support a copyright infringement claim. In fact, the court went so far as to caution the plaintiff to be careful of Rule 11 in considering whether to amend his complaint, suggesting that his claim against Swift was baseless.

The court next addressed the plaintiff’s allegation that Swift had copied his song. Because direct evidence of a defendant’s copying is rare, coping can also be proved by evidence that the defendant had access to the plaintiff’s copyrighted work and that the plaintiff’s work and the defendant’s work are substantially similar. The court explained that access is almost never a problem, given the Internet; because Braham’s song was on YouTube, it was accessible to the defendants.

As to substantial similarity, however, the court found that Braham had a problem. The Ninth Circuit Court of Appeals’ test for substantial similarity has two parts: an “extrinsic” test and an “intrinsic” test. L.A. Printex Industries, Inc. v. Aeropostale, Inc., 676 F.3d 841, 846 (9^th Cir. 2012), as amended (June 13, 2012). The extrinsic test, which can be determined as a matter of law, is met if the two works are objectively similar in ideas or expression. Id. The intrinsic test is a subjective test for the factfinder to determine and is met if an ordinary, reasonable audience would think that the two works are substantially similar. Id. In applying the extrinsic test, the court found that Braham’s song and “Shake It Off” were not objectively similar. Braham’s song used short phrases, while a key component of “Shake It Off” was the repetition of the last word of the phrase (“haters gonna hate, hate, hate, hate, hate” and “players gonna play, play, play, play, play”).

Under the standard for a motion to dismiss as set forth in Ashcroft v. Iqbal, 556 U.S. 662 (2009) and Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), the court held that Braham had not pled facts sufficient to allege a plausible claim for copyright infringement. The court denied the plaintiff’s request to proceed in forma pauperis, but said that plaintiff could continue with his suit if he paid the filing fees. In her conclusion, borrowing from Swift’s own lyrics from several other hit songs, the court emphasized the deficiencies in the plaintiff’s complaint:

“At present, the Court is not saying that Braham can never, ever, ever get his case back in court. But, for now, we have got problems, and the Court is not sure Braham can solve them. As currently drafted, the Complaint has a blank space – one that requires Braham to do more than write his name. And, upon consideration of the Court’s explanation in Part II, Braham may discover that mere pleading Band-Aids will not fix the bullet holes in his case. At least for the moment, Defendants have shaken off this lawsuit.”

If you’re a fan of intellectual property or the National Football League, you may have heard about last July’s ruling in the United States District Court for the Eastern District of Virginia. There, Judge Gerald Bruce Lee affirmed the Trademark Trial and Appeal Board’s ruling that the team’s moniker is offensive to Native Americans, and therefore ineligible for trademark protection under the Lanham Act, which prohibits registration of disparaging marks. This battle was fought over more than 20 years. The effect is that the Redskins can continue to use the mark, but they do not have the trademark protections provided by the Lanham Act. The Redskins, clearly unhappy with this result, have appealed the matter to the Fourth Circuit of Appeal. That matter is currently pending and the opening briefs were recently filed.

In its opening brief, the Redskins immediately attacked the District Court’s ruling that the Redskins’ registration is not entitled to First Amendment scrutiny because registered trademarks are “government speech” and the registration is a government subsidy “program.” Counsel for the Redskins, Quinn Emanuel and Arnold & Porter, argue that this notion is disturbing. Specifically the opening brief states that: “The PTO has registered hundreds if not thousands of marks that the Team believes are racist, or misogynistic, vulgar, or otherwise offensive. By way of example only, the following marks are registered today…DANGEROUS NEGRO shirts… DAGO SWAGG clothing…BAKED BY A NEGRO bakery goods….These are not isolated instances. The government routinely registers pornographers’ marks” as well. These marks are clearly offensive, and like the Redskins mark, racially charged.

The Redskins argued that this is not government speech, nor is the government subsidizing these marks. Instead, the government is a regulator who determines whether a trademark meets certain criteria, such as distinctiveness. And according to the Redskins, because the registration constitutes government regulation, a ban on registering disparaging trademarks unconstitutionally burdens speech based on content and viewpoint; both of which are prohibited by the First Amendment.

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A longstanding battle between Google and the authors of published books has been resolved (at least for now) in favor of Google. The Second Circuit Court of Appeals has held that Google’s use of copyrighted books in its Library Project and Google Books website, without the permission of the authors, is fair use and therefore not copyright infringement. The Authors Guild v. Google, Inc. (2^nd Cir. 2015) 804 F.3d 202.

In 2004, Google began its Library Project. Google entered into agreements with some of the world’s leading research libraries, including the University of California, the University of Michigan, Harvard, Stanford, Columbia, Princeton, the New York Public Library, and Oxford. Under the agreements, the libraries submitted certain books to Google which Google digitally scanned, made machine-readable texts, and indexed the texts. Google has now scanned and indexed over 20 million books. Some of the books were copyrighted, while others were in the public domain. Most of the books were out of print, non-fiction books. The digital copies are stored on Google’s servers.

The public can access Google’s database of machine-readable texts through the Google Books website. On the website, the user can search for key words and find all books that include the key words and the number of times the search terms appear in each book. The search results also include a short summary description of each book and may include a link to purchase the book or the names of the libraries where the book is located. The website also offers the user the ability to see up to three snippets (segments of about an eighth of a page) of the text of the book. Searches for different words will turn up different snippets, but one snippet out of every page and one page out of every ten pages of each book are permanently inaccessible to the user (referred to by Google as “blacklisted”). In 2005, Google agreed to remove the snippet feature for any book at the copyright owner’s request. Google does not permit advertising in the Google Books searches and does not get paid for any sales of books.

According to its agreement with the libraries, Google allows each library to download a digital image and a machine-readable text copy of every book that the library has submitted to Google. The libraries are required to follow copyright laws and police their users to prevent violations of copyright laws.

In 2005, the plaintiffs filed a putative class action against Google in the Southern District of New York, alleging copyright infringement. The district court granted class certification, but on appeal, the Second Circuit vacated the decision. The Second Circuit held that the district court should resolve Google’s fair use defense before deciding class certification.

Google moved for summary judgment on its fair use defense. The district court granted the motion in 2013, dismissing the case. The Second Circuit affirmed the district court’s decision on October 16, 2015.

The Court of Appeals explained that “the ultimate goal of copyright is to expand public knowledge and understanding . . . “ The doctrine of fair use, developed by the courts and now codified in section 107 of the Copyright Act of 1976, permits unauthorized copying in certain circumstances in order to promote the expansion of knowledge. Fair use is an affirmative defense, for which the defendant has the burden of proof. The analysis of fair use is not clear-cut, but depends on the particular facts of each case.

In determining whether the fair-use defense applies, courts must consider the following factors: (1) the purpose and character of the use (including commercial versus a nonprofit educational purpose); (2) the nature of the copyrighted work; (3) the amount and substantiality of the work copied; and (4) the effect of the use on the market for the copyrighted work. 17 U.S.C. §107. Courts have emphasized the fourth factor, the effect of the use on the market for the copyrighted work, noting the importance of protecting authors’ rights to profit from their work. The first factor, the nature and character of the use, is also important, especially if the use is for a new or transformative purpose that is not a substitute for the original work.

The Second Circuit applied the four factors of section 107 to Google’s Library Project and the Google Books website to decide whether Google’s use constituted fair use. As to the first factor, the court held that the factor was met because Google’s creation of a digital, searchable database and its provision of snippets of text to the user was a new and transformative use. The possibility that Google might indirectly profit from its Google Books website service was not significant enough to override the transformative nature of its use because the Google search was not a substitute for the original work. The court emphasized that even if Google’s use was commercial, a commercial use is not presumed to be unfair; for example, the copying of copyrighted works in news reporting, book reviews, and parody is done for a profitable purpose, but is almost always fair use. The court pointed out that the reverse is also true; copying done for a nonprofit educational purpose is not presumed to be fair use.

In addressing the second factor, the nature of the copyrighted work, the court said that this factor was rarely dispositive. The fact that the copyrighted works Google copied were nonfiction works did not change the court’s analysis or conclusion.

With respect to the third factor, the amount and substantiality of the work copied, the court explained that the copying of smaller or less significant portions of a copyrighted work is more likely to be fair use. The rationale is that such copying is less likely to be a substitute for the copyrighted work, and therefore, not likely to affect the copyright owner’s profits. However, the fact that Google had copied the entire book was not determinative. The court held that this factor was met because Google did not provide the entire copy to the public, but needed to make a copy of the entire work in order to provide its transformative use (the ability to search for a particular term throughout the entire work and find out how many times the term was used). The court said that Google’s restrictions on the snippet feature were substantial and would prevent the user from obtaining a substitute for the copyrighted work.

The fourth factor, the effect of the use on the market for the copyrighted book, is the most important factor. If the copy serves as a substitute for the copyrighted work, there is no fair use. The court found that Google’s searches and its snippet feature did not provide a substitute for the copyrighted work.

After thoroughly analyzing the four factors of section 107 and considering several other arguments made by the plaintiffs, the court held that Google’s use was a non-infringing fair use. In reaching this conclusion, the court reiterated the beneficial value to the public of Google’s Library Project and Google Books website, describing these uses as “highly transformative.”