Christopher Phelps & Associates, LLC v. R. Wayne Galloway v. Simonini Builders, Incorporated, Third Party Donald A. Gardner Architects, Incorporated Donald A. Gardner, Incorporated Frank Betz Associates, Incorporated, Amici Supporting

Citations: 477 F.3d 128; 81 U.S.P.Q. 2d (BNA) 1609; 2007 U.S. App. LEXIS 3117Docket: 05-2266

Court: Court of Appeals for the Third Circuit; February 11, 2007; Federal Appellate Court

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R. Wayne Galloway constructed a retirement home using architectural plans copyrighted by Christopher Phelps Associates, LLC, leading Phelps Associates to file a copyright infringement suit against him. The jury found Galloway liable, awarding Phelps Associates $20,000 in damages but determined Galloway had no profits to disgorge. The district court declined to issue an injunction, concluding that the jury's verdict sufficiently compensated Phelps Associates.

On appeal, Phelps Associates argued for a new trial on damages and an injunction against Galloway regarding the future lease or sale of the infringing house, along with the destruction or return of the infringing plans. The Court of Appeals agreed that the district court mistakenly instructed the jury to consider Phelps Associates' copyright as a derivative work, affirming, however, that this error was harmless. 

The court also concurred with Galloway’s position that a permanent injunction to prevent him from leasing or selling the house was inappropriate, as it would contravene the "first sale doctrine" under 17 U.S.C. § 109(a). Nevertheless, the court vacated the district court’s denial of injunctive relief and remanded the case for reconsideration of other forms of equitable relief, such as requiring Galloway to destroy or return the infringing plans, in alignment with the principles established by eBay Inc. v. MercExchange, L.L.C.

R. Wayne Galloway, preparing for retirement, sought to build his dream home on a lot he owned near Lake Wylie, North Carolina. Unsatisfied with an architect's designs, he and his son-in-law visited Lake Norman, where they found a French-country style home they liked. Galloway contacted the home's owner, Mrs. Gina Bridgeford, who allowed him to use the plans on the condition he would not build in her area. Mrs. Bridgeford believed she owned the plans due to her payment for them. After receiving permission, Galloway obtained a copy of the plans, which included a copyright notice stating that the plans were protected and could only be used to build one home. Galloway altered the plans to reflect his name and address and began construction in September 2001, unaware that he was infringing copyright. Subcontractors, some of whom checked with the original design firm, Phelps. Associates, warned Galloway about potential legal issues, but he dismissed their concerns. In early 2003, Phelps. Associates learned of Galloway's unauthorized construction and sent him a cease and desist letter in July. Galloway halted construction, which was over halfway completed, and Phelps. Associates subsequently registered the plans with the Copyright Office and initiated legal action against him for copyright infringement.

Phelps Associates sought compensatory damages, disgorgement of profits, and injunctive relief against Galloway for copyright infringement of its architectural design. Principal Christopher Phelps testified that Phelps Associates would have charged Galloway $20,000 for a custom house design similar to the Bridgeford house, but would not have sold him the actual design. Expert testimony indicated Galloway's completed house would be valued at $1.1 million, yielding over $200,000 in potential profits. In contrast, Galloway claimed he would incur a loss of approximately $160,000 upon completion, having spent about $660,000 to date with an additional estimated cost of $250,000 to $300,000 for completion. The jury ultimately ruled in favor of Phelps Associates, awarding $20,000 in damages and finding Galloway had no profits to disgorge. Phelps Associates requested injunctive relief to prevent the completion, lease, or sale of the house, but the court denied all requests, determining that the monetary award made Phelps Associates whole. On appeal, Phelps Associates argued that the district court incorrectly instructed the jury regarding the nature of its copyright as a derivative work and made erroneous evidentiary rulings. Phelps Associates did not secure an injunction pending appeal, and Galloway has since completed the house and paid the judgment. The appeal will address whether the jury was misinstructed about the copyright status of the Bridgeford design.

A derivative work is defined as one that is based on preexisting works, encompassing revisions, transformations, or adaptations. Copyright protection for such a work only covers new material added by the author and does not extend to the preexisting components. The copyright for a derivative work is independent of any rights associated with the underlying work. Phelps Associates contended that the jury was misled into believing their copyright was limited to minor modifications to the Bridgeford Residence, resulting in no attributed profits for infringement. Galloway argued that the instruction was correct, asserting that Phelps Associates' copyright was confined to new elements of the Bridgeford Residence. However, it was concluded that the Bridgeford Residence was not a derivative work under the Copyright Act, as Phelps Associates held a copyright for the entire design. The distinction emphasized that a copyright exists independently of registration, which merely serves as evidence and is required for legal action. Phelps Associates owned the copyright for both the Bell and Brown Residence and the Bridgeford Residence, the latter being a modification of the former, and it registered the entire design rather than as a derivative work.

Phelps Associates' registration of the Bridgeford Residence design enabled it to sue for copyright infringement regarding the entire design, despite some components being part of the earlier Bell and Brown Residence design. Under 17 U.S.C. § 411, a copyright owner can sue for all elements of a registered work if they hold a copyright on those elements, regardless of their registration status. Therefore, even if the Bridgeford Residence was deemed a derivative work, Phelps Associates could claim damages for infringement on all components, as it owned the copyright to them. 

The district court's jury instruction was erroneous, implying that the jury could not award damages based on the full design. However, this error was deemed harmless, as the jury's verdict indicated they understood to award damages based on the complete Bridgeford design. The court correctly instructed the jury that Phelps Associates was entitled to actual damages and profits from the infringement, defining actual damages as the market value or a reasonable licensing fee. Phelps Associates provided evidence of charging a $20,000 fee for the design, which the jury awarded, aligning with the presented licensing fee. 

The verdict might have been different had the jury focused on the derivative work aspect, potentially leading to a lower award based solely on the newly added design elements from the Bridgeford Residence. However, there was no evidence presented regarding the market value of these specific elements, leaving the jury without a basis for awarding anything less than the full fee.

Phelps Associates sought disgorgement of profits from copyright infringement, with the district court instructing the jury that a copyright holder is entitled to recover all profits made by the infringer. Profits are defined as the infringer's gross revenues from the infringing activity minus the legitimate expenses incurred in creating the infringing work. Galloway, the infringer, was tasked with demonstrating his construction expenses; failure to do so would result in the jury finding his gross revenues as his profits.

Galloway needed to prove that any claimed expenses were incurred specifically for the construction of the house in question. The jury did not receive evidence to determine profits from minor design changes, such as the addition of a dormer, leading them to conclude Galloway realized $0 in profits. This decision aligned with the evidence presented, including Galloway's valuation and the county tax assessment. 

The jury's verdict indicated they found no profits from the entire house design, suggesting they did not accept that profits were generated from the design changes. Despite the court's instructions regarding derivative works and damage apportionment, the jury's $0 profit ruling demonstrated they considered no profits were proven. The court also mandated Galloway to prove any profits attributable to non-infringing conduct; without such proof, all profits were deemed tied to the infringement. Galloway did not provide evidence to support apportionment, leading the jury to treat the entire house as infringing on Phelps Associates' copyright, ultimately concluding that no profits were attributable to Galloway's actions.

The jury awarded Phelps Associates the full amount of actual damages claimed but found that Galloway had not realized any profits. Had the jury identified profits and Galloway met the burden of apportionment, some profits would have been awarded to Phelps Associates. The jury's conclusion that there were no profits indicates that the erroneous derivative work instruction did not affect the damage award and was therefore harmless. Phelps Associates' request for a new trial based on this instruction is denied. 

Additionally, Phelps Associates contended that erroneous evidentiary rulings warranted a new trial. However, the review concluded that the district court did not abuse its discretion in its rulings. Specifically, Galloway's receipts and ledger, used to demonstrate expenses for his house, were permissible under the business records exception to hearsay rules. Similarly, a Mecklenburg County tax assessment was admitted as it qualified under the agency records exception, reflecting reliable governmental processes. 

Phelps Associates also challenged Galloway’s lay testimony on property value. This testimony was deemed appropriate as it was based on Galloway’s perception and did not constitute expert testimony. The court held that property owners are competent to testify about their property’s value without needing expert qualifications. Finally, the district court found that Phelps Associates' expert testimony, intended to rebut the tax assessment and Galloway's valuation, was "unhelpful" and "potentially misleading," which justified its exclusion. Overall, Phelps Associates' arguments for a new trial on damages were rejected, and the jury's verdict was affirmed.

After the jury's verdict, Phelps Associates sought injunctive relief under 17 U.S.C. § 502 and § 503(b) to prevent the completion, lease, or sale of a house and to require the destruction or return of infringing plans. The district court denied the motion, stating that the jury's award of $20,000 in actual damages had made the plaintiff whole, and there was no likelihood of further infringement since only interior finishing remained on the house. The court determined that equitable considerations did not support granting the relief requested.

Phelps Associates argued that the court erred in denying injunctive relief solely based on the damage award, asserting that receiving damages does not negate the right to an injunction. They cited case law indicating that a copyright holder is entitled to an injunction when infringement is proven and a threat of continuing infringement exists.

The court rejected Phelps Associates' claim, referencing the Supreme Court's decision in eBay Inc. v. MercExchange, which clarified that injunctive relief is not automatic upon finding copyright infringement. Instead, a plaintiff must demonstrate: (1) irreparable injury, (2) inadequacy of legal remedies, (3) a balance of hardships favoring the injunction, and (4) alignment with public interest. Even with this showing, the decision to grant an injunction lies within the court's equitable discretion. The court then applied these principles to assess Phelps Associates' requests and noted that the request to enjoin the completion of the house was moot, as the house had already been completed.

Phelps Associates seeks a permanent injunction to prevent Galloway from leasing or selling a house they claim is an infringing copy of their copyrighted work. They argue that since the completed house infringes on their copyright, Galloway's potential actions would also infringe their exclusive rights under 17 U.S.C. § 106(3). Phelps Associates contends that damages awarded for past infringement do not preclude future injunctive relief for prospective harm, as future economic injury cannot be reliably quantified. They assert that the potential lease or sale of the infringing house constitutes a separate infringement under the Copyright Act, justifying their claim for ongoing profits from the infringement.

However, the "first sale doctrine" under 17 U.S.C. § 109(a) allows the owner of a lawfully made copy to sell or dispose of it without the copyright holder's permission. Since Galloway's house is deemed an infringing copy that has already been addressed through copyright remedies, he may sell or otherwise dispose of the house after fulfilling any judgment related to its unlawful construction, thereby limiting Phelps Associates' ability to seek further liability.

Phelps Associates argues that the first sale doctrine does not apply because Galloway's house, constructed from a design not "lawfully made," constitutes an infringement for any future lease or sale. They assert that the illegal acquisition and use of the design permanently restricts the house's transferability until they, as copyright holders, relinquish their claim. However, the court's judgment in this case, which awarded damages to Phelps Associates and did not mandate the destruction of the house, effectively legitimizes the copy under § 109(a) of the Copyright Act. The court's ruling means that the house is now considered a lawfully made copy because the illegal nature of its creation has been addressed by the legal remedies provided. 

The document further explains that, similar to how a converter of property gains title after satisfying a conversion judgment, an infringer acquires good title to a physical copy following the resolution of a copyright infringement judgment. This principle extends to situations where a transfer is compelled, such as through a judicial sale. The Second Circuit has confirmed that the first sale doctrine can apply even in involuntary transactions, rejecting the notion that copyrighted goods are exempt from standard legal remedies until a voluntary sale occurs. Legislative history supports that a copy need only be "lawfully made" to qualify under § 109(a), even without explicit authorization from the copyright owner, distinguishing legal copies made under compulsory licensing from infringing copies.

Under the first sale doctrine, an infringer may sell or dispose of any copy not ordered for destruction by the court after satisfying the judgment for infringement, even if the copy was originally pirated. By pursuing an infringement action against Galloway, Phelps Associates effectively transferred its interest in the property in exchange for appropriate remedies under the Copyright Act. Once these remedies are sought and a judgment is issued, the copyright holder loses the right to sell that specific manifestation of their copyright. 

Phelps Associates contends that this interpretation amounts to a judicially-created compulsory license, which is generally disfavored, citing Sony Corp. v. Universal City Studios. However, the use of Sony is argued to be inappropriate; the remedies under the Copyright Act are broader than mere license payments, entitling the copyright holder to actual damages, market price of the license, and disgorgement of the infringer's profits. The infringer also risks the court ordering the destruction or other disposition of the infringing article.

In typical piracy cases, such orders are common. The legal framework ensures that potential infringers are motivated to negotiate with copyright holders, as infringers are stripped of both licensing fees and profits from the infringement. Denying Galloway rights under the first sale doctrine would improperly expand the Copyright Act's remedies in this context. Architectural works, as expressions of copyrighted plans, primarily serve functional purposes, which historically limited their copyright protection. The Architectural Works Copyright Protection Act amended this, but Congress expected that injunctions would not be routinely applied to substantially completed houses that violated architectural copyrights. An injunction would be overly broad, affecting many properties unrelated to the infringement.

The requested injunction would encompass materials, labor, and features associated with the Galloway house, including the swimming pool and fencing, thereby adopting a punitive nature not supported by the Copyright Act, which does not permit punitive damages (Bucklew v. Hawkins, Ash, Baptie. Co., 329 F.3d 923, 931). The injunction would also challenge the longstanding judicial hesitance to restrict the transferability of real estate (Williams v. First Fed. Sav. Loan Ass'n, 651 F.2d 910). Although Galloway holds clear title to the house, he lacks rights to the design itself, akin to owning a book without the ability to replicate its content (Red Baron-Franklin Park, Inc. v. Taito Corp., 883 F.2d 275). Phelps Associates retains copyright over the design, while the district court denied an injunction for future leasing or sale of the house. 

Phelps Associates argued the court erred in denying injunctive relief for the return or destruction of infringing plans. The district court's equitable discretion was questioned, as it may have categorized its denial without adequate examination of the traditional equitable factors outlined in eBay (eBay, 126 S.Ct. at 1839). The court found that Galloway was "made whole" through a jury award but did not address the issue of the infringing plans or potential future infringements adequately. Although the house is nearly complete, the court failed to consider the risks of further infringement from the plans, leading to the conclusion that the district court did not fulfill its equitable duties. Consequently, while the jury's verdict and the refusal to enjoin future leasing or sale of the house are affirmed, the request for injunctive relief concerning the plans is remanded for reconsideration. The order is affirmed in part, vacated in part, and remanded.