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(Reuters) - In a major lawsuit testing the legitimacy of music downloads, Capitol Records LLC has won a court ruling that the start-up ReDigi Inc has infringed its music copyrights.
U.S. District Judge Richard Sullivan in Manhattan said ReDigi was not authorized to allow listeners to use its platform to buy and sell "used" digital music tracks originally bought from Apple Inc's iTunes website.
The decision made public on Monday is a blow to early efforts to create online marketplaces for used digital goods, akin to how used books, for example, might be sold in stores.
It is also a victory for Capitol, a Vivendi SA unit that had sued ReDigi in January 2012 to protect its copyrights on works by artists like Beastie Boys, Coldplay, Norah Jones, Lady Antebellum and Katy Perry.
"This will profoundly affect the economics of any digital re-sale marketplace," by limiting what can be sold as "used" or forcing sellers to obtain copyright holders' approval before transacting business, said Bill Rosenblatt, president of consulting firm GiantSteps Media Technology Strategies.
According to Nielsen SoundScan, which tracks sales of recorded music, digital music sales accounted for 55.9 percent of U.S. music sales in 2012, after surpassing physical purchases for the first time in the prior year.
ReDigi did not immediately respond to a request for comment. Lawyers for both companies did not immediately respond to similar requests.
Sullivan said some open issues remain over Capitol's performance and display rights, as well as damages and injunctive relief that could result in ReDigi being shut down. He directed both companies to advise in writing by April 12 on the next steps in the case.
Created by technology entrepreneur John Ossenmacher and Massachusetts Institute of Technology Professor Larry Rudolph, ReDigi was launched in October 2011, and calls itself "the world's first pre-owned digital marketplace."
The platform allows listeners to swap music tracks at a fraction of the cost of buying them on iTunes. ReDigi makes money from fees on each transaction.
Capitol complained that the platform allowed the unauthorized reproduction and distribution of its music, including through the streaming of 30-second clips. It sought damages of $150,000 per infringement.
In February 2012, Sullivan denied Capitol a preliminary injunction to shut down the service, saying the label failed to show irreparable harm.
But in his new decision, which is dated March 30, Sullivan said ReDigi's service "infringes Capitol's reproduction rights under any description of the technology," and does not deserve protection under the theory of fair use.
"ReDigi facilitates and profits from the sale of copyrighted commercial recordings, transferred in their entirety, with a likely detrimental impact on the primary market for these goods," Sullivan wrote. "It is beside the point that the original phonorecord no longer exists. It matters only that a new phonorecord has been created."
Sullivan also said ReDigi was not protected by the "first sale" doctrine, which lets people buy and sell copyrighted works after the creators first put them into the marketplace.
He distinguished the case from a March 19 U.S. Supreme Court decision, in Kirtsaeng v. John Wiley & Sons Inc, that said U.S. copyright holders cannot block products they make elsewhere from being resold in the United States.
To sell music bought from iTunes on ReDigi, a user "must produce a new phonorecord on the ReDigi server," Sullivan wrote. "Because it is therefore impossible for the user to sell her 'particular' phonorecord on ReDigi, the first sale statute cannot provide a defense."
E-books, MP3 songs and digital videos bought from iTunes or Amazon.com Inc are effectively rentals, which means they cannot be re-sold once used.
Earlier this year, Amazon was awarded a patent for an online mechanism to allow customers to sell or transfer digital goods. Apple has applied for a patent covering a similar system.
Joe Wikert, general manager and publisher at O'Reilly Media, Inc., described the Capitol Records ruling as "not a good first step" in the development of marketplaces for used digital goods.
"Both Amazon and Apple have been working on patents, which are insurance policies for both of them in my view." Wikert added. "They have been sitting on the sidelines watching the ReDigi case."
Asking all copyright holders for permission to re-sell digital content would be "impractical for all intents and purposes," he said.
The ruling was disappointing because ReDigi planned to give a cut of proceeds from re-sales to copyright holders and the firm was escrowing money for record labels from digital music transactions that had already happened on its nascent service, Wikert explained.
The case is Capitol Records LLC v. ReDigi Inc, U.S. District Court, Southern District of New York, No. 12-00095.
Reporting by Jonathan Stempel in New York and Alistair Barr in San Francisco; Editing by Grant McCool