The landmark decision will not affect the right of the entertainment industry to take action against individual file-sharers.
The Ninth Circuit Court of Appeals unanimously threw out the case against Streamcast Networks Inc., the company behind the Morpheus file-sharing software, and Grokster Ltd, saying that, while the companies provide the software used by file-sharers to swap illegally copied digital files, the software can also be used for legitimate purposes.
In the opinion, written by Judge Sidney R Thomas, there was much reference to a 1980s decision on Sony's Betamax video recorder which, at the time, had been accused of infringing TV and movie studios' copyrights. Sony won that case because the machine had significant non-infringing uses.
On this occasion, said the judge, "The technology has numerous other uses, significantly reducing the distribution costs of public domain and permissively shared art and speech, as well as reducing the centralised control of that distribution."
But Grokster and Morpheus could still have been liable if they were found to have been aware of specific infringements and had failed to take action.
"In the context of this case," said the Court, "the software design is of great import."
The design of P2P software has evolved. The first mainstream P2P service, Napster, required users to connect to its servers to identify the files that could be downloaded from another user's home computer, a system known as centralised P2P.
This centralisation was key to Napster being found liable for the illegal use of its software. Ultimately the service was shut down due to the cost of fighting legal battles against the music industry.
But Grokster and Morpheus are decentralised, meaning that once the users have the networking software, they no longer need to connect to the companies' servers to access other users' computers. Accordingly, the companies do not know what files are being exchanged, and cannot stop the network operating or exercise control over user activity.
This means, said the Appeals Court, that they are not responsible for any illegal use their customers make of the software.
The Court was hesitant to extend the scope of copyright law to cope with the new technologies, as the entertainment industry was urging. It warned:
"The introduction of new technology is always disruptive to old markets, and particularly to those copyright owners whose works are sold through well-established distribution mechanisms. History has shown that time and market forces often provide equilibrium in balancing interests, whether the new technology be a player piano, a copier, a tape recorder, a video recorder, a personal computer, a karaoke machine, or an MP3 player. Thus, it is prudent for courts to exercise caution before restructuring liability theories for the purpose of addressing specific market abuses, despite their apparent present magnitude."
StreamCast's lawyer, Fred von Lohmann of the Electronic Frontier Foundation, said:
"Today's ruling will ultimately be viewed as a victory for copyright owners. As the court recognised today, the entertainment industry has been fighting new technologies for a century, only to learn again and again that these new technologies create new markets and opportunities. There is no reason to think that file sharing will be any different."
Neither the RIAA nor the Motion Picture Association of America had commented on the ruling at the time of writing.