Economics of Property Law

Four Topical Areas

• Property• Contracts• Torts• Criminal

Property Law

• How is property defined?• What is the Coase Theorem?• How should property rights be

defined?• When are there opportunities for

bargains?

What is home ownership?• Can you do anything you want

with your home?

Potential Constraints on Use (enjoyment of property)• Government constraints• Lender’s constraints• Other private contractual

constraints• Constraints by neighbors

Nuisance – anything that hinders your ability to enjoy your property

Goals of property law

• Traditional legal analysis.– To explain how human beings exert

their sole ownership over things. – No particular overarching goal except

for legal consistency. – Property is typically viewed as bundle

of rights that attaches to ownership. • The economic goal of property law:

– To foster the efficient use of society’s scarce resources.

Property is a bundle of rights

• They describe what you may or may not do with what you “own.”

• They protect you against trespass, the unauthorized use of your property.

• Rights can change, unexpected changes in rights can erode all rights

• Alternative bundles of rights can affect incentives to use resources efficiently– Rights may be bundled or unbundled

Property is a bundle of rights

• An inalienable right cannot be transferred• A fee simple estate grants the owner of

land the maximum bundle of rights under the law– In some nations the government claims all

mineral rights. In those nations a fee simple estate would not contain mineral rights

– Zoning laws and environmental regulations may reduce the bundle of rights

• Restrictions on an individual’s rights can sometimes increase the value of the bundle when negative rights in a neighbors property are acquired

Possible Reasons for Changes in Property Rights

The existence of property rights depends upon enforcement. The ability to enforce property rights may depend upon changes in:– Law– Technology– Costs– Tastes– Discoveries

Bargain theory

• Voluntary exchange can create a cooperative surplus– Equal to the difference between the

joint value after the exchange and the joint value before the exchange

• Threat values are represented by the non-cooperative solution– Welfare given noncooperation (no

exchange)– The status quo

Social surplus

• Social contract creates a social surplus– Individuals can reduce the resources used to

defend property rights when property rights are enforced by the state

• Societies create property as a legal right to encourage production, discourage theft, and reduce the costs of protecting property.

What is an efficient solution?

• Maximizes joint profits (welfare) given an initial distribution of wealth

• Does not necessarily maximize profits for any individual player

• What is a Pareto Optimum?

Pareto Optimum

• Starts with given wealth distribution• If a value enhancing exchange is

possible, we are not at a Pareto optimum

• Each distribution of wealth has a corresponding Pareto optimum

• Does a Pareto Optimum maximize welfare? (only given the initial distribution)

Coases’ Theorem

• When property rights are well defined

• And transactions costs are zero– What are transactions costs?

• Property finds its way to whoever values it the most by bargaining– Externalities are eliminated– The solution is Pareto efficient when

transactions occur

What are transactions costs?

• The costs of effectuating an exchange or transaction. – Search costs: the costs associated

with finding someone with whom to transact.

– Negotiation costs: the costs of finding a mutually acceptable price, delivery date, and other terms and conditions of the transaction.

– Enforcement costs: the post-bargaining costs of monitoring the transaction and guaranteeing that its terms are kept.

Coase Theorem

• When will parties bargain to an exchange or other transaction? – Under two conditions:

• When transaction costs are low, and • When there is a “cooperative surplus.”

– There is a “cooperative surplus” if the maximum price the buyer is willing to pay is greater than the minimum price the seller is willing to accept.

– If the transaction costs are less than the cooperative surplus, then there is scope for a bargain.

– And if a bargain takes place, both parties are better off. Voluntary exchange is mutually beneficial.

Coase Theorem

• Suppose transactions are too expensive?– Initial distribution may produce inefficient

solution– Property may not find its way to the most

valued user– Legal decision does matter if it affects

transactions costs• How should the property right be determined?

• In these circumstances, the law might help to reduce transaction costs so that the parties can effectuate a transaction that is mutually beneficial.

Profits before legal action

No Filter Filter

No Scrubbers

100 200

1000 1000

Scrubbers300 200

500 500

Laundry

Electric Company

The electric company emits pollutants which negatively impact the laundry.

Joint Profits

No Filter Filter

No Scrubbers

1100 1200

Scrubbers 800 700

Laundry

Electric Company

The efficient solution maximizes joint profits.

Profits before legal action

No Filter Filter

No Scrubbers

100 200

1000 1000

Scrubbers300 200

500 500

Laundry

Electric Company

Rule 2 Damages• Maximum amount E will pay L equals $200

– L’s threat value• Minimum amount L will accept for installing

a filter and avoiding damages equals $100– E’s threat value

• The difference is the cooperative surplus = $100 = $200 - $100– This is also the difference between the non-

cooperative outcome and the most efficient solution

• If transactions costs are greater than $100 there is an inefficient outcome.

Rule 3 Injunction

• The maximum amount that E would willingly pay to avoid an injunction is $500– L’s threat value

• The minimum value that L would accept to avoid exercising the injunction is $100– E’s threat value

• The cooperative surplus is $400 = $500 - $100

• If transactions costs are greater than $400 there is an inefficient outcome.

Legal Rules - Consequences

• With bargaining, the legal rule is irrelevant from an efficiency perspective.

• The legal rule is not irrelevant to the participants. It determines relative wealth.

• Without bargaining the injunction can lead to the worst outcome.– The injunction provides the greatest

incentive for bargains• The example assumes the court can

accurately assess damages.

Why do courts generally require the mitigation of damages?

• Mitigation rule– The victim must reduce damages

when it is efficient to reduce damages.

Liability and Coase

• When transactions costs are high the assignment of liability will affect efficiency.

• When bargaining is not possible, efficiency requires that the right to damages be provided the party who values it the most.

• In the previous example, who values the right the most?

• There may be a possibility for a third non-governmental party to create an efficient solution.– A single buyer purchases the utility and the laundry– The assignment of the property right is reflected in the

use value of the resource.

The Protection of Property Rights

• Legal remedies– Monetary damages

• Equitable remedies– Non-monetary remedies

Damages or Injunction?

• Monetary damages impose a liability rule– Court must determine value of damages

• An injunction imposes a property rule– The parties can bargain for the subject of

the injunction • The impact of the injunction can be privately

modified– An injunction does not have to be enforced– The value of the damage is determined by

the bargaining parties, not the courts.

Damages or Injunction?

• If transactions costs are high, the more efficient remedy is damages when the parties do not achieve a bargain.• An injunction could result in the most inefficient solution

when there were no bargaining

• With damages there is a choice between damages or abatement– Polluter can efficiently decide whether to pay

damages or abate– Damages may produce an inefficient result if the

court cannot accurately assess damages

Damages or Injunction?

• When transactions costs are low and it is difficult to assign a monetary value to damages, an injunction may be more efficient.– The parties can determine relevant

values

When are transactions costs likely to be high?• When agreement is required

among many parties.• When it is difficult to determine the

source of the externality.• When the parties find it difficult to

place a value on the damages.

Remedies for harmful externalities

• In the law a harmful externality is termed a nuisance– It hinders your right to enjoy your property.

• Should damages or injunctions be the preferred method of dealing with public nuisances (a public nuisance offends the public at large)?– Transactions in public externalities are costly

• What does the Coase theorem suggest?

• Injunctions have been the traditional method for dealing with a public nuisance.

Boomer v. Atlantic Cement Company

(NY 1970)Damages or injunction?• A cement plant emits pollutants affecting the

surrounding neighbors. Is the negative externality caused by the factory or by the presence of the residents? The pollution is a nuisance (A nuisance reduces my ability to enjoy my property). However, the cost to the neighboring properties is small compared to the financial impact from eliminating the emissions. – There are many homeowners. Is it likely a bargain could

be struck?• Should the court award an injunction or

monetary damages? Are there economic reasons for preferring monetary damages more than an injunction? Previous case law indicates that an injunction would be warranted. – Investment in the plant is in excess of $45,000,000.

There are over 300 people employed there. Estimate of cost to homeowners was $185,000.

– There was a significant disparity in the economic consequences of equitable relief (an injunction).

– Who values the right the most?

Boomer v. Atlantic Cement Company (NY 1970)

• What would happen if the court issued an injunction?

• What would happen if the court did nothing?

• What would happen if the court required damages? How do you measure permanent damages, the right to permanently damage the plaintiff?

Possible Damage Standards

• Diminution in market value• Voluntary price at which the

plaintiff would sell the right to pollute.

Boomer v. Atlantic Cement Company (1970)

• The court considers two alternatives– Grant the injunction but postpone its effect to a

specified future date to provide an opportunity for technical advances to permit defendant to eliminate the nuisance

– Grant the injunction conditioned on the payment of permanent damages to plaintiffs which would compensate them for the total economic loss to their property present and future caused by defendant's operations.

• The court selects the second option– Trial court found for plaintiffs but refused to issue

an injunction against the Cement Co. – Instead, trial court awarded $185,000 in

permanent damages to all plaintiffs together. – Court of Appeals (through Judge Bergan) fears that

issuing an injunction will lead to loss of 300 jobs and $45 million of capital invested in the plant.

Spur Industries v. Del Webb (Ariz. 1972)

This was previously an agricultural area with numerous feedlots owned by Spur. Because of the relatively low price of land in the region, several tracts in the surrounding area were purchased and a residential development, Sun City, was built. The development grew and the odors from the feedlots made it impossible to sell nearby homes. Del Webb, the developer, complained that the odors made the feedlots a public nuisance. The court agrees with the plaintiff that the feedlots are both a private and public nuisance.

Should the operation of the feedlots be enjoined or should damages be awarded? Who should pay the damages?

Coming to a Nuisance DoctrineIn the so-called �coming to the nuisance� cases, the courts have held that the

residential landowner may not have relief if he knowingly came into a neighborhood reserved for industrial or agricultural endeavors and has been damaged thereby. …�People employed in a city who build their homes in suburban areas of the county beyond the limits of a city and zoning regulations do so for a reason. Some do so to avoid the high taxation rate imposed by cities, or to avoid special assessments for street, sewer and water projects. They usually build on improved or hard surface highways, which have been built either at state or county expense and thereby avoid special assessments for these improvements. It may be the case that they desire to get away from the congestion of traffic, smoke, noise, foul air and the many other annoyances of city life. But with all these advantages in going beyond the area which is zoned and restricted to protect them in their homes, they must be prepared to take disadvantages.�

Were Webb the only party injured, we would feel justified in holding that the doctrine of �coming to the nuisance� would have been a bar to the relief asked by Webb, and, on the other hand, had Spur located the feedlot near the outskirts of a city and had the city grown toward the feedlot, Spur would have to suffer the cost of abating the nuisance as to those people locating within the growth pattern of the expanding city. �

There was no indication in the instant case at the time Spur and its predecessors located in western Maricopa County that a new city would spring up, full-blown, alongside the feeding operation and that the developer of that city would ask the court to order Spur to move because of the new city. Spur is required to move not because of any wrongdoing on the part of Spur, but because of a proper and legitimate regard of the courts for the rights and interests of the public.

Spur Industries v. Del Webb (Ariz. 1972)

• Court holds that Webb is entitled to a permanent injunction because of the large number of people involved (this is a public nuisance, not just a private nuisance).

• The court decides that Del Webb is entitled to the injunctions, but that Del Webb must pay Spur for the relocation costs– “[it] does not seem harsh to require a developer, who

has taken advantage of the lower land values in a rural area as well as the availability of large tracts of land on which to build and develop a new town or city in the area, to indemnify those who are forced to leave as a result. … Webb must indemnify Spur for a reasonable amount of the cost of moving or shutting down.”

Fontainebleau v. Eden Roc(Fl. 1959) A private nuisance

• Fontainebleau Hotel was constructing a tower that would cast a shadow over the pool at the Eden Roc Hotel. Did the Fontainebleau have the right to extend the height of its hotel or did the Eden Roc have the right to the sunshine the added floors would block? An efficient solution to this problem will depend on first defining who owns what. How will the court define property rights in this case? Does it matter? According to Coase, with respect to efficiency the initial distribution of rights may not matter. It only matters subsequent exchanges of right are prohibited by the market.

• What are the potential private bargains?

Fontainebleau v. Eden Roc(Fl. 1959) A private nuisance

• Eden Roc constructed in 1955, a year after the Fontainebleau

• The decision mentions the English rule of “ancient lights.” This light entitlement was defined in the English Prescription Act of 1832. The rule states that if you have had an unobstructed view of the sun from your window for the last 20 years, then you have a right to that light. The light from your window is an “ancient light.”Courts in this country have not upheld this rule.

• The court decides there is no legal right to the free flow of light and air from the adjoining land.– Does this decision have any impact on property values?– How does this decision impact on the market for solar easements?

How would we expect the solar rights to be allocated? Shade Trees or Solar Panels

The Tower

Eden Roc’s New Tower

The AIDS Home – Other Considerations

• Supposed the AIDS home owned the surrounding property

• Injunction with moving cost constraint

• Efficient solution will reveal itself through costless negotiations

Hicks-Kaldor Efficiency

• Provides the rationale for benefit-cost analysis used by government agencies

• Those who gain are willing to fully compensate the losers and losers are unwilling to deter the gainers with bribes– Gainers can gain consent of the losers– Losers cannot deter gainers with bribes

• Actual payments need not occur

Hicks-Kaldor Standards

Kaldor Gainers willing to pay the minimum needed to get consent from the losers for use (losers have the property right)

Hicks Gainers not willing to accept the maximum amount the losers would pay to avoid use (gainers have property right)

Suppose the government plans to build a highway that will benefit some residents and harm others. If it is Hicks-Kaldor efficient then

• Those who benefit from the highway would be willing to pay the losers for their consent to build the highway

• (losers have right)• Those who will benefit from the highway are unwilling to

accept a payment from those who are harmed not to build the highway.

• (gainers have right)

Kaldor Hicks Example

• Assume the highway would generate $10 million in benefits for the wider community and $7 million in reduced property values for the surrounding residents. – If the property right belonged to the

surrounding residents they should be willing to sell their consent for anything above $7 million.

– If the property right belonged to the wider community they would not accept less than $10 million to forgo building the highway.

How is Hicks-Kaldor efficiency different from Pareto efficiency?

• It assumes that regardless of the initial distribution of rights, the project would be built if bargains occurred.– The income effect does not change the

result– However rights (wealth) are distributed

you get the same result• No bargains actually occur. No side

payments are made.– One side ends up worse off.

Zoning Regulations

• Attempt to create complementary use rather than substitute use

• Generate widespread communal benefits that outweigh cost (Reciprocity of advantage)– Assumes that private bargaining would not occur

because of high transactions costs• Economic rationale is based on scale of

coordination• May be used to benefit the haves at the

expense of the have nots.

Euclid v. Ambler 1926• Supreme Court case on validity of local police

power for zoning• Euclid was a small commuter suburb that

wanted to forestall encroachment of Cleveland’s industry

• Ambler owned real estate, mostly zoned industrial/commercial, but some was zoned residential. The zoning reduced the value of its property.

• Ambler claimed a taking without due process.• Court upheld city’s right to zone based on two

criteria: legitimate public interest and due process

Fifth Amendment

No person shall be held to answer for a capital, or otherwise infamous crime, unless on presentment or indictment of a Grand Jury, except in cases arising in the land or naval forces, or in the Militia, when in actual service in time of War or public danger; nor shall any person be subject for the same offense to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.

Penn Central Transportation v. NYC (1978)

• The company was denied the right to build a tower over Penn Station because of its landmark status. The company argued that this was an unconstitutional taking because it eliminated a profitable opportunity

• The majority found that the restriction did not interfere with its ability to earn an adequate return on its investment– The addition would have increased the firm’s profitability– This was not protected by the Fifth Amendment– “the submission that appellants may establish a "taking" simply by

showing that they have been denied the ability to exploit a property interest that they heretofore had believed was available for development is quite simply untenable. …"Taking" jurisprudence does not divide a single parcel into discrete segments and attempt to determine whether rights in a particular segment have been entirely abrogated. In deciding whether a particular governmental action has effected a taking, this Court focuses rather both on the character of the action and on the nature and extent of the interference with rights in the  parcel as a whole -- here, the city tax block designated as the "landmark site.“

Minority Disagrees• Only in the most superficial sense of the word can this

case be said to involve "zoning." Typical zoning restrictions may, it is true, so limit the prospective uses of a piece of property as to diminish the value of that property in the abstract because it may not be used for the forbidden purposes. But any such abstract decrease in value will more than likely be at least partially offset by an increase in value which flows from similar restrictions as to use on neighboring properties. All property owners in a designated area are placed under the same restrictions, not only for the benefit of the municipality as a whole but also for the common benefit of one another. In the words of Mr. Justice Holmes, speaking for the Court in Pennsylvania Coal Co. v. Mahon, … (1922), there is "an average reciprocity of advantage."

The minority disagreed

• Zoning regulations typically provide reciprocal benefits– The costs of landmark preservation are largely borne by the owner of

the historical site. – “Where a relatively few individual buildings, all separated from one

another, are singled out and treated differently from surrounding buildings, no such reciprocity exists. “

• Does a reasonable return depend on the value of the property and does the value of the property depend on its potential uses?– the landmark regulation permitted the same use as had been made of

the Terminal for more than half a century– “Difficult conceptual and legal problems are posed by a rule that a

taking only occurs where the property owner is denied all reasonable return on his property. Not only must the Court define "reasonable return" for a variety of types of property (farmlands, residential properties, commercial and industrial areas), but the Court must define the particular property unit that should be examined. For example, in this case, if appellees are viewed as having restricted Penn Central's use of its "air rights," all return has been denied.”

Penn Central Air Rights

• Penn Central’s air rights could be sold to surrounding buildings

• Those who purchased the rights could build beyond current height restrictions

Hispanic Homebuyers (2002)• Hispanic homebuyers have been moving suburban areas• Some can only afford the homes by renting out rooms

– “Then the Trimbles discovered how Mr. Deanda was paying the mortgage for the small two-family house. Downstairs was Mr. Deanda's immediate family of four. The two-bedroom flat upstairs housed his mother, two brothers, a sister and sister-in-law. Five men Mr. Deanda said were his nephews moved into the basement. Though zoned for six people, the home contained 14.”

• This has benefited sales agents, mortgage companies and banks and has also boosted home prices.

• In response the Virginia legislature passed a bill banning sleeping in any room except bedrooms but was subsequently withdrawn.

• Chicago suburb reduced the number of unrelated individuals who can live in a home.– Inspectors conduct predawn raids.

• "If I'm going to sink $30,000 into my house, I want to know my neighborhood is going to stay nice,” says Sheri Buttstadt, who is renovating her house in one of Elgin's reviving historic neighborhoods. "If you can barely afford the mortgage, you don't have money to fix the roof or the screen door."

Hispanic Homebuyers (2002)

• Can this problem be explained in terms of property rights?– Are immigrant homeowners

appropriating rights that are not theirs?

• Can it be analyzed in terms of Coasian bargains?

Would you pay a sex offender to move?• Related story:

Would You Pay a Sex Offender to Move?

• Residents Decide Not To Help Sex Offender Move Out

Fifth Amendment

No person shall be held to answer for a capital, or otherwise infamous crime, unless on presentment or indictment of a Grand Jury, except in cases arising in the land or naval forces, or in the Militia, when in actual service in time of War or public danger; nor shall any person be subject for the same offense to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.

Eminent Domain and Takings - the right of the state to take private property for public use

• Should the government have the right to take property?• Fifth Amendment and Eminent Domain

– “nor shall private property be taken for public use, without just compensation”

• Why finance the government by taxes rather than takings?– Broad based taxes create fewer market distortions

• What is a public use?– Should eminent domain be used to transfer properties to the

University of Dayton?– What about a shopping mall that removes a blighted area and

increases the communities tax base?– What are the problems associated with transferring property

for private use?• What is just compensation?

– Market value or subjective value?– Value to the private owner– Value to the government– Should the private owner be denied the cooperative surplus?

Eminent Domain and Takings

• Possible reasons for eminent domain– Holdouts (high transactions costs)– Insider trading

• Compare two methods of compensation – Market value plus the cost of relocation– Property owners asses their own property

value. Property owners agree to pay taxes based upon self-assessed value. If the government takes the property, it pays self assessed value as just compensation.

Kelo v. City of New London (SC 2005)

• Kelo’s property was condemned for economic development and would receive just compensation

• The property will be transferred for private use development project

• The development will benefit the community• “Promoting economic development is a

traditional and long accepted function of government. There is, moreover, no principled way of distinguishing economic development from the other public purposes that we have recognized.”

Stop the Beach Renourishment v. Florida Dep't of Environmental Protection, et al. (to be decided by SC 2010)

• State intends to create beachfront which would be a public beach

• Homeowners would be deprived of beach front property

• Is this a taking without just compensation?

• SC unanimously rejects takings claim– The landowners had no right to the

submerged land– The state held the common law right to

restore the shoreline

Compensation for takings in public and quasi-public use

• Public use– Market value plus relocation– Moves property from less values private use to more

highly valued public use– Public appropriates the entire cooperative surplus

• Quasi-public use – public takings conveyed to private use- What price should be set on the transferred property?– Pre-condemned market value transfers entire

cooperative surplus to private developer– Post-condemned market value allows state to

appropriate cooperative surplus• Surplus could be shared with initial owners

Takings

• Do takings reduce all property values because they increase uncertainty?

• When is this right efficiently exercised?– Moves resource to more highly valued use

• Should just compensation include subjective value?

Regulatory Takings

• Partial takings– Examples, wetlands, zoning

• Regulations typically do not require compensation

Lake Tahoe (2002)

Can government regulations result in a compensable taking?• Many people purchased undeveloped lots with expectation

of development on Lake Tahoe• Government imposed restrictions on development while

planning studies were undertaken• Landowners claimed that they were deprived of using their

property (6 year delay)– Is this a partial or a total taking? Is the right to development a

separate right?– How would you calculate this loss?

• SC: "A rule that required compensation for every delay in the use of property would render routine government processes prohibitively expensive or encourage hasty decision making.…Such an important change in the law should be the product of legislative rule making rather than adjudication.”– The land will recover value when the prohibition is lifted.

Rights in Intellectual PropertyEconomic Characteristics

• High fixed cost – Most costs are upfront

• Low variable cost– Mainly distribution costs

• Short-run cost approaches zero– Marginal cost pricing would

encourage efficient use, but deter investment

Government intervention may take three different forms

• Government supply of information• Government subsidization of private

provision– Research funds– Prizes (Longitude Prize, McCain’s

proposed green battery prize)• The creation of private property

rights in information

Private Rights in Intellectual Property

• Patents• Copyrights• Trademarks

“the Congress shall have power to promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective writings and discovery”–US Constitution, Article I, Sec. 8

Patents• Must be ‘non-obvious” and have practical utility• 20 year monopoly (previously 17 years)• Defined by duration and breath.

– Duration• time between registration and expiration

– Breath• How similar must another invention be before it infringes on a

patent– Broad patents encourage basic research and

narrow patents encourage development» Broad patent encourages fast research» Narrow patent encourages complementary research

– Law decides this based on the “doctrine of equivalents’ which is unpredictable

» How similar must inventions be before there is patent infringement

What determines optimal duration and breath?

Financing Invention with Patents

• Monopoly profits– Provides incentive for investment– Inefficient provision during the

life of the patent (MB>MC)• Alternatives

– Prizes and awards– Government investment (solar

and wind technology)– Government purchase

Bids for Patents

The Mother-in-Law of Invention:  “The patent system sucks because it over rewards and under rewards. Here's a way to make the system work better.” (Steven Landsburg) 

• Government buys the patent and places it in the public domain– What price?– Auction patent– Based on flip of a coin government pays auction price

• If government wins, it places the patent in the public domain– Third bid price to overcome collusion

Patents on Human Genes

• District Court held that human gene sequences used in genetic testing are not patentable, the Court of Appeals disagreed.

– ASSOCIATION FOR MOLECULAR PATHOLOGY, et at v. UNITED STATES PATENT AND TRADEMARK OFFICE (2010)

– Natural organisms cannot be patented– Man made products from human materials are patentable (insulin)

• Gene Ruling Could Have Wide Implications

Copyrights• Protect original expression

– Written work– Music– Art– Software

• No registration is necessary• It does not protect you from independent creation. This

protection is provided by a patent.• Involves tracing costs for use of work

– Historical photographs– Musical material

• Breath– The uses to which copyright material can be put without

authorization.– Fair use and derivative use

• Duration– Creators life plus 70 years– Corporations have 95 years

Derivative WorkUS Copyright Office Circular 14: Derivative Works notes that:

A typical example of a derivative work received for registration in the Copyright Office is one that is primarily a new work but incorporates some previously published material. This previously published material makes the work a derivative work under the copyright law. To be copyrightable, a derivative work must be different enough from the original to be regarded as a "new work" or must contain a substantial amount of new material. Making minor changes or additions of little substance to a preexisting work will not qualify the work as a new version for copyright purposes. The new material must be original and copyrightable in itself. Titles, short phrases, and format, for example, are not copyrightable.

Derivative Use (Fair Use?)

• Shepard Fairey used an AP photo to produce his Hope Poster• He was sued by AP for violating their copyright• At first he denied using the photo, but finally admitted using

the photo and argued this constituted fair use.• The case was settle with a confidential agreement

Law Professor Weighs In On 'Hope' Squabble

– Professor Lastowka’s four factors to determine fair use

• Purpose and character of use• Transformative or non-transformative

• Effect upon the market• Commercial or non-commercial use• Is the owner harmed?

• Amount used• Significant component

• Nature of the copyright• Artistic or factual

Copyrights and Fine Art

• The copyright does not typically accompany the sale of the work of art

• The artist typically retains the right to make copies.

• The ownership of an original painting, or any other work alone does not give the owner the right to reproduce. When the artwork is sold the artist loses the ownership of the artwork but still keeps the ownership of the copyright.

• The copyright could be sold separately.

Section 202 of the 1976 Copyright Act

Ownership of a copyright, or of any of the exclusive rights under a copyright, is distinct from ownership of any material object in which the work is embodied. Transfer of ownership of any material object, including the copy or phonorecord in which the work is first fixed, does not of itself convey any right in the copyrighted work embodied in the object; nor, in the absence of an agreement, does transfer of ownership of a copyright or of any exclusive rights under a copyright convey property rights in any material object.

Trademarks • Symbols that identify a product.

– Typically a name, word, phrase, logo, symbol, design, image, or a combination of these elements

– Value of the trademark is derived from the value of the product. – You cannot sell the trademark independently of the good to

which it is attached.• Trademarks need not be registered

– Registration of trademarks (U.S. Trademark Office)– It must be tied to a particular product or service– A trademark cannot be a generic name

• Lowers consumer search costs and provides an incentive for producers to provide quality products– Establishes credibility– Consumer confusion is the basic test for infringement

• Trademarks last until abandoned– You must protect your trademark,; otherwise, it becomes part of

the public domain• Examples: aspirin, escalator, thermos, yo-yo and zipper

– Must periodically renew registered trademarks

Examples of Genericized Trademarks

• Aspirin• Escalator• Thermos• Yo-yo• Zipper• Linoleum• Kerosene• Netbook• Trampoline

HELL’S ANGELS MOTORCYCLE CORP. V. VS. WALT DISNEY MOTION PICTURES GROUP, INC., ET AL.March 8, 2006

The complaint filed by the legendary Hell’s Angels Motorcycle Club against Walt Disney, Buena Vista Motion Pictures, and a movie production company, alleging trademark infringement and dilution for developing and producing 'Wild Hogs,' a movie about "[a] group of middle-aged wannabe bikers look[ing] for adventure out on the open road, where they soon encounter a chapter of the Hell’s Angels."

Complaint settled out of court

California Art Royalties Tax

• 5% of the purchase price of any artwork that has appreciated and sells for more than $1,000

• Inalienable right• The tax is a forced unbundling of

future rights from present rights that must be commonly owned.

Capitalized Value

• A Perpetuity never repays principal

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Present Value and Capitalized Value

• The present value of any asset is the capitalized value of expected future returns– These can consistent of consumption

values or investment returns– Anything that reduces expected future

returns will reduce present value• Buy if present value to you exceeds

market price• Sell if present value to you is less than

market price

Boomer v. Atlantic Cement Company (1970)

• Remedy• Grant the injunction conditioned on the payment of

permanent damages to plaintiffs which would compensate them for the total economic loss to their property present and future caused by defendant's operations.

• Right to permanently damage the property of plaintiff will affect future returns

• This should be reflected in present value

Capitalized Value of Finite Stream

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• V1 = price before tax

• V2 = price after tax

• T = V1- V2 = present value of tax

• V2 + T = V1

Can V2 + T ever exceed V1?

- Only if V2 and T are not independent

The Art Market

• Buyers will only purchase if their present value is greater than or equal to the market price

• Sellers will only sell if the sale price is greater than their present value

• For a sale

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How might different discount rates affect size of cooperative surplus?

• Why might discount rates differ?– Income and wealth– Risk profile

• How would this affect the relative valuation of T?

Present Value of Art – Divergent Discount Rates

• Suppose V1-V2 is invested at i, then it will grow to t in the future

• If “i” is the required return of the client, then the client will not pay more than V2.V2 = V1-(V1-V2)

The pre-tax price less the discounted value of the tax and administrative costs

• Suppose the artists has a higher discount rate than the client, then the discounted value of the future tax is worth less to the artist, but the price of the buyer is willing to pay will be discounted by V1-V2.

Does the royalty change the relationship between the artist and the client?

• Regardless of the tax, might it affect the future sales price so that V2 +T is greater than V1?

• Does it create a common interest between the artist and the client in seeing the resale value appreciate?

Does the tax have a differential impact on different groups of artists?– Established versus struggling artists– California versus non-California artists– Active versus in-active artists

Does the tax increase of decrease the production of fine art?

Does it have an impact on the average holding period?

Inalienability by Legal Rules

• The efficiency of a transfer cannot increase by prohibiting it.

• Is there an economic rationale for inalienability?– Cooter and Ulen - “Inalienability rests on conventional

morality and political philosophies that stress values other than Pareto efficiency.”

• Negative impact on those who are not party to the exchange (availability of drugs, guns, liquor, water rights)

• Parties to exchange are incompetent (children cannot sell property)

• Paternalism (the state knows best, liquor)– Might it be an efficient means of controlling a dangerous

product when restrictions on use are ineffective? (drugs)– Might be used to redistribute wealth – restrictions on

death transfers, spendthrift clauses, homesteading– Might permit transfer by superior means (blood)

• Inalienability may not eliminate all economic value in the asset– Owner may still have possession and use value

Andus v. Allard444 U.S. 51 (1979)

Can government restrictions on sale result in a compensable taking?

• Federal acts designed to protect endangered birds made prohibited commercial transactions in particular species

• The regulations did not apply to possession or transportation of parts taken before the acts took effect

• The Supreme Court decided that regulations could extend to prohibiting commercial transactions in birds that were taken before the acts.

• The prohibition of sale does not involve a taking in violation of the Fifth Amendment

Andus v. Allard444 U.S. 51 (1979)

“In the instant case, it is not clear that appellees will be unable to derive economic benefit from the artifacts; for example, they might exhibit the artifacts for an admissions charge. At any rate, loss of future profits -- unaccompanied by any physical property restriction -- provides a slender reed upon which to rest a takings claim. Prediction of profitability is essentially a matter of reasoned speculation that courts are not especially competent to perform. Further, perhaps because of its very uncertainty, the interest in anticipated gains has traditionally been viewed as less compelling than other property-related interests.”

What is a sale?

• I sell you the right to view my bird any way you want over the next 100 years.

• I lease the bird to you for 100 years.• Present value of a $1 perpetuity at

5% is $20.• Present value of a $1 annuity for 100

years at 5% is $19.85.• A 100 year lease would be close to

sale value

Who Owns Your Body Parts?

• Some organs may be transferred by not sold while you are alive

• Who owns your organs after your death?

Colavito v New York Organ Donor Network (New York 2006)

• The wife donated her dead husband’s kidneys to her husband’s life long friend.

• As required by law donation must be made through a donor network.

• Given a series of mishaps Colavito did not receive the kidney and died; one kidney was bad and the other was transplanted into another patient.

• Colavito accused the organ network with conversion (stealing) her property

• They could only be stealing if Mrs. Colavito owned the organs– Did she have a property right in her husband’s organs?

Colavito v New York Organ Donor Network (New York 2006)

• No one can have a property right in a dead body• A next of kin has a right to possess the body for purposes of

burying it, and a corresponding duty to do so (a quasi-property right).

• There may be causes of action for improper autopsy or mutilation• A specified donee has no common law right to the organ• The wife only had quasi-property right in body of donor sufficient

to direct manner of burial, and no monetary value would be assigned to kidney, for public policy reasons.

• This quasi-property right is also a foundation for a close relative's claim of negligent mishandling of a corpse, for which emotional damages are recoverable

• Dilemma– A corpse has zero value, but transplant organs and tissues can be highly

valued– Brothers admit stealing parts from 244 corpses

Colavito v New York Organ Donor Network (New York 2006)

“We begin with an observation. The common law on this subject extends back for centuries while organ donation and transplantation are measured by mere decades. When discussing body parts of deceased persons, it is unlikely that our forbears had in mind that human organs might be transplanted to extend life or improve health.

As the common law developed, body parts were known to have value, not for transplantation, but for the study of medicine and anatomy. A good deal of the law arose out of religious and cultural sensibilities involving grave robbery, desecration of corpses and, later on, unauthorized autopsies.

Unlike other instances in which we consult the common law, this inquiry cannot possibly yield answers with perfect congruity considering the different context in which common law courts have dealt with this subject. Although the case before us is unprecedented, the common law offers enough guidance for us to answer the question confidently”

“These decisions have in common the concept of a decent burial for an undesecrated body. We have been careful about characterizing causes of action that impose liability for violating these sensibilities. In all instances, we have disclaimed any reliance on a theory of property rights in a dead body. Later cases in New York have continued to recognize causes of action for improper autopsy or mutilation but none have strayed meaningfully  from the doctrine that there is no common law property right in a  dead body.”

Moore v. Regents of the University of California(CAL 1991)

• While being treated for leukemia cells to be used in medical research were removed from Moore without his knowledge

• A cell line was patented that produced substantial royalties, $3 billion

• Moore sued claiming conversion (theft)• The Cal. SC found that Moore had no proprietary interest

in the cells– Granting Moore a property right would impede research– Property rights to researchers enhances productivity

• His fiduciary right to be informed may have been breached– Patient should be aware of related commercial interests

• What was the value of the cells at the time of removal and before research?

Moore v. Regents of the University of California(CAL 1991)

• Majority

–  the subject matter of the Regents' patent--the patented cell line and the products derived from it--cannot be Moore's property. This is because the patented cell line is both factually and legally distinct from the cells taken from Moore's body. Federal law permits the patenting of organisms that represent the product of "human ingenuity," but not naturally occurring organisms. 

– we do not purport to hold that excised cells can never be property for any purpose whatsoever, the novelty of Moore's claim demands express consideration of the policies to be served by extending liability

• Dissent

– Although a patient may not retain any legal interest in a body part after its removal when he has properly consented to its removal and use for scientific purposes, it is clear under California law that before a body part is removed it is the patient, rather than his doctor or hospital, who possesses the right to determine the use to which the body part will be put after removal.

– the majority's holding simply bars plaintiff, the source of the cells, from obtaining the benefit of the cells' value, but permits defendants, who allegedly obtained the cells from plaintiff by improper means, to retain and exploit the full economic value of their ill-gotten gains free of their ordinary common law liability for conversion.

Establishment of rights in fugitive property

• Fugitive property– Property with ill-defined boundaries or objects that move

around• Possible rules

– First possession (Finders keepers)• Ease of application• Preemptive investment - Possible overinvestment because of

potential economic rents• Geostationary orbits?

– Tied ownership• Ownership is tied to a complementary right

– Mineral deposits• Principle of accession – Ownership of new thing tied to owner of

proximate or prominent property.• May be costly to administer

Rule of first possession

• Benefits to the investor– Production– Scarcity (appropriation of rents)

• May result in preemptive investment (too much investment)

Tied ownership

• Ties ownership of the fugitive property to an existing ownership right– Right to subsurface deposits follows

surface rights– Discourages preemptive investments

• High administrative costs may deter productive investments

Pierson v. Post (1805)First possession versus tied ownership

• Pierson was engaged in a fox hunt. Foxes were considered a nuisance and the killing of a fox created a social benefit. Post interfered with the hunt by killing the fox and carrying it off. Pierson sued for damages.

• By pursuit, did Post gain a property right in the fox that prevented Pierson from taking the game?

• Does Post who engaged in the expenses of pursuit have the property right in the fox or does Pierson have the right by first possession?

Pierson v. Post (1805)

• How might this decision affect the investment in the exploitation of natural resources?

• How might this decision affect litigation costs?

• Is there a cooperative solution?• The court found for Post.

– It established the right of first possession.

What impact will the Internet have on property rights in musical performances?

Royalty Tax is a Forced Unbundling of Rights

• The market has traditionally transferred the entire bundle of rights at the initial sale.

• Possible reasons why– It satisfies the objectives of buyers and

sellers– The mechanism for dividing present and

future rights is too costly• Does the royalty tax provide a less

costly mechanism for unbundling rights that enhances efficiency?

Unbundling and Takings

• A partial taking may become a total taking when property rights are unbundled

• Any good may be viewed as the sum of its parts– A “good” may be viewed as an efficient package– Compensating only total takings may promote

inefficient unbundling– Specialized rights may be unbundled when it

enhances the total value of the components (the sum of the parts is greater than the whole)

Unbundling of Rights

• Examples of unbundling– Mineral rights unbundled from land rights– Life estate unbundled from a death estate– Common stock and preferred stock– Copyright is separate from the work of art– The right to produce may be unbundled

from the right to pollute• The law may restrict the owner’s

ability to restructure rights– Ex., zoning regulations on lot size

Economics of Unbundling• Allow unbundling when it enhances market

value– Private individuals are in the best position to

determine market value• Problems related to unbundling

– It may increase the future cost of assembling• Assembling residential plots into a commercial park

– It may hinder standardization that impacts third parties by raising cost

• United Shoe Machinery – Antitrust law required unbundling of lease and service may increase cost of lease

– It may hinder the efficient use of the individual components when the uses are antagonistic

• Creates mutually negative externalities

Quarto Mining v. LitmanOhio Supreme Court (1975)

• The coal under the surface lands owned by the defendants was conveyed to Quarto Mining in 1906, along with grants of mining rights, rights of way for the purpose of transporting coal both from the defendants' land and from other lands, and options to purchase the surface land for prices of $100 per acre and $200 per acre for the purpose coal extraction.

• “The essential issue, as it was presented to the trial court, was whether an option, without time limitation, to purchase surface ground necessary for the exercise of mining rights granted incident to the sale of the underlying coal was specifically enforcable, or was void by reason of the rule against perpetuities as a restraint against alienation.”

• The appeals court found the provision void according to the rule against perpetuities. The Ohio Supreme court reverses.

Do the options violate the rule against perpetuities?

– The rule imposes a time limit on property restrictions. Life plus 21. The property must pass unrestricted to the unborn when they are 21 years of age. This is a “generation skipping rule.”

– Doe it create a restriction that prevents the property from being efficiently utilized• Would you invest in the surface?

Options

• An option on real estate grants the holder the power to compel the owner to transfer property

• The option may discourage the owner from improving property and others from buying the property.– A purchase option to buy as part of a

lease does not deter development

Quarto Mining• “The fundamental defect of a perpetual option is

that the right to alienate the property is divided into two roughly equivalent interests, and these interests may be so antagonistic as to effectively prevent the transfer of a fee simple estate.”

• “…the long-term land purchase option which expresses a fixed amount as to  the price to be paid upon its being exercised may possibly bring about a restraint upon the practical power of alienating the optioned land.”

• “A bare option to purchase land which is unlimited as to time is void as an impermissible restraint upon alienation, but an option which is appurtenant to a mineral estate and is limited to the necessary and reasonable use of the overlying surface estate for the exercise of mining rights is a presently vested part of the mineral estate, and is not void as a restraint upon alienation.”

Quarto Mining

– The options are reasonably necessary for mining

– The options increase the value of the package

– Would the option be valid if it were not tied to mineral extraction?

• Why would the private market ever create an unrestrained option?

– Does the buyback provision stated in 1906 dollars prevent the efficient use of the surface?

• The parties could always renegotiate the terms

The Court Changes the Terms of the Contract

The provisions in the Litman deeds required payments of $ 100 and $ 200 per acre for any land conveyed to the grantee. These provisions date from 1906, and the changes in the purchasing power of the dollar, the likelihood of changes in the level of development and value of the property, and the simple fact that almost 70 years have passed since these deeds were written are all factors indicating that the 1906 prices cannot be conclusive. Although those prices might have expressed the intent of the parties at that time, and for a reasonable time thereafter,   it is most unlikely that such prices are at present equitable, in light of widespread economic changes. "Depreciation of the currency or other medium of payment contracted for has frequently been held to justify the court in withholding specific performance, or at least conditioning it upon payment of the actual value of the property contracted for. * * *"

In the instant cases, unless the parties agree on a price for the property to be conveyed, the trial court should condition the granting of specific performance upon the payment of the actual value of the property sought by plaintiff

Subprime Mortgage Crisis

• Does the government engage in a taking if it forces lenders to renegotiate mortgages?

Moral Hazard

• The contract or implied agreement creates incentives for one or both parties to engage in behavior that is contrary to the purpose of the agreement.

Inalienability

• One right in a bundle of rights– Alienation – the right to sell or transfer– Possession– Use– Others

• Prohibition on the sale of rights– Regulation restricts transfers, inalienability prohibits

them• Examples in cases

– Inalienability of labor rights after 7 years– In alienability of tax on sale of artists property

• Other examples– Humans– Human organs– Endangered species– Votes– Gun control– Homesteading

Public Goods

When everybody owns everything, nobody owns anything

Characteristics of Public Goods

• Non-excludable• Indivisible• Non-rivalry in

Consumption• Spillovers• Externalities• Interdependence of

production and consumption

Tragedy of the CommonsGarret Hardin, Science (1968)•Depletion of an open access

resource• Common ownership• Own use ignores the costs imposed on

others• One more animal placed on the common

grazing area enhances the wealth of the owner but decreases the feed for other animals.

•Externalities are public and private

• Private externality• Affects a small number of people

• Public externality• Affects many people• Has the characteristics of a public good

Should private markets be allowed to impose restraints upon alienation?• A restrain upon alienation restricts the buyer on how

he or she may use the good or transfer the dood• Typically, if the original owner restricts future use, it

lowers the present market value– Thus, the original owner pays for the restriction– General assumption that the present owner can most

efficiently decide the most profitable allocation of the resource• Can there be restraints that enhance market value?

– Non-compete clauses– Sale of stock to outsiders– Franchise agreements– Sublets– Resale price maintenance

• Is it possible for the social cost of the private restriction to exceed the private cost?– Example: Restraints that restrict future sales based on race and

religion– Agreement between A and B affects C

Restraints on Alienation

• The general rule is that the part who owns the resource can be determine its value in use

• An existing restraint on alienation can lower value to the present owner

“Rule against perpetuities”

Common law rule imposes a time limit on property restrictions.

Restriction may only last 21 years beyond a life in being

Some jurisdictions have replaced the rule with a 90 year limit.

Prohibiting restrictions on inheritances

• Examples of possible restraints The property may not be sold but must pass

to the oldest male heir in perpetuity. Property may only be used for residential

purposes• Negative result of prohibiting restrictions

– Circumvention – legal costs (Death and gift taxes)– Depletion – an increased incentive to consume

now • Positive result of prohibiting restrictions

– Restrictions cannot prevent the resource from being used in its most valued alternative by future generations

Is the market in information imperfect?

• Information is a public good, characterized by– nonexcludability [implies nonappropriability]– nonrivalry in consumption [implies that appropriating the

value of information is inefficient]• Hard for individuals who have produced information to

appropriate its value– Buyers cannot determine the value until they have it

• Can this explain all the get rich quick programs on TV?

• Information is costly to produce and cheap to transfer– Anyone who receives the information becomes a

potential competitor.– Suppose you had information on current acreage in

soybeans? How would you appropriate the value of that information?

• Sell it?• Use it to speculate.

• Private markets may produce a sub-optimal amount of information.– Undersupply flows from non-appropriability– Oversupply from speculative investments

• Stock brokers don’t share their information and over invest

California Labor Law

• The California Labor Code contains a “Seven-Year Statute” that restricts most service contracts to a maximum of seven years

• Law expressly permits recording contracts that specify a set number of albums

• Recording Artists Coalition (RAC), an organization consisting of several prominent recording artists has mounted a campaign to eliminate the special exemption. The claim recording companies can take advantage of naïve young artist.

• Will this benefit beginning musicians?• How do you define exploitation?

How will eliminating the exemption affect the following?

• New artists• Established artists• Recording companies

– Impact of current contracts– Impact on future contracts

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