The order does not affect the legality of Napster's file-swapping service, which has already been shut down as a result of previous legal decisions. Rather, San Francisco Federal Judge Marilyn Hall Patel's order opens a potential can of worms for the major labels as they seek to push their own Internet music-distribution services.
With Napster charged with copyright infringement by the record industry, the company's attorneys have long sought to make a case that the big record labels invalidated their rights by engaging in copyright "misuse."
Specifically, Napster argued that the labels have sought to impose anti-competitive licensing terms with online rivals even as they have created joint ventures among themselves aimed at tapping the same market.
Friday's decision gave new life to those arguments.
"The evidence now shows that the plaintiffs have licensed their catalogues of works for digital distribution in what could be an overreaching manner," Patel wrote. "The evidence also suggests the plaintiffs' entry into the digital distribution marketplace may run afoul of antitrust laws."
With Friday's ruling, it seems Napster's gamble has paid off. The company has tried to use the threat of a detailed, public look behind the music labels' ordinarily private business practices as leverage in settlement negotiations.
The ruling will have little impact on Napster's immediate operations. But the scales have now tipped substantially back in Napster's favor as the two sides resume negotiations after an unfruitful month of court-sanctioned settlement talks.
"I think the labels would be very unhappy to see any of this come to pass," said Jupiter Media Metrix analyst Aram Sinnreich, who closely follows the online music business. "If anything, this will accelerate their desire to settle things in a more peaceable fashion."
Patel's ruling also marks the end of a run of record-industry court victories that has awarded the industry near total control over the business of online music distribution.
Since the Napster dust-up, the record labels have watched as online music start-ups have been forced out of business while their own joint ventures, MusicNet and Pressplay, have gained prominence.
This legal success provided much of the spark for Patel's decision Friday.
"Even on the undeveloped record before the court, these joint ventures look bad, sound bad and smell bad," Patel wrote, reiterating her comments from late last year. "Even a naif must realize that in forming and operating a joint venture, (the companies) must necessarily meet and discuss pricing and licensing, raising the specter of possible antitrust violation."
Last summer, well after Napster had already closed its doors, the company cut a surprise deal with subscription service MusicNet to gain access to songs from Time Warner Entertainment, BMG Music and EMI Recorded Music. But it later told the court that the terms of that agreement were unfair, because it was barred from negotiating separately for any other major labels' content.
Napster had been making the argument that the labels were acting unfairly for months. But for the first time, the idea stuck. In her decision Friday, Patel made it clear that the labels' online business practices were suspicious, despite their contention that they had not linked hands to shut out rivals.
The record labels argued in court that all of the activity Napster was complaining about was actually taken by MusicNet, not the labels themselves. Record executives involved in MusicNet say they were taken by surprise at the initial deal with Napster, which had been spearheaded by then-MusicNet CEO Rob Glaser, RealNetworks' chief executive.
Glaser "violated our contract," said one label executive associated with MusicNet not long after the Napster deal. "He really screwed up."
Nevertheless, Patel said the labels were responsible for the actions of their joint venture.
"MusicNet did not suddenly appear full-blown from the head of a fictitious entity," she wrote. The labels "can not hide behind the shell of a joint venture to protect themselves from misuse claims. The court views with great suspicion (the labels') claims of ignorance as to MusicNet's activities."
A hearing on the copyright misuse issue in Napster's case has been set for March 27.
"Napster's allegations of misuse are without merit, as the discovery ordered by the court will confirm," said Cary Sherman, general counsel for the Recording Industry Association of America. "We look forward to providing the court with evidence to refute Napster's claims."
Napster General Counsel Jonathan Schwartz said the company was pleased that the court granted Napster's request to "examine two critical issues."
"We will continue to pursue those issues in litigation as we continue amicable settlement and licensing discussions that will benefit consumers and rights holders alike," he said in a statement.
Patel also appointed a "Special Master," or court adviser, to help scrutinize the labels' ownership claims on the songs they say Napster users have stolen.
While Napster isn't saying the labels don't own the music, it is raising questions about how they have accounted for their ownership. Those inquiries head into unwelcome territory for the labels, because they carry the potential of dramatically reducing the length of time labels can own sole copyrights to the works under question.
Analysts, including Sinnreich, expect the two sides to settle more quickly as a result of Patel's order, perhaps well before any results come back from the two new investigations. Napster has repeatedly said it wants to launch its own subscription service--with music from the major labels--before the end of the first quarter of this year. Although that timetable may now be ambitious, the decision should help rekindle negotiations.
But the fact that Patel has opened these doors means that even if the same issues are put aside this time around, they could come up in future file-swapping lawsuits. The labels, along with the big movie studios, are suing Napster successor Streamcast--distributor of the popular Morpheus software--as well as overseas file-swapping companies Kazaa and Grokster.
The Streamcast case will have its first hearing in a Los Angeles federal court March 4.
Napster and, by extension, Patel aren't the first to raise questions about the labels' online business practices.
Digital music start-ups complained about the labels' restrictive licensing practices all the way through the Internet boom. It was too late for many, but last year, the Department of Justice opened its own antitrust investigation into the labels' online dealings. While the investigation appears to be ongoing, no claims or official actions have been filed.
Although some lawmakers have lined up on the labels' side, several legislators are preparing a tilt at the labels' online practices. One bill, sponsored by Virginia Democrat Rich Boucher, would force the labels to allow Internet companies to use music, though the price could still be high.
Some artists have also questioned labels' rights to put their music online. Online distribution rights weren't included in contracts written before the birth of the Internet, and some musicians have challenged the labels' ability to do this without getting new permissions.
On Thursday, rhythm and blues artists who recorded albums dating back to the 1950s scored a victory on this issue when a federal appeals court in New York reinstated a copyright suit against the major record companies over the sale of the artists' works online.