There were two huge stories in the Napster saga last week. One was Federal Judge Stephen Wilson's ruling in favor of Streamcast and Grokster — the first big blow against the record labels. The other, in sharp contrast, was the newly filed lawsuit against Napster's main investors (Hummer Winblad and its partners Hank Barry and John Hummer). While the former is hugely important news in the evolution of digital content distribution, the later is of obvious interest to venture investors like me.

In the much-quoted joint statement by Universal and EMI (the two companies that sued Hummer), the labels asserted:

Businesses (as well as those individuals or entities who control them) premised on massive copyright infringement of works created by artists, should face the legal consequences for their actions.

The labels seek $150K in damages per copyright violation, as well as unspecified punitive damages.

The implications of this lawsuit to the investment community are massive. If it is true that investors themselves can be held liable for investing in businesses that are later determined to be premised on some infringing act, such a ruling would truly have a chilling effect. After all, how is copyright infringement different from patent infringement? If Hummer Winblad is liable for investing in Napster, which was later determined to violate the rights of certain copyright holders, what is to keep Intel, for example, from suing investors in any semiconductor company that is later determined to infringe one of Intel’s many seminal semiconductor patents?

The very idea turns the law of corporations on its head. And in so doing it makes for some very conservative investing going forward. Fear alone would greatly extend the patent and copyright monopolies granted by Congress — companies seeking to innovate in areas adjacent to those dominated by established companies would find it difficult to get funding. And innovation would be quelled. I’m no lawyer (I withdrew from the bar several years ago), but I find it hard to believe that any court would allow such an outcome. Venture capitalists and entrepreneurs alike should rally against such strong-arm tactics and call them out for what they are, a blow to technology, innovation and entrepreneurialism.

Update: I received a copy of the complaint and wrote more on this subject in this post.