StreamCast recasting for downloading within legal limits.

Don't count StreamCast Networks Inc. out--not yet anyway.

The Woodland Hills-based firm was one of the two online file-sharing networks hit by last week's U.S. Supreme Court ruling in a case pitting movie studios and music labels against online startups that offer free music downloads.

While Hollywood claimed victory after the ruling, which found that StreamCast and Grokster Ltd. may be held liable for allowing consumers to illegally download music and movies, others believe that the file-sharing I companies have a future--if the business models can be tweaked.

"They'll have to find a legitimate scenario for the use of the technology, sharing photos with your friends or access to independent music, where the rights are already given," said Ted Schadler, principal analyst at Forrester Research in Cambridge, Mass. The ruling harkened to earlier court decisions regarding peer-to-peer file sharing companies such as Napster and 321 Studios, which were forced to close after losing in court. (Napster was later resuscitated and now offers paid music downloads.)

StreamCast and Grokster had wanted to avoid Napster's fate through their file-sharing model, which was slightly different. Unlike Napster, StreamCast distributes its Morpheus file-sharing software, but did not store the copyrighted material. That was instead left on users' hard drives.

The case is being sent back to the U.S. District Court in Los Angeles for trial, where one of the key issues will be whether StreamCast induces the users of its Morpheus software to illegally share copyrighted material.

In an opinion written by Justice David Souter, the court called StreamCast's unlawful intent "unmistakable." But StreamCast was in the midst of several changes when the Supreme Court decision was released. It had just launched its newest version of Morpheus and had already begun to market itself as a site with legitimate services.

The software that allows consumers to download songs and other content for free is also a destination for independent artists who want to sell their songs without having to deal with big record companies.

"If anything, the Morpheus version that just came out provides copyright owners with the means to sell and promote or distribute their content to Morpheus and peer-to-peer users," said Michael Weiss, chief executive of StreamCast. "The real winners here would be the independent artists and labels that are embracing peer-to-peer before the big entertainment conglomerates get into it in a large way."

Second act?

In its ruling, the court focused on how StreamCast and Grokster failed to prevent copyright infringement and actually encouraged consumers to illegally download songs through their marketing and advertising.

In particular, StreamCast invited Napster users to its site. The company's internal documents made frequent references to Napster, which was forced to start charging for downloadable music after the 2001 decision by the 9th Circuit Court of Appeals.

"The key issue is whether StreamCast is encouraging consumers, and that rests on advertising," said James Nguyen, partner and co-chairman of the entertainment and media practice of Foley & Lardner LLP.

A venture-backed startup originally founded in Franklin, Tenn., StreamCast has been fighting off the studios' lawsuit since it launched following the demise of the free Napster. By June 2002, StreamCast hired a Nashville entertainment lawyer and the San Francisco firm Brobeck Phleger & Harrison LLP.

Even if StreamCast wins the case in U.S. District Court in Los Angeles, where it originally was tossed out by a federal judge, the studios are expected to appeal, which would drag things out for months or years.

Meantime, legal bills could pile up into the millions as the case enters the particularly costly phase of discovery. "It' s saddled with crippling legal bills as it fights the lawsuit," said Michael Page, a partner at Keker & Van Nest LLP, who represented Grokster in the recent case. "Defending the suit has got to be a big burden."

Weiss said that the company will stay in business but admitted that he is looking for alternative revenue sources. In the next few weeks, he said the company will announce new video games and music to be available on Morpheus for a fee.

He declined to give specifics, but said StreamCast already has deals with some video game publishers and anticipates future deals with independent musicians and artists. "Ninety-eight percent of the musicians out there don't have a major label recording contract," he said. "We make it easier for two users to communicate with one another. There are ways to monetize that."

As to legal costs, Weiss said he expects to come up with the cash, despite admitting "concerns."

"It's unfortunate we can't use more of our cash in development and have to divert it for legal fees. But so be it if that's what we have to do. And we think at the end we will prevail," he said.