The court reversed a decision made by the U.S. 9th Circuit Court of Appeals last summer that neither Grokster nor StreamCast Networks could be held liable for the copyright infringing activities of their users. In making that decision, the appeals court sided with claims made by both companies that their software products were no different than videotape recorders and, like VCRS, were capable of both infringing and non-infringing uses.

However, the Supremes disagreed with the appeals court, saying that nothing in the historic Sony Corp. of America v. Universal City Studios Supreme Court ruling of 1984 – which established the legality of VCRs and introduced the public to such concepts as “fair use” and “time-shifting” – made it permissible for companies to encourage copyright infringing activities.

And that seems to be the crux of the biscuit. Not that P2P file sharing has non-infringing uses, but rather that companies may not encourage infringing activity, such as through advertising or marketing.

“The question is under what circumstances the distributor of a product capable of both lawful and unlawful use is liable for acts of copyright infringement by third parties using the product,” Justice David Souter wrote in the court’s opinion. “We hold that one who distributes a device with the object of promoting its use to infringe copyright, as shown by clear expression or other affirmative steps taken to foster infringement, is liable for the resulting acts of infringement by third parties.”

So it’s not the P2P software itself that’s the issue, but how companies advertise and market such software. And there certainly is precedent for such a concept. Liquor companies don’t extol how much of a buzz one gets from consuming their products, nor do gun manufacturers advertise their wares for holding up convenience stores.

But the Supreme Court cited many instances where both StreamCast and Grokster positioned their products as tools to illicitly acquire copyrighted material.

“Grokster and StreamCast are not, however, merely passive recipients of information about infringing use,” Souter wrote. “The record is replete with evidence that from the moment Grokster and StreamCast began to distribute their free software, each one clearly voiced the objective that recipients use it to download copyrighted works, and each took active steps to encourage infringement.”

How did Grokster and StreamCast encourage their users to infringe upon copyrights? The court’s opinion is replete with examples, such as Grokster’s practice of sending its users a newsletter promoting copyrighted material that could be found using the company’s product. Another example cited was StreamCast execs monitoring the number of songs being traded with the intent to have more copyrighted songs available through Morpheus than through competing P2P products.

“In addition to this evidence of express promotion, marketing, and intent to promote further, the business models employed by Grokster and StreamCast confirm that their principle object was use of their software to download copyrighted works,” Souter wrote, explaining that both companies derived income from selling advertising streamed to their users. The more users, the bigger the audience, thus increasing the price of the advertising.

“While there is doubtless some demand for free Shakespeare, the evidence shows that substantive volume is a function of free access to copyrighted work. Users seeking Top 40 songs, for example, or the latest release by Modest Mouse, are certain to be far more numerous than those seeking a free Decameron, and Grokster and StreamCast translated that demand into dollars,” Souter wrote, not only summarizing the issue as the court saw it, but also handing down the hippest Supreme Court decision in history. Modest Mouse?

One of the issues often cited before the Supreme Court issued its decision was that any ruling that favored the entertainment industry would be an impediment against new technology, and that innovation might be stifled if inventors were forced to consider how any new technology might contribute to copyright infringing activities. Although the Supreme Court went to great lengths in its decision to differentiate between what a product was capable of and the intent of the makers of that product, that didn’t stop the Electronic Frontier Foundation from pounding the paranoia drum.

“Today the Supreme Court has unleashed a new era of legal uncertainty on America’s innovators,” EFF’s senior intellectual property attorney, Fred von Lohmann, said in a statement. “The newly announced inducement theory of copyright liability will fuel a new generation of entertainment industry lawsuits against technology companies. Perhaps more important, the threat of legal costs may lead technology companies to modify their prooducts to please Hollywood instead of consumers.”

Needless to say, the entertainment industry embraced the court’s decision.

“Today is a good day for music fans and the 17,000 musicians, composers, artists, engineers, producers and songwriters that are the members of The Recording Academy,” National Academy of Recording Arts & Sciences President Neil Portnow said in a statement. “By unanimously upholding the rights of creators, the Supreme Court has defended an environment for legal online music services to thrive.”

There were similar statements issued by organizations such as ASCAP, BMI, the American Federaton of Musicians, the RIAA and the Recording Artists’ Coalition, in which each organization praised the Supreme Court’s decision while, at the same time, sounded the death knell for P2P companies.

However, the Supreme Court’s decision wasn’t really about whether a company may distribute P2P software or maintain a P2P network as it was about how such software or network may be marketed, and it’s conceivable that a company could run a thriving P2P business without even mentioning the availability of copyrighted material on such a network.

In other words, the Supreme Court’s decision may have placed both Grokster and StreamCast up the proverbial creek without a paddle, but the issue of file-sharing is far from settled.