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It's certainly not illegal. There are free market ways to protect physical books, like what Larry McMurtry did when he was around.
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How did it end up in front of a federal judge?
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The suit was probably brought to shine a light on the practice. It is doubtful the lawyers believed in the case.
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Who pays for that?
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IMO this issue has enough juice to become a thing. I could imagine lawyers wanting to plant their flag on this issue.
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How can this become a thing?
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Maybe not for mass market commercial paperback, but if rare or out of print books are going into the shredder, I can see some laws getting passed about that.
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Why would anyone think that was illegal?