In all fairness, you'd have to expect this kind of follow up from a copyright troll - they are not going to just stop at one letter, and each letter is going to get progressively more threatening - that's the way these things go, whether it's copyright or parking notices.
Of all the cases they refer to, how many involved embedded (hotlinked) images? If you consult with a lawyer, make sure they fully understand the technical issues here - the fact that the image itself was never stored on your server, it was embedded using HTML (by a third party, not you). Again, make sure they understand the concept of embedding. You are not making a 'copy' of the image, your member was merely using HTML to point to an image stored on a different server.
To my knowledge, these is no court in the world that that said this is copyright infringement. If such case law existed, you'd expect most forums would have disabled image embedding by now and the lawsuits would be crushing the courts.
They then write that in my response to their letter I confirmed that the images did indeed appear on my website and that I removed them. However, since I state that as I did not upload the infringing images myself nor did they have a physical presence on my server that I am not liable. They then write that they intend to rely on Case C-324/09
The link is incorrect, [this appears to be the correct one. Talk about tenuous. That case is about ebay sellers engaging in trademark infringement (not copyright infringement) and ebay's potential liability in indirectly assisting with it . It's a completely different issue to hotlinking. At most that case might be used to argue against secondary liability, however my reading of that is that the court felt it only applied under very strict circumstances, particularly where it seemed ebay was not acting to resolve the issue quick enough and where Ebay were also actively marketing these auctions via Google ads. [URL="http://jiplp.blogspot.co.uk/2011/08/loreal-v-ebay-warning-to-online.html"]This site explains it further](http://curia.europa.eu/juris/document/document.jsf?text=&docid=113346&pageIndex=0&doclang=en&mode=req&dir=&occ=first&part=1&cid=25181). It also appears that this is a general EU ruling, not UK law.
IMO even to the secondary liability issue, this case has zero relevance to your example. They are clearly (IMO) ignoring the hotlinking aspect here, which quite frankly is ultimately the most critical aspect! That case is not about hotlinking whatsoever. I wonder if they can be so quick to point you to UK case law that covers hotlinking?
Did they include the actual URL to the image itself, or are they just referring to the URL on your site that was hotlinking to it? Personally I would start using that actual image URL in all my correspondence to underline the fact that the image was NOT hosted on my server.
Clearly any alleged infringement is occurring on the image host web site. It is them who should be at the receiving end of this, not you.
Seriously, IMO this is pure and utter trolling. The problem is the more you communicate with them, the more likely you end up saying something they can twist and use against you.
Talk to a lawyer if you wish as he can send them a letter giving them the finger, but it's a shame as these guys just cost you £200 to have that letter drafted. I would also point out that it is unlikely to end there, they'll carry on threatening as it costs them nothing to send these letters to you and there's currently no law against this type of extortion. You can also be sure that there's many other people receiving the EXACT same letters. They no doubt have an entire series of letters already written. It's a business model. No doubt the next letter will be offering you a 'deal' where they kindly offer you a reduced rate to make this all go away. Sound familiar?
Personally I would send them back a letter quick-sharp re-iterating that the image was not stored on your server. Explain the concept of embedding/hotlinking and how unbeknownst to you, a member of your site hotlinked to the image being hosted on a different server. Give them the actual url of the image. Point out that the case law they pointed to does not discuss HTML hotlinking. Point out that the moment you were made aware of the hotlink you, as a courtesy, immediately deleted the HTML embedding code.
However, that's me, I have a strong interest in copyright law and I would word it very carefully, but I am unfortunately not a lawyer, so to be safe you should probably talk to one. IMO this is the kind of case that the EFF would be interested in, in which case you would probably get free representation from one of their UK affiliate members. Because if the trolls did somehow manage to get some kind of judgement on this in a UK Court, it could have consequences across the EU - i,e. all user generated content sites would have to disable embedding immediately.
But I will eat my foot if this ever ends up in court - the issue for the trolls is that if a UK court were to throw it out (which they should), that's the end of the business model, so these things never go to court unless they can find someone who they know 100% for sure will not turn up to court (hence they get a default judgement, which is fairly empty when it comes legal precedents, but does however make their threatening letters look 10 times more scary - 'look, we took this sap to court and we won'. They rely on the uncertainty factor - 'will I be the first one they sue?'.
Some links that may be of interest: