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Content cases are always hard for hosting companies. I recently had somone hot linking content from one site to another. The problem really got sticky because both of the the sites were hosted by my company with two different clients.
We offer hotlink protection services, but the customer need to activate it on their domain. We for protection via TOS or AUP, most companies state that if your site content is legal, then you can use it. And copyright need to be proven.
Generally as a rule, we ask the offending customer to remove the image, or copy from their site, but they don't have too. And we as the hosting company do not need to "down" the site unless we get a court order. If we choose to we can.
Again content issues are never say to deal with, and generally should be handled by the law. Dreamhost may have been in the wrong, but they were with in their rights as a hosting provider to do with the client as they wised till a court order was issues.
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