Before the Copyright Act of 1976, creators seeking copyright were required to claim copyright in order to gain and preserve the legal benefit. Sometime after, the law was changed by Congress--all works were automatically copyrighted upon creation. (To the best of my reading, the automatic copyright was retroactively applied to works created between 1976 and 1992.) Kahle, along with Larry Lessig, argued that the change from "opt-in" copyright to "opt-out" copyright was significant enough to require Constitutional review under the 1st Amendment.
The district court and circuit court rejections were written on the basis of the earlier Supreme Court case Eldred v. Ashcroft. In 2002, the Supreme Court rejected the argument that extending copyright to the life of the author plus 70-years was unconstitutional, writing that the law had not changed "the traditional contours of copyright protection."
"The district court dismissed the case in November 2004, ruling that the Supreme Court had already addressed Kahle's arguments in Eldred. On Monday, the Ninth Circuit agreed and upheld the lower court's dismissal. In its opinion, the Ninth Circuit accused the plaintiffs of making "essentially the same argument, in different form, that the Supreme Court rejected in Eldred." Neither court was persuaded by the contention that the switch to an opt-out regime changed the "traditional contours" of copyright law."
Link to arstechnica article
Additional commentary: The Center for Internet and Society, Wired Blog