I did not want to join in this topic but I feel there is a major lack of understand of US copyright (and trademark) laws and as an artist that was also told I was not allowed to sell some of my goods I feel I have to join in. I am going to go over the basics of copyright law as best I can and to the best of my understanding. I am not a lawyer so do not take my word for this. I have done my own research on this topic but that does not mean my understand of it is absolutely correct. Please, do your own research on US laws and correct me if I am wrong. I am going to use the Legend of Zelda and Nintendo for my examples since most people are familiar with it. And I apologize, this is going to be long.
Copyright law allows the original creator of a work to make copies of their work, distribute their work (selling it, giving it away), display their work, and making derivative works. Now this "derivative works" part is where thing get a bit complex.
Nintendo owns the copyright to the Legend of Zelda, this allows them to make more games based on it. This also allows them to make movies, music, plays, poster, t-shirts, jewelery, ect., based on the Legend of Zelda because they own the rights to it. This also means they are the only ones allows to make games, movies, music, plays, posters, t-shirt, jewelry, ect based on it. Under this if you, an random person that is not Nintendo, make a fanart piece for the Legend of Zelda you cannot display it or distribute it in any way. This means you are not allowed to display it (post it online, print it out and tape it to a public wall) or distribute it (sell it, give it away).
So yes, according to copyright law all fanart is illegal if you display or distribute it. Unless you are granted permission from the copyright owners to create, display, and distribute such a work. But there are two loopholes that allow for fanart to be displayed and sold as it is in Artist Alley, parody and fair use. Both of these are in the gray area and if you were to be sued you would have to prove that your work fell under at least one of them.
Parody is when you make fun of something. If you drew Link in a way that made fun of him or the Legend of Zelda games it could be protected by parody. If Nintendo took you to court over this it could come down to if the judge thought it was funny or not. If you drew Link and used him to make fun of something else, that was not Legend of Zelda related, this would not be protected under parody. Parody protects you making fun of the same thing, not using it to make fun of something else.
Fair use is a far more complex. Fair use has four guidelines:
(Copied from US code 107 link: http://www.law.cornell.edu/uscode/text/17/107
(1) the purpose and character of the use, including whether such use is of a commercial nature or is for nonprofit educational purposes;
(2) the nature of the copyrighted work;
(3) the amount and substantiality of the portion used in relation to the copyrighted work as a whole; and
(4) the effect of the use upon the potential market for or value of the copyrighted work.
If we take #1 verbatim fanart is still illegal when you sell it. But more and more it is being interpenetrated as if it was created solely for profit or to provide stimulation of creativity and enrichment of the community. This is because in today's society nothing is free and everyone wants to make a little money off of all of their hard work. So, for #1 fanart should pass as long as it is original fanart.
#2 does not really apply to fanart in the anime/games community since we are dealing mostly with visual media and this has more to do with other types of work. Please read up on it if you are curious.
#3 Is more about using an copyrighted work exactly in another piece. If you took a picture of Link from the cover of the game and then added him to a much larger piece of work would that be allowed? This really depends on what you made and how much of it was original. This really should not apply here because we are dealing with original works with copyrighted characters. Again, please read up on it if you are curious.
#4 This is the other big one, especially for craftsers like me. If you draw Link in your own style how does that drawing effect the market value of the all of the Nintendo made Legend of Zelda merchandise? For prints, not much, because it is your own style which Nintendo is not replicating.
Now, for craftsers, if you make a Link costume how does that effect the market value of the all of the Nintendo made Legend of Zelda merchandise? Again, not a lot because to my knowledge Nintendo does not offer a Link costume for you to purchase.
But if I make a Link plushie how does that effect the market value of the all of the Nintendo made Legend of Zelda merchandise? This one is harder to answer because Nintendo does offer Link plushies. Now your plush might be in a completely different style, for example you make him into an onigiri, you are probably okay. But if you made a plushie similar to the ones Nintendo offers this gets a bit harder to say you have little to no effect on the market value because you are directly competing with them. In general that is what you want to avoid.
Also, parody is still protected here, if I make a Link plushie that would directly compete with the Nintendo made ones but it was making fun of Link or the Legend of Zelda games I would still be fine even though it could/would effect the market value of the other Zelda merchandise.
@Hachimitsu-ink About those Perler bead creations, if the creator of those is distributing them they are no better then someone who traces art work and they are breaking copyright law. They are creating exact replicas of copyrighted images that belong to Nintendo and Capcom. This is a clear violation of copyright law because there is no originality involved in this, there is no style change, no parody, nothing. If they had taken Link from Wind Waker and turned him into a 16-bit pixel art and turned that into a Perler bead creation this would have been fine to sell. This is because they are creating something that Nintendo did not. Also, I know at least east coast conventions banned the Yaoi/Yuri paddles because of con goers being harassed by other over zealous con goers. People would get a smack in the bottom and such, this caused some major problems and the best solution was to ban the paddles. This would not have happened if people would not have hit other people, especially strangers. I know other conventions have had to start looking at banning the high-fiving across opposite direction escalators due to similar problems.
Also, as an east coaster that moved west and I am now attending west coast conventions I can tell you these cons are much more open then the large east coast conventions. Otakon full-out banned all fanart one year, it did not go over well and was removed but harsh restrictions were put in place instead. They have since banned almost all crafts that are not original and you cannot put your fanart on buttons at all. Artist at Otakon are also only allowed 10 prints of each fanart piece and at least half of their artwork must be original. They also require artist mark which pieces are fanart and which are original so that they can check that you are following the rules. All this extra policing has led to a need for more staff members and in turn higher table prices. (I found Fanime's $75 fee to be cheap.) So please, do not blame Fanime staff, they are doing their best and trying to protect us, the artists, as well as themselves.
So, general rules to follow with fanart because I know: tl;dr
1. Use your own style or apply another style (Wind Waker styled Naruto characters)
2. Create something new (do not redraw/recreate official works)
3. Do not directly compete with any official merchandise even if you are creating/recreating it yourself
And everyone please, please, go read up on US copyright law yourself if you are selling in any AA, it is extremely important to know what your rights are and what you can and cannot do.