From what I understand, the actual process of fair use boils down to "the judge decides in his/her gut if the use is fair, and then writes up the analysis to justify coming to that conclusion." If you look at the recent SCOTUS opinion in Google v Oracle, you can see how two judges can look at the same facts and come to almost diametrically opposed fair use analyses. My further understanding is that generally the #1 overriding concern in fair use analysis is money, which means you're more likely to see analysis along Thomas's dissent than Breyer's opinion.
In this case, let me give a fair use analysis that is going to suggest that this isn't fair. Factor 1 weighs against fair use: it's not transformative because, well, transformative is extremely narrowly interpreted against fair use. Factor 2 weighs against fair use because, well, it's factor 2 and it weighs against fair use unless the underlying copyright was paper-thin in the first place. In factor 3, it's weighing against fair use because it's not copying the minimal amount of the original work to get what it needs (it copied the watermark after all!). And factor 4 of course weighs against fair use because you're essentially creating stock images which is naturally in the exact same market that a stock image provider is in.
If you wanted to write a fair use analysis that finds fair use, you'd argue instead that the work was transformative, and the amount copied also weighs in favor of fair use (thus converting factors 1 and 3 to weigh in favor of fair use). You might try to argue that it's a completely different market, but I'm incredibly skeptical that such an argument could win over both a district court and an appeals court (although Breyer's opinion in Google v Oracle did basically follow this thread of analysis, its repetition is unlikely since everyone wants to pretend that Google v Oracle has 0 impact to anything outside of software). Such an analysis is possible, but unlikely, since the unspoken factor of "could you have paid for this" tends to be the factor that wins out over everything else.
Note that we are going to have a SCOTUS case in the fall that will specifically explore transformative uses in the context of fair use: Warhol v Goldsmith (https://www.scotusblog.com/case-files/cases/andy-warhol-foun...). I'm not going to hold my breath that the use will be found fair, though.
In this case, let me give a fair use analysis that is going to suggest that this isn't fair. Factor 1 weighs against fair use: it's not transformative because, well, transformative is extremely narrowly interpreted against fair use. Factor 2 weighs against fair use because, well, it's factor 2 and it weighs against fair use unless the underlying copyright was paper-thin in the first place. In factor 3, it's weighing against fair use because it's not copying the minimal amount of the original work to get what it needs (it copied the watermark after all!). And factor 4 of course weighs against fair use because you're essentially creating stock images which is naturally in the exact same market that a stock image provider is in.
If you wanted to write a fair use analysis that finds fair use, you'd argue instead that the work was transformative, and the amount copied also weighs in favor of fair use (thus converting factors 1 and 3 to weigh in favor of fair use). You might try to argue that it's a completely different market, but I'm incredibly skeptical that such an argument could win over both a district court and an appeals court (although Breyer's opinion in Google v Oracle did basically follow this thread of analysis, its repetition is unlikely since everyone wants to pretend that Google v Oracle has 0 impact to anything outside of software). Such an analysis is possible, but unlikely, since the unspoken factor of "could you have paid for this" tends to be the factor that wins out over everything else.
Note that we are going to have a SCOTUS case in the fall that will specifically explore transformative uses in the context of fair use: Warhol v Goldsmith (https://www.scotusblog.com/case-files/cases/andy-warhol-foun...). I'm not going to hold my breath that the use will be found fair, though.