IP: Gray market goods spell trouble for companies

Two circuit decisions highlight the importance of registering copyrights and trademarks.

For companies selling their products in both the U.S. and in foreign markets, gray market goods may pose numerous challenges. Gray market goods are genuine goods bearing a company’s legitimate trademarks that the company intends for sale outside of the U.S., but that are imported into the U.S. and sold without the company’s authorization. A company may intend a product for sale in a foreign market, rather than the domestic market, for a number of reasons. For example, consumer preferences regarding product formulations and packaging may differ between foreign and domestic markets. Product pricing also may vary in different markets based on differences in the relative wealth of consumers in the foreign and domestic markets. 

Gray market goods pose challenges for companies because, although they are the company’s authentic products, they can cause the company and its brand to lose goodwill when differently constituted products enter the domestic market under the company’s authentic brand. Even when gray market goods are identical to a company’s domestic goods, they may damage a company’s relationships with authorized domestic distributors who may be forced to compete with lower-priced authentic foreign products. Moreover, the company will likely suffer losses in sales volume and profit margins when its authentic products are purchased relatively cheaply overseas and then resold into the domestic market, undercutting the company’s U.S. sales. Indeed, gray marketers generally import gray goods in order to profit from currency variations, tax differences and the manufacturer’s differing product pricing structures in foreign and domestic markets.

Despite these challenges, gray market goods are generally considered legal, as long as they do not differ in any material way from the U.S. version of the producer’s goods. Under certain circumstances, however, a company may institute a trademark or copyright action to obtain relief from gray marketers.

If the gray market product is materially different from the corresponding U.S. version of the product, a trademark cause of action is available. Courts have considered differences in quality control, differences in formulations, alteration of serial numbers, lack of warranty coverage, differences in physical appearance, and non-English labels and instructions, among other things, to be material. When these or other differences that consumers will likely consider relevant are present, a trademark owner may seek exclusion of the gray market goods under Section 42 of the Lanham Act, and the trademark owner or its distributors may obtain injunctive and monetary relief under Sections 32 or 43 of the Lanham Act. 

In contrast, where the gray market product does not differ in any material way from the parallel U.S. product, the Lanham Act provides no relief. In these situations, companies may turn to copyright protections. Specifically, if the product itself, or its packaging, contains copyrightable subject matter, then copyright law is available as an enforcement tool. Importantly, unlike the trademark cause of action, a copyright infringement suit may be brought even when the domestic and the gray market goods are identical.

Companies should note however, that the first-sale doctrine, if applied broadly, could render the copyright laws largely inapplicable to gray market intrusions. Under the first-sale doctrine, once the copyright owner sells a copy of a copyrighted work, the owner loses the right to control that copy, meaning that the purchaser and any later purchasers can resell the item without interference from the copyright owner. Because gray goods are “first sold” by their producer before they find their way into the U.S. via the gray market, the first-sale doctrine could bar most copyright claims against gray marketers. But recent decisions by the 9th and 2nd Circuits, as well as a recent non-decision by the Supreme Court, have constrained the first-sale doctrine, thereby bolstering copyright claims against gray marketers.

For example, in Costco Wholesale Corp. v. Omega, S.A., the 9th Circuit held that the first-sale doctrine does not bar copyright claims when the goods featuring copyrightable subject matter are first sold outside of the U.S. In this case, authentic Omega watches, manufactured in Europe and intended for sale in Paraguay, were imported into the U.S. where they were sold at U.S. Costco outlets for hundreds of dollars less than the prices authorized domestic Omega distributors could offer.  

Price was the only difference between the gray market timepieces from the Paraguay market and their U.S. counterparts. Accordingly, Omega could not allege that the gray market watches were counterfeit because they were authentic Omega products, and Omega could not assert a trademark claim because there were no material differences between the watches from Paraguay and those authorized for U.S. distribution and sale. Omega had a different strategy in mind, focused on copyright law. It incorporated a logo on the back of its watches and then obtained a U.S. copyright registration for the logo. When faced with the influx of gray market watches, Omega argued that Costco was selling watches bearing Omega’s copyrighted logo without Omega’s permission, thereby infringing Omega’s exclusive right to distribute copies of the copyrighted logo under Sections 106 and 602 of the Copyright Act. Costco countered that the first-sale doctrine barred Omega’s claim, because Omega had already consented to the overseas sale of each watch bearing the copyrighted Omega logo, and after the first sale it cannot further control distribution of the watches. 

For the 9th Circuit, the case hinged on the fact that the Omega watches bearing the copyrighted logo were foreign-made copies of a work under U.S. copyright protection. Because Omega’s product bearing the copyrighted logo was made overseas, the first-sale doctrine could not bar Omega’s enforcement of its valid U.S. copyright registration for the logo.  

The Supreme Court granted Costco’s petition for certiorari. The court, with Justice Kagan recused, split 4-4, and for all intents and purposes affirmed the 9th Circuit’s decision while leaving the 9th Circuit’s treatment of the first-sale doctrine non-binding outside of the 9th Circuit.   

On August 15, the 2nd Circuit interpreted the first-sale doctrine in a similar fashion when it affirmed a lower court decision holding that the first-sale doctrine only bars copyright suits when the copyrighted items are manufactured in the U.S. In John Wiley & Sons, Inc. v. Supap Kirtsaeng, the textbook maker John Wiley brought a copyright suit against a foreign national studying in the U.S. The student obtained lower-priced John Wiley textbooks from Wiley’s Asian affiliate and then resold them on eBay for a profit. The 2nd Circuit rejected Kirtsaeng’s reliance on the first-sale doctrine, holding that the first-sale doctrine only applies to copyrighted works physically manufactured in the U.S.

With two recent circuit decisions limiting the application of the first-sale doctrine, and considering the powerful remedies available under copyright law, such as injunctive relief and statutory damages, companies facing gray market problems should carefully evaluate the copyrightable aspects of their products and register their copyrights. If a company’s gray market enforcement program incorporates copyright protections in addition to trademark protections, the company may in some instances successfully counter gray market goods even when the gray market goods are not materially different from the company’s domestic goods. 

Contributing Author

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Christopher Dolan

Christopher Dolan is a shareholder in Brinks Hofer Gilson & Lione’s Chicago office and a member of its Trademark Practice Group. His practice focuses on...

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