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Article: “Gray-Market” Goods Now Less Gray

July 01, 2013
Business Litigation Reports

Companies selling goods internationally frequently seek to maximize their profits by charging different prices in different countries in response to national market conditions. Often, goods sold in the United States can be purchased more cheaply abroad. As a consequence, arbitrageurs attempt to purchase the lower-priced goods abroad and re-sell them in the United States at prices below those demanded by their manufacturers.

There is no law expressly prohibiting the importation of goods made by, or under the authority of, a product’s manufacturer. Manufacturers have, therefore, sought to keep out “gray-market” or “parallel” imports by trying to invoke the protections of laws enacted for other purposes. To that end, many have sought to use the United States Copyright Act. Copyright protection has been claimed not only in the appearance of, and artwork on, product packaging and logos, but also in labels, product inserts, and instructions for use.

Invocation of the copyright laws relied on the premise that the “first sale” doctrine—which allows a person who has purchased a product to re-sell it—does not apply to goods first sold abroad. Rather, Section 602(a)(1) of the Copyright Act provides that the importation into the United States—without the authority of the copyright owner—of copies of works acquired outside the United States “is an infringement of the exclusive right to distribute copies” conferred by Section 106 of the Copyright Act. However, Section 109(a) limits the scope of Section 106. It provides that owners of particular copies “lawfully made under this title” may, “without the authority of the copyright owner, . . . sell or otherwise dispose of the possession of that copy.”

Goods Made for Export and Re-Imported
In Quality King Distributors, Inc. v. L’Anza Research International, Inc., 523 U.S. 135 (1998), the Supreme Court held unanimously that products manufactured in the United States and then exported are subject to the “first sale” doctrine, meaning that the copyright laws cannot be invoked to prevent their importation into the United States. The Quality King court also suggested in dictum that products lawfully manufactured and purchased abroad would not fall within the “first sale” doctrine and, hence, would be infringing under Section 602(a)(1) if imported into the United States:
     If the author of [a] work gives the exclusive United States distribution rights—  
     enforceable under the [Copyright] Act—to the publisher of the United States
     edition and the exclusive British distribution rights to the publisher of the British
     edition, . . . presumably only those [copies] made by the publisher of the United
     States edition would be “lawfully made under this title” within the meaning of §
Id. at 148.

Goods Lawfully Made Abroad
That dictum has now been rejected. In Kirtsaeng v. John Wiley & Sons, 568 U.S. ____, 133 S. Ct. 1351 (2013), Justice Breyer, writing for a six-person majority, concluded that even though copyright laws are national in character, works “lawfully made under this title” include works made abroad for purposes of the “first sale” doctrine.

The case arose after Supap Kirtsaeng, a Thai student who earned mathematics degrees from Cornell and USC, discovered that he could buy his text books far more cheaply in Thailand than in the United States. Following that epiphany, Kirtsaeng imported text books from Thailand and sold them on e-Bay, earning a profit of $1.2 million. Wiley sued and prevailed in both the district court and the Second Circuit.

Justice Breyer’s majority opinion, in which Justices Roberts, Thomas, Alito, Sotomayor and Kagan joined, offered numerous reasons for refusing to apply the Quality King dictum. Several of those reasons were based on admissions made by the Solicitor General, after being given leave to participate in the oral argument. Relying on the Solicitor General’s concession that pirated works made abroad are nonetheless “subject to” the Act, the Supreme Court majority concluded that the Copyright Act is not strictly territorial in its application. The Court later cited further examples: the “display” right conferred by the Copyright Act is not violated by a display in this country of a copyrighted work purchased abroad; there is no violation of the right to “publicly perform” a copyrighted work when a consumer uses a video arcade game manufactured abroad; and Section 110(1) of the Copyright Act is not violated when a teacher performs or displays copyrighted works in the course of face-to-face teaching activities, even if those works were made abroad.

The majority also noted that in Bobbs-Merrill Co. v. Straus, 210 U.S. 339 (1908), the Supreme Court first recognized the “first sale” doctrine. Based on the Solicitor General’s acknowledgment that, “a straightforward application of Bobbs-Merrill” would not prohibit purchasers of authorized copies purchased abroad from asserting the “first sale” defense, the Court held that principles of statutory construction could be applied to construe the current Copyright Act, enacted in 1978, in a manner consistent with earlier law. Justice Breyer buttressed those conclusions with frequent references to legislative history, including “for those who find legislative history useful” a jab at Justice Scalia, who, along with Justice Kennedy, had joined in Justice Ginsburg’s dissenting opinion.

The majority additionally relied on various amicus briefs to enumerate a parade of horribles that could result from adopting the dissenters’ position. Among other potential problems, libraries having imported books in their collections could be sued for infringement, as could be any person selling a foreign-made car that contained software, as all modern cars do. Naturally, the dissent pointed out that those horribles were likely illusory given that it had been generally believed for 15 years that Quality King’s dictum expressed the law yet such suits never materialized.

For their part, the dissenters were persuaded that the manufacturers’ ability to engage in differential pricing should be preserved and that, in enacting the 1976 Act, Congress had intended to “protect copyright owners against the unauthorized importation of low-priced, foreign-made copies of their copyrighted works.”

Limited Application of the Copyright Act
Although Kirtsaeng diminished the role that the copyright laws can play in blocking the importation of lawfully-made products, it did not entirely eliminate the Copyright Act as a source of protection. Section 602(a)(1), for example, still forbids the unauthorized importation of certain copies lawfully made abroad, including books brought into the United States prior to their authorized sale here; copyrighted goods made by a foreign printer who is not the copyright owner; and leased films sent to the United States by foreign film distributors.

Application of the Tariff Act
In some instances, Section 526(e) of the Tariff Act, 19 U.S.C. § 1526(e), can be invoked to prevent the importation of “gray-market” goods. Notwithstanding that in K Mart Corp. v. Cartier, Inc., 486 U.S. 281 (1988), the Supreme Court held that Section 526 should benefit only domestic U.S. trademark owners having no corporate affiliation with the foreign manufacturer, the Third Circuit has held that a U.S. importer that is a wholly owned subsidiary of a foreign manufacturer can invoke Section 526 to bar parallel imports. See Weil Ceramics & Glass, Inc. v. Dash, 878 F.2d 659 (3d Cir. 1989). Further, the Fifth Circuit has held that even if a foreign manufacturer and the U.S. trademark owner maintain a close business relationship, the U.S. trademark owner may nonetheless invoke Section 526 to bar parallel imports. United States v. Eighty-Three Rolex Watches, 992 F.2d 508 (5th Cir.), cert. denied, 510 U.S. 991 (1993). See, also, Vittoria N. Am., L.L.C. v. Euro-Asia Imports Inc., 278 F.3d 1076 (10th Cir. 2001) (evidence of close cooperation did not disqualify U.S. importer and trademark owner from invoking the Tariff Act against a parallel importer).

Application of Lanham Act
Section 42 of Lanham Act, 15 U.S.C. § 1124, may be used to prevent the importation of goods bearing marks or names that infringe a registered trademark under certain circumstances. Some courts have held that Section 42 is violated if the imported goods are materially different from the U.S. goods. Lever Bros. Co. v. United States, 981 F.2d 1330 (D.C. Cir. 1993). Accord, Société Des Produits Nestle, S.A. v. Casa Helvetia, Inc., 982 F.2d 633 (1st Cir. 1992). The Second and Third Circuits, however, have held that Section 42 does not apply to prevent parallel imports. See Weil Ceramics; Olympus Corp. v. United States, 792 F.2d 315 (2d Cir. 1986). Accord, Yamaha Corp. v. ABC Int’l Traders Corp., 703 F. Supp. 1398 (C.D. Cal. 1988). Based on the Lever Bros. case, the U.S. Customs Service amended its regulations to permit U.S. trademark owners, upon application, to restrict the importation of goods that bear genuine trademarks identical to, or substantially indistinguishable from, those appearing on articles authorized for importation by the U.S. trademark owner. To invoke such protection, there must be a likelihood of consumer confusion caused by physical and material differences between the “gray market” articles and those bearing the authorized U.S. trademark. A ban is possible even if, as in Kirtsaeng, the foreign manufacturer is a subsidiary of the U.S. trademark owner, and even if, as in Quality King, the goods are manufactured in the U.S. The Customs Service regulations do, however, provide a significant exception. An importer is not subject to the ban if the goods are labeled in accordance with disclosures prescribed by the Customs Service.

When claims are brought under Sections 32(1)(a), 42, and 43(a) of the Lanham Act, the “material difference” test is used to determine whether the imported goods should be allowed into the marketplace. As the First Circuit held in Nestle, “Liability necessarily turns on the existence vel non of material differences between the products of a sort likely to create consumer confusion.” The Federal Circuit has explained that even small differences can be material if consumers “would be likely to consider the differences between the foreign and domestic products to be significant when purchasing the product.” Gamut Trading Co. v. United States Int’l. Trade Comm’n, 200 F.3d 775 (Fed. Cir. 1999). Even purely esthetic differences have been found to be material because consumer demand is “necessarily subjective or even fanciful.” Martin’s Herend Imports, Inc. v. Diamond & Gem Trading USA Co., 112 F.3d 1296 (5th Cir. 1997). Similarly, failing to offer product labeling in English has been found to be a material difference. See Original Appalachian Artworks, Inc. v. Granada Elecs., Inc., 816 F.2d 68 (2d Cir. 1987). In other instances, material differences between products intended for sale in the United States and products intended for sale abroad have been found when there is inferior warranty protection or inferior post-sale support services for the imported products. See SKF USA Inc. v. Int’l Trade Comm’n, 423 F.3d 1307 (Fed. Cir. 2005); Perkins School for the Blind v. Maxi-Aids, Inc., 274 F. Supp. 2d 319 (E.D.N.Y. 2003).

State Regulations
California, New York, and certain other states require retailers of parallel imports to disclose various types of information to consumers, including product incompatibility with U.S. standards, lack of English language instructions, lack of coverage by the manufacturer’s warranty, incompatibility with U.S. broadcast frequencies, unavailability of replacement parts, and the like. See, e.g., Cal. Civ. Code §§ 1797.8-1797.86; N.Y. Gen. Bus.§ 218-aa. The failure to make all statutorily required disclosures to consumers can result in injunctive relief and monetary penalties.