New Strategies for Grey Market Protection in Wake of Kirtsaeng

In March, the Supreme Court issued its decision in Kirtsaeng v. John Wiley & Sons, Inc., 133 S.Ct. 1351 (2013), where it held that the copyright “first sale” doctrine applies to items manufactured and sold abroad by the copyright owner.

The decision makes it harder for intellectual property owners to control importation of “grey goods” – items manufactured abroad by the owner or its licensees, and then imported into the U.S. to take advantage of better pricing here. However, there remain a number of strategies for controlling such importation and resale.

Kirtsaeng Decision

The facts in Kirtsaeng are illustrative of a typical grey goods scenario. John Wiley & Sons is a publisher of English-language academic textbooks. It obtains the rights to copyright in the text, graphics, etc. from various authors and designers, so it owns all copyrights in the books. U.S. versions are published and sold in this country.

Foreign versions are generally printed, published and sold in Asia. The Asian versions are of lesser quality, and bear a legend that state that their sale is only authorized outside the United States.

Supap Kirtsaeng was a Thai national studying mathematics in U.S. universities. He had relatives and friends purchase Asian versions of John Wiley’s textbooks in Thailand, where they were relatively inexpensive, ship them to the U.S., and then he sold them here at a profit.

The Supreme Court held that John Wiley’s copyright claims were barred by the “first sale doctrine,” which holds that once a copyright owner sells a copy of its protected work, the purchaser is free to resell the copies. Although that doctrine was recognized by the Supreme Court as long ago as 1908 in Bobbs–Merrill Co. v. Straus, 210 U.S. 339 (1908), lower courts struggled with how the doctrine applied in the international context.

Specifically, Section 109(a) of the Copyright Act formulates the first sale doctrine as permitting resale of a copy “lawfully made under this title.” Does that formulation have a geographic component – does it mean, made under U.S. copyright law – or does it only exclude pirated works?

The Supreme Court, overturning Second and Ninth Circuit precedent, held that there is no geographic component to the statute. If the copyright owner authorizes a sale (or manufacture) anywhere in the world, the first sale doctrine attaches, and the new owner is free to resell in the U.S.

Needless to say, the decision makes it much harder for copyright owners to control the flow of grey goods from abroad into the U.S., which, as in the Kirtsaeng case, often implicates efforts to engage in arbitrage of price differentials among different markets.

Trademark Law

One alternative that remains useful for some businesses is trademark law. In fact, John Wiley had also asserted trademark claims against Kirtsaeng, but dismissed them with prejudice after it prevailed on the copyright claims.

Generally, under trademark law, goods produced anywhere in the world under the trademark owner’s authority are genuine and may be imported and sold into the U.S. A notable exception, however, is where the goods abroad are “materially different.”

Consumers in different countries often have different needs, expectations and tastes, and the same model item made under the same trademark might differ abroad to conform to local demands. Where such goods are “materially different” from the U.S. version, their importation and sale in the U.S. infringes the U.S. trademark.

A classic case is Societe des Produits Nestle, S.A. v. Casa Helvetia, Inc., 982 F.2d 633 (1st Cir. 1992). The plaintiff owned trademark rights in the world famous PERUGNIA line of chocolates. Most of the chocolates were manufactured in Italy and distributed from there throughout the world.

In Venezuela, however, a local licensee used the same mark for chocolates; the Venezuelan version had a different, sweeter formulation to suit local tastes and different packaging. The First Circuit held these to be materially different and their sale in the U.S. a trademark violation.

Another classic case is Original Appalachian Artworks, Inc. v. Granada Electronics, Inc., 816 F.2d 68 (2d Cir. 1987). The plaintiff manufactured “Cabbage Patch Dolls,” a craze in the 1980s. The dolls came with “adoption papers,” including the name and personality of the doll. The manufacturer created a version with Spanish language adoption papers meant for export to Latin America. These version were held “materially different” and hence their sale in the U.S. infringing. See id. at 72-74.

Based on the district court opinion in Kirtsaeng, 2009 WL 3364037 (S.D.N.Y. 2009), it appears that John Wiley had a good case for claiming its Asian version books were materially different. It alleged that the Asian versions were made with thinner paper and different bindings, different cover and jacket designs, fewer internal ink colors, if any, lower quality photographs and graphics, and often lacked accompanying academic supplements and CD-ROMs to be used in conjunction with the textbooks. Had John Wiley been able to prove these allegations, it would likely have made out a good case for trademark infringement.

Material differences need not be obvious and are often quite subtle – as the Nestle court observed, “for it is by subtle differences that consumers are most easily confused.” Material differences in packaging or accompanying documentation or manuals, differences in warranty coverage and defacement of serial numbers have all been held to constitute material differences.

For example, in one case in 2008, Hyundai Const. Equip. USA v. Chris Johnson Equip., 2008 WL 4210785 (N.D. Ill. 2008), the defendant imported Hyundai brand construction equipment from Korea for resale in the U.S. A federal court in Illinois held the equipment materially different for several reasons, including that it had been sold without the standard warranty available in the United States, and some of the units had safety, operation, and maintenance instructions and safety decals in Korean rather than in English.

Companies concerned about grey market issues would be well-advised to consider introducing differences in their products intended for sale in foreign markets to take advantage of the “material differences” doctrine. Such differences might be as subtle as differences in warranty coverage (for example, items sold in Asia would only be serviced in Asian service centers) or language of accompanying manuals, decals, etc.

Patent Law

Patent law also provides possible protection for grey market concerns. Patent law has its own version of the first sale doctrine, which is termed the “patent exhaustion” doctrine. A sale of the patented device by the patent owner will exhaust all patent rights and permit resale.

Since Jazz Photo Corp. v. ITC, 264 F.3d 1094 (Fed. Cir. 2001), the Federal Circuit has consistently held that sales abroad do not exhaust U.S. patent rights. Unlike Copyright law, the place of manufacture is irrelevant – an authorized U.S. sale will exhaust the U.S. patent rights; an authorized sale outside the U.S. will not.

The Federal Circuit has adhered to this position as recently as Ninestar Technology Co., Ltd. v. International Trade Com'n, 667 F.3d 1373 (Fed. Cir. 2012), a case concerning ink cartridges bearing a patented design manufactured in China and imported into the U.S.

Although many observers believed the Supreme Court might overturn that ruling in light of the Kirtsaeng decision, in March 2013, less than a week after Kirtsaeng case was decided, the Supreme Court denied certiorari in Ninestar. 132 S.Ct. 2707 (2012).

One notable exception to this rule is where a product is made and sold abroad not by the patent owner, but by a licensee who holds rights including the U.S. and the foreign country, such as a worldwide license. In Tessera v. ITC,646 F.3d 1357 (Fed. Cir. 2011), the Federal Circuit held that sales made under such a license, even if made abroad, exhausted such patent rights, since the product had indeed been authorized by the patent owner through the license for U.S. sale, and the patent owner had been paid (or at least was due) a payment for such sale.

A similar result was recently reached in Multimedia Patent Trust v. Apple Inc. 2012 WL 6863471 (S.D.Cal. Nov 09, 2012), which distinguished Ninestar on similar grounds.

Some products may be subject to patent protection, including design patent protection, which protects novel ornamental designs for industrial products. Many of the leading foreign patent exhaustion cases in the Federal Circuit have involved Fuji Film, which holds a series of utility and design patents for single-use cameras. Fuji has used these rights to great effect to control grey market importation of refurbished cameras from abroad.

Finally, there are two ways that a rights owner might still be able to obtain protection against grey market importation under the Copyright Act. Kirtsaeng itself suggests one way. It noted that under the Copyright Act of 1909, the first sale doctrine allowed transfer of articles “the possession of which has been lawfully obtained.” The current Act, in contrast, applies only to an “owner” of a copy “lawfully made under this title.”

The shift, from possession to ownership, the Court suggested, was meant to exclude cases where the recipient received the copy only by lease, not ownership. For example, in the 1970s, it was common for theater owners to receive copies of feature movies only by lease, not by sale. The new language was meant to exclude them from the protections of the first sale doctrine. In some industries, it might be possible to avoid the first sale doctrine through leasing, rather than selling, the authorized copies.

A second, more useful way, albeit one not clearly discussed in Kirtsaeng, would be to divide copyright ownership territorially among different companies. As the dissent in Kirtsaeng pointed out, it has long been held that copyrights, like other forms of intellectual property, are territorial; U.S. copyright law is of no effect abroad.

See, for example, United Dictionary Co. v. G. & C. Merriam Co., 208 U.S. 260, 264 (1908) (copyright statute requiring that U.S. copyright notices be placed in all copies of a work did not apply to copies published abroad because U.S. copyright laws have no “force” beyond the United States’ borders.)

A company like John Wiley, for example, could divide its copyrights territorially – U.S. copyrights would be held by a U.S. company and exploited for books printed and sold here. The Asian copyrights would be transferred to a foreign subsidiary for exploitation there. The Asian version textbooks would only be authorized by the copyright owner there, not here.

Kirtsaeng itself is ambiguous whether this works. On the one hand, it states that the phrase “lawfully made under this title” is meant to exclude pirated copies; presumably those made by a foreign subsidiary are not pirated. Furthermore, in reciting the facts of the case, the opinion state, that John Wiley “assigns to its wholly owned foreign subsidiary . . . rights to publish, print and sell Wiley’s English language textbooks abroad.”

On the other hand, most of the opinion concerns whether the statutory phrase “lawfully made under this title” has a geographic component (the majority held it does not) – the opinion states in several places that authorization by the “copyright owner” anywhere in the world invokes the first sale doctrine. Thus, for example, the Court described Kirtsaeng’s reading of the statute as applying the first sale doctrine to cases where “copies are manufactured abroad with the permission of the copyright owner.”

The current Copyright Act, unlike its 1909 predecessor, expressly permits a copyright to be divided and sold in separate pieces to separate parties. Thus Section 201(d)(1) states that “ownership of a copyright may be transferred in whole or in part” and Section 201(d)(2) states that “[a]ny of the exclusive rights comprised in a copyright, including any subdivision of any of the rights specified by Section 106 may be transferred . . . and owned separately.”

Both the legislative history and subsequent case law have applied this divisibility doctrine to include geographic division, e.g., the right to copy or publicly broadcast the copyrighted work in a particular geographic area.

Such an arrangement – transferring foreign rights to a foreign affiliate, and then arguing that sale in the U.S. is not authorized because the goods were never authorized by the U.S. rights owner – would certainly be ineffective in a trademark case, because Section 5 of the Trademark Act, 15 U.S.C. § 1055, codifies what is known as the “related companies” doctrine, whereby all companies under common control are treated as one for trademark purposes.

Whether a similar doctrine will be applied in copyright cases is now unclear, and the Kirtsaeng opinion seems to not have focused on the question, even though it was present on the facts of that case. Until then, we expect some copyright owners to try this strategy to protect against grey market imports.

Summary

Kirtsaeng has made protecting against grey market importation more difficult. Rights owners still have alternative strategies they may wish to implement: (1) marketing “materially different” versions of their products in the foreign markets, and labeling them with the same trademarks used in the U.S.; (2) patent law protection, including design patents; and (3) dividing foreign copyrights from U.S. copyrights and having each held by different companies.


A previous version of this post appeared in the New York Law Journal, June 7, 2013