Lawyers Sue Too Much, Except When They Don’t

Last week, I discussed the scary court decision, Universal Furniture Int’l, Inc. v. Frankel, in which the owners of a company were found liable for their company’s copyright infringement, even though they were not defendants in the original lawsuit against the company. The copyright owner sued the company and won, and then, when the company filed for bankruptcy, the copyright owner filed a separate suit against the owners. As I explained, if the company is small enough, the owners will be too close the acts of infringement to avoid personal liability. To the court, the only question was whether the copyright owner had to re-prove the copyright infringement. The court held that it didn’t have to because the exact same acts of infringement were involved.

So how does one explain Burberry Ltd. v. Horowitz? In that case, Burberry, the well-known clothing manufacturer, brought an action for trademark infringement against a company called Designers Imports, on grounds that Designers Imports was selling counterfeits of Burberry’s clothing. The court agreed, found Designers Imports liable for $1.5 million, and issued an injunction. Somewhat later, Burberry sued one Asher Horowitz for exactly the same acts of trademark infringement, on grounds that he was “the principal, sole shareholder and sole officer” of Designers Imports. Based on what we read last week, open and shut case, right?

Well, no. In a “summary decision” (i.e., a non-precedential decision, usually reserved for decisions that are so straightforward they require little analysis), the Second Circuit took pretty much the same facts as Universal Furniture and reached the exact opposite conclusion. It held that because Horowitz is so closely tied to his company, Burberry was precluded from bringing a second action against him. The court basically held: if you have a chance to “join” (i.e., bring into the lawsuit) a business owner or manager, you had better do it during the first lawsuit against the business, or else you’ll lose your chance to do it later.

The rationale for this decision is that it wastes judicial resources to keep having the same lawsuit over and over. Then again, if you followed the Universal Furniture decision, you aren’t really using that many resources because you don’t have to re-litigate the main issues.

The result was awesome for Horowitz. His company is ruined, of course, but he is now immune to personal liability. True, he’s not completely out of the woods. Burberry can try to “pierce the corporate veil” when it tries to collect the judgement against Horowitz’s company. However, if Horowitz treated his corporation like a separate legal entity—i.e., he didn’t drain the business of money, didn’t treat it like a personal bank account, kept the company reasonably well capitalized, held shareholder meetings and respected the other “corporate formalities,” etc.—he should be able to shield his personal assets from collection.*

* Last week, I noted that corporations, LLCs and similar corporate entities protect owners from personal liability in contract actions, but not tort actions. It would have been somewhat more accurate to say that the corporate form protects the owners’ assets from being used to satisfy the corporate entity’s debts, including judgments. The key is to make sure the corporation really is separate and apart from the owners. If the owners fail to treat the corporate entity correctly, the creditor can “pierce the corporate veil” and reach the owners’ assets. If the owners want to have their corporate veil pierced, the easiest way to do that is to drain the company of assets as soon as it appears it will be liable for something. In that case, courts will definitely “follow the money.”

“The First Thing We Do, Let’s Sue Everyone.”

The bothersome part about this decision is that it will encourage rights holders to “sue everyone”—i.e., every owner who might have been involved in the infringement—to avoid losing the chance later when it turns out the company can’t satisfy the judgment.

There’s an important limit on this decision: it applies only to those “in privity” with the company, that means parties that “control” the company during the earlier lawsuit. Employees and low-level managers are still on the hook for a second lawsuit, but owners are in good shape because either they controlled the company or they didn’t participate. Lawyers are often accused of suing too many defendants, thus over-complicating lawsuits, but decisions like this only encourage such over-suing. Further, suing the owners in their personal capacities is distasteful. It comes across as a heavy-handed, intimidating power play. Better to sue just the company, and if you win, you can decide whether you need to go after the owners personally. Well, I guess it’s nothing personal: we gotta sue you now because if we might lose the chance later.

I honestly can’t reconcile Universal Furniture and Burberry. In one case, “privity” between owner and company meant automatic liability for the owner in a later lawsuit. In the other case, the exact same privity protected the owner from personal liability. The only thing I can think of is that the Fourth Circuit (which decided Universal Furniture) does not apply claim preclusion to prevailing parties, as the Second Circuit does. I’m also not very convinced about the Second Circuit’s rationale for applying claim preclusion against a victorious party. Normally, plaintiffs are permitted to pick and choose whom they sue, and the “sue everyone” attitude is one that courts really should discourage.

Which Is Simpler: A = C – B; or A = A?

Meanwhile, in Chicago, there was yet another case in which the owner of IP rights tried to enforce those rights against a company and its owners. In this case, Asher Worldwide Enterprises LLC v. Housewaresonly.com Inc., the plaintiff originally brought claims for copyright infringement against Housewaresonly.com, accusing it of copying its copyrighted product descriptions from its website.

After some litigation and a transfer of venue, Asher Worldwide decided to amend its complaint to add Housewaresonly.com’s owners, Mr. and Mrs. Rubin. In support, Asher Worldwide alleged that the Rubins were the ones who personally engaged in the copying, they control Housewaresonly.com’s operations, and Housewaresonly.com is the Rubins’ “alter ego.”

Now, last time, I mentioned that the correct way to analyze who is liable for a tort is (1) locate the human beings who actually participated in the tort (e.g., the driver of the delivery truck that got into the action), then (2) see if the human beings’ actions were within the scope of their employment. If the answer to (2) is “yes,” then the potential defendants are all of the human beings involved in the tort plus the employer.

Alas, in connection with actions for infringement of IP, it’s so common to first sue the company, then the individuals, tests have developed that essentially look through the telescope backward. Really, the only question is whether the individual—employee, supervisor, high-ranking manager, or owner—personally participated in the infringement. Where a manager or supervisor gave direct orders to infringe IP, that’s still participation. The harder question is whether developing and supporting policies that inevitably lead to infringement of IP is sufficient. However, since rights holders typically sue the company first, then the individuals, the question usually gets asked the other way around: when a claim for infringement is brought against a company, under what circumstances may the company’s owners and managers be held liable for the company’s infringement?

The Seventh Circuit identifies three instances in which high-ranking managers and owners may be liable for their company’s IP infringement:

  1. The manager or owner “acts willfully and knowingly—that is, when he [or she] personally participates in” the act of infringement;
  2. The manager or owner “uses the corporation as an instrument to carry out his [or her] own willful and deliberate infringements”; or
  3. The manager or owner “knowingly uses an irresponsible corporation with the purpose of avoiding personal liability.”

Instances (1) and (2) are nothing more than personal involvement in the act of infringement. Instance (3) would appear to cover a situation in which someone takes over a pre-existing corporate entity that is known to be committing infringement or forms a corporate entity to do so (though that seems to overlap with instance (2)). So: more complex rule, but same result.

The court held that Asher Worldwide pleaded enough to make the Rubins defendants, which should surprise no one. Note that in this case, unlike Universal Furniture and Burberry, there is no second action—the plaintiff is just amending the complaint in the original lawsuit—so claim preclusion doesn’t rear its confused head.

Thanks for reading!