Don’t Ignore it; Manage it.
Let’s say you’re a retailer. You buy stuff from a reputable manufacturer or middleman and turn around the sell it to the general public. You’re pretty safe from most intellectual-property concerns, right? If what you’re selling turns out to be counterfeit, that’s not your problem, right? You did all you could to avoid counterfeits, mostly by making sure your sellers are reputable. Besides, you didn’t do anything wrong—whoever made the counterfeit did. The same thing goes for patent infringement—not your fault, right?
It might not be your fault, but it is, unfortunately, still your responsibility, as a recent case involving Fossil and Macy’s demonstrates. Intellectual property law cares not (much) about morality and “fault,” but can and will impose liability on parties we’d otherwise think of as blameless. As a business owner or manager, all you can do is take sensible steps to reduce your company’s exposure.
What Is Downstream Liability?
Welcome to the horrible world of “downstream liability.” Unfortunately, it is an infringement of trademark and patent rights to sell infringing items; and it’s an infringement of copyright to “distribute” copyrighted materials. Patent, copyright and trademark laws don’t care very much about “fault.” If someone up your supply chain got careless or greedy or stupid and infringed someone else’s patent, trademark or copyright, you’re on the hook to the extent you sold[ref]In patent law, it’s also an infringement to “offer” an infringing article “for sale,” but that rarely results in damages.[/ref] infringing goods.
Not your fault? Doesn’t matter. Much. It’s not as though your seller said, “Here you go, and oh, by the way, these are totally infringing.” Patent, trademark and copyright don’t care about “fault” or “innocence”—at least, not for purposes of determining who is an infringer. They do care very much about fault—“willfulness,” “bad faith” and “innocence”—when it comes to how badly to punish you. Usually, lack of bad intent just avoids increased damages, as is the case with patent law[ref]Treble damages for “willful” patent infringement.[/ref]. Sometimes true reasonable ignorance can avoid damages altogether[ref]If you were liable for trademark infringement, “good faith” can sometimes—but not always—avoid having to “disgorge” your profits.”[/ref], but usually not.
There is one very important exception to this “downstream” liability, and that’s for used goods. Once something’s been sold, its intellectual property rights are said to be “exhausted,” i.e., used up (not tired!). So you’re free to re-sell a patented vacuum cleaner, book or Mercedes Benz. Obviously, there’s a difference between the business-to-business sales that take place in a supply chain, where the intent is to re-sell a “new” article, and a sale to a buyer who intends to use the article and maybe later re-sell it as used.[ref]Alas, there is an exception to this exception: software that’s been licensed and not sold (assuming you can tell the difference). Fortunately, we already have a blog post that addresses this vexed issue.[/ref]
Another sort-of exception are marketplaces, both real and online, in which the provider doesn’t control what is sold, such as flea markets and eBay. These players would still be on the hook under theories of secondary liability, but that would require proof of either knowledge (contributory infringement) or control (vicarious infringement), which aren’t always available. In Tiffany, Inc. v. eBay, Inc., eBay was held not to be liable for infringing Tiffany’s trademarks when eBay subscribers sold counterfeit Tiffany’s goods, but only barely.
The results of this downstream liability can be devastating. Years ago, I had a client who was sued for patent infringement for goods it only sold. It’s unusual for a patent holder to sue retailers—usually it’s more efficient just to sue the manufacturer—but the patent holder in this case wanted to put pressure on the manufacturer by suing its customers, an increasingly common tactic. We held our breath as we checked how many accused items we sold, and it turned out to be just a handful. Whew! That allowed us to settle early, but what if it had been a popular product? What if we had sold 100 units? 1000 units? My client could have been wiped out[ref]Much would have depended on how things went with the manufacturer, since the patent holder can’t recover twice for the same thing.[/ref].
The Rationale of Strict Liability
At this point, you might ask whether this is really very fair. You can’t possibly know for certain whether everything you buy for retail is non-infringing. That’s true, but intellectual-property law isn’t much for morality. Patent, copyright and trademark laws[ref]But not trade secret law. It does have a knowledge element.[/ref] have what is called “strict liability,” i.e., no knowledge or intent requirement. They are economic laws, and efficiency (along with a dollop of industry protection), not morality, guides them.[ref]The scope for self-interested hypocrisy is pretty broad here. Rights holders and their targets love to talk about intellectual property as economic laws when it suits them but not when it doesn’t. Rights holders, for example, love the economic rationale for strict liability but still use the morally charged metaphor of “stealing.”[/ref] Although it’s hard for you to know what is and isn’t infringing, it’s harder for rights holders to keep track of many potential acts of infringement. You have a handful, a few dozen, hundreds of sellers and perhaps thousands of potentially infringing products, but rights holders have many magnitudes more points of potential infringement to keep track of. Intellectual-property law has decided to put the burden on manufacturers, middlemen, warehousers, retailers, internet service providers, and so forth to affirmatively avoid infringement.
The other rationale is “unjust enrichment.” If you benefited from someone else’s intellectual property, you still benefits regardless of whether you knew about it or not. So intellectual-property law will usually make you give back those “wrongful” profits. Which would be OK, if you hadn’t already spent the profits…
Romag v. Fossil and Macy’s
If this ever happens to you, you’ll at least be in very good company. Ever hear of Fossil or Macy’s? Not too long ago, they were rung up for both patent infringement and trademark infringement because of high-end magnetic purse clasps. Of course, neither Fossil nor Macy’s makes purse clasps or even purses. Instead, Fossil designs fashionable purses[ref]Sorry, “handbags.”[/ref] and arranges with the manufacturers to make the purses according to Fossil’s specifications. Fossil, in turn, either sells the purses directly or through another retailer, such as Macy’s.
Unfortunately, one of the manufacturers had been buying ROMAG-brand high-end magnetic clasps from a supplier that wasn’t authorized by Romag to make or sell the clasps or to sell them under the ROMAG brand. It’s hard to tell how this happened. Perhaps the supplier was just a willful infringer, trying to pass its clasps off as ROMAG quality, and fooling the purse manufacturer. Or, perhaps that manufacturer tried to save some money by purchasing knock-off ROMAG clasps. Worse, perhaps the supplier used to be an authorized manufacturer of ROMAG clasps and had lost its authorization, without telling anyone, either because Romag discontinued its relationship or because the relevant license had simply expired.[ref]This latter possibility seems unlikely in this case because apparently the clasps didn’t quite match Romag’s specifications, suggesting an imperfect knock-off rather than a loss of authorization.[/ref]
Fossil trusted its manufacturer, and Macy’s trusted Fossil. I’m sure these are all reputable dealers. But intellectual-property law doesn’t care about “reputable.” Except that Fossil and Macy’s were able to avoid being held as “willful” infringers, which at least kept a lid on damages. So, there’s that. And Fossil and Macy’s are big enough to absorb the surprisingly modest judgments of about $42,000 against Fossil and $12,500 against Macy’s.[ref]These figures are so low that Fossil and Macy’s can legitimately claim victory in the lawsuit. Based on this earlier June 27th order, it appears the judge slashed a multi-million dollar verdict on the trademark claims because Romag was unreasonably dilatory in bringing its claims. As for the patents claims, it appears the jury just wasn’t in a very generous mood.[/ref]
What You Can Do to Manage the Risk
As you can probably guess, it’s impossible to be 100% protected against downstream liability. It’s a business risk. But there are a few things you can do to decrease your exposure to downstream liability.
- Know who your suppliers are and who their suppliers are. Trust is the front line against downstream liability, but it’s increasingly difficult to form a close enough relationship with your suppliers to really trust them (other than blindly). Supplies are often sourced overseas, where business reputations and norms can be impenetrable to outsiders. There’s no substitute for a trusted agent in the relevant region who can tell you who is likely to counterfeit and who isn’t.
- Make sure your suppliers are legally bound not only to indemnify you but to to “defend” you (i.e., pay your legal costs), if the supplier’s goods put you in a rights holder’s crosshairs. Indemnity by itself isn’t enough because the cost of defending yourself might be more than you can easily bear. Also, make sure your indemnity provision is enforceable. Legal relations with suppliers are frequently haphazard and important provisions wind up on the wrong side of the “battle of the forms.”[ref]In a typical scenario, there’s a request for a quote, a quote, a purchase order and then an invoice, each of which might have conflicting provisions. This is known as “the battle of the forms,” and there is a complex set of rules for determining which provisions survive and which don’t. It’s surprising how frequently important provisions, like indemnities, arbitration provisions and warranty disclaimers, are introduced too late in this sequence to be enforceable.[/ref] Try to avoid overly complex indemnity provisions—they’re easy to mess up.
- If you do have an enforceable indemnity provision, go read it and follow its directives carefully. Many indemnity provisions can be waived unless certain notice requirements are met.
- Make sure your supplier can actually make good on the indemnity provision. The best-written, more rock-solid indemnity is only as good as the supplier’s ability to pay up. More subtly, it also depends on your ability to hale the supplier into court to enforce the indemnity, if necessary, which can be tricky if the supplier is foreign.[ref]A jurisdiction clause can help (assuming it’s enforceable), by allowing you to enforce the indemnity in your local court, but only so much. You’ll still need to go where the suppliers’ assets are to enforce your local judgment.[/ref]
- Make sure your (enforceable) agreement with your supplier allows you to terminate or at least suspend your obligation to keep buying product in the event the product is infringing. You’d feel pretty dumb if, after agreeing to stop selling a certain item because you concluded it was probably infringing, you still to keep buying the item.
- If you receive a cease-and-desist letter, take it seriously. If you’ve read this blog post, you’ve already figured this one out. This isn’t to say that you need to roll over once you receive one. But you need to evaluate the risks the rights holder poses[ref]And, sorry, but that probably means engaging an intellectual property lawyer.[/ref] and make a business decision. Although we usually hear about unreasonable rights holders—because that’s usually a condition for a case to make it to a decision—most rights holders are willing to negotiate with you reasonably and in good faith to solve the problem.
- Look into intellectual property insurance, but be prepared to find it unaffordable.[ref]The fact that insurers are reluctant to cover intellectual property claims should tell you something about the nature of those claims.[/ref]
Thanks for reading!
Disclaimer To be absolutely clear, we’re not giving you legal advice here, just outlining what the legal issues might be. What you should do specifically will depend on your own specific facts and circumstances, both legal and non-legal. I know this sounds self-serving, but: if you have any concerns about “downstream” liability, you should talk to a lawyer who is conversant with intellectual-property law and, ideally, also “Article 2 of the UCC” (the law that governs the sales of goods).