Supreme Court Decision Clarifies Law on Gray Market Imports; Focus for Importers Remains Due Diligence

In Kirtsaeng, the Supreme Court reversed a ruling from the 2nd Circuit U.S. Court of Appeals that affirmed a $600,000 penalty against a Thai student for violating textbook publisher Wiley's copyrights. While studying in the U.S., Supap Kirtsaeng had arranged for his family and friends to legally purchase cheaper but nearly identical Asian editions of textbooks, and then sold them in the U.S. on eBay at a profit. The 2nd Circuit found that the first sale doctrine, which permits distribution of copyrighted material after the first legal sale, does not apply to goods made abroad.

The ruling created a third interpretation of the first sale doctrine among the Circuit Courts of Appeal -- the 9th circuit had ruled in 2008 that the first sale doctrine applies to goods made abroad as long as the first sale is made in the United States, while the 3rd Circuit had ruled in 1988 that the doctrine isn't limited by national borders. Given the disagreements between the Circuits, the Supreme Court decided to hear the case.

In a 6-3 ruling March 19, the court ruled the first sale doctrine is not limited by borders, and so a copyright is exhausted when a good is legally made and sold abroad. The ruling further clarified the scope of the copyright first sale rule, a topic which had been the subject of a series of Supreme Court cases. In its 1998 Quality King v. L’Anza Research decision, the court said the copyright first sale doctrine applied to a product that was made in the U.S. but first sold abroad. Then, in 2010, the Supreme Court allowed to stand the 9th Circuit’s decision on the inapplicability of the first sale doctrine to products made abroad in Costco v. Omega, when the justices deadlocked 4-4 after Justice Elena Kagan recused herself.

The Supreme Court’s decision broadly affects the multi-billion dollar parallel “gray” market, said Fred Paliani, president of the American Free Trade Association, which represents parallel market importers. The industry cuts across all different types of product lines, he said, “whether it’s consumables, electronics, automobiles, you name it.”

“The large discount retailers, almost all have some parallel market goods in their inventory,” said Lee Sandler of Sandler, Travis & Rosenberg. Companies selling parallel market goods that have been involved in litigation over the issue include large firms like Kmart, Quality King, and Costco, he said.

After the Supreme Court in its 1988 K Mart v. Cartier decision said that trademarks on products made abroad are exhausted on the first sale, even when sold abroad, some companies had been relying on copyrights to control sales of their products on the secondary market, said Larry Friedman of Barnes Richardson. For example, Quality King involved a copyrighted label on a shampoo bottle, while Costco-Omega had to do with a logo on the back of a watch, he said. “You could use a copyright to protect really any kind of product as long as it’s embellished with some original work of authorship.”

But now, unless Congress changes the law on the copyright first sale doctrine, the Kirtsaeng ruling “really takes the last good theory away from domestic industry,” said Friedman.

Latest in a Series of Battles over Gray Market Imports

Kirtsaeng is only the latest chapter in a series of battles over parallel market imports, said Sandler. “This has been a battle that has swung from administrative rulemaking, to the courts, to Congress, and then keeps repeating that cycle,” he said. “Maybe not in that order, but all three branches of the government have become the battleground from time to time.” Legal arguments used in the fight have also changed over time. “Copyright is the choice of law today, but previously it was trademark law,” he said. And before that it was customs law, Sandler said.

“It’s a battle that doesn’t seem to ever come to a conclusion,” Sandler said. “Whoever loses goes and picks a different ground, and they may go to the hill … or they can go to international trade agreements,” he said.

The executive branch has consistently come down on the side of the copyright holders in court cases on the first sale doctrine, said Fred Paliani. It submitted an Amicus brief in favor of Wiley in the Kirtsaeng case, as well as briefs supporting Omega in Costco, and L’Anza in Quality King. At least before Kirtsaeng, it was pushing for language making the first sale doctrine national in scope in the Trans-Pacific Partnership negotiations.

Now that U.S. law is unsettled, the United States’ international push for restrictive first sale provisions may be blunted, said Irene Calboli, professor of law at Marquette University. Calboli, currently a visiting professor at the National University of Singapore, attended the recent TPP negotiations in the country. A draft text of the TPP intellectual property chapter included language that restricted the first sale doctrine to goods made in the country of the copyright-holder.

Several countries that currently do not restrict their first sale rules to domestically produced products may be more hesitant to follow the U.S. position now that it has been undermined by the Kirtsaeng decision, Calboli said. “That can become a point of leverage for these negotiators to retain their established international exhaustion that they have now,” she said.

Given the consequences of the Supreme Court’s decision in Kirtsaeng, U.S. copyright holders will be making a push for Congress to change the law so the first sale doctrine excludes goods made abroad, Calboli said. “I’m sure the lobbying is already frantic right now,” she said.

Due to the Kirtsaeng decision, the position of the U.S. Trade Representative in favor of a nationally-restricted first sale provision in trade agreements has now been cast into doubt, and the agency may wait to see how the issue is resolved before it decides on its next move, said Mark Wu, professor at Harvard Law School and former USTR director for intellectual property. “USTR traditionally has sought to advance proposals in the IP chapter that conform with US law,” he said. “I don’t expect that this principle will change. Therefore, my view is that what happens to the U.S. position in ongoing negotiations will depend on how Congress decides to respond to the Court’s ruling, with the White House closely consulting the Hill.”

Adding nationally-restricted first sale doctrine provisions to the final version of the TPP was going to be a tough sell for the USTR anyway, Wu said. Many current U.S. trade agreements don’t have such language because of the difficulty in coming to agreement on the issue. “Despite the push toward regulatory harmonization, I don’t foresee that the final text of the IP chapter will deal with the issue of copyright exhaustion, given the complexities involved in the practices of the different negotiating partners,” he said.

Focus for Importers Remains Due Diligence

But whatever form TPP may take, and however U.S. law may change, the focus for importers will remain on due diligence, said Susan Kohn Ross of Mitchell Silberberg. The ruling does not change regulatory requirements for importers: “you really have to be able to establish that these goods came from a legitimate licensee, and if you can do that then you're fine,” she said. “But that's always been the rule.”

Importers dealing in goods that have a third-party’s label on them still have to make sure the goods came from a legitimate licensee. The ruling may have clarified the scope of the first sale doctrine’s application, but it still doesn’t allow resale of goods that were illegally produced or sold. “Getting the first and last page of the contract isn't enough,” she said.

Industry discussions on the customs reauthorization bill have included talk of identifying best practices for making sure imports don’t violate intellectual property rights, Kohn Ross said. Currently, two models are being discussed. One way to allow importers to perform better due diligence on intellectual property issues is the posting of authorized licensees on intellectual property holders’ websites. Importers sourcing products from abroad could check to see if a potential supplier is listed as authorized, easing compliance with intellectual property laws and potentially avoiding penalties for the importer.

For companies that are more reticent to publicly disclose the structure of their supply chain, a consistently monitored email address for inquiries by importers has been discussed, Kohn Ross said. That way, importers that want to know whether a potential sale would be authorized and legal could get a quick response from the rights holder.