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International First Sales and Imports Under U.S. and European IP Laws

Tuesday, July 16, 2013

By Lothar Determann, Ben Allgrove, Pamela Church, and Gary Shapiro, Baker & McKenzie LLP  

In light of the United States Supreme Court's March 19, 2013, decision in Kirtsaeng v. John Wiley & Sons, Inc.,1 companies have started to review their distribution models and contracts, whether they sell books, music, videos, software licenses, or other products that come with copyrighted labels. In this process, companies should not only focus on U.S. copyright laws, but also take foreign copyright laws into account, as well as other intellectual property law regimes, contractual mechanisms, and competition laws.

This article provides an overview and practical recommendations.

1. International Exhaustion Under U.S. Copyright Law

Until recently, companies were comfortable that under U.S. copyright law, they could prevent unauthorized importation of products containing or bearing copyrighted materials. Nationally based intellectual property rights typically enable companies to time international releases and distinguish prices for different territories or regions. The United States has consistently opposed international exhaustion in global trade negotiations, as it can make territory-based pricing and distribution policies impractical.

Under intellectual property laws around the world, innovators receive exclusion rights as a reward and incentive to stimulate inventions, works of authorship, and investment in other intangibles. Intellectual property owners commercialize their rights in different ways. Some use the intellectual property in their business to make products or services. Others charge fees for licenses to use. Some sell their intellectual property rights outright. Copyright owners often distribute copies of their works for a fee.

To maximize their return on investment, intellectual property owners design distribution models in ways to secure the maximum price a particular customer is prepared to pay. Given that customers in some jurisdictions and economic situations are willing and able to pay more than others, the intellectual property owner seeks to charge different prices and to control the distribution chain to prevent arbitrage in secondary markets.

This is true for drug companies that are willing to sell patented drugs at a cheaper price in developing countries with dire needs yet less funds available—so long as the same drugs do not come back to undermine price levels in developed countries where higher prices can be obtained. This is also true for movies made primarily with an audience in one country in mind, but which can be distributed at lower prices also in other countries.

According to the record of the facts in Kirtsaeng v. Wiley, this is also true with respect to English language academic text books that Kirtsaeng was apparently able to resell on a part-time basis, while studying mathematics, to generate arbitrage profits on revenues of between $900,000 and $1.2 million in only a few years.2 In Kirtsaeng, however, the U.S. Supreme Court gave the copyright first sale doctrine a global scope, holding that copies of books lawfully made and first sold abroad could be imported into the United States and resold without the U.S. copyright owner's consent.

Supap Kirtsaeng imported books from Thailand and asserted the “first sale doctrine” as a defense when a U.S. copyright owner, John Wiley & Sons Inc., sued him for copyright infringement. Lower courts had rejected the defense based on territoriality considerations: The first sale doctrine did not apply, because the copies were not made in the United States and no authorized first sale had occurred in the United States. The U.S. Supreme Court reversed and found that an authorized first sale outside the United States also operates as a defense to a copyright claim.

This dramatic turn promises to disrupt markets for copyrighted goods around the globe.3

2. International Exhaustion in Other Jurisdictions—Specifically, the European Common Market

Every country has its own territorial intellectual property law regime. Some jurisdictions apply international exhaustion and make it easier to import copyrighted works, for example in the interest of bringing down price levels domestically. Other jurisdictions let exhaustion apply only once a copy of a work of authorship or other product protected by intellectual property laws has been sold by the intellectual property owner or with its consent in the particular jurisdiction.

For example, in Europe, international exhaustion needs to be considered in two parts.

The first question is whether international exhaustion applies at the boundary to Europe, in particular at the borders of the Common Market in the European Economic Area (EEA, 27 EU Member States plus Norway, Lichtenstein and Iceland). The answer to that is no.

The European Court of Justice, as it then was (now the Court of Justice of the European Union), confirmed in the 1998 Laserdisken case4 that copyright could still be used to prevent importation of protected works into the EEA. This is often termed as “fortress Europe.”

This is also reflected in Recital 28 of the Information Society Directive,5 which states that the reproduction right “should not be exhausted in respect of the original or of copies thereof sold by the right holder or with his consent outside the Community.”As such, as the law currently stands, Dr. Kirtsaeng could not have imported books from Thailand into the EEA against the publisher's wishes.

The second question is whether international exhaustion exists between Member States of the EEA. The answer here is more complex. The reason for this is that one of the fundamental principles underlying the European project is that there should be an “Internal Market” free of barriers to trade.

This is reflected in Articles 34 and 35 of the Treaty on the Functioning of the European Union. While copyright remains a national right in Europe, the Internal Market trumps national IP rights in the priority stakes.

This was recently illustrated in the seminal 2011 FAPL case.6 In FAPL the claimant owned the copyright in certain sports broadcasts. The claimant licensed that copyright on a country-by-country basis within Europe and engaged in price arbitrage. In particular, the cost of a license in the United Kingdom was much more expensive than a license in Greece.

The defendant, Mrs. Murphy, located in the United Kingdom, purchased a Greek decoder card and accessed the Greek broadcast in the United Kingdom. She was sued for copyright infringement (and criminally prosecuted). In her defense, she pleaded that the Internal Market principle prevented the claimant from exercising their copyright in this way.

The Court of Justice of the European Union agreed. It held that the “essential subject matter” of copyright could still be protected without territorial licensing which conflicted with the Internal Market principle. While the copyright in the sports broadcast was not exhausted as such, the effect was the same—the Greek broadcast could be accessed in the United Kingdom.

Another aspect of this topic is that exhaustion needs to be assessed on a right by right and content type by content type basis. For example, the Court of Justice of the European Union held in 2012 in the UsedSoft case7that Oracle could not prevent the resale of its software (licensed in digital form) because its copyright in the copies in question were exhausted on the first sale.8 The EU Court of Justice held that the first sale doctrine would even allow a licensee to make a new software copy for resale and transfer purposes so long as the original software copy is made “unusable,” a view that a U.S. court has recently expressly rejected with respect to digital music files.9 Very recent first instance jurisprudence from the German courts applying UsedSoft indicates that this approach is unlikely to be applied to digital content other than software.

With respect to trademarks, the EU Court of Justice decided in 1998 that a trademark owner could prevent the import and sale in the EEA of trademarked eyewear products that it had sold at lower prices in countries outside the EEA Common Market.10 Only a first sale within the EEA exhausts distribution rights in the EEA.

3. International Exhaustion Under Patent Law

The Kirtsaeng decision leaves U.S. copyright and patent law with conflicting approaches to international exhaustion. In contrast to the statutory first sale rule under Section 109 of the Copyright Act, 17 U.S.C. §109, the United States has a judge-made patent exhaustion doctrine which holds that an authorized, unrestricted sale of a patented product exhausts the patentee's rights in the product. The Federal Circuit has made it clear under the Jazz Photo case11 and others that a U.S. patent holders rights are only exhausted by an authorized sale in the United States, whether or not the non-U.S. sale was authorized by the patent owner. Hence a sale outside the United States would still subject the buyer to patent liability if it sought to import the patented product into or distribute it in the United States without specific authority.

In March, the Supreme Court denied cert in an international exhaustion case,12 and in a May 13 opinion on exhaustion,13 the court did not discuss its international scope, so for now Jazz Photo remains the governing rule in this area.

Why do we now have international copyright exhaustion and U.S. bound patent exhaustion? The short answer is that the Supreme Court majority felt it was compelled to avoid a geographic limit on copyright exhaustion as a matter of statutory interpretation in light of Section 104 of the Copyright Act (which specifically applies U.S. copyright law to foreign works), Section 109, and the related legislative history, while on the other hand there has been a geographic limit on the patent exhaustion doctrine almost since its inception and both the Supreme Court and Federal Circuit have long reiterated that U.S. patent law has no extraterritorial effect. Policy-wise, as Justice Ginsburg's Kirtsaeng dissent noted, in trade negotiations the United States opposes international exhaustion to support IP holders in establishing different prices in different territories, something particularly beneficial to our patent intensive industries, such as pharmaceuticals.

While Kirtsaeng has changed U.S. copyright law in March 2013, U.S. patent law remains unchanged and territorial for the time being. Consequently, patent owners, consumers, and licensees of patented products need to do a more granular analysis of international sales transactions than in the copyright sphere, as international exhaustion does not apply to non-U.S. sales.

Determining what is a non-U.S. sale can raise very complex issues, however, especially where the parties are domestic and foreign, or foreign subsidiaries of domestic entities. For example, is the location of the sale based on the terms of the contract or the physical transfer of the property? If the contract terms are determinative, it is important to be clear in global agreements where a sale is concluded. If facts pertaining to delivery and shipment are relevant, the question arises whether contract terms can modify the impact of territorial exhaustion. Even on the delivery side, it can be unclear for example whether the delivery to the carrier or the physical acceptance of the goods at the destination consummates the sale.

A further complexity involves determination of the law that will govern where and when a sale occurs. Is it U.S. law, and if so is it federal or state law, or is it the relevant foreign law? With exhaustion now on the radar screen, these issues are likely to come to the fore in international sales transactions. Companies and consumers need to re-assess the situation and prepare for change.

Manufacturers of patented products, as well as consumers of patented products purchased abroad need to be mindful of U.S. statutes impacting international transactions. Section 271(a) of the Patent Act, 35 U.S.C. §271(a), establishes liability for importing patented inventions without authority of the patent owner or licensee. Under Section 271(f), an infringer can be liable for exporting all or substantially all the components of a patented invention and inducing the combination of those components outside the United States. Under Section 271(g), the process patents amendments, the patent owner has the right to exclude others from using or selling in the U.S. products made by a U.S. patented process outside the United States. The International Trade Commission has authority to act against the importation of infringing goods under 19 U.S.C. §1337.

4. International Exhaustion Under Trademark Law

U.S. trademark law also recognizes a trademark exhaustion principle, but it is not established by the Federal statute governing trademarks, the Lanham Act. It arises under case law and is derived from the function of a trademark, which is to identify the genuine source of a product, distinguish it from others and signify that all products bearing the mark enjoy a similar level of quality.

The test for infringement is whether the use of the mark in question creates a likelihood of confusion, mistake, or deception. Courts in the United States have long recognized that trademark rights are exhausted on the authorized manufacturer's first sale, and accordingly a reseller generally does not need a license from the trademark owner to sell the product to others, as long as the product is genuine and unchanged.14

If the product is altered or repackaged in a material way, such that the consumer could be deceived or misled as to the standard of quality expected of a product bearing the mark, the product is no longer considered genuine, and the “first sale” defense does not apply. This can particularly be a problem for goods which are tailored for the specific tastes, needs and government regulations of a non-U.S. market, but end up in the U.S. market. Product packaging and instructions may be in a foreign language and lack effective warranties and customer support. Products may comport with different electrical standards or be formulated for conditions that exist in other locales. Such differences may be material to a purchasing decisions and cause confusion or mistake.

Section 42 of the Lanham Act, 15 U.S.C. §1124, and Section 526 of the Tariff Act of 1930, as amended, 19 U.S.C. §1526, empower U.S. Customs to prevent the importation of goods if the trademark owner can demonstrate that the imported goods copy or simulate a registered trademark and are physically and materially different than the authorized goods sold in the United States. Customs regulations have essentially codified the rule established in Lever Brothers Co. v. United States,15 which interpreted Section 42 of the Lanham Act to say that if there are physical and material differences between the imported goods which were manufactured under authority abroad and the U.S. goods sold under the same brand, the U.S. trademark owner can prevent unauthorized importation (the “Lever Rule”).

However, if the imported merchandise or its packaging bears a conspicuous and legible label stating that the product is not a product authorized by the U.S. trademark owner for importation and is physically and materially different from the authorized product, it will not be detained under the Lever Rule. See 19 C.F.R. §133.23(b).

5. Kirtsaeng’s Reach

While Kirtsaeng v. Wiley was about books, the Supreme Court examined a variety of factors favoring international exhaustion of the copyright owner's exclusive right of distribution, including the implications for products other than books. The court noted that many products these days contain or come with some copyrighted materials.

“[A]utomobiles, microwaves, calculators, mobile phones, tablets, and personal computers” contain copyrightable software programs or packaging. … Many of these items are made abroad …. A geographical interpretation would prevent the resale of, say, a car, without the permission of the holder of each copyright on each piece of copyrighted automobile software. …

The Court worries about the resale of foreign-made consumer goods “contain[ing] copyrightable software programs or packaging.”

This ruling could affect other products, including software, particularly if courts in the United States look to foreign law to determine whether an importer or reseller owns a particular software copy for purposes of U.S. copyright law, too. For decades, software companies have stressed that they only license—never sell—software copies and that the first sale doctrine cannot apply to software copies that the copyright owner never sold. In the United States, software companies have largely prevailed with this position, but as indicated above with regard to the EEA, not everywhere else.16

Kirtsaeng modifies the U.S. perspective on international exhaustion. The question is, how much?

With respect to whether a defendant owns a copy as a matter of copyright law, courts in most jurisdictions around the world will look only to the copyright law that applies in their own jurisdiction. The scope of protection under intellectual property laws is determined by the law of the country where the alleged infringement occurred. U.S. courts are generally hesitant to decide cases based on foreign intellectual property laws even where the U.S. court has personal jurisdiction over a defendant, because they do not want to interfere with the sovereignty of the foreign state that granted the intellectual property right.

In some cases involving infringement in the United States of works created abroad, U.S. courts have looked to foreign copyright law to determine copyright ownership, noting that the U.S. Copyright Act does not contain express conflicts of law rules. This results in the necessity to interpret and determine foreign laws regarding one part of the copyright law analysis (copyright ownership) and local laws regarding other parts (including copyrightability, infringement, and defenses) and produces a “hornets nest” with a “host of issues.”17

Courts may feel compelled to consider foreign laws regarding ownership where the foreign jurisdiction has the most significant relationship to—and policy interests in—the ownership question.

Itar-Tass Russian News Agency v. Russian Kurier Inc.,18 is one of the few cases where a U.S. court deferred to foreign law to determine the question of copyright ownership. In that case, the question arose whether copyrights to Russian newspaper articles republished in the United States were owned by the individual Russian authors or Russian newspapers, newspaper compilation services, news reporters, or a news reporter's union. The answer depended on complex questions regarding contractual relations between newspapers and employees in Russia, which the U.S. court was not comfortable deciding under principles of U.S. law. While considering Russian law regarding copyright ownership, the court noted that U.S. copyright law applied to all other questions, including infringement and defenses. “On infringement issues, the governing conflicts principle is usually lex loci delicti.”

With respect to copies sold in the United States, the United States tends to have the most significant relationship to and interest in the question of ownership regarding the particular copies sold. Therefore, in the context of copyright law disputes, a strong argument lies that U.S. courts should decide the question whether an importer or reseller owns a copy with the rules developed under U.S. copyright law, regardless of who may be the owner as a matter of the laws of any other country where the copies at issue may have been licensed, sold, bought, stolen or leased before they show up in the United States.

But, we shall see—Kirtsaeng can be expected to encourage unauthorized importers to test the law on this.

6. What to Do?

What can manufacturers do?

Software manufacturers should review and revisit their distribution models and reconsider technological measures and contractual clauses that mitigate against sales treatment.19

Manufacturers of other products containing or bearing copyrighted materials need to prepare for the possibility that foreign-made copies, purchased abroad, will arrive on the U.S. market. One reaction anticipated by the dissenting U.S. Supreme Court justices is that manufacturers will raise prices abroad to reduce the incentives for arbitrage. Another option for some companies is to be more strategic with respect to separating versions with text in different languages in and on products, manuals, labels and packaging (as opposed to including translations with every product). Many other alternatives are available for particular products, industries and market segments—and they are likely to come to a store near you.

U.S. “exclusive licensees” of copyrighted goods will also need to evaluate whether Kirtsaeng has adversely affected their value proposition, as grey market goods entering the United States now cannot be stopped either by the copyright owner or the U.S. exclusive licensee, potentially diluting the value of a “exclusive” U.S. license.

On the trademark side, manufacturers should consider whether versions of products destined for non-U.S. markets are or should be physically or materially different from those intended for the U.S. market. Trademark owners should ensure that their marks are registered with the U.S. Patent and Trademark Office and with U.S. Customs as such are preconditions to availing oneself of the remedies for parallel imports afforded by Section 42 of the Lanham Act and Section 526 of the Tariff Act and the regulations thereunder.

Whether a company welcomes international exhaustion as a removal of restrictions on global commerce or loathes it as a disruption of carefully designed distribution models, every manufacturer, trader, marketplace operator, and consumer has to prepare itself for upcoming change and consider new opportunities and risks. Put in a checklist format, considerations include the following

  • As a marketplace operator, review the legitimacy of cease-and-desist demands.
  • As a trader, assess additional arbitrage opportunities.
  • As an end user, look for alternate channels of supply from low price jurisdictions.
  • As a manufacturer, re-evaluate the viability of territorial pricing, consider making different products for different countries, consider a selective distribution system that affords more control over the channel, or adopt technical protection measures and end user contract terms that enhance control at the consumer level.
  • Revise contracts (and contract templates) to reduce the risk or enhance the chances that exhaustion applies, domestically and internationally, or that sales are deemed to take place in a jurisdiction that triggers exhaustion.
  • Update support and services policies to strengthen or reduce manufacturer leverage through ongoing interaction with customer base.
  • As an exclusive licensee, negotiate for better pricing where exhaustion may impair exclusive rights and re-assess the value of “global licenses” to evaluate if principles of national or international exhaustion may make them less than they seem.
  • Prepare for a flood of grey market goods by implementing or updating anti-counterfeiting policies.
The authors are partners with Baker & McKenzie in London (Ben Allgrove), New York (Pamela Church), Palo Alto (Lothar Determann), and San Francisco (Gary Shapiro). The opinions expressed are those of the authors only, not those of their law firm or its clients.

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