Court Splits 4-4, Lets Stand 9th Cir. Refusal To Apply First Sale Rule to Gray Goods

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With the recusal of the newest justice, Elena Kagan, the U.S. Supreme Court deadlocked Dec. 13 over the question of whether the Copyright Act's first sale doctrine applies to genuine goods produced for an overseas market and imported as gray-market goods without the authorization of the manufacturer. The 4-4 tie in this case thus left intact the Ninth Circuit's ruling that the first sale doctrine did not bar an infringement action in this case, but that ruling will have no precedential effect outside the Ninth Circuit (Costco Wholesale Corp. v. Omega S.A., U.S., No. 08-1423, 12/13/10).

Experts consulted by BNA said that this result leaves unanswered a question that is important not only in copyright cases, but in other cases involving intellectual property produced overseas and imported into the United States without the authorization of the U.S. rights holder.

Because of the deadlock, no written opinions were issued; the court simply said that the appeals court's decision had been “affirmed by an equally divided court.” Kagan has recused herself from more than 20 cases because of her involvement in them during her 14-month tenure as U.S. solicitor general prior to being seated on the court. This is the first instance in which her recusal has resulted in a tie vote.

This case was notable in that it represented an attempt by a manufacturer to block sales of gray-market goods through a copyright infringement action. Generally, such attempts to block importation give rise to claims of counterfeiting or trademark infringement. However, such claims were not applicable here because the goods in question were genuine.

Copyright Claim Based on Importation of Logo.

The case pitted Swiss luxury watch maker Omega S.A. against Costco Wholesale Corp., whose membership warehouse chain is the third largest retailer in the United States and is among the top 10 retailers worldwide. Omega had produced a batch of wristwatches in Switzerland intended for sale outside the United States. Costco acquired some of these watches from a distributor that had acquired them legally and offered them for sale.

Asserting copyright interest in the logos that appeared on the watches, Omega brought a copyright infringement claim against Costco under a provision giving copyright owners control over copies of works acquired overseas.

Under the Copyright Act, 17 U.S.C. §602(a)(1):  

Importation into the United States, without the authority of the owner of copyright … of copies … of a work that have been acquired outside the United States is an infringement of the exclusive right to distribute copies …. 




However, the U.S. District Court for the Central District of California ruled that this provision did not apply in this case, because of the first sale doctrine, 17 U.S.C. §109(a), which says:  

[T]he owner of a particular copy … lawfully made under this title, or any person authorized by such owner, is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy or phonorecord. 




The U.S. Court of Appeals for the Ninth Circuit reversed, ruling that the first sale doctrine did not apply in this case, because the watches had been manufactured overseas and thus had not been “lawfully made under this title.” Omega S.A. v. Costco Wholesale Corp., 541 F.3d 982, 88 USPQ2d 1102 (9th Cir. 2008) (76 PTCJ 658, 9/12/08). Costco petitioned the Supreme Court for review (78 PTCJ 156, 6/5/09) and the court invited a brief from the Office of the U.S. Solicitor General (78 PTCJ 693, 10/9/09). The government recommended against granting certiorari (79 PTCJ 702, 4/9/10), but the court decided to hear the case (79 PTCJ 784, 4/23/10) and oral arguments were heard in November (81 PTCJ 44, 11/12/10).

Amici curiae supporting Omega's position included the Office of the Solicitor General, and several parties representing IP rights holders: the Intellectual Property Owners Association, the American Watch Association, the Association of American Publishers, the Business Software Alliance, the Software and Information Industry Association, the American Bar Association, Fujifilm Corp., Seiko Epson Corp., Epson America Inc., Epson Portland Inc., the Motion Picture Association of America, and the Recording Industry Association of America (81 PTCJ 6, 11/5/10).

Costco's position was also supported by several amici--mostly consumer advocates, distributors, and retailers, including Public Citizen, the Retail Industry Leaders Association, the National Association of Chain Drug Stores, Inc., Gamestop Corp., Movie Gallery Inc., Quality King Distributors Inc., Target Corp., Public Knowledge, the Electronic Frontier Foundation, Intel Corp., eBay Inc., Google Inc., the NetCoalition, the Computer and Communications Industry Association, and the Internet Commerce Coalition.

A brief by the American Intellectual Property Law Association supported neither party but urged the court to resolve the ambiguities in the statute.

During the arguments, members of the court expressed skepticism of both sides' arguments regarding the proper interpretation of Sections 602 and 109(a) (81 PTCJ 44, 11/12/10).

Issue Important to IP Rights Holders, Consumers.

According to a listserv comment by patent attorney Harold C. Wegner of Foley & Lardner, Washington, D.C., even though this case was brought in the context of copyright law, it represents an open issue for patent law, namely the question of whether U.S. patent law recognizes the doctrine of international patent exhaustion.

“The Supreme Court in more than a century of dealing with patent exhaustion still to this day has never issued an opinion with a holding that accepts or denies the doctrine of international patent exhaustion,” Wegner said.

“It's an issue that needs Supreme Court resolution,” according to Charles L. Gholz of Oblon, Spivak, McClelland, Maier & Neustadt, Alexandria, Va. Gholz, whose practice centers on patent interference litigation, wondered how long it would be before the court got another opportunity to address question of the applicability of the first sale doctrine in such cases.

“[W]ho will present the issue again in a situation where the Supreme Court will be able to muster nine votes?” Gholz asked.

Consumers Left 'Up in the Air.'

Sherwin Siy of the consumer advocacy group Public Knowledge, which filed an amicus brief in this case, expressed disappointment with the result.

“There are many basic consumer issues at stake, and having the court uphold the lower ruling on a tie vote leaves many of those issues up in the air," Siy said Dec. 13 statement. Should the Ninth Circuit's ruling be adopted nationwide, it “means that anyone, from a single person, to a giant corporation, which resells goods made abroad, could find themselves sued under copyright law unless they determine where a product was made and purchase the licensing rights."

This puts all secondary markets at risk, Siy said, including “auction houses, pawnshops, and online marketplaces like eBay, Craigslist, and Amazon.”

Outcome Is a 'Blow to Consumers.'

Roger E. Schechter, a law professor at George Washington University, Washington, D.C., said he was also disappointed by the court's failure to take action in the case.

“First, the outcome is blow to consumers,” he told BNA. “It allows a maker of branded goods to enforce a system of international price discrimination--charging variable prices to consumer in different national markets--without any fear of inter-brand competition from third party importers,” even when the goods are identical in both markets.

Schechter also said that letting the Ninth Circuit's ruling stand gives companies the incentive to manufacture goods abroad, so as to retain greater control by avoiding application of the first sale doctrine. This may be an impetus to push even more manufacturing jobs overseas, he said.

“This seems a dubious interpretation of congressional intent underlying the copyright statute,” he said. “Indeed, for years, an importation clause in the statute was specifically designed to protected American book publishers!”

Schechter also voiced discomfort at the thought that Omega was able to use copyright law to enforce its distribution decisions, because “the copyrighted material provides minimal value to the consumer. The only copyrighted material in this case was a design that appears on the back of the watch, and is not even visible when the watch is being worn.”

He called this “an opportunistic use of copyright law to achieve purposes that it was never meant to address. If the case had been brought under trademark law, of course, Omega would have lost because the foreign goods were physically identical to those manufactured in the U.S.”

He expressed the hope that pro-consumer members of Congress would take up this issue and support legislation to amend the statute to explicitly apply the first sale doctrine in cases like this.

“There is no reason why the intellectual property laws should become a tool to support international price discrimination schemes in industrial goods, with resulting high prices to consumers and incentive to move jobs overseas in the middle of floundering economy,” Schechter said.

Tracy L. Reilly, a law professor at the University of Dayton, told BNA that ”The stakes at issue in the marketing and trading industries are huge. On the one hand, manufacturers like Omega are economically injured by such third-party activities because their ability to profit and offset marketing costs by charging higher prices in teh national market is undercut. At the same time, resale stores like Costco will be affected if these practices are banned because they will no longer be able to purchase imported items cheaper and subsequently pass on these savings to their consumers.”

Reilly said that it was true that this decision would likely encourage manufacturers to move production overseas in order to take advantage of the enhanced control offered. However, she said, “I think that the court got it right by literally interpreting the three pertinent sections of the Copyright Act. What is needed is an amendment … clarifying the sections at issue …. It is not for the court to contour these sections in order to fashion a ruling that favors good policy.”

She noted further that the failure of the court to assemble a majority on the question makes it possible that parties like Costco might be banned from importing such goods in some states but not in others.

Hope That Issue Will Come Up Again Soon.

Joshua D. Sarnoff, a law professor at DePaul University, Chicago, said, “It is a shame that Justice Kagan had to recuse herself, as the issue of international copyright exhaustion is very important and the 4-4 split on the Supreme Court reflects the substantial uncertainty that currently exists in this area.”

Sarnoff noted that the members of the court seemed dissatisfied with any textualist argument offered by the parties on this issue. Furthermore, he told BNA, “the court and public remain deeply divided over the competing policy concerns that Congress has not clearly resolved.”

He said that he hopes that it will not be too long before the court grants certiorari in a similar case.

Jeanne M. Gills of Foley & Lardner, Chicago, said she expects that the issue is indeed likely to come up very soon, particularly on the patent exhaustion side of the equation.

“My sense is the more of a global economy we come--and because this is not a decided issue on the patent side--that we haven't seen the last case like this,” Gills said. “In the short term this may provide some additional assistance to those companies that worry about gray-market goods. This gives them another avenue to prevent the sale of gray market goods. Gut I don't think the last thing has been said on international exhaustion. … I see this issue being teed up again.”

Furthermore, Gills told BNA that with the Supreme Court failing to issue a precedential decision or a written opinion, the U.S. Court of Appeals for the Federal Circuit is going to have more flexibility to reason through the issue and will not feel bound to agree with the Ninth Circuit.

Relief That Ninth Circuit Not Reversed This Time.

Speaking as “a lawyer in the Ninth Circuit, which gets reversed a lot” by the Supreme Court, Neil A. Smith of Ropers Majeski Kohn & Bentley, San Jose, Calif., told BNA that he was pleased that the appeals court's ruling was not reversed in this instance.

“I will continue to advise clients concerned with the gray market, to find a way to put a copyrightable logo 'bug' on each item or package to stop importation of authorized foreign products,” Smith said.

Herbert C. Wamsley of the Intellectual Property Owners Association also expressed support for the affirmation of the Ninth Circuit's ruling, but was left unsatisfied by its non-precedential nature.

“IPO would have preferred a definitive ruling in favor of Omega, which we supported with an amicus brief,” he told BNA. “The fact that four justices would have overturned the 9th Circuit is of concern. The practices and economics of copyright-based industries require that copyrights in different countries be treated separately and that rights granted in one country do not apply in another.”

Wamsley also said that this case has been of interest for the patent community, even though it came about in a copyright context.

“Although patent rights were not involved in Costco v. Omega, international exhaustion is an important issue in patent law as well,” he said. “Some day we will see another case at the Supreme Court on this issue.”

Kagan's Views Might Not Be Predictable.

Matthew J. Dowd of Wiley Rein, Washington, D.C., echoed the view that had the court issued a precedential decision, its impact would not have been limited to copyright law.

Dowd noted the submission of an amicus brief by Intel Corp., which said that “it would make little sense to analyze the first-sale doctrine for copyrights without being informed by the analogous doctrine for patents.”

Intel's brief noted that in patent law, the exhaustion doctrine relies on an examination of the question of authorization and whether the IP rights holder had been duly compensated.

“Thus, even though a specific statutory section of the Copyright Act was at issue, the reasoning of the court could have impacted the Federal Circuit's approach to first-sale issues involving patents,” Dowd said. According to Dowd, it is inevitable that there will be another case that raises the question of interpreting Section 109(a), and in such a case, it should be expected that more parties will seek to focus on the issues as they relate to patents.

He also said that the court's failure to create a precedent here may encourage other circuit courts addressing the question “to write a forceful opinion defending one view versus the other.”

Dowd noted that the Second Circuit has scheduled oral arguments for Jan. 12 in Pearson Education Inc. v. Liu, 93 USPQ2d 1139 (S.D.N.Y. 2009) (78 PTCJ 768, 10/23/09), which “raises substantially the same issue.” This case represents an opportunity for that court to make a statement on the question, he said.

Also, the fact that it was Kagan's recusal that made the 4-4 tie possible reveals that Kagan is the swing vote on this question. That, combined with the fact that Kagan was the solicitor general who recommended that the court deny Costco's petition for a writ of certiorari, will make her the target of future arguments by litigants.

However, Dowd said, it would be a mistake to assume that her solicitor's brief indicated her views.

“Many may read that brief as an indication of which way she would have voted, had she not been recused. Such a reading is too simplistic,” Dowd said. “Her … brief did argue that the Ninth Circuit's opinion was consistent with precedent, … [b]ut her brief also acknowledged that 'the court of appeals' reasoning could result in adverse policy consequences, particularly if carried to its logical extreme.' ”

No Settlement Until Congress Acts.

Brian H. Pandya of Wiley Rein, Washington, D.C., said, “The decision today upholds the status quo for gray market goods. A decision to reverse the Ninth Circuit could have had sharp consequences for companies that employ parallel distribution chains around the globe.”

However, he added that it will be necessary for Congress to clarify the statutory provisions implicated.

“This is an issue that is not going to be settled until Congress steps in and clarifies the language of Section 109 of the Copyright Act as to whether the first sale doctrine extends to products made and sold overseas,” he said.

By Anandashankar Mazumdar

Charles L. Gholz, Joshua D. Sarnoff, Neil A. Smith, Herbert C. Wamsley, and Roger E. Schechter are members of this publication's board of advisors.

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