{"id":14030,"date":"2011-07-20T10:07:15","date_gmt":"2011-07-20T15:07:15","guid":{"rendered":"http:\/\/law.marquette.edu\/facultyblog\/?p=14030"},"modified":"2011-07-20T10:37:42","modified_gmt":"2011-07-20T15:37:42","slug":"combatting-gray-markets-a-copyright-protected-distribution-right-or-a-sherman-act-violation","status":"publish","type":"post","link":"https:\/\/law.marquette.edu\/facultyblog\/2011\/07\/combatting-gray-markets-a-copyright-protected-distribution-right-or-a-sherman-act-violation\/","title":{"rendered":"Combatting Gray Markets: A Copyright-Protected Distribution Right or a Sherman Act Violation?"},"content":{"rendered":"

At one time, the prospect of stating legal claims against gray market importers looked bleak. \u00a0Product manufacturers tried trademark protection, but trademark law proved disappointingly unsuccessful.\u00a0\u00a0One company has now turned to copyright protection, and this company obtained a Ninth Circuit decision that found a\u00a0store using a gray market importation scheme unable to raise a defense to copyright infringement.\u00a0 The company is Omega S.A., a Swiss luxury watch manufacturer known for producing the Seamaster line of watches appearing in many James Bond films, and the case is Omega S.A. v.<\/em> Costco Wholesale Corp.<\/em>,\u00a0541 F.3d 982 (9th Cir. 2008). <\/em>In spite of Omega’s favorable Ninth Circuit judgment and opinion,\u00a0 market-wide legal questions about Omega’s distribution practice remain.\u00a0 Regardless of whether or not a manufacturer could state a claim for copyright infringement against gray marketers, infringement defendants may answer back by counterclaiming an antitrust violation.\u00a0 And if an antitrust counterclaim can halt copyright enforcement, then Omega’s win at the Ninth Circuit would end up a hollow victory at best or an academic stroll through the Copyright Act at worst.<\/p>\n

Here are the facts of Omega v. Costco<\/em>. \u00a0Omega maintains a tight grip on\u00a0its authorized distribution channels. \u00a0Omega attempted to gain control of its watches\u2019 distribution by engraving a design on the back of its watches (pictured below) and registering this design at the U.S. Copyright Office\"\"<\/a>.\u00a0Omega sold watches with these designs to their authorized distributors.\u00a0 Somewhere along the distribution line, however, the watches ended up in the hands of distributors outside of Omega\u2019s authorized channels abroad.\u00a0 As the Ninth Circuit recognized, this is a paradigm gray market importation scheme, in which products meant to be sold in one territory are imported into another, usually for cheaper prices. <\/em>One of Costco\u2019s suppliers based in New York imported watches from these unauthorized distributors and eventually transferred the watches to Costco, which then sold these watches to\u00a0its customers in California.\u00a0One of those purchasing customers turned out to be a plant employed by Omega.<\/p>\n

Omega then sued Costco for violating their exclusive right to distribute\u00a0\u00a0its copyrighted works and for importing them without Omega\u2019s authorization. \u00a0Costco asserted the first-sale defense, arguing that Omega\u2019s right to control\u00a0the distribution of its watches under both the distribution and importation statutes ends with its first transfer to its authorized distributors. \u00a0Costco v. Omega<\/em>\u2019s ending at the Supreme Court was a bit anticlimactic, with the U.S. Supreme Court evenly divided 4-4 (Justice Kagan didn\u2019t take part in the non-decision).\u00a0 This led to a summary affirmance of the Ninth Circuit\u2019s decision below and no rule from the Supreme Court resolving the statutory tension in the Copyright Act.<\/p>\n

<\/p>\n

In the midst of the statutory construction issues dominating the Supreme Court briefs, Costco suggested that Omega’s distribution controls might pose antitrust problems. \u00a0This issue popped up very briefly; in one sentence and in one footnote, Costco’s first merits brief surmised that Omega’s distribution controls might qualify as a vertical restraint of trade sanctionable under the antitrust laws. \u00a0The issue was mentioned only in passing, but how briefly it appeared should not downplay the importance of the issue. \u00a0As noted above, to the extent that gray market importation is still a subject of debate, other litigants may very well challenge practices meant to stamp out gray markets under the antitrust laws.<\/p>\n

Following Costco’s argument, Omega’s authorized distributor agreements could be characterized as vertical territorial restraints. \u00a0These distributor agreements might also involve vertical pricing fixing or vertical refusals to deal, but for the sake of brevity, this post will consider Omega’s practice as a vertical territorial restraint. \u00a0Vertical territorial restraints occur when companies up and down a distribution chain enter into agreements that limit the geographic areas into which they will sell their products.<\/p>\n

These restraints used to be treated as per se <\/em>illegal under the antitrust laws, but they are categorically unlawful no longer. \u00a0Taking the\u00a0per se <\/em>position on vertical territorial restraints was\u00a0United States v. Arnold, Schwinn & Co.<\/em>, 388 U.S. 365 (1967). \u00a0 Justice Fortas, writing for the majority, believed that limiting to whom distributors may transfer a manufacturer’s products is “so obviously destructive of competition that their mere existence is enough.” \u00a0Drawing upon other vertical restraint cases, the Supreme Court in Schwinn <\/em>expressed concern that allowing manufacturers to dictate how their products move down the distribution chain “would violate the ancient rule against restraints on alienation and open the door to exclusivity of outlets and limitation of territory further than prudence permits.”\u00a0\u00a0The Supreme Court in Schwinn<\/em> skirted a number of lingering questions. \u00a0One question was explicitly left off the table: how the principle of protecting the free alienation of property would apply to patents.\u00a0\u00a0Other matters left out were robust analyses of the economic efficiencies hampered or harnessed by vertical territorial restraints.\u00a0\u00a0A majority of the Supreme Court concluded as much ten years after Schwinn<\/em> in Continental T.V., Inc. v. GTE Sylvania, Inc.<\/em>, <\/em>433 U.S. 36, 54 (1977). \u00a0GTE Sylvania <\/em>overruled Schwinn<\/em>, noting how untethered the nature of a manufacture-to-distributor transaction is to the economic efficiencies and effects on different markets. <\/span><\/em>The GTE Sylvania<\/em> Court also flagged and examined the economic literature regarding how vertical restraints reduce intrabrand competition among retailers but allows manufacturers to enjoy new efficiencies in their interbrand competition with other manufacturers. \u00a0In other words, while there is a possibility that harm to intrabrand competition might be serious enough to warrant antitrust scrutiny, not all vertical territorial restraints are per se<\/em> illegal.<\/p>\n

The Supreme Court’s decision in GTE Sylvania <\/em>to step away from per se <\/em>illegality is not limited to vertical territorial restraints. \u00a0In like sense, the U.S. Supreme Court once treated resale price maintenance — whereby a manufacturer commands that distributors not set retail prices at, above, or below set figures — as per se <\/em>illegal.\u00a0\u00a0Albrecht v. Herald Co.<\/em>, 390 U.S. 145 (1968) (maximum resale price maintenance);\u00a0Dr. Miles Medical C<\/em>o. v.\u00a0Jo<\/em>hn D. Park & Sons Co.<\/em>, 220 U.S. 373\u00a0(1911) (minimum resale price maintenance). \u00a0Both of these cases\u00a0have since been overruled. \u00a0State Oil v. Khan<\/em>, 522 U.S. 3 (1997); <\/em>Leegin Creative Leather Products, Inc. v. PSKS, Inc.<\/em>, 127 S. Ct. 2705 (2007). \u00a0As GTE Sylvania<\/em>, Khan<\/em>, <\/em>and\u00a0Leegin <\/em>indicate, there are pro-competitive reasons for manufacturers to agree with distributors to limit the scope of distribution, whether through prices or geographic regions. And these reasons carry enough weight that the Supreme Court believes it imprudent to penalize every single one of these agreements. \u00a0Moreover, these cases signal that hostility toward vertical restraints as potential antitrust problems is subsiding.\u00a0 In fact, the IP and Antitrust <\/em>treatise\u00a0authors argue that “the rule of reason for purely vertical nonprice restraints has resulted in something approaching automatic legality for such arrangements.” \u00a0Herbert Hovenkamp et al., IP and Antitrust<\/em>, \u00a7 24.3b1.<\/p>\n

The antitrust analysis does not end with the Supreme Court’s treatment of vertical restraints in themselves. Adding another wrinkle is that the territorial restraint here was enforced using a copyrighted design, calling forth the ongoing confusion around how intellectual property and antitrust law should coexist. \u00a0For decades, courts and academics have been confounded by the tense intersection between intellectual property and antitrust law. \u00a0In fact, they cannot even agree on how to name it: In a\u00a0lecture<\/a> before the Antitrust Committee of the New York City Bar Association, Professor Mark Lemley listed several of these names: the relationship, conflict, tension, interaction, interface, or collision between intellectual property and antitrust policy.<\/p>\n

That the antitrust laws and intellectual property rights are hopelessly mired in irreconcilable doctrinal conflict is far from being a necessary or inevitable conclusion.\u00a0 Hovenkamp et al.,\u00a0supra<\/em>,\u00a0\u00a7 1.3. \u00a0In fact, Ward Bowman, Jr. argued that both intellectual property and antitrust promote wealth maximization and prevent restrictions on output. \u00a0Ward Bowman, Jr.,\u00a0Patent and Antitrust Law: A Legal and Economic Appraisal <\/em>(1973), reprinted in part in<\/em> Hovenkamp et al.,\u00a0supra<\/em>,\u00a0\u00a7 1.3; Mark A. Lemley, Milton Handler Lecture: The Intersection Between Antitrust and Intellectual Property Part 1-3<\/a>.\u00a0 They both have their own roles in accomplishing these ends: antitrust law protects the overall free market environment while intellectual property rights create incentives to innovate.\u00a0 Hovenkamp et al., supra<\/em>,\u00a0\u00a7 1.3; <\/em>Lemley, supra<\/em><\/a>.\u00a0\u00a0Without intellectual property, the argument\u00a0goes,\u00a0the market will stagnate. \u00a0Hovenkamp et al.,\u00a0supra<\/em>,\u00a0\u00a7 1.3; <\/em>Lawrence A. Sullivan & Warren S. Grimes,\u00a0The Law of Antitrust: An\u00a0Integrated Handbook<\/em> \u00a7 15.1 (2d ed. 2000); Lemley,\u00a0supra<\/em><\/a>.<\/p>\n

That being said, intellectual property’s economic justifications\u00a0do not give intellectual property owners carte blanche to enforce their intellectual property rights abusively nor in bad faith. \u00a0To be sure, some courts treat certain\u00a0intellectual property enforcement practices, such as tying agreements and possibly others, as\u00a0pernicious enough to the competitive process that they should not be tolerated under the antitrust laws, even if the intellectual property laws alone\u00a0would allow them.\u00a0\u00a0Image Technical Servs. v. Eastman Kodak Co.<\/em>, 125 F.3d 1195, 1216, 1218 (9th Cir. 1996);\u00a0Data General v. Grumman Systems Support<\/em>, 36 F.3d 1147, 1182 (1st Cir. 1994);\u00a0but see\u00a0In Re Independent Service Organization Antitrust Litigation<\/em>, <\/span><\/em>203 F.3d 1322, 1327, 1327-28 (Fed. Cir. 2000) <\/span><\/em>(“[A]\u00a0patent owner may not take the property right granted by a patent and use it to extend his power in the marketplace improperly, i.e. beyond the limits of what Congress intended to give in the patent laws.” (quoting\u00a0Atari Games Corp. v. Nintendo of America, Inc<\/em>., <\/span><\/em>)<\/span>; <\/span>SCM Corp. v. Xerox Corp<\/em>., 645 F.2d 1195, 1206 (2d Cir. 1981) (“[C]onduct permissible under the patent laws cannot trigger any liability under the antitrust laws.”).\u00a0 After all, the point of intellectual property in the United States is the economic\u00a0quid pro quo of granting a property right in exchange for enriching society with new artistic and utilitarian creations; intellectual property does not, however, exist only to shower creators and innovators with pecuniary benefits or to further the\u00a0Lockean notion that\u00a0labor makes property.\u00a0\u00a0Feist Publications v. Rural Telephone Services<\/em>, 499 U.S. 340, 352-60 (1991); Mazer v. Stein<\/em>, 347 U.S. 201, 219 (1954).\u00a0 In the final analysis, innovation and antitrust policy coexist best when they are balanced: bad faith and baldly anticompetitive intellectual property enforcement\u00a0should be sanctioned, while the\u00a0antitrust laws simultaneously allow intellectual property owners to reap the fruits of their patents, copyrights, and trademarks, among other rights.\u00a0 Herbert Hovenkamp,\u00a0Federal Antitrust Policy <\/em>\u00a7 5.5a (3d ed. 2005).<\/p>\n

Applying this complicated and sometimes conflicting set of legal rules, one can plausibly find pro-competitive reasons for allowing Omega to control its distribution channels this tightly. \u00a0In terms of interbrand competition — such as may be the case with other luxury watch designers, like Tag Heuer, Breitling, Movado, and Rolex — constraining distribution channels can protect a company\u2019s brand reputation.\u00a0 In economic terms, limited distribution to authorized sellers prevents free riding by low-end discount stores that can sell goods for cheaper prices while shirking the customer service and presentation of higher end shops.\u00a0 Cf. Leegin<\/em>, 127 S. Ct. at 2715.\u00a0 This is especially true for a luxury designer like Omega. \u00a0With the risk of free-riding by discount stores,\u00a0a niche market for luxurious goods and the luxe shopping experience could become endangered.\u00a0 Cf. id. <\/em>at 2715-16. \u00a0If Omega\u2019s fine watches can be had at lower prices than Omega would prefer at stores like Costco, then its brand may very well lose some of its exclusivity and cachet, a key asset to Omega’s ability to compete with other luxury designers.<\/p>\n

Furthermore, the circuit decisions cited above demonstrate that the courts have been reluctant to extend antitrust liability to intellectual property enforcement when the underlying intellectual property right is legitimately and duly granted. <\/em><\/em>For its part, the Federal Circuit has limited antitrust liability for patent infringement to the serious cases of fraud before the USPTO, objectively baseless sham litigation, and other situations in which a patent is extended beyond its statutorily granted property right, such as tying agreements. In Re Independent Serv. Org. Antitrust Litigation<\/em>, 203 F.3d 1322, 1326-28 (Fed. Cir. 2000).\u00a0\u00a0The Federal Circuit thus imposed a high burden on patent infringement defendants to show that intellectual property is being used in such an unduly exclusionary fashion as to warrant antitrust liability. \u00a0Id.<\/em> at\u00a01327.\u00a0 In the copyright arena, the U.S. Supreme Court has demonstrated support for copyright owners realizing the value of their intellectual property. \u00a0Broadcast Music, Inc. v. Columbia Broadcasting System<\/em>, 441 U.S. 1, 19 (1979) (“Although the copyright laws confer no rights on copyright owners to fix prices among themselves or otherwise to violate the antitrust laws, we would not expect that any market arrangements reasonably necessary to effectuate the rights that are granted would be deemed a\u00a0per se<\/em> violation of the Sherman Act.”).\u00a0 In the First and Ninth Circuits, there is still a doctrinal presumption that intellectual property rights are being used legitimately.\u00a0 Furthermore, there is close to explicit authorization in the Copyright Act for copyright owners to control their protected products’ distribution.\u00a0 Hovenkamp et al., supra<\/em>,\u00a0 \u00a7 24.3b1. \u00a0Each of these doctrines heavily weigh against the already hard antitrust case to win.<\/p>\n

Challenging Omega’s use of its copyrights as an antitrust violation thus would likely prove to be a daunting uphill battle.<\/p>\n","protected":false},"excerpt":{"rendered":"

At one time, the prospect of stating legal claims against gray market importers looked bleak. \u00a0Product manufacturers tried trademark protection, but trademark law proved disappointingly unsuccessful.\u00a0\u00a0One company has now turned to copyright protection, and this company obtained a Ninth Circuit decision that found a\u00a0store using a gray market importation scheme unable to raise a defense 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