With Supreme Court Deadlock, Cloud Lingers Over Gray Market Goods

By Lisa Tittemore. Chair of our Trademark and Copyright Practice Groups

December 2010 IP Update

Copyright law can have a direct impact on the availability and pricing of the products we purchase.  This is true in many ways, one of which was recently addressed by the United States Supreme Court in Costco v. Omega, a case involving Costco’s sale of gray-market watches.

In Costco, the court had the opportunity to address a persistent conundrum involving the “first sale doctrine” and answer the question:  May a distributor — without the authorization, and even against the will of the copyright owner — resell copyrighted products in the U.S. that were made abroad, intended only for sale abroad, and purchased abroad?  The justices’ 4-4 tie left the question unanswered, to the disappointment of the many people watching the Court and hoping for a definitive resolution.

It is well established that the purchaser of a copyrighted work made within the U.S. may resell or otherwise transfer it to another party without violating the copyright owner’s rights.  The first sale doctrine, codified in the Copyright Act at 17 U.S.C. § 109, explicitly permits this further distribution after an authorized first sale of a “lawfully made” work, and “exhausts” the copyright owner’s exclusive right of distribution.

Only the distribution right may be exhausted, not the other exclusive rights of the copyright owner (e.g., the right to copy, the right to make derivative works).  Thus, if you buy a copyrighted book, you may resell the book or give it as a gift to someone else, but you may not make additional copies of it to distribute.

For many years, and especially since the Supreme Court’s 1998 decision in Quality King Distributors, Inc. v. L’Anza Research International, Inc., copyright scholars have debated the legality of importing into the U.S. for distribution copyrighted goods which were made abroad and intended only to be sold abroad (so called “gray market goods”). The question turns largely on what constitutes a “lawfully made” item in this context.

In Costco v. Omega, Omega sued over Costco’s sale in the U.S. of authentic Omega watches which were unauthorized gray market goods.  Costco had obtained the watches from a third party which had purchased them from authorized Omega distributors overseas.  On the back of the watches was a symbol that Omega had registered with the U.S. Copyright Office, enabling Omega  to assert a claim under the Copyright Act.

According to Omega, Costco had threatened to sell “indirect merchandise” if Omega did not agree to Costco’s terms for carrying Omega watches in its stores.  After failing to reach agreement, Costco proceeded to acquire the watches from sources outside the U.S. even though it knew that Omega did not authorize the  imports.

The trial court initially barred Costco from selling the watches.  Later, the judge withdrew the injunction, accepting Costco’s argument that the first sale doctrine prevented Omega’s copyright infringement claim.

On appeal, the Court of Appeals for the Ninth Circuit reversed the trial judge’s ruling, holding that the Supreme Court’s ruling in Quality King did not invalidate the Ninth Circuit’s “general rule” that the first sale doctrine provides a defense to infringement “only insofar as the claims involve domestically made copies of U.S.-copyrighted works.”

Because the goods involved in Costco v. Omega were made overseas, the Ninth Circuit held that the first sale doctrine did not apply to bar Omega’s infringement claims, and remanded the case to the district court.

In Quality King, the Supreme Court had determined that products made in the United States and sold abroad but subsequently re-imported into the United States without the copyright owner’s consent would be covered by the “first sale doctrine” and thus would preclude a copyright claim.  In Quality King, the Supreme Court did not address whether the first sale bar would also apply to works made abroad.  However, Justice Ginsburg’s concurrence hints that the first sale bar would apply only to goods made within the U.S.

The Ninth Circuit expressed concern that applying the first sale doctrine “to foreign-made copies would violate the presumption against the extraterritorial application of U.S. law.”  That is, U.S. law is presumed to apply only to conduct occurring within or having effect within the United States unless explicitly provided otherwise by statute.

Copyright scholars had hoped that Costco v. Omega would answer the question long left open by Quality King.  Unfortunately, the newest justice, Elena Kagan, could not participate in the decision because of her earlier involvement in the case as U.S. Solicitor General. Without a ninth justice to break the tie, the Supreme Court was deadlocked.

As a result, the Ninth Circuit’s decision–that the first sale doctrine does not bar an infringement claim for foreign-bought items resold in the U.S.–stands intact, but the ruling has no precedential effect outside the Ninth Circuit.  Thus, courts in other circuits may reach differing conclusions, and in those circuits, the question remains an open one.  Should a similar case reach the Supreme Court in its current composition, Justice Kagan’s vote will likely be the tiebreaking vote.

In the meantime, companies concerned about the sale of gray market goods in the U.S. will want to find ways to affix copyrighted works onto their goods as a way to stop the importation of products that were made abroad for foreign sale only, in the hopes that the Ninth’s Circuit’s rule will be adopted elsewhere and ultimately affirmed by a majority of the Supreme Court.

Because under U.S. trademark law, where the goods are authorized for sale abroad and legitimately bear the company’s trademarks, companies are generally unable to pursue claims for trademark infringement.  Accordingly, seeking protection under the copyright laws has now become a favored alternative for such companies.

Critics of the Ninth Circuit’s decision fear that it encourages international price discrimination whereby brand owners can charge different prices for the same goods in different markets without competition from third party importers. Retailers believe that they should be allowed to import as they see fit any legitimate, non-pirated items that had already been sold once at a price of the copyright owner’s choosing.

Now, however, if the Ninth Circuit decision gains wide acceptance, the implications could extend beyond the importation of large quantities of gray market goods.  In fact, individual resellers and libraries might face the burden of having to research the origins of every copyrighted article that they own before selling it or lending it out.

Critics also argue that from an economic perspective, the court’s opinion may create perverse incentives for companies to move their manufacturing facilities abroad in order to avoid application of the first sale doctrine and retain control over the downstream distribution of all sold items.

Such opponents may seek to promote these policy questions before Congress rather than leave the issue to the courts.