Alert February 10, 2010

The Problem of Grey Market Goods: Practical Suggestions for Protecting Your Brand

Many trademark owners increasingly find themselves faced with the unenviable position of needing to take action against their own marks, and specifically trying to defeat the sale of grey market goods.  Historically, these actions focused on curbing the sale of goods meant for distribution and sale abroad, which were imported into the United States without the U.S. trademark owner’s consent.  However, the paradigm now includes products manufactured for sale in the United States that have been diverted from the brand owner’s authorized channels of distribution.  Fortunately, courts appear to recognize the challenges trademark owners face when confronting the sale of grey market goods.  To this end, a recent decision by the U.S. Court of Appeals for the Second Circuit is both encouraging and instructive for brand owners.

In Zino Davidoff S.A. v. CVS Corp., 571 F.3d 238 (2d. Cir. 2009), the Second Circuit considered whether the unauthorized removal of a unique production code from an otherwise authentic product could justify a finding of trademark infringement.  The court’s decision, which affirms the lower court’s preliminary injunction and enjoins CVS from selling such products, articulates many of the concerns expressed by trademark owners.  In recognizing how grey market goods frustrate the efforts of brand owners to protect the quality of their brands, the decision provides an insight into how brand owners may successfully combat grey market competition.

Zino Davidoff S.A. v. CVS Corp.

Zino Davidoff (“Davidoff”) markets and sells, among other items, a line of cologne and fragrances under the mark COOL WATER.  As part of a quality control program, Davidoff created and placed on each unit of its COOL WATER products a unique production code (“UPC”).  The UPC provides relevant information about that particular unit, such as the time and place of production, and the ingredients used. 

Davidoff limited sales of its COOL WATER products to luxury retailers, and had declined to sell its products to CVS.  Nonetheless, CVS obtained and sold Davidoff’s COOL WATER fragrances.  After first demanding that CVS cease any sale of the COOL WATER products, Davidoff sued CVS alleging trademark infringement, unfair competition and trademark dilution under the Lanham Act. 

Through court-ordered investigation, and armed with its UPC-placement practice, Davidoff was able to determine that CVS was selling both grey market and counterfeit goods.  In fact, the grey market goods had the UPCs removed, either by (i) cutting away the UPC from the packaging, (ii) using chemicals to wipe away the UPC or (iii) grinding away the UPC from the bottom of the fragrance bottle. 

CVS voluntarily agreed to cease selling the counterfeit products, but refused to stop selling the grey market products.  Davidoff then sought a preliminary injunction forbidding CVS from selling the grey market goods.  The lower court granted the motion and CVS appealed.

The Second Circuit’s Analysis

In its appeal, CVS argued that the grey market goods were genuine Davidoff goods sold in their original packaging with the Davidoff trademarks clearly visible and unaltered.  As such, CVS maintained, there could be no trademark infringement because the mere removal of the UPCs did not negate the authenticity of the goods or the marks associated with those goods.   

The Second Circuit disagreed.  Recognizing that the Lanham Act does not generally impose liability on the sale of genuine goods bearing a trademark because such a sale would not cause confusion, the court nonetheless explained that goods are not genuine if they do not conform to the trademark holder’s quality control standards.  Thus, in the court’s view, the issue was not whether the grey market goods were genuine Davidoff goods, per se.  Rather, the court explained, the focus was on whether the removal of the UPCs interfered unlawfully with Davidoff’s trademark rights and its ability to exert quality control.  In the Second Circuit’s view, therefore, a trademark owner’s ability to control quality is paramount.

Davidoff explained that the UPCs helped Davidoff to detect and prevent counterfeit and defective products, as well as to effectuate any necessary recalls.  Citing this policy, the court explained that “[a] trademark holder is entitled to an injunction against one who would subvert its quality control measures upon a showing that (i) the asserted quality control procedures are established, legitimate, substantial and nonpretextual; (ii) it abides by these procedures, and (iii) sales of products that fail to conform to these procedures will diminish the value of the mark.” The court concluded that Davidoff satisfied this burden and that the removal of the UPCs exposed Davidoff to the risk of damage to the reputation of its COOL WATER mark.

In addition to recognizing Davidoff’s right to control the quality of its product, the court also concluded that the removal of the UPCs materially altered the product sold under the mark.  Explaining that cutting or burning away the UPCs detracted from the value of Davidoff’s otherwise luxury product, the court articulated another basis to grant an injunction against CVS: CVS was selling COOL WATER products that were materially different from Davidoff’s genuine trademarked product. 

The court explained when determining what constitutes a “material” difference between grey market goods and genuine trademarked product, it requires “no more than a slight difference which consumers would likely deem relevant when considering a purchase of the product.”  Thus damage to the appearance of the product – and the resultant material differences between the altered product and the genuine trademarked product – further frustrated CVS’s attempts to overcome the injunction.

Next Steps for Trademark Owners

Grey market goods and the problems created by the unauthorized sale of these goods are not limited to luxury items.  On the contrary, products as diverse as children’s dolls and energy drinks have been the subject of grey market disputes. (See, e.g. Original Appalachian Artworks Inc. v. Granada Electronics, 816 F.2d 68 (2nd Cir. 1987) (dolls); Red Bull GmbH v. Lamont Distributors, Inc. 09-cv-02602 (E.D.N.Y. June 2009) (energy drinks); Societe des Produits Nestle, S.A. v. Casa Helvetica, Inc., 982 F.2d 633 (1st Cir. 1992) (chocolates); Davidoff & CIE, S.A. v. PLD Int’l Corp., 263 F.3d 1297 (11th Cir. 2001) (fragrance).  And while trademark owners cannot insulate themselves entirely from the risks posed by the grey market, there are certain steps every trademark owner should take to protect itself against the dangers of the grey market. 

For example, in Davidoff, the Second Circuit emphasized the role the UPCs played in the brand owner’s anti-counterfeiting program.  The court repeatedly explained that the only relevant question regarding the UPCs was whether they were a bona fide control device upon which the brand owner relied.  It is therefore important for brand owners to have decisive and articulated quality control measures in place.  This could include a formal written policy for inspection and handling of a product, or a unique production code affixed to each product.  A quality control program – even for those products meant for sale in the United States through authorized distributors – should be comprehensive and detailed.

It is important to not only have these measures in place, but to actually utilize the procedures to monitor the quality of the products.  Davidoff suggests that courts will not entertain a quality control program that is neither established nor enforced. 

Maintaining quality control standards is one way to combat grey market goods, whether those goods are products meant for sale abroad or products meant for sale in the United States through authorized distributors.  It would also be helpful for brand owners to differentiate those products meant for sale in the United States from products which are meant for distribution and sale outside of the Unites States.  This may be accomplished by providing instructions, ingredient lists or any warranty information in a particular language targeted to a particular jurisdiction.  And while the threshold for establishing “materiality” in the context of grey market goods may be relatively low, any differences in packaging should be as conspicuous as possible.

For example, relying on such differences in packaging to identify grey market goods, brand owners Red Bull GmbH and Red Bull North America have been aggressively attacking the sale of grey market RED BULL-brand products in the United States.  See, e.g., Consent Judgment, Red Bull GmbH et al. v. Kassir Import-Export Co. et al., 1:06-CV-2301-CC (N.D. Ga. 2009) (citing material differences between toll free contact numbers, missing deposit information and differences in spellings of words); Complaint for Damages and Injunctive Relief, Red Bull GmbH et al. v. Lamont Dist., Inc., et al., Inc. 09-cv-02602 (E.D.N.Y. June 19, 2009) (identifying omitted or different nutritional information, unfamiliar ingredients identified on the cans, a lack of required U.S. federal and state nutritional, deposit and volumetric information); and Complaint for Damages and Injunctive Relief, Red Bull GmbH et al. v. Central Supply, 09-cv-04034 (E.D.N.Y. September 18, 2009) (citing wording written in British English and a London address rather than a U.S. address in California). 

The Second Circuit’s decision is encouraging for brand owners and their efforts to maintain the integrity of their products and brands.  However, it remains incumbent upon brand owners to create and enforce programs which will protect this integrity.  Such programs should be written and communicated both to the public and to the brand owner’s authorized sellers.  Educating consumers and authorized distributors about the perils of the grey market is the brand owner’s best defense against the market’s detrimental effects.