White Paper. Stopping Unauthorized Online Sales and Product Diversion February 2016

Transcription

1 White Paper Stopping Unauthorized Online Sales and Product Diversion February 2016

2 Companies from many industries have long been contracting with distributors to sell products on an exclusive basis. As technology has evolved, however, it has become easier for anyone to sell products on the internet, and the diversion of products to unauthorized online sellers poses a serious threat to companies. These companies are facing pressure on all sides: from authorized distributors, internal financial managers, and customers. For authorized distributors, the proliferation of diverted products on ebay, Amazon, and other websites often sold at prices that are significantly lower than those at which authorized distributors must charge is frustrating and demoralizing. When authorized distributors see the high volume of unauthorized sellers and products available online, they begin to question the company s commitment to stopping unauthorized sales, leading to complaints, decreasing motivation, and even termination of their agreements with the company. The company must not only deal with these issues with its distributor network, but it must also confront the fact that product diversion directly harms the company s bottom line by reducing prices and diverting revenue. Unauthorized sales also damage a company s brand and its reputation with customers. Diverted products are often sold without any instructions, warranty, customer service, or quality controls, which materially affects the quality of the products the customers receive and those customers experiences. In short, although the problem is obvious, the solution is not. Many companies are still struggling to identify effective tools to combat the problem of product diversion. A New Approach Is Needed There are three common strategies that companies have used to combat product diversion, none of which have proven to be effective or efficient in stopping unauthorized online sales: 1) retaining technology companies to identify unauthorized products and to remove those products from third-party websites; 2) using outside counsel to file lawsuits against unauthorized sellers and authorized distributors involved in diverting products; and 3) coordinating enforcement efforts through in-house personnel. First, there are many technology companies offerings services designed to combat unauthorized sales. While these technologies can be effective in identifying diverted products, they are far less effective in actually stopping the sale of diverted products. This is primarily because websites like Amazon and ebay will typically not honor takedown requests from the technology companies, which seek the removal of products sold outside their clients distribution channels. Amazon, for example, states on its website that it respects the rights of manufacturers to enter into agreements with distributors, but also that it would not be appropriate for Amazon to assist in enforcement activities. Technology companies are more effective in securing the removal of counterfeit products and copyrighted images than they are in stopping the sale of diverted products. And, even if one of these technology companies is able to remove a product sold by an unauthorized seller online, this very rarely stops the seller from re-listing the product under a different user name or on a different website. Thus, the most common result of employing a technology company as the primary weapon against product diversion is a never-ending game of Whac-A-Mole the company succeeds in removing a product listing, and the unauthorized seller simply re-posts the product in another manner. In other words, it might be possible for technology companies to help get some products to disappear from websites, only for the companies products to then reappear. For these and other reasons, technology and monitoring companies have been unable to provide truly effective solutions for companies in dealing with high volumes of unauthorized sellers.

3 Second, the use of outside counsel to combat product diversion has been similarly ineffective. Law firms have traditionally employed standard litigation tactics (e.g. serving subpoenas, filing lawsuits, or attempting to obtain injunctions) at standard billable hourly rates. While such an approach can be effective against individual unauthorized sellers, it quickly becomes cost-prohibitive when employed as the primary strategy to combat product diversion. Moreover, most law firms do not supplement their traditional legal techniques with the important technology and investigation aspects of pursuing unauthorized sellers; using all of these tools is necessary to maximize their effectiveness. Third, some companies have tried to combat product diversion by using in-house resources (e.g. in-house legal department, compliance group, or some combination). This approach generally involves using internal employees to review data collected by a monitoring company to identify unauthorized sellers and send them cease and desist letters. However, many internal employees lack the experience and knowledge to combat product diversion and, therefore, the internal approach is often unsuccessful. For example, many experienced unauthorized sellers will be more likely to ignore a cease and desist letter sent by company personnel than a letter from a law firm; the internal employees struggle to efficiently identify the unauthorized sellers; and the internal employees do not know how to overcome the First Sale Doctrine defense. Further, because only the largest companies can have a dedicated group to combat unauthorized sales, the internal employees tasked with stopping product diversion often have other job duties as well. Stopping product diversion can thus become either an afterthought or a drain on the company s internal resources. After seeing several company clients come to us frustrated with their unauthorized seller problem, Vorys conducted a significant amount of research and analysis and worked with a team of cyber investigators and technology companies to develop a new approach to handling this unauthorized seller problem. Our goal was to integrate the legal, technology, and investigation-based techniques into a comprehensive system that maximized the strengths of each strategy and increased the efficiency of enforcement. We have employed this program for many different companies and have seen great results in reducing product diversion and the number of unauthorized sellers of the companies products. This white paper explains the system we developed and how it can be used to address the issue of unauthorized sales and the damages it is causing companies. Tailoring Policies, Procedures and Agreements to Support Enforcement The first step in our unauthorized seller enforcement program is to conduct a thorough review and analysis of a company s policies and procedures. This review helps us to understand the company s business and to focus on key aspects of the contractual relationship between the company and its authorized distributors that can be used to support claims against unauthorized sellers. Our review goes beyond examining the provisions designed to prohibit authorized distributors from diverting products. We also focus on the customer benefits and product quality controls because, ultimately, these aspects can play an important role in determining whether a company has legal grounds to stop third-party resellers. In response to trademark infringement claims, third-party resellers often invoke the First Sale Doctrine as a defense. The First Sale Doctrine generally provides that an individual who purchases a trademarked product acquires the right to resell that product. Thus, as a general matter, a consumer who purchases a product can resell that product on websites such as ebay or Amazon. See, e.g., Sebastian Int l, Inc. v. Longs Drug Stores Corp., 53 F.3d

4 1073, 1074 (9th Circ. 1995) ( Resale by the first purchaser of the original article under the producer s trademark is neither trademark infringement not unfair competition. ). Fortunately, there are exceptions to the First Sale Doctrine, which do not protect resellers who offer trademarked goods that are materially different than those sold by the trademarked holder (emphasis added). Beltronics USA, Inc. v. Midwest Inventory Distrib., LLC, 562 F.3d 1067, 1072 (10th Cir. 2009) (quoting Davidoff & CIE, S.A. v. PLD Int l Corp., 263 F.3d 1297, 1302 (11th Cir. 2001)). Courts have found that the threshold for establishing a material difference is low. 1 Only a single material difference is necessary to give rise to a trademark infringement claim, 2 and material differences do not have to be physical to establish trademark infringement. More specifically, courts have recognized both customer benefits and quality controls as establishing the necessary material difference. For example, courts have held that when a product does not come with certain benefits or services that a customer typically receives through authorized sales such as a warranty, money-back guarantee, instructions, or post-sale customer service 3 the product is materially different from diverted products sold without such benefits. See, e.g. Beltronics USA, Inc. v. Midwest Inventory Distrib., LLC, 562 F.3d 1067, 1073 (10th Cir. 2009). Similarly, courts have held that trademark holders have the right to control the quality of their distribution and that unauthorized resellers who do not follow these same quality controls commit trademark infringement. See, e.g., Shell Oil Co. v. Commercial Petroleum, Inc., 928 F.2d 104, 107 (4th Cir. 1991) ( A product is not truly genuine unless it is manufactured and distributed under the quality controls established by the manufacturer ). As a result, there are a number of things companies can do to create material differences between the products sold through their authorized channels and those sold by unauthorized sellers outside the authorized channels. Implementing such differences and memorializing them in contracts with authorized distributors is, therefore, critical to establishing a strong basis for stopping unauthorized sellers. Many companies already offer a warranty or money-back guarantee. By clarifying that such benefits apply only to products sold by authorized dealers and not to products sold online by unauthorized retailers 4 the company can establish a clear material difference between authorized and unauthorized products to support a claim for trademark infringement. Similarly, resellers who cannot or do not meet a trademark owner s quality control standards including certain packaging, tracking codes, pre-sale consultations or storage instructions, among others cannot invoke the First Sale Doctrine. Thus, another practical way of strengthening trademark claims against unauthorized sellers is to implement such 1 Courts have held that consumers are more likely to be confused by products that are not identical but nonetheless bear strong similarities in appearance of function. Societe Des Produits Nestle, S.A. v. Casa Helvetia, Inc., 982 F.2d 633, 641 (1st Cir. 1992). As a result, the threshold of materiality must be kept low enough to take account of potentially confusing differences differences that are not blatant enough to make it obvious to the average consumer that the origin of the product differs from his or her expectations. Id. 2 Id. (holding that any difference between the trademark owner s product and the allegedly infringing product that consumers would likely consider to be relevant when purchasing a product creates a presumption of consumer confusion sufficient to support a Lanham Act claim ). 3 Differences in post-sale services can be material. See SKF United States, Inc. v. ITC, 423 F.3d 1307 (Fed. Cir. 2005). 4 Note that some states may have consumer protection laws prohibiting discrimination against consumers based solely on whether they purchased a product from an authorized distributor. Before implementing policy to limit the application of warranties or money-back guarantees, it is important to consult experienced legal counsel.

5 practices into a company s authorized distribution process that unauthorized sellers cannot, or will not, follow. In addition, we also recommend that companies add language to their agreements with authorized distributors that will support tortious interference with contract claims against third-party resellers. For example, if an authorized distributor is not permitted to sell products to another for purposes of resale, anyone who purchases products from an authorized distributor and then re-sells them online has arguably induced a breach of contract between the company and its authorized distributor. Then, when a company provides notice to an unauthorized seller online that his or her actions have caused a breach of the company s distribution agreement, if the unauthorized seller continues to sell the products, the company has a claim that the unauthorized seller is knowingly causing a breach of the agreement. 5 See, e.g., Australian Gold, Inc. v. Hatfield, 436 F.3d 1228, 1236 (10th Cir. 2006) (affirming trial court s finding of tortious interference where defendants acquired tanning products in violation of corporation s agreements with its distributors and continued to resell such products after receiving notice that such actions violated the corporation s distribution agreements). We have compiled a list of a number of material differences, quality controls, and contractual provisions that companies should consider in structuring their own policies and procedures. Before proceeding with an enforcement program, we recommend having a legal team familiar with all these issues review and provide recommendations to the company about the policies, procedures, and contractual provisions it should implement to maximize the strength of their legal claims against unauthorized sellers. The Graduated Enforcement System Once a company has structured its policies, procedures, and contractual documents to maximize the strength of its legal claims against third party unauthorized sellers, the next step is to create an enforcement system that most effectively and efficiently achieves the company s goals within realistic budget constraints. Based on years of working with various companies on online seller enforcement issues and collaboration with technology and investigative experts, we believe the best system is an integrated system that combines technology, cyber investigators and specialized legal enforcement to address unauthorized sales through a graduated enforcement program. The program uses a standardized, flat fee service to deter as many unauthorized sellers as possible, while reserving more costly traditional legal tactics for the most troublesome and persistent sellers. The key to the program is the combination of technology, cyber investigation, and legal services provided at a single flat fee price point. The program begins by using technology to 5 In addition to adding provisions to support claims against the third party unauthorized sellers, there are a number of other provision companies can add to their agreement to further deter their own distributors from diverting products, and/or selling them in unauthorized channels. These provision include: liquidated damages provisions (e.g. $1,000 for each unit in each instance of a prohibited, unauthorized and/or noncompliant sale); provisions explicitly prohibiting product diversion; provisions prohibiting selling quantities of products greater than those typically purchased for consumption; provisions requiring that certain records are maintained so the company can verify sales and their legitimacy.

6 identify unauthorized product sales and unmask unauthorized sellers. Then, working with the company, we select a number of unauthorized sellers to receive send cease and desist letters, which can be sent either by the law firm or the company. These letters are designed to cull a large percentage of unauthorized sellers through a relatively low cost, low effort process. For persistent unauthorized sellers, we employ additional legal strategies, including sending draft complaints to the unauthorized sellers, subpoenas, or filing lawsuits and seeking injunctions transferring the unauthorized sellers websites and proceeds to our client, which are billed at the law firm s hourly rates. This approach allows a company to control costs and reduce the overall volume of unauthorized sellers while still maintaining the ability to use the hammer of a lawsuit against high-volume or problematic resellers. For the technology portion of our program, we have worked with technology developers to develop software specifically designed to track key information about unauthorized sellers. This software scans the internet for pertinent information related to the unauthorized sales and sellers, including the following: the screen names or private website domain names for the problematic sellers; the number of products being sold; the website or websites on which the products are being sold; links where private messages and electronic cease and desist (ec&d) letters can be sent; and the percentage of the products being sold below the intended price. This software also provides reports that rank the unauthorized sellers for each website, from the highest volume sellers to the lowest. Typically, we provide a full report to clients each month with the above-described information. The information in the report helps clients to see the scope of the problem. The client then has the discretion to have ec&ds sent to a chosen number of unauthorized sellers, either by the law firm, by the client, or by both. Typically, the law firm targets a select number of higher volume unauthorized sellers by first sending a robust cease and desist letter to them electronically, through an online messaging system. Amazon and ebay, for instance, each have the means for companies to privately contact unauthorized sellers on their websites. The lengthy and powerful ec&d typically includes the following features: a detailed explanation of why their sales are illegal; an explanation that courts in the company s state will have jurisdiction over them; if it is a foreign website, an explanation of the potential de-indexing of their website from Google or seizing the website altogether; citations to cases filed against unauthorized sellers (when available), as well as cases in which large damages were awarded to the company whose products were diverted; and demands that the seller cease and desist all sales of the company s products and identifies the source of their products.

7 We also provide draft ec&ds to clients that they can send to the lower volume sellers, which are usually less threatening but generally will: inform the sellers that they are violating the company s trademarks and/or contractual rights; explain that the company is taking enforcement actions against unauthorized sales to ensure customers are getting quality products to protect authorized distributors; explain that this is part of the commitment to the success of the company s distributor program and the satisfaction and confidence of its customers; and explain that if they do not remove the products, the company might bring in their legal counsel. After the ec&ds are sent, we track the unauthorized sellers closely to determine whether they comply with the ec&ds. High volume sellers that do not comply are targeted for additional investigation to obtain their identities. The investigators can use a variety of tactics to obtain these unauthorized sellers identities, including: 1) purchasing products and obtaining identification information through payment transactions and product packaging (e.g. return address information); 2) running extracted information through advanced law enforcement databases and cross-referencing identifying information with the cyber investigator s databases; or 3) using open-source intelligence or other identification systems. Once investigators have obtained the identities of these remaining high volume sellers, we then send them physical (non-electronic) cease and desist letter to their addresses. These physical cease and desist letters sent in hard copy via a traceable delivery service are effective because the sellers will realize that they are no longer hidden/anonymous and that a law firm has made the effort to unmask their identities and determine their locations. After the above steps have been completed, the next steps are to evaluate which targeted sellers have still not complied with the letters (if any) and also to obtain relevant information related to any new sellers. At the end of the monthly cycle, we send a report with retrospective and prospective information. In the retrospective portion of the report, we provide the number of sellers who have complied with the letters and the identities of the sellers obtained, and we recommend legal tactics to stop any remaining non-compliant unauthorized sellers. The prospective portion of the report identifies unauthorized sellers who have yet to be targeted and recommends a list of such sellers to target with the flat fee ec&d approach for the upcoming month. Throughout the life of the program, the client retains discretion to control its scope and cost. Clients can increase or decrease the number of sellers targeted in the flat fee portion of the program (with a corresponding increase or decrease in the flat fee charged) and can ratchet up or down the level of targeted legal enforcement against persistent unauthorized sellers. For unauthorized sellers who do not comply with our ec&ds and physical cease and desist letters, we can recommend a number of steps in a graduated enforcement process to secure compliance. These tactics include: sending a draft complaint to indicate that legal action is imminent; filing a lawsuit against the unauthorized sellers (they can be named personally if they have been identified, or we can file a John Doe lawsuit to obtain discovery

8 through third parties (e.g. Amazon and/or PayPal) to identify the proper defendants); negotiating with the sellers and preparing and executing settlement agreements; obtaining temporary restraining orders to freeze the online sellers PayPal accounts; obtaining injunctions to order that the online sellers cease selling the company s product; obtaining injunctions ordering the transfer of the unauthorized sellers website domains to the company; and/or obtaining court orders that can be used to de-index the unauthorized sellers e- commerce websites from Google and other search engines. This process, which is billed using hourly rates, also benefits from efficiencies. We use attorneys who focus their entire practices on online seller enforcement issues and who have billable hour rates lower than standard rates to handle day-to-day enforcement efforts. We also have complaint and case law templates that allow us to move quickly and costeffectively without re-inventing the wheel on each case. The above-described process operates on a repetitive monthly basis. An illustration of how this graduated enforcement system works can be seen below:

9 Given that most companies have budget constraints, they typically target between five and 20 unauthorized sellers through the flat fee program. The goal of the program is to reduce the number of unauthorized sellers and products each month, as illustrated below: Impact of the Graduated Enforcement System The graduated enforcement system which can be tailored to fit the needs of each company can produce numerous positive benefits. Clients have seen a significant reduction in the number of unauthorized sellers online in comparison to competitors. Results have been quick multiple companies have reduced the percentage of the unauthorized sellers by 40 to 50 percent within three months of implementing the graduated enforcement system. The program also produces intangible benefits by deterring unauthorized sellers and increasing the morale of authorized distributors. By way of an analogy: burglars tend to identify softer targets and avoid houses that have alarms or guard dogs. Similarly, we have found that taking an aggressive approach to enforcement tends to deter unauthorized sellers and product diverters, who instead focus their efforts on other companies who do not operate such an aggressive system. By producing a noticeable reduction in unauthorized sales, a company can boost the morale of its authorized distributors while positively adding to the company s bottom line. Many companies choose to publicize the results of the program to their distributors, which demonstrates that they are taking serious action to protect their distribution channels and brands. By aggressively stopping unauthorized sellers, a company can create a culture that excites its authorized distributors, as they can see the efforts the company is undertaking to help protect them. Having happy and motivated distributors is obviously beneficial to a company in selling its products and maintaining a strong brand. In conclusion, we believe that the graduated enforcement program offers a unique approach to combat the problem of product diversion. It is the result of years of experience that have led us to combine the best aspects of existing strategies in a far more cost-effective and user-friendly program. This white paper is for general information purposes and should not be regarded as legal advice. Please contact the author if you want more information or have questions about the discussed solutions, systems, or programs.

10 Authors: Whitney C. Gibson Partner Whitney is the leader of the firm s illegal online seller enforcement team. Whitney has developed custom programs for companies confronting unauthorized sales, grey market sales, counterfeit sales, Minimum Advertised Price (MAP) violators, and other illegal sales on the internet, combining legal, technological and investigative tools and services. He also serves as co-editor of the firm s Online Seller Enforcement blog. Michael Bronson Partner [email protected] Michael has substantial experience with enforcement, counseling, and litigation relating to product diversion and unauthorized sales, as well as other internet brand and reputation protection issues. He also defends corporations in complex commercial litigation, business disputes, and False Claims Act cases throughout the country. Patrick Hagan Partner [email protected] Patrick s practice includes complex civil litigation and corporate investigations, as well as work involving internet brand and reputation protection issues such as product diversion and unauthorized sales. He also counsels clients in responding to data breaches, including handling investigations initiated by state and federal regulators. Adam Sherman Partner [email protected] Adam focuses his practice on trademark and copyright protection, unfair competition, brand protection, internet defamation, and commercial litigation. Adam also has experience handling cases that involve contract disputes, trade secrets, torts, privacy issues and fiduciary duties. He also serves as co-editor of the firm s Online Seller Enforcement blog.