SELLING OVER THE INTERNET: Seller Beware

IVAN HOFFMAN, B.A., J.D.


        The Internet has not been an untamed wilderness for many years and is regulated in extensive ways.  A recent case out of the Tenth Circuit demonstrates the applicability of contract law, trademark law, tort law and other laws and how violation of those laws can lead to substantial damages and other significantly unfavorable results.  Those selling others’ products take careful note.

        In Australian Gold, Inc. et. al. vs. Brenda Hatfield et. al., these were the facts in summary form:

        Plaintiffs were manufacturers and a distributor of indoor tanning lotions which were sold exclusively through indoor tanning salons.  As part of the marketing and distribution of these products, the manufacturers provided training to the distributors of their products and operators of the salons.  In the manufacturer’s agreement with ETS Inc., the exclusive distributor of their products, it provided that such products would only be sold to such tanning salons and in ETS’ agreements with sub-distributors, ETS also provided that such products could only be sold in such tanning salons.  In the words of the Court (“Products” refers to the said products):

Since 2001, these agreements have generally prohibited distributors from selling Products over the internet or  selling Products to anyone else who will sell them to the general public over the internet. [footnote omitted]  Plaintiffs enforce the integrity of these agreements by attempting to stem the flow of Products to businesses other than tanning salons, and have spent over $1 million on such efforts.
        Defendants are parties who sold the Products and other products over the Internet without the consent of the plaintiffs.  Defendants used various names of companies and operated numerous web sites in such activities.  Defendants used pictures and names of the Products and plaintiffs’ trademarks on their sites and in the meta tags for their sites, (read “Keywords, Meta Tags and Trademarks”) including paying a search engine optimization firm to provide high placement through the use of such meta tags.  Defendants obtained the Products initially from distributors of the Products who in doing so violated the said agreements discussed above and then from an unauthorized source who sold the Products “out of a van for cash only.”  At one point, although defendants removed the plaintiffs’ Products from their sites, they continued to refer to such Products in their said meta tags.

        After a trial, a jury awarded plaintiffs millions of dollars in compensatory and punitive damages against the defendants and the court enjoined the defendants from continuing to sell the Products or using the plaintiffs’ trademarks.

The Appellate Decision

        The Court ruled on numerous bases as follows (I do not discuss the jurisdictional issues since they are not germane to the intellectual property and other issues that are the subject of this article):

        1. Tortious Interference with Contract.

        The Court ruled that the underlying agreements between plaintiffs and their distributors were legal and valid and thus could form the basis for this claim on the part of plaintiffs.  The Court stated:

The agreements between ETS and its distributors provide that "ETS may also terminate this Agreement . . . after . . . Distributor's and/or Subdistributor's          failure to comply with any suggested price for Products that is announced from time to time by ETS."  Defendants argue that this provision in ETS's agreements  with its distributors makes those contracts per se invalid under the Sherman Act as vertical price-fixing agreements, and thus that the agreements cannot form the basis of a valid tortious interference claim.

Under the Sherman Act, 15 U.S.C. [section] 1,

[i]ndependent action is not proscribed.  A manufacturer . . . generally has a right to deal, or refuse to deal, with whomever it likes, as long as it does so independently. . . . [T]he manufacturer can announce its resale prices in advance and refuse to deal with those who fail to comply. And a distributor is free to acquiesce in the manufacturer's demand in order to avoid termination. [citing cases]

In this case, ETS's distributor agreements are the sort of "independent  action[s]" that Monsanto condones.  The agreements specifically state that "ETS does not request and will not accept Distributor's agreement to comply with any such suggested price, and nothing herein shall be deemed to constitute Distributor's agreement with ETS as to the resale price for Products that Distributor may charge."  Thus, the agreements are ETS's unilateral statements of  the terms on which it will deal with distributors, and as such are permissible  under Monsanto. [footnote omitted]

        As to the “tortiousness” of the conduct of the defendants, the Court stated:
To recover on a tortious interference claim under Oklahoma law, a plaintiff must establish that "the interference was malicious and wrongful, and that such       interference was neither justified, privileged nor excusable."  Morrow Dev. Corp. v. Am. Bank & Trust Co., 875 P.2d 411, 416 (Okla. 1994) (emphasis omitted).  It  is lawful to "interfere with the contractual relations of another if [this is done] by fair means, if [it is] accompanied by honest intent, and if [it is done] to better    one's own business and not to principally harm another."  Del State Bank v.Salmon, 548 P.2d 1024, 1027 (Okla. 1976).
        The Court ruled that there were ample facts upon which the trial court could find that the defendant’s acted tortiously to interfere with the contractual rights of the plaintiffs with their distributors.  The Court upheld the substantial damages awarded against the defendants by the trial court.

        2. Trademark Infringement.

        The Court ruled that the conduct of the defendants was a clear violation of the Lanham Act in that there was substantial evidence that such conduct would create a likelihood of confusion in the minds of the public.   The Court ruled that the conduct of the defendants created “initial interest confusion.”  (Read “Initial Interest Confusion in Trademark Disputes.”).

        The Court stated:

In this case, we recognize another variant of potential confusion: "initial interest confusion."  Initial interest confusion results when a consumer seeks a         particular trademark holder's product and instead is lured to the product of a competitor by the competitor's use of the same or a similar mark.  See Buckman,      183 A.L.R. Fed. 553.  Even though the consumer eventually may realize that the product is not the one originally sought, he or she may stay with the competitor.  Id.  In that way, the competitor has captured the trademark holder's potential visitors or customers.  Id.

Even if the consumer eventually becomes aware of the source's actual identity, or where no actual sale results, there is nonetheless damage to the trademark.  This damage can manifest itself in three ways: (1) the original diversion of the prospective customer's interest to a source that he or she erroneously believes is authorized; (2) the potential consequent effect of that diversion on the customer's ultimate decision whether to purchase caused by an erroneous impression that two sources of a product may be associated; and (3) the initial credibility that the would-be buyer may accord to the infringer's products-customer consideration that otherwise may be unwarranted and that  may be built on the strength of the protected mark, reputation and goodwill.  See BigStar Entm't, Inc. v. Next Big Star, Inc., 105 F. Supp. 2d 185 (S.D.N.Y. 2000).

The federal courts, though not using the phrase "initial interest confusion," have acknowledged the potential for such confusion for decades.  See, e.g.,          Grotrian, Helfferich, Schulz, Th. Steinweg Nachf. v. Steinway & Sons, 523 F.2d 1331 (2d Cir. 1975).  Initial interest confusion in the internet context derives from the unauthorized use of trademarks to divert internet traffic, thereby capitalizing on a trademark holder's goodwill. [emphasis added]
 …

In this case, as noted above, Defendants used Plaintiffs' trademarks on Defendants' Web sites.  Defendants also placed Plaintiffs' trademarks in the metatags of Defendants' Web sites.  Further, Defendants paid Overture.com to list Defendants in a preferred position whenever a computer user searched for Plaintiffs' trademarks.  All of these actions were attempts to divert traffic to Defendants' Web sites.  While viewing Defendants' Web sites, consumers had the          opportunity to purchase Products, but also to purchase lotions from Plaintiffs'competitors.  Moreover, Defendants continued to use the trademarks to divert internet traffic to their Web sites even when they were not selling Products.  Thus, Defendants used the goodwill associated with Plaintiffs' trademarks in such  a way that consumers might be lured to the lotions from Plaintiffs' competitors.  This is a violation of the Lanham Act.

        The Court ruled that the disclaimers placed in defendants’ web sites were legally inadequate to prevent such confusion and thus did not shield defendants from liability.

        3. The First Sale Doctrine.

        The Court stated:

Because in general "the right of a producer to control distribution of its trademarked product does not extend beyond the first sale of the product[,] [r]esale by the first purchaser of the original article under the producer's trademark is neither trademark infringement nor unfair competition."  Sebastian Int'l, 53 F.3d at 1074.  "It is the essence of the `first sale' doctrine that a purchaser who does no more than stock, display, and resell a producer's product under the producer's trademark violates no right conferred upon the producer by the Lanham Act."  Id. at 1076.  "When a purchaser resells a trademarked article under the producer's trademark, and nothing more, there is no actionable misrepresentation under the statute."  Id.

However, the first sale doctrine does not protect resellers who use other  entities' trademarks to give the impression that they are favored or authorized dealers for a product when in fact they are not.  See  D 56, Inc. v. Berry's Inc., 955 F. Supp. 908, 910-20 (N.D. Ill. 1997) (addressing a defendant's use of a plaintiff's trademark and promotional materials in the defendant's store displays and advertising).  In this case, Defendants' use of Plaintiffs' trademarks on the internet was such an act.  Defendants' intentional use of Plaintiffs' trademarks on Defendants' Web sites, in the metatags for the Web sites, and with Overture.com  constitutes more than merely displaying and stocking trademarked items.  See Eli Lilly & Co. v. Natural Answers, Inc., 233 F.3d 456, 465 (7th Cir. 2000).  Thus, Defendants' actions were indicative of an intent to cause consumer confusion, and  are not shielded by the first sale doctrine.  See id.

        For a related set of issues in terms of the use of another’s trademarks, read “Beanie Babies Collector’s Guide: Another Study in Fair Use” and “Beanies”: Dilution and Generic Legal Issues.”

        4. Other Issues:

        There were other issues presented to and decided by the Court including issues about damages, injunctive relief, discovery matters and sanctions related thereto as well as trade secrets related to such discovery matters but they are not sufficiently relevant to the main topic of this article and thus, to avoid an unduly long article, I will not discuss those matters here.

Conclusion

        I repeat:  The Internet has not been an untamed wilderness for many years and is regulated in extensive ways.  This case demonstrates the applicability of contract law, trademark law, tort law and other laws and how violation of those laws can lead to substantial damages and other significantly unfavorable results.  Those selling others’ products take careful note.

Copyright © 2006 Ivan Hoffman.  All Rights Reserved.

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This article is not legal advice and is not intended as legal advice.  This article is intended to provide only general, non-specific legal information.  This article is not intended to cover all the issues related to the topic discussed.  The specific facts that apply to your matter may make the outcome different than would be anticipated by you.  This article is based on United States law.  You should consult with an attorney familiar with the issues and the laws of your country.  This article does not create any attorney client relationship and is not a solicitation.

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