Last week, the U.S. Supreme Court heard oral argument on the propriety of resale in the U.S. market of foreign-manufactured gray market goods under the Copyright Act. Omega, S.A. v. Costco Wholesale Corp., 541 F.3d 982 (9th Cir. 2008), cert. granted sub nom. Costco Wholesale Corp. v. Omega, S.A., 130 S. Ct. 2089 (U.S. April 19, 2010) (No. 08-1423). If the decision is upheld by the Supreme Court, the Copyright Act would provide a viable remedy to prevent the importation into, and distribution within, the U.S. of foreign-made gray market goods. If the decision is reversed, the Copyright Act will provide a defense to the sale by retailers of goods in the U.S. that were intended by the manufacturer to be sold outside the U.S., no matter where those goods were made. Manufacturers, however, also possess remedies under the Lanham Act to prevent the sale of trademarked goods of a lesser quality or that are materially different than those goods sold in the U.S.

"Gray market goods" are generally understood to be genuine goods produced for sale in authorized markets that are imported for sale into unauthorized markets. For instance, a manufacturer may sell a product to distributors outside the U.S. at a lower price than to U.S. distributors to address certain market conditions. They also may sell similar but different quality products exclusively in certain markets outside the U.S. and prohibit the distributors from selling the goods outside of designated foreign markets. Despite such arrangements, goods intended for one market often are imported into another market for sale in competition with more expensive or different quality goods.

Omega sued Costco alleging that the warehouse retailer violated the Act by selling in the U.S. watches bearing Omega's copyrighted globe logo that were made abroad and intended for resale in Europe. Costco countered that the watches were genuine, identical to Omega watches sold in the U.S. and there was nothing restricting U.S. retailers from selling them. The Ninth Circuit found that Costco could be liable for its sale of copyrighted Omega watches manufactured abroad and specifically stated that Costco was not entitled to assert a defense under the "first sale doctrine."

It is undisputed that Costco did not import the watches at issue; rather Costco obtained the Omega watches from a supplier in New York after the watches had been imported. Omega commenced a copyright action under §§ 106 and 602 of the Copyright Act. Section 602(a) of the Act provides that "[i]mportation into the United States, without the authority of the owner of the copyright under this title, of copies ... of a work that have been acquired outside of the United States is an infringement of the exclusive right to distribute copies ... under section 106." 17 U.S.C. § 602. In its answer, Costco alleged that Omega's claim was barred under § 109 of the Act, which provides that "the owner of a particular copy ... lawfully made under this title ... is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy." 17 U.S.C. § 109 (emphasis added). Section 109 codifies the "first sale doctrine," which provides that once a copyright owner consents to the sale of a copy of a work, it may not thereafter exercise the distribution right with respect to such copy. Although the district court initially granted a preliminary injunction against Costco, it later granted Costco's summary judgment motion, and Omega appealed. The Ninth Circuit reversed and opined that § 109 of the Act provides no defense under § 602 with respect to foreign-made copies of a U.S. copyrighted work. The Ninth Circuit relied on BMG Music, Inc. v. Perez, 952 F.2d 318 (9th Cir. 1991), which had ruled that § 109 protection extends "only to copies legally made and sold in the United States." Additionally, the Ninth Circuit reasoned, among other things, that "the application of § 109(a) to foreign-made copies would impermissibly apply the Copyright Act extraterritorially in a way that the application of the statute after foreign sales does not." 541 F.3d at 988. The Supreme Court then granted Costco's request for certiorari.

A key issue for the Supreme Court is how to interpret its decision in Quality King Distributors, Inc. v. L'anza Research Int'l, Inc., 523 U.S. 135 (1998). Many retailers have viewed Quality King as legitimizing the sale of certain gray market goods. In that case, the Supreme Court addressed whether the importation into the U.S. of certain U.S.-made goods that were designated for sale in a foreign market violated the Copyright Act. L'anza Research International, a California-based manufacturer, sold numerous U.S.-manufactured beauty products bearing its copyrighted labels to a distributor in Malta with the understanding that the products would be offered for sale only outside the U.S. L'anza charged substantially lower prices for its goods outside the U.S. market. After the shipment made its way back to the U.S., L'anza sued the salons that had purchased and resold the unauthorized products. The Supreme Court determined that § 602 "does not categorically prohibit the unauthorized importation of copyrighted materials. Instead, it provides that such importation is an infringement of the exclusive right to distribute copies 'under section 106.'" Id. at 144. The Supreme Court also found that "[a]fter the first sale of a copyrighted item 'lawfully made under this title,' any subsequent purchaser, whether from a domestic or from a foreign reseller, is obviously an 'owner' of that item. Read literally, § 109 unambiguously states that such an owner 'is entitled, without the authority of the copyright owner, to sell' that item." Id. at 145. The Court noted that "[t]he whole point of the first sale doctrine is that once the copyright owner places a copyrighted item in the stream of commerce by selling it, he has exhausted his exclusive statutory right to control its distribution." The Court noted, however, that the first sale doctrine "applies only to copies that are 'lawfully made under this title.'" Id. at 152. Justice Ginsburg also noted in a concurring opinion: "I join the Court's opinion recognizing that we do not today resolve cases in which the allegedly infringing imports were manufactured abroad." Id. at 154. It is clear that Quality King stands for the proposition that the Copyright Act does not provide a remedy for copyright owners to control distribution rights of goods manufactured in the U.S. but designated for sale outside the U.S. The question the Supreme Court will be addressing in Omega is whether or not the Act provides a remedy to prevent U.S. distribution of copyrighted goods made outside the U.S.

Costco contends that the copies it distributed were "lawfully made" under the Copyright Act because Omega as a copyright owner sanctioned the manufacture of the watches. It is Costco's position that it is irrelevant that the goods were made in a foreign country. Costco further argues that its U.S. resale of the watches is protected under the first sale doctrine in § 109 because its distribution of the watches in the U.S. does not involve extraterritorial application of the Act. Court briefs supporting Costco have been filed by eBay, consumer advocate groups and mass market retailer associations. The amici contend that the first sale doctrine codified in § 109 is broad in scope and that there was no intent that that defense of § 109 extends only to the resale or disposition of goods manufactured domestically and not those manufactured abroad. They argue that buyers and sellers need confidence that lawfully produced and purchased goods may be resold free from claims of copyright infringement. Some have suggested that the Ninth Circuit's decision, if upheld, could have the unintended negative consequence of encouraging overseas manufacturing so that a copyright owner can better control distribution of copyrighted goods in the U.S. market.

Based on its statutory construction, Omega argues that the goods manufactured overseas for distribution overseas do not implicate any rights under the Copyright Act. Omega's position is supported by the U.S. Solicitor General and various associations that advocate on behalf of the rights of intellectual property owners that have filed supporting amicus briefs.

If the Ninth Circuit decision is upheld, the Copyright Act would provide a remedy for copyright owners to prevent the sale in the U.S. of gray market goods manufactured abroad and intended for sale outside the U.S. In particular, unlike current protections against gray market goods under trademark laws discussed below, it would provide redress in those instances where the foreign manufactured gray market goods are identical in quality to authorized goods in the U.S. market. Because of the long terms of protection for copyrighted works under the Copyright Act, copyright registration would provide an inexpensive and enduring remedy to prevent the importation of foreign-made gray market goods. On the other hand, if it is determined that the Copyright Act cannot be used to stop gray market goods manufactured overseas from being imported and resold in the U.S., retailers would be insulated from claims under the Copyright Act for the sale in the U.S. of copyrighted goods identical to those intended for the U.S. market.

Preventing importation of gray market goods into the U.S. market has been an increasingly expensive issue for intellectual property owners. If license and distribution agreements with foreign distributors of copyrighted goods contain provisions expressly prohibiting the distributor and any affiliated parties from exporting to, or selling in, the U.S. market, the manufacturer can sue the distributors who violate the agreements. Omega may have had contract claims against its foreign distributor. Because oftentimes companies do not want to pursue litigation in foreign courts, consideration should also be given to including exclusive U.S. court jurisdiction or arbitration provisions permitting enforcement in the U.S. and U.S. governing law clauses in any agreement with a foreign distributor. Contract claims, however, are not available against other parties in the distribution stream such as distributors and retailers who acquire and resell gray market goods.

Retailers as well as manufacturers should be aware that trademark law may be used to prevent the sale of certain gray market goods in the U.S. The resale of genuine trademarked goods generally does not constitute trademark infringement. Similar to the first sale doctrine under the Copyright Act, trademark protections under the Lanham Act are generally exhausted after the trademark owner's first authorized sale of a product. The doctrine, however, does not hold true with respect to the sale of trademarked goods that do not meet the trademark owner's quality standards, or are materially different from those sold by the trademark owner, in a given market. Societe Des Produits Nestle, S.A. v. Casa Helvetia, Inc., 982 F.2d 633, 644 (1st Cir. 1992). Such differences can include, for example, quality of ingredients, removal of serial numbers or bar codes, products without standard warranties, maintenance and safety information only in a foreign language and components that fail to comply with U.S. federal regulations. Manufacturers that sell different products in different jurisdictions should consider employing and enforcing quality control and tracking systems to distinguish authorized goods in one market from unauthorized goods imported from another market. Under certain circumstances, trademark owners also can register their marks with the U.S. Customs Service to prevent unlawful importation of gray market goods into the U.S. market.

It is estimated that the gray goods sales total in the billions of dollars annually. Copyright and trademark owners, as well as traditional and e-retailers, will benefit from predictability and uniformity of laws and decisions governing gray market goods. Retailers should consider the implications of this case pending a decision by the Supreme Court. In addition, prior to purchasing trademarked foreign-made goods for resale in the U.S., retailers should examine whether such goods are of the same quality as goods sold in the U.S. Copyright and trademark owners need to develop strategies for addressing gray market goods that are tailored to their products, manufacturing practices and market distribution.