Gray Market Goods – Limiting Warranties

Can a manufacturer limit the product warranty it provides for gray market products and/or refuse to warrant gray market products sold by unauthorized resellers? If so, how should this be communicated to customers and are any best practices that businesses use to minimize the impact gray market products have upon their relationships with valued customers and retailers?

I. What is the Gray Market?

The gray market has been defined as the unauthorized sale of new branded products diverted from authorized distribution channels or imported into a country for sale without the consent or knowledge of the manufacturer. Deloitte LLP estimates that the gray market “siphons as much as $63 billion in US industry sales.” See, Losing $63 Billion to Gray Market is Sleuth Obsession, Bloomberg, July 2006. The problem has increased in the current economy as resales, knock-offs and gray goods are funneled into the market. Some manufacturers have taken measures to discourage the gray market sales of their products, such as by refusing to warrant products sold outside of their authorized distribution network.

II. How are Warranties Managed for Gray Market Products?

The question of whether gray market goods must be warranted to the same extent as “legitimate” goods has not been directly addressed by the courts. However, cases addressing related issues suggest that manufacturers can refuse to warrant gray market products.

Product warranty issues are often litigated in the context of Lanham Act trademark-infringement disputes. Section 1114(a) (1) of the Lanham Act prohibits using any “reproduction, counterfeit, copy, or colorable imitation” of a registered mark in commerce when such use is likely to cause confusion, mistake, or deception. 15 U.S.C. §1114. However, the resale of a purchased product by its lawful owner does not infringe on the manufacturer’s trademark, since the sale is unlikely to result in confusion regarding the product’s origins. 17 U.S.C. §109; See Sebastian Int’l, Inc. v. Consumer Contacts (PTY) Ltd., 847 F.2d 1093 (3d. Cir. 1988).

There have been cases where manufacturers or authorized retailers, in attempting to prevent the unauthorized importation of products, have claimed that gray market imports are “materially different” products whose sale infringes on their trademarks rights, because the products are not warranted to the same extent as products sold by authorized distributors. These claims (often successful in trademark cases) highlight that courts have at least recognized that there can be a difference in the way manufacturer’s handle warranties for “legitimate” verses “gray market” products

In Swatch S.A. v. New City, Inc., the plaintiff, an exclusive U.S. distributor of Swatch products (watches, watch parts, jewelry and electronics), claimed that the defendant, an unauthorized retailer selling gray market Swatch products, infringed on the plaintiff’s intellectual property rights. 454 F.Supp.2d 1245, 1248 (S.D. Fla. 2006). Specifically, plaintiff alleged that the watches sold by the unauthorized retailer were “materially different” because “the warranties on watches sold by Defendant were “void.” The court, in holding that the difference in warranty constituted a material difference, stated: “By its own unambiguous terms, the [swatch] warranty is of no effect if the warranty card is not endorsed by an authorized dealer. The goods sold by Defendant, an unauthorized dealer, therefore, cannot qualify for coverage under the warranty.” Id. at 1251.

In fact, the case law is peppered with examples where manufacturers assert that warranties for the same product sold through different channels (legitimate verses gray-market sales) is evidence of trademark or copyright infringement. See e.g., Yamaha Corp. of America v. U.S., 961 F.2d 245 (DC. Cir. 1992) (“According to Yamaha-America, the gray-market products have the following physical differences: . . . they are not covered by the same warranties.”). Further, courts—aware of the different warranties being offered—have not question the legality of the practice, but rather highlight the practice as evidence of trademark infringement. See, Kia Motors America, Inc. v. Autoworks Distrib., 2009 U.S. Dist. LEXIS 15642, *12-13 (D. Minn. Feb. 26, 2009) (“The Court concludes that KMA has met its burden of establishing that there is a material difference between KMA's parts and Defendants' parts, namely the material difference is that Defendants' parts lack KMA's warranty.”).

The conclusion reached from the case law precedent is that manufactures can and do distinguish between products sold through authorized dealers with warranties and those sold through gray market channels. The courts have not limited this distinction.

Bottom Line: A manufacturer is not required to warrant gray market products and can differentiate its warranty or provide no warranty for gray market products.

III. What about the Federal Magnuson-Moss Warranty Act – Can a manufacturer limit a warranty only to persons who have purchased product through an authorized dealer?

The Magnuson-Moss Warranty Act (MMWA) establishes requirements for written warranties for consumer goods. 15 U.S.C. 2301 et. seq. The MMWA does not specifically address whether a company can limit warranties only to products purchased from authorized dealers. The Federal Trade Commission’s interpretation of the MMWA suggests that limiting warranty coverage to certain persons—including, presumably, those who do not purchase their product through an authorized retailer—is acceptable.

Under the MMWA, a manufacturer that provides a written warranty for a consumer product must clearly and conspicuously disclose in a single document in simple and readily understood language, the following information: The identity of the party or parties to whom the written warranty is extended, if the enforceability of the written warranty is limited to the original consumer purchaser or is otherwise limited to persons other than every consumer owner during the term of the warranty. FTC Consumer Practices, 16 C.F.R. § 701.3 (2007) (emphasis added).

The language of § 701.3 implies that a manufacturer can specify limitations on the persons to whom a warranty extends and such limitation could include gray market purchasers. Given that the relevant case law discussed above supports such an interpretation, a reasoned analysis concludes that § 701.3 permits a manufacturer to refuse to warrant gray market products, as long as such limitation is clearly disclosed pursuant to the other requirements of the MMWA.

IV. Are there best practices for disclosing to consumers a gray market warranty policy?

There is no single strategy for managing gray-market warranty claims. Most companies do not have a specific policy, but manage the issue on a case-by-case basis. Companies should consider a consistent strategy based on important business factors, such as:

a. quality of the product b. number of warranty claims expected c. cost of performing warranty service d. size of the gray market problem e. relationship with authorized retailers f. frequency or repeat sales to same customer base g. specific industry or market place drivers h. potential for harm to brand reputation by refusing to warrant.

Where a manufacturer decides not to warrant gray market products, consideration should be given to restatement of this policy on the company’s warrant documentation. It would be prudent to also inform authorized dealers so that they do not accept warranty claims on gray market products. The balance here is that a gray market warranty policy may save money on warranty service, but it may also damage the brand and reputation of the manufacturer (e.g., if the retailer opts to push sales to products that provide a more fulsome warranties because it increases income for sales and warranty claims). This is a business decision that must be answered in order to determine the ultimate warranty policy.

V. Are there strategies to limit warranty claims for gray market products?

The most obvious, but perhaps the most difficult strategy for reducing gray market warranty claims is to reduce the gray market. It is often difficult to keep tight control over the authorized distribution network—but consider developing strong relationships with authorized retailers and using serial numbers or other means to track products to the market.

As noted above, a manufacturer could also inform customers, both pre- and post purchase, that gray market products will not be warranted. This might be accomplished through provision of a limited written warranty, providing warranty coverage only to the original purchaser, adopting a warranty registration process and disclosing warranty terms through product literature, authorized dealers, and company internet sites. If a customer decides to forego products with warranty coverage in favor of a less expensive gray market products, the company will have in place a warranty policy that clearly articulates who is eligible for warranty coverage.

There is no single model or best practices that have been deployed to respond the explosion in sales of gray market products. What might be a good strategy for one company could be completely opposite for another company. As a practical example, the warranty on a national branded camera states “[we] will service products purchased only through an authorized retailer [and] declines gray-market repairs even if a customer is willing to pay for them.” See, Some see red over gray-market goods, USA TODAY, Dec. 11, 2006, http://www.usatoday.com/tech/products/2006-12-10-gray-market_x.htm. On the other hand, Apple Computer’s Limited Warranty covers all “hardware products manufactured by or for Apple that can be identified by the “Apple” trademark, trade name, or logo affixed to them.” This warranty covers all gray market products, as long as the serial number has not been removed or defaced. Apple Hardware Warranty, http://images.apple.com/legal/warranty /docs/cpuwarranty.pdf.

Listed below are some other exemplar manufacturers, and the extent to which they warrant their gray-market products:

Nintendo: Provides the same warranty to gray market and legitimate hardware, provided the owner can prove the date the product was purchased, and provided the serial number has not been altered, defaced, or removed. Nintendo, U.S. & Canada Warranty, http://www.nintendo.com/consumer/manuals/warrantytext_eng.jsp.

Sony Ericsson: Reserves the right to refuse warranty service unless a customer provides proof of purchase from an authorized dealer specifying the date of purchase and serial number. Sony Ericsson, Limited Warranty,http://www.sonyericsson.com/cws/download/1/835/2/1192957031/ LimitedWarranty_R1c_EN.pdf.

Ticino Watch Company: Provides warranty coverage only for products purchased through an authorized dealer and accompanied by a warranty certificate stamped and signed by the authorized dealer showing the date of purchase and model number. Ticino Watch Co., TICINO U.S.A., L.L.C. Warranty Service, http://www.ticinowatches.com/service.html.

Conclusion

A manufacturer can limit or refuse to provide a warranty for gray market products. However, companies must carefully consider the business risks of such a warranty policy. If a consumer buys a gray market product, and it fails to perform as expected, there may be damage to the brand and reputation of the manufacturer. The manufacturer may want to stand behind its product through warranty to protect the significant resources it has invested in branding and reputation. It may also want to provide warranty coverage so that warranty service and the service parts meet the manufacturer’s high quality standards.

Even with the above considerations, the manufacturer may want to limit warranty costs and support its dealer network by promoting its warranty service for sales through authorized channels. If the manufacturer decides to exclude warranties for gray market products, there should be a clear articulation of this policy in the written limited product warranty. There should also be consideration of pre-sale information on the manufacturer’s product web site and in product literature to inform customers of the company’s warranty policy. This may reduce warranty claims and help mitigate the number of disgruntled consumers.