The legality of the sale of “grey market” goods continues to be a thorn for manufacturers, who have had a lot of trouble policing sales for diverted or substandard goods, as well as counterfeit goods, that are rife in secondary channels of trade.
With the rise of online purchasing in the COVID-19 era, unscrupulous resellers and counterfeiters have made a fortune at the expense of legitimate businesses, particularly exclusive distributors who often pay dearly for the privilege of exclusivity, only to see their rights undermined via cross-border and e-commerce sales.
An October decision of the Quebec Court of Appeal in Costco Wholesale Canada Ltd. v. Simms Sigal & Co. Ltd. 2020 QCCA 1331, represents a significant win for exclusive distributors in the war against grey marketers, even where the source of the goods is known to be clearly legitimate. In fact, the manufacturer, Rock & Republic Enterprises Inc. (R&R) was also held liable to the exclusive distributor Simms, for knowingly selling the diverted goods to parties that they knew would in turn sell the goods to Costco.
The facts of this case are not unusual. In 2006, Simms obtained exclusive distribution rights to sell R&R jeans in Canada. These R&R jeans were well known to be “high end” and sold at between $250 to $325 a pair through a variety of high end retailers in Canada, hand picked by Simms. In the spring of 2009, a U.S. distributor for R&R offered Costco a chance to carry R&R jeans at a discounted price, resulting in sales in Canada starting in November of 2009.
Simms immediately received complaints, by its own retailers, of the Costco sales. On Nov. 12, 2009, Simms sent a cease and desist letter to Costco, demanding that it cease all sales of R&R jeans and noting that the CA number (a garment identification number issued under the Textile Labelling Act, RSC 1985 c. T-10) featured on the products belonged to Simms. It threatened litigation based on unfair competition under the Trademarks Act, RSC 1985 c. T-13, as amended, among other claims.
Costco responded through its own legal counsel on Nov. 13, 2009, asserting its right to make grey market sales and indicating that there was no legal requirement for it to remove the CA number already sewn into the R&R jean labels. A few days later, Simms responded by stating that the existence of its CA number on the products meant that the goods were destined for Simms and that consumers would perceive the goods to have been supplied by Simms to Costco by virtue of the affixed CA number.
Undeterred, Costco continued to sell the R&R products with the Simms CA number until February 2010, then continued to order significant quantities of R&R jeans with a new CA number. In July of 2010, Simms sent another demand letter to Costco, reasserting that the sales violated its exclusive distribution rights in Canada to sell R&R jeans and claiming serious damages. When Costco merely reiterated its rights to sell grey market goods, Simms sued for over $6 million in damages and $500,000 in punitive damages against Costco. A 10-day trial took place in September 2016 and a 111-page judgment issued on Nov. 22, 2017.
Since Costco was not a party to the exclusive distribution contract, the trial judge held Costco liable for interference with economic relations. The trial judge found that the sales of R&R jeans was a significant draw for Costco using what it termed the “treasure hunt” effect, where consumers were excited to find high end products at a significant discount in a warehouse environment. The trial judge held that punitive damages of $500,000 were justified due to Costco’s awareness and reckless indifference to the exclusive distribution rights of Simms, of which Costco learned as a result of the initial cease and desist letter in November of 2009, highlighting the fact that the R&R goods bore the CA number belonging to Simms. It was also alleged to hurt Simms’ reputation for sales of the high end goods to have landed in Costco’s discount warehouses.
The Quebec Court of Appeal upheld every aspect of the trial judge’s decision, including the significant punitive damages award, finding that interference with contractual relations was made out by the failure of Costco to respect Simms’ contractual rights once notified of those rights. The Appeal Court relied on the Supreme Court of Canada decision in Clairol Inc. of Canada v. Trudel  2 S.C.R. 236 in recognizing that a defendant has an obligation not to even indirectly interfere with the contractual rights and financial interests of a plaintiff under civil law.
It should be noted that the Civil Code of Quebec was relied upon both at trial and in the Court of Appeal, as well as in the decisions cited, to find liability. However, it would be very easy for another Canadian court to find favour in the arguments based on the tort of interference with economic relations. It’s worth noting as well that the letters from Costco’s legal counsel had gone to some lengths to argue that the sale of grey market goods was not illegal.
Although Costco was only provided with a copy of the exclusive distribution contract in August of 2010, the Quebec courts held that “Costco was fixed with sufficient knowledge of the Simms’ exclusivity that it was required to respect that exclusivity” when Costco was advised of the existence of the contract in the initial demand letter of November 2009. Costco’s continued ordering and selling of the R&R jeans showed deliberate disregard for the rights of Simms, as well as its continued refusal to provide the name of the source of its goods, which the courts held justified the punitive damages award by disregarding the rights of Simms.
Costco’s aggressive actions by continuing to order goods and refusing to disclose its source, in the face of serious allegations and assertions of third-party rights, has arguably lowered the bar on what would normally result in punitive damage awards. The Appeal Court rejected arguments that the trial judge’s ruling on punitives was a marked departure based on “malicious and high handed conduct” normally required to give rise to punitive damages. The amount of the punitive damages was also upheld based on the amount that the $500,000 represents to the overall assets of Costco’s parent company.
The case is a cautionary tale for grey market sellers, due to the significant punitive liability imposed on Costco, which was not in breach of contract itself, but merely was made aware of the exclusive distribution rights, which it blatantly disregarded. There is also reason for concern for larger companies participating in grey market sales, where punitive damages awarded may be increased based on the size of their operations.
This article was originally published by The Lawyer’s Daily (www.thelawyersdaily.ca), part of LexisNexis Canada Inc.